Petroleum

An Unlikely Friendship: On the Board of Russia’s Rosneft

British Petroleum has had a seat on the board of Russia’s Rosneft for almost a decade, controlling almost 20 percent of the Russian energy giant and making BP Rosneft’s largest shareholder.  It’s an unexpected partnership, perhaps – but more so, an expedient one.  Amongst a storied history in Russia, the origins of BP’s partnership with Rosneft go back to one of the largest disasters in the field of energy’s history.

Deepwater Horizon

On the night of April 20, 2010, situated above almost 5,000 feet of water and tapping into a well that extended 18,000 feet into the earth, the Deepwater Horizon oil rig exploded.  Releasing tens of thousands of barrels per day of oil onto the ocean floor, British Petroleum attempted to initiate emergency procedures to close the well, only to have the rig’s blow-out preventer – its fail-safe mechanism – fail.  The spillage continued, covering thousands of square miles under the water through two more failed closure attempts before it was finally slowed with a temporary solution that allowed BP to siphon off the majority of the outflow to tankers.  On August 3rd, almost four months later, procedures were initiated to close the well permanently, and by September 17th the “bottom kill” – closing the well via cement injection through an adjacent well – was complete. The successful seal of the well was announced two days later, but the damage was already done.  Over four million barrels of oil had leaked into the sea, more than a thousand miles of coastline had been coated in oil, and eleven people, along with hundreds of thousands of marine life, had been killed.  

British Petroleum was charged with 14 criminal charges including eleven counts of felony manslaughter, sued by the Department of Justice for violating the Clean Water Act, and barred by the Environmental Protection Agency from entering into any new federal contracts.  In addition to the roughly 40 billion spent to mitigate the disaster, almost ten billion was also paid to the victims of the spill as well to the DOJ and other government agencies. BP was also fined by the Securities and Exchange Commission for misleading investors about the extent of the damage from the spill, and British Petroleum’s stock price saw a quarter of its value erased.  Reeling from the damage to its reputation as well as its books, BP – a once-great oil supermajor – became increasingly vulnerable.  

 

BP’s History in Russia

BP had been operating in Russia for over ten years when the Deepwater Horizon disaster hit.  Its first venture, in 1997, was a ten percent investment stake in Russia’s fifth-largest oil company at the time, Sidanko.  Two years later, a heated dispute over the validity of rival claims to Sidanko oil fields erupted. Accusing Tyumen Oil (TNK) of using tactics to unfairly acquire valuable Sidanko assets, the claim was settled with the return of the oil field in exchange for a newly-issued 25 percent share of Sidanko.  The two companies, along with one other Russian oil player and the arm of British Petroleum operating in Russia, agreed to merge to create conglomerate TNK-BP in 2003. Owning 50 percent of the venture, BP became one of Russia’s largest-ever foreign investors. The other half was owned by Russian oligarchs Viktor Vekselberg, Mikhail Fridman, German Khan and Leonid Blavatnik, operating under the moniker Alfa Group, Access Industries and Renova (AAR).  The TNK-BP operation was wildly successful. With production rising over 40 percent and reserves increasing by more than 30 percent, TNK-BP returned billions of dollars to British Petroleum shareholders, while padding the tax coffers of the Russian government by ten times as much.  

In 2008, Russian authorities raided the offices of TNK-BP.  Amid swirling rumors of takeover attempts, speculation abounded as to whether the action stemmed from the Russian partners in AAR or the Russian government itself, who had purportedly expressed interest in the business.  Two months later, TNK-BP was barred from using key foreign specialist staff. Finally, in June, the Russian arm of TNK-BP accused British Petroleum CEO Robert Dudley of poor performance. Emphasizing Dudley’s expiring employment contract, the dispute spiraled out of control, with the BP CEO citing “unprecedented investigations, proceedings, inquiries and other burdens” and “sustained harassment of the company and myself.”  Perceiving the maneuver as a coup, executives criticised the proceedings as some of the most egregious treatment received in 100 years of working around the globe, with Robert Dudley’s permission to work in Russia being revoked one month later. Culminating in his exit from Russia amidst rumors of attempts to poison him, Robert Dudley left Russia in August while vowing to manage the company from abroad. He resigned at the end of the year.

