By John Helmer in Moscow
If anyone needed convincing, the paper which British Petroleum (ticker BP:LN) signed yesterday with Mikhail Fridman and his Russian shareholding partners proves that defying the law of gravity is unlikely to succeed for long; even if the world’s weakest prime minister, Gordon Brown, and his foreign minister David Miliband, have tried to stake their short-term political careers on it; and even if the Financial Times has tried to make the inevitable fall appear to be a masterly exercise in BP negotiating skill.
To hang on to the 23% of its global oil reserves located in Russia, 25% of its current oil production, and a comparable amount of its market capitalization, BP has been trying to defy a losing position since Robert Dudley, BP’s chief operative in Moscow, was found out, having tried to negotiate secretly with Gazprom the sale and purchase of the 50% stake in TNK-BP.
TNK-BP (TNBP:RU) is the 50/50 joint venture which BP shares with the Russian trio of Fridman,Len Blavatnik, and Victor Vekselberg; reflecting the names of their respective holdings, Alfa, Access and Renova, they are collectively known as AAR.
Dudley, BP’s chairman Peter Sutherland, and chief executive Tony Hayward, may have thought their proposed deal had the blessing of Gazprom’s chairman at the time, Dmitry Medvedev, and Gazprom’s chief lawyer, Konstantin Chuichenko. By the time the latter duo had moved into the Kremlin in May — Medvedev as president, Chuichenko as head of the president’s Main Control Department — Dudley and his masters had apparently convinced their contacts at Downing Street and the Secret Intelligence Service that their scheme was a test of strength between the new Russian president, and Prime Minister Vladimir Putin and his deputy, Igor Sechin, who are usually in charge of such matters. Sechin is also chairman of the board of Russia’s leading oil company, Rosneft.
Fridman identified the folly of foreign companies playing Russian politics against Russians, claiming publicly that Dudley’s secret not only violated the terms on which he worked as chief executive, reporting to both sets of shareholders on the TNK-BP board. It also violated the elementary rules of Russian politics — there are no secrets; and there are no one-sided deals.
According to both Financial Times and Russian media reports and public statements by BP and AAR, the September 4 memorandum of understanding between Hayward and Fridman — if it sticks — requires Dudley to be ousted by December 1. This was the first, and principal demand of the Russians throughout the six-month conflict, since BP’s hapless Gazprom deal was uncovered, and Medvedev lined up with Putin and Sechin to repudiate it.
Alastair Graham, head of BP Russian Investments, had told the FT six weeks ago that the campaign against Dudley was “a smokescreen for [the Russian] attempts to seize control of TNK-BP.” In fact, BP had been trying to take control of TNK-BP from AAR. If you believe the former, you can declare the reported new deal, a victory for BP. According to the FT, the agreement is BP’s victory because it “preserves its 50 per cent stake in TNK-BP after a r struggle with its local partners that focused attention on the rights of foreign investors in Russia. The memorandum of understanding, agreed this week by BP’s board, follows a long-running dispute over BP’s most important international venture….The outline agreement, steered by Tony Hayward, BP’s chief executive, and chairman Peter Sutherland, was reached after fears that BP’s interest in TNK-BP could be at risk because of its fight with its Russian oligarch partners. BP’s control of TNK-BP had also come under pressure from multiple investigations by the Russian authorities into its labour practices. Under the deal, the 50-50 equity split of the partnership would remain unchanged.”
In a briefing on the agreement he has signed, Hayward claimed yesterday: “the outline deal announced today, provided the details can be agreed in good faith, is an acceptable compromise. ” Sechin announced: “We are pleased that the conflict has been settled and the parties to the negotiations have reached an agreement on the shareholder level without involving third parties, including the state. This sends the right single to the entire market.”
If you are the Russian shareholders, you see the outcome positively, but not in the way the Englishmen have reported. According to the press reports, the replacement for Dudley, and new CEO of TNK-BP, must be independent of BP, and his powers will be substantially reduced from Dudley’s prior mandate — a big loss for the men who sit on St. James’s Square, BP’s headquarters in London.
