On April 30, 2004, the Carnegie Endowment for International Peace hosted a meeting on the challenges faced by the Tyumen Oil Company (TNK) before and during its merger with British Petroleum (BP), as well as TNK-BP’s plans for the future development of the Russian energy sector. The speaker was Viktor Vekselberg, Chairman of the Board of the Renova Russian-American investment group, which is one of the owners of TNK-BP, and also the Chairman of the Board of Siberian-Urals Aluminum (SUAL). Dr. Anders Åslund, Director of the Russian and Eurasian Program at the Carnegie Endowment, moderated the session.
Click here for Dr. Vekselberg's presentation (PDF format).
Dr. Vekselberg started out by noting that the TNK-BP merger is of great interest to the world business community, and discussing it would bring out issues important to Russia and its development. Prior to the merger, TNK was already one of the largest Russian oil companies in terms of geography, its holdings stretching from Sakhalin in the east to Lesychansk, Ukraine in the west. Today, TNK-BP produces 1.3 million barrels per day, which puts in third place in Russia, behind YUKOS and LUKOil. TNK-BP is not complacent about this position and would like to exceed it.
The company, employing over 100,000 people, currently owns five oil refineries, as well as a network of over 2,000 service stations.
The $8 billion merger between TNK and BP, is to date the single largest investment deal in the former Soviet Union. The merger, which took place in 2003, was unusual because of the ownership and management structure it resulted in. BP and a consortium of Russian investors (Alfa, Access and Renova) each own 50 percent of the company. Later, TNK-BP added a 50 percent stake in Slavneft to its holdings, but the latter continues to operate as a separate company, Sibneft shareholders being the owners of the other 50 percent of its stock.
Noting that mergers like that of TNK-BP are much less likely in the near future for a range of reasons, Dr. Vekselberg proceeded to explain the justification behind the union. There have been rumors about Russian businessmen trying to shift their assets abroad by selling their stakes in Russian companies. Dr. Vekselberg noted, however, that this was not the case in the TNK-BP merger. Three years before the deal with BP, TNK realized that it could not accomplish its long-term goals without a strategic alliance. The possibilities of finding a strategic partner in Russia were limited, as was the prospect of increasing assets simply by gaining more oilfields.
At this point, TNK appointed Goldman Sachs as its financial advisor, and met with the “big players” of the global oil market. BP emerged as one of the leaders in TNK’s quest for a partner, because of its presence on the Russian market: it owned the Sidanco oil company and a chain of service stations, and was also involved in energy projects on Sakhalin. BP was thus prepared to expand its presence in Russia.
While choosing a prospective partner, TNK also analyzed their management principles, and the principles that would govern relations between TNK and the foreign investor if a merger took place. A large number of oil companies that lead the world market are built on a strictly top-down management structure. TNK’s interlocutors only wanted to make a deal if they were allowed to buy a controlling stake in the new company. However, TNK wanted a merger in which the Russian management would remain in place and would capitalize the assets it had already built up. After a long series of discussions, TNK and BP arrived at a 50-50 ownership structure for the planned new company. Dr. Vekselberg pointed out that the Russian oil sector lags far behind its Western counterparts in terms of technology, and thus TNK needed a serious partner that would help it bridge and eliminate this gulf. TNK also needed access to financial resources for large-scale investment projects. To the surprise of TNK, BP accepted all these principles, and that was how TNK-BP came about.
At the beginning of the merger talks, TNK was only willing to sell a 25-percent stake to BP, but this was not acceptable to BP. To many businessmen and experts, a 50-