BP had become a Rosneft shareholder via its initial public offering on the London stock exchange two years before.  After control of TNK-BP was ceded to AAR in 2009, BP, still licking the wounds from its Russian ouster, was dealt the crippling blow from Deepwater Horizon.  With its reputation damaged, stock price falling, and international doors closing to its operations, BP garnered the increasing risk of becoming a takeover target.  In 2011, regardless of the role the government was speculated to have played in Robert Dudley’s exile, British Petroleum sought an alliance with the state-owned Rosneft.  

Agreeing to a $16 billion share swap along with a campaign to explore Russian oil fields offshore in the Arctic, the plan was ill-fated.  AAR, still partners with BP under TNK-BP, attempted to block the deal, citing the restriction on oil development outside the company pursuant to the shareholder agreement.  The conflict escalated, with BP continuing to pursue the alliance with their previous 1.25 percent share of Rosneft as valid precedent, while AAR took the matter to arbitration in a Swedish court.  The court ruled in AAR’s favor. Legal channels exhausted, Rosneft and BP offered to buy out the partners at a premium in a last-ditch effort to free BP from its legal conflict. The oligarchs refused, resulting in the official loss of the deal as well as a $3.1 billion fine to be paid to Rosneft for the failure, exacted by a court decision in Russia.  

Only one option remained.  With time running out and Rosneft beginning to look to other partners for their Arctic exploration, BP put their 50 percent stake in TNK-BP up for sale.  The only genuine contender for the shares was Rosneft. In a neatly exacted solution, Rosneft agreed to purchase British Petroleum’s stake in TNK-BP in 2012, giving BP a 13 percent equity stake in the Russian oil giant with another 5.7 percent to be acquired with cash it received from the sale.  The deal gave BP a financial cushion in managing the fallout from its Macondo disaster. It additionally brought new opportunities for growth at an imperative time. Bringing BP’s total investment in Rosneft to 19.75 percent – making British Petroleum its largest shareholder – the deal also proffered two seats on the company’s board.

Mutual Security

For BP, the Rosneft deal was a lifeline.  However, while some analysts estimated that BP would be cash negative for years on its new Arctic drilling ventures, the agreement positioned British Petroleum as one of the premier producers in an oil rich area full of future potential.  With its technological expertise and experience in offshore drilling, BP would have access to oil fields in the Arctic that were estimated to hold more than 50 billion barrels of oil as well as 6.4 trillion cubic meters of natural gas. Despite the increased expense associated with complex Arctic exploration, BP would also benefit from Russia’s graduated tax system, engineered to minimize the cost of such endeavors by affording the lowest tax rates to the projects with the most difficulty.  

Russia, meanwhile, would have a new partner with the resources and knowledge necessary to develop its oil fields in the South Kara Sea.  Russia’s oil prospects in Western Siberia had been waning, its decade-old oil fields depleting with only temporary solutions for increased production.  With aging fields threatening its position as a global energy producer, the Kremlin hoped that the BP deal would encourage similar alignments between companies like Gazprom and Shell.  It would also show that such alliances were possible, after international infamy from BP’s previous exit and its previous dealings with companies like its own domestic Yukos. The hotly contested Yukos takeover, accomplished years prior, illustrated another attraction of the BP deal for Russia – the ability to further consolidate control of its national oil market under Rosneft.  Meanwhile, globally, international partnerships could help Moscow broaden and further stabilize its energy business.  

 

Igor Sechin

Financial stability and untapped market access were not the only benefits British Petroleum received in the Rosneft deal.  In its fraught history with Moscow, BP had learned one thing – politics were not to be separated from business in Russia. The vivid personification of this idea came in the form of one character, Igor Sechin.  The president of Rosneft and longtime ally of Vladimir Putin, Sechin was the man largely known to be responsible for the destruction and subsequent acquisition of Yukos assets that catapulted Rosneft to prominence.  Additionally, Sechin’s name had been implicated as a driving force in BP’s previous misadventures involving Robert Dudley. According to U.S. diplomatic cables, it was Dudley himself who speculated his involvement; yet, when nominated to Rosneft’s board by Prime Minister Dmitry Medvedev, it was Igor Sechin who declared the British Petroleum CEO – reinstated to his position after the Deepwater Horizon spill – “a very good candidate.”  In the years that followed, they would work closely together to consolidate the remainder of TNK-BP under Rosneft and develop oil fields in the Arctic as well as other areas of Russia. The cash flow of Rosneft quadrupled, resulting in record production and a place in the top ten oil and gas companies in the world. BP, meanwhile, remained free from external entanglements such as its complicated relations with its former business partners and other legal salvos from competitors.  Working in tandem with the Russian oil sector’s eminence grise, Dudley described British Petroleum’s evolution at an investor conference in 2014. “It’s a different company now; the company can weather things.”

International Criticism

The relationship with Sechin and Rosneft drew shock and dismay from abroad.  Still navigating its embroiled relationship with U.S. regulators after the Gulf disaster, BP’s new ties with Russia prompted a swift response from Congress over national security concerns.  British Petroleum was one of the largest oil suppliers to the United States military. House Energy and Commerce Committee members cited multiple concerns for which they wanted deeper scrutiny and analysis.  The House Natural Resources Committee, meanwhile, called for an inquiry from the U.S. Committee on Foreign Investment on the grounds that British Petroleum’s American assets were U.S. regulated, and likewise controlled large portions of assets sensitive to U.S. production like the crucial Trans-Alaska Pipeline System.  Representative Edward Markey emphasized his misgivings. “BP once stood for British Petroleum. With this deal, it now stands for Bolshoi Petroleum.” Outside the U.S., other critics pointed to the BP-Rosneft deal as an attempt to legitimize the Yukos takeover while simultaneously protecting the Russian government by diluting their share of the contested assets.  International lawyer Robert Amsterdam, having represented the later-imprisoned Yukos CEO Mikhail Khodorkovsky, spoke out against BP’s about-face with the Kremlin, labeling British Petroleum as “the Patty Hearst of international corporate governance”. Robert Dudley, meanwhile, even amidst calls to isolate Moscow following the annexation of Crimea and again in 2018 amid a host of other concerns, has held fast, assuring investors that, “We absolutely stand by our investments in Russia.”  

A third of BP’s production and almost half of their reserves come through its partnership with Rosneft.  Its relationship, however, remains delicate. As incoming CEO Bernard Looney takes the top spot at British Petroleum, it has been announced that, despite his new position, he will not likewise succeed Robert Dudley’s seat on the board of Rosneft.  Owing to “his unrivaled experience of both the international oil market and Russia,” Dudley will stay on, while senior BP officials emphasize that the relationship with Moscow is complicated. Emanating from necessity, the partnership forged after the Deepwater Horizon disaster fashioned a definitively unique relationship between British Petroleum and Rosneft that stands to this day.

 

Sources

 

Pallardy, R. (2010). “Deepwater Horizon Oil Spill.” Encyclopedia Brittanica.

Kramer, A. (2008). “Denied Visa, Chief of BP Joint Venture Is Forced to Leave Russia.” New York Times.

Walters, G. (2018). “Did Russian operatives try to poison BP’s CEO?” Vice.

Brower, D. (2011). “BP’s Russian pips about to squeak as BP Rosneft deal likely.” Petroleum Economist.

Chazan, G. (2011).  “BP, Rosneft Deal Draws U.S. Criticism.” The Wall Street Journal.

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