Other reported provisions indicate that the holding company for the joint venture will now have 3 independent directors, and 4 each for BP and TNK-BP. But the affiliated and subsidiary companies will remain at parity between the Russian shareholders and BP. BP thus loses operational control. In addition to Dudley, its key financial and operational executives have already resigned, and more than half of its secondees on the TNK-BP payroll have lost their Russian visas, and been reassigned.
The MoU between BP and AAR allows for an initial public offering (IPO) of up to 20% of shares in TNK-BP’s assets, to be issued in a year or two. This allows both sides to sell into the market, and it means two things — TNK-BP’s share price goes up in anticipation; Gazprom and Rosneft, the two state Russian energy companies, will consider what they would like to do. The current freefloat is only 5%. A larger freefloat ought to lift the market cap of TNK-BP — another plus for the Russian shareholders, compared to the status quo ante. Predictably, TNK-BP’s share price rose in Thursday’s trading.
AAR had been clear from the beginning that Dudley’s plot had been to oust them from their shareholding at a discount to the value BP placed on TNK-BP’s assets in its own capitalization. An independent audit by DeGolyer and MacNaughton confirmed last year that TNK-BP’s Total Proved Reserves were 8.225 billion barrels of oil equivalent, applying US methodology on a life of field basis. BP says its reserve figure is 17.8 billion barrels, and includes in the count its share of TNK-BP. That makes TNK-BP’s reserves 23% of the BP total. If you were imaginative, and applied that proportion of BP’s market capitalization (at the time the conflict broke into the open) of GBP105 billion ($213 billion) to value TNK-BP, you might figure that TNK-BP should be worth $53 billion. And that should indicate that a half-share of TNK-BP, held by AAR, should be valued at $27 billion.
But in June, the market cap of TNK-BP as a whole was just $35 billion; the half-share $17.5 billion. The fight, which BP and its supporters portrayed in the London press as a defence of foreign investment rights in Russia against local predators, was in reality about the $10 billion difference between the two prices, and the much bigger difference BP has calculated that might accrue to BP’s reserve balance, if Fridman and his associates were replaced as the TNK-BP partner with Gazprom, and its enormous reserves.
Today’s share prices reflect the fall of oil in global markets; a worldwide contraction in economic growth prospects; a slowdown in Russian growth rates; the dwindling of the pound; and the rise of the dollar. BP is currently worth GBP94.8 billion ($177 billion). BP’s share price fell 1% on the news of the Russian agreement; TNK-BP’s share price rose 8%, making the company’s market cap currently $27.4 billion.
The trajectory of TNK-BP’s share had been rising through much of the six-month conflict — but not from Dudley’s or BP’s efforts. So long as the Moscow market judged that AAR stood the better chance of winning the contest for operational control of the company, TNK-BP becomes more valuable, and BP less so. A clever arbitrageur should have been betting on the widening spread between the two share prices. That in turn has meant that noone in the market believed what they were reading in the bulletins issued from St. James’s Square to the FT. That is to say, the Russian investment community has expected TNK-BP to be worth more if BP lost its battle than if it won. This is also how Putin, Sechin, and Medvedev have figured the outcome.
And so it will be. By trying to fight Fridman behind the arras at the Kremlin, Dudley, Hayward and Sutherland are going to enrich their adversaries, at their own expense. By trying to play Medvedev and Chuichenko off against Putin and Sechin, they have substantialy increased the likihood that the IPO price for a 20% stake in TNK-BP will be considerably higher than Fridman’s sale target of six months ago; and that a Russian state company may enter the shareholding to assure firm Russian control of the oil reserves.
BP has been forced to give up the lucrative scheme in which it paid its executives through TNK-BP revenues. But it preserves what counts at St. James’s Square — the market cap of BP; the BP share price; and the bonuses Sutherland, Hayward and their associates earn, so long as the Russian reserves continue to be booked on BP’s ledger.
In one sense, too, BP has scored a political victory. BP’s shareholders and senior executives will come out of this affairmuch better off than Prime Minister Brown and Foreign Minister Miliband.