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Russia reaches investors’ tipping point after BP affair sours

Russia reaches investors’ tipping point after BP affair sours

Last Updated: 10:25pm BST 26/07/2008
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After TNK-BP’s president Robert Dudley fled Russia earlier this week, foreign investors fear they are witnessing a return to the dark days of the ‘Wild East’. Adrian Blomfield reports from Moscow

Not since the arrest of Yukos proprietor Mikhail Khodorkovsky in 2003 – perhaps not even since the rouble crash of 1998 – have foreign investors been so dejected about Russia.

Consider these comments from leading western fund managers, bankers and strategists in the hours since Robert Dudley, the chief executive of TNK-BP, was forced to flee Russia on Thursday:

“The last train carrying the optimists out of Russian equities has just left the station,” was one reaction. “The place looks rotten to the core,” was another.

“There is no longer an investment case for Russia now,” opined a third. “Russia has reached tipping point.”

A fourth agreed: “The Russian government doesn’t care about foreign investors. If foreign investment gets stomped on, then so be it.”

For businessmen whose attitude towards the country has generally been one of extreme optimism, often in defiance of political trends and the counsel of those whose fortunes do not depend on Russia, this is despondent stuff.

Dudley is a symptom rather than a trigger for the gloom.

Four months after Dmitry Medvdev became president vowing to inculcate in his people a respect for the rule of law, the country’s already tarnished investment climate has once again taken on the hue the lawless 1990s, a decade when Russia was known as the Wild East.

Nor has it just been BP, through its 50 per cent stake in TNK-BP, which has been caught up in what looks like a state-sanctioned assault on private property rights.

   St Basil's Cathedral, Kremlin, Red Square, Moscow, Russia
The sun sets on confidence in Russia

In recent months William Browder, who ran what used to be Russia’s largest foreign portfolio investment fund, has revealed a staggering fraud in which three of his companies were stolen with the apparent collusion of interior ministry officials.

More recently, Mechel, a large steel firm, fell victim to what critics claim is a politically motivated campaign by the state anti-monopoly authorities.

On Thursday, Vladimir Putin, who gave up the presidency to become prime minister in May but remains Russia’s most powerful man, launched a chilling attack on Igor Zyuzin, Mechel’s owner.

Zyuzin had failed to turn up to a meeting with the prime minister, purportedly to explain improper pricing practices, because he had been admitted to hospital with heart failure. It was not an excuse that impressed Putin, who summoned up all the menace of his KGB past to deliver a warning to the hapless tycoon.

“Of course, illness is illness,” the prime minister announced in a televised meeting with officials in the city of Nizhny Novgorod. “But I think Igor Vladimirovich (Zyuzin) should get better as soon as possible otherwise a doctor will have to be sent to see him to clear all these problems up.”

Putin then ordered the state prosecution service to look into bringing a criminal investigation against the company. Investors, remembering similar assaults on Yukos in 2003, quickly took the hint and shares in Mechel fell 30 per cent on Friday.

But it is the saga of TNK-BP, and the murky role the state has played in it, that has spooked foreign investors so much.

BP’s Russian billionaire partners, who own the other 50 percent of the TNK-BP joint venture, have clearly used highly unorthodox tactics that could have only been sanctioned at state level to gain an upper hand in their shareholder dispute.

Since things began to get nasty between the two sides, BP has faced a cocktail of lawsuits from obscure minority shareholders, labour investigations, an industrial espionage enquiry and visa hassles that have forced the withdrawal not just of Dudley but also of all the company’s 148 specialist contractors.

For all this, sympathy towards BP has been pretty underwhelming in Russia, with the British company accused of often acting in an underhand way itself.

Ever since a deal was signed between BP and four billionaires representing a consortium called Alfa-Access-Renova (AAR), a major dispute between the two sides has seemed inevitable.

Neither party had been particularly chummy to begin with. The Russian businessmen and BP fought endless court battles for four years for control of the bankrupt assets of a struggling company called Sidanko, once Russia’s sixth largest oil company.

The spat was settled in 2001, and paved the way for the creation of TNK-BP two years later, a tie-up whose much vaunted launch was personally witnessed by Putin and Tony Blair.

Yet the two sides always had different priorities, especially as the world moved into an era of high oil prices and low supply.

BP, as the world’s third largest oil company, needed greater reserves and was therefore more focused on greenfield development than the Russian oligarchs – Mikhail Fridman, Viktor Vekselberg, Len Blavatnik and German Khan, Fridman’s partner.

The Russian quartet was unhappy to see capital spending at TNK-BP surge 53 per cent last year as a result of BP’s efforts to find new deposits – even though each of the four is still said to take home £5 million a day in profits.

Yet AAR insists it is not greed and a desire for quick profits that motivates it, merely a difference in prioritising strategy.

Without TNK-BP, which accounts for 23 per cent of BP’s global energy production, the British company would be unable to replace its reserves. Already growing more slowly than rivals like Exxon-Mobil, a failure to expand in Russia would ultimately result in BP’s share of the global energy market dwindling.

