TNK-BP

Why its Russian mess should not surprise BP

November 8, 2011: 8:42 AM ET

How much did BP know about the Russian oil company TNK before it agreed to become its partner?

By Katie Benner and Alex Konrad

TNK-BPFORTUNE -- BP's problems in Russia have garnered as much attention as the gushing profits the company has made from an eight-year-old partnership with Russian oil firm TNK. Even as BP has raked in billions from TNK-BP -- $2 billion in dividends in the first nine months of 2011 alone – top BP employees have fled Russia, BP's Russian offices have been raided twice, and TNK has blocked BP from doing business with the Russian energy company Rosneft. BP, it seems, has been a victim of TNK, a powerful company that is usurping control of what was to be a partnership of equals.

But documents, which surfaced at the end of October as part of an ongoing legal dispute, suggest that BP executives saw TNK as a ruthless and dishonest company that would stop at nothing to seize control of lucrative energy assets, even before BP decided to partner with the Russian company.

The documents – including internal BP emails, BP reports, US Embassy cables, and even correspondence from former British Prime Minister Tony Blair – were found in discovery by an oil company based in Canada called Norex Petroleum. Norex first sued TNK's owners, AAR, in federal court a decade ago for allegedly stealing a valuable oil field. BP was eventually included in the legal dispute, since TNK-BP now owns the oil field in question. A federal judge dismissed the case, saying that it was outside her jurisdiction. Last month Norex filed a memorandum opposing a motion to dismiss a new lawsuit in New York Supreme Court. All emails, memos, and reports cited in this story were filed by Norex last month.

When asked to discuss Norex's recent filing, a BP spokesman wrote: "The allegations from Norex involve conduct that pre-dates the formation of TNK-BP and had nothing to do with BP." Scott Hershman, a lawyer for the TNK defendants, said: "The federal courts have rejected Norex's claims and their supposed evidence multiple times in a case that was finally resolved last year in TNK-BP's favor with the dismissal of Norex's claims."

No matter who wins the case, the documents found in discovery paint a picture of BP as a cynical company that put profits ahead of prudence. "BP decided to make a 'deal with the devil' in 2003… to protect its interests in Russia," Alex Rotzang, chairman of Norex, asserts in a statement. Some corporate governance groups feel that the documents found by Norex should worry investors. "This seems like the latest example of BP taking a calculated risk that goes wrong," says Kimberly Gladman, director of research at GMI, a corporate governance ratings firm. "Whether Deepwater Horizon or Russia, the company does due diligence, but gambles anyway."

A stolen oil field

BP got its first glimpse of TNK-style justice in the 1990s, when TNK and Norex fought for control of a lucrative oil field called Yugraneft. Yugraneft was owned by Norex and Chernogorneft, a subsidiary of the Russian oil company Sidanco. BP later bought 10% of Sidanco, which also gave it a stake in the oil field.

Norex claims in its lawsuit that TNK did two things to seize control of Yugraneft. First, in 1998 a TNK-related creditor sued Chernogorneft for an unpaid bill. When both Chernogorneft and BP offered to pay the bill, the creditor refused to take the money. With an outstanding bill, Chernogorneft was forced into what Norex claims was a ginned-up bankruptcy.

BP was so worried about the proceedings that the company prevailed on then Prime Minister Tony Blair to intervene. Blair wrote a letter to Vladimir Putin in September of 1999, expressing his dismay. "[BP fears] that what should and could be a healthy and profitable company will be manipulated into bankruptcy and collapse," Blair wrote. "The case… will be critical to future in-flows of foreign direct investment, so vital to Russian economic revival."

But a regional judge – whom Norex says in its complaint was appointed by "TNK's then Chairman" -- ultimately declared Chernogorneft bankrupt.

Norex alleges that TNK then took control of the Chernogorneft bankruptcy auction. Only TNK-related companies were allowed to participate in the closed auction. When Sidanco officials obtained court orders to postpone the proceedings, armed guards blocked bailiffs from delivering the documents, according to a declassified CIA memo obtained by Norex. TNK ultimately bought the assets for just $176 million, about a third of the company's worth, according to the memo.

"We regard the entire bankruptcy process as invalid," Howard Chase, BP Russia's then-director of external affairs wrote in an email. Chase, who is now Director of International Affairs for BP (BP), also wrote: "We understand that the fun went on right to the end. Sidanco officials were prevented by armed guards from entering the Chernogorneft offices to serve an injunction – just another day in Russia!"

Norex's stake in Yugraneft dwindled, and was eventually taken by force, according to the complaint. "Two days later… [TNK official Alexander Berman], six TNK attorneys, and sixteen TNK militia members dressed in fatigues and carrying AK-47 machine guns forcibly entered Yugraneft's corporate offices, falsely declared that Berman had been elected Yugraneft's General Director, and took control over Yugraneft's oil filed. On July 6, 2001, [TNK's private armed militia members] cut off Yugraneft's phone and Internet service, and occupied Yugraneft's oil field and field office, causing Yugraneft's foreign employees to flee the country."

