BP's Russian Joint Venture Falters

BP's profitable joint venture, TNK-BP is crumbling over a wrangle with its Russian partners about reinvesting dividends

By Stanley Reed in London and Miriam Elder in Moscow

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TNK-BP is Russia's third-largest producer, with 1.6 million barrels a day

Mikhail Friedman (L), of the Alfa group and oil firm TNK, and BP chief executive John Browne. Yuri Kadobnov/AFP/Getty Images

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In the fall of 2003, BP's (BP) then-chief executive officer, John Browne, flew to Moscow to kick off a groundbreaking Russian joint venture called TNK-BP. Browne was thrilled with the deal, which gave the British oil giant a position in a key country, but he was well aware of the risks. Russia, Browne said aboard BP's wood-paneled Gulfstream 5, is sure to be a big player in energy. "The question is whether you can work there," he said.

Five years later, Browne's successor, Tony Hayward, is discovering that the answer might just be no. Hayward is locked in a dispute with BP's Russian billionaire partners, a group called Alfa, Access/Renova, or AAR. The fight has driven TNK-BP's CEO, Robert Dudley, out of the country and has cast doubt over BP's once-golden future in Russia. "We're committed to finding a solution that's acceptable to all parties," Hayward says. "Whether that's possible," he adds, "we'll see."

Knowing the difficulties of Russia—and the bare-knuckled operators he picked as partners—Browne crafted a deal he hoped would stand the test of time. He struck a 50-50 joint venture agreement with the Russians, who had bought oil fields during the freewheeling privatizations of the 1990s. Both sides gained equal representation on TNK-BP's board. The Russians got to nominate the chairman, and chose MikhailFridman, AAR's leader. BP nominated Dudley, an American and a longtime protege of Browne, to be CEO. The company was incorporated in the British Virgin Islands, and disputes were to be settled by arbitration in Stockholm—something both sides are now considering.

VICTIMS OF SUCCESS

The deal was inked in June 2003, in a gala ceremony at 10 Downing St. in London, with Russian President Vladimir Putin and British Prime Minister Tony Blair looking on. Marrying BP's know-how to Russian resources has been a big success. TNK-BP's production has grown faster than any other Russian player's, and its 1.6 million-barrel daily output makes it the country's third-largest oil company. On July 29, BP reported that its share of TNK-BP's net income for the first half of 2008 was $2.1 billion, almost triple what it was for the same period in 2007. Over the years, BP and AAR have each gotten dividends totaling $10.2 billion from the venture.

Those fat payouts haven't kept the relationship from going rancid. At a board meeting in November, the two sides found themselves far apart on the dividends. Dudley argued that with production flattening and profits flagging because of steep Russian taxes, it made more sense to slash dividends and plow earnings into new fields and equipment, while the Russians wanted to keep the cash flowing. "Any CEO who comes to the board with a plan like that should immediately submit his resignation," says Stan Polovets, CEO of AAR. Eventually, the two sides agreed to go ahead with a capital expenditure of $4.4 billion for 2008 and to pay out $1.2 billion in dividends to each group in the first quarter, a TNK-BP spokesperson says.

But this spring, the spat got nasty. AAR called for Dudley's dismissal and demanded changes in governance, including an independent CEO. On July 15, Polovets wrote to Dudley saying AAR now opposes capital spending of more than $3.5 billion this year and threatening to hold the CEO personally responsible for anything the company spent over that amount. For his part, BP chief Hayward says the Russian shareholders want "to tear up the agreement that they willingly signed."

For the past few months, BP has been slapped around by various state agencies. In March, Russia's secret service, the FSB, swooped in on a Moscow cafe and arrested a Russian-American working for TNK-BP, charging him with industrial espionage. In April, Tetlis, a company founded by former employees of Fridman's Alfa Bank, filed a lawsuit in the Siberian city of Tyumen against TNK-BP, alleging it had improperly hired technical experts from BP. Tetlis won the first round, but BP plans to appeal.