While BP adds $20 to its value for every barrel of oil it adds to its books, AAR gets little from expanding reserves. This is because TNK-BP already has 16 years worth of supplies against an average of about 11 for most oil majors and expanding reserves doesn’t make sense, AAR says.

“We have been very aggressive on capital expenditure,” says Stan Polovets, chief executive of AAR. “But we want to create wealth for all shareholders not just one. We want to see CAPEX spent on boosting production and international expansion.”

But while AAR has pushed for TNK-BP to expand its assets through international downstream and refinery investment, BP has refused to do so for fear of creating a rival to itself.

For AAR’s shareholders, this amounts to being treated as minority partners in what is supposed to be a 50-50 venture.

“From the first day, BP regarded TNK-BP as a subsidiary,” Vekselberg, one of Russia’s richest men, said.

Even so, these disputes could have been resolved but for one major issue. According to the terms of the tie-up, none of the shareholders could sell their stakes in TNK-BP until December last year.

As the clause began to run out, Gazprom, the state energy giant which the Kremlin has turned into the world’s third largest company by market capitalisation, sent off signals that it wanted to acquire a stake in TNK-BP.

As everyone in Russia knows, Gazprom and Rosneft, the other major state energy company, tend to get what they want.

Rosneft succeeded in acquiring most of Yukos’ assets after a series of dubious auctions. Shell was forced to surrender its majority stake in a project on Sakhalin island, while TNK-BP was forced to do the same with the massive Kovykta gas field, to Gazprom after both companies came under pressure from state organisations.

According to AAR and several independent energy analysts, BP approached Gazprom and attempted to secure a deal to become its partner in TNK-BP at the expense of the Russian shareholders.

“BP has very actively and fairly successfully propagated a myth that AAR wanted to sell,” said Polovets. “This is total nonsense.”

“BP would dearly love us to sell because they would prefer Gazprom or Rosneft as a partner as it opens up access to new deposits and reduces the demands on them to perform.”

Many in Russia have long questioned BP’s often obsequious attitude to the Kremlin. Lord Browne, the former chief executive, regularly praised Putin’s genius even after the loss of Kovykta.

But BP’s shareholders were particularly enraged at the dubious role which TNK-BP played in one auction last year for Yukos assets.

A week after Lord Browne met Putin for private talks, TNK-BP agreed to participate in the auction as the only rival to Rosneft. Ten minutes into bidding, the company withdrew with the price of the assets still £250 million below their market value.

Commentators suggested that TNK-BP’s sole purpose was to give the sale an air of legitimacy.

Even so, the strategy allegedly employed by AAR – which suspiciously only began complaining of its differences with BP this year – have been far from pretty.

The use of state organisations, from the FSB, the KGB’s successor, to the Federal Migration Service and the courts, once again raises questions about the improper collusion of politics with big business.

Shortly after AAR complained about the average remuneration of specialist expatriate BP employees contracted to TNK-BP – estimated at £300,000 a year – the expatriates found themselves running into visa difficulties.

Then a little known company called Tetlis registered at a fictitious address launched legal action over the hiring of the foreigners at TNK-BP a week after buying a tiny stake in the company.

Fingers were pointed at Fridman’s Alfa Group, which had used similar tactics in a dispute with Norwegian telecoms group Telenor, which owned a 50 per cent stake in Vimpelcom, Russia’s second largest mobile phone provider.

But the nastiest dispute came in May when AAR demanded Dudley’s dismissal at a meeting with BP executives in Cyprus, accusing him of inefficiency and discrimination.

BP refused to sack Dudley, who has been TNK-BP’s chief executive since its inception. Since then, Dudley has faced questioning by tax authorities on dubious grounds and repeated refusals to renew his visa on the claims that he did not have a valid employment contract, charges which BP denies.

On Thursday, he finally surrendered to the inevitable and left the country. BP said his departure had been forced by “continual harassment” and intimidation.

Its chairman, Peter Sutherland, accused AAR of reverting to the tactics so common in the Yeltsin era for settling business disputes.

“It’s just a return to the corporate raiding activities that were prevalent in the 1990s,” he said.

Even those normally sympathetic to AAR expressed their disquiet.

“It’s a tactical victory for the Russian shareholders but it’s a bad business and a bad reflection on the state of the Russian economy,” said Vladimir Milov, president of Russia’s Institute of Energy Policy.

“It’s a signal that Russia is not yet ready to become an international financial centre.”

Yet one question remains unanswered. How high up does the state’s support for the campaign against BP go? So far both Putin and President Medvedev have refused to get involved, even as Russia’s foreign investor reputation nosedives.

Whether or not the two men are unable or unwilling to intervene in the dispute is almost beside the point now. For whatever reason, the Kremlin has tarried too long.

The era of foreign investor confidence in Russia is over. To restore it will take both time and a desire from the Kremlin to obey its own laws – something that has not been shown for several years.

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