A calculated risk

After TNK took control of the Yugraneft oil field, documents show that BP officials were worried. "If a reversal of this illegal sale cannot be achieved... then we need to prepare to exit Sidanco over the next month," Mike Townshend, a longtime BP executive, wrote in an email to fellow executives in the fall of 1999.

BP also commissioned at least three background checks into TNK prior to forming the joint venture. The results: worrisome descriptions of TNK's management and owners, Access-Renova and Alfa Group (AAR). A 2001 report noted that Alfa had close ties with the Russian government and was one of the most influential financial-industrial groups in the country. Alfa Group co-founder German Khan, who is currently the executive director of TNK-BP, was described as "explosive" in a 1999 internal BP report and "notorious" in an email written by a BP executive in 2002.

But TNK's power within Russia also made the company an extremely compelling partner. According to a BP report, also from 1999, TNK was pressuring BP to reach some sort of compromise over the Chernogorneft matter. The report says that a high level TNK executive suggested "that BP Amoco - TNK should buy and operate Chernogorneft as a separate alliance company." BP officials distanced themselves from Norex in 2002, when Norex sued TNK over Yugraneft. "While our history is intertwined with the events that befell Norex, we long ago parted company on the road to where we find ourselves to-day," wrote BP official Sam Bennett, in an email dated February 27, 2002. Bennett had worked at Sidanco. "Our official response should be that this is nothing to do with us."

In the end, BP decided to partner with TNK and hope for the best. In February 2003, BP announced the 50-50 joint venture (which would absorb, among other things, Sidanco's assets), and said that it would put $6.5 billion into the partnership. (The deal also included a provision indemnifying BP from any losses, claims or demands of any nature that might arise from TNK's dispute with Norex, according to an internal BP document.)

Lord Browne, then CEO of BP, called the deal "a major strategic step into a country with massive oil and gas reserves and immense potential for future growth." Brown went on to say: "BP entered Russia five years ago when we bought 10% of Sidanco. We had a tough time initially… and learned a great deal about doing business in Russia."

Oppenheimer analyst Fadel Gheit has no doubt that BP knew that it was courting trouble when it formed the joint venture with TNK. Gheit says that he saw Alpha co-founder Mikhail Friedman arrive at a meeting for the deal with four bodyguards carrying machine guns. "It was the most ridiculous scene that I've ever witnessed," he says. "Investment meetings with people carrying machine guns?"

Since partnering with TNK in 2003, BP's relationship with TNK has deteriorated. At first, there was a "low-level guerilla war carried on inside [TNK-BP]," Norex says in its complaint, citing former BP CEO Lord Browne's own autobiography. But by 2008, the relationship had unraveled. Bob Dudley was forced out of Russia, where he was serving as CEO of TNK-BP. (Dudley is now the CEO of BP). Tony Hayward, BP's then-CEO, told the Telegraph that Dudley felt he had to "think about his safety." That year, Russian police raided BP's lawyers' offices. U.S. officials believed that the harassment would continue unless TNK got more control over the partnership, according to a 2008 U.S. State Department cable leaked to Wikileaks.

This year, a deal between BP and Russia's state-owned oil company Rosneft was blocked by TNK (Exxon (XOM) ultimately won the deal). A group of TNK-BP minority shareholders, with ties to TNK, sued BP for mishandling the Rosneft deal. Fitch Ratings says that if the lawsuit gains traction in the Russian courts, it could trigger a review of BP's credit rating. Again, Russian agents raided BP's Moscow offices, this time prompting David Cameron to raise concerns about the Russian legal system with the country's President Dmitry Medvedev.

Most energy companies operate in places where unsavory things happen, points out Brian Youngberg, an analyst with Edward Jones. And Jason Gammel, an analyst at Macquarie, notes that only Exxon has historically been able to do business in Russia without making concessions to a strong Russian partnerBut if nothing else, the deal with TNK, "points to the fact that BP did not really understand how to manage risks [of doing business in Russia]," says GMI's Gladman.

It seems that TNK, being on its home turf, has the power within Russia to gain ever more control over TNK-BP. That puts BP in a precarious situation. As BP itself noted in a 1999 report, "BP Amoco is playing the game on a Russian pitch, by Russian rules, officiated by corrupt politicians in TNK's pockets." The partnership, though troubled, accounts for 20% of BP's reserves and 10% of the company's profits; and BP would be loathe to lose TNK-BP's contribution to the bottom line. But it seems that BP must remain at TNK's mercy to keep the money coming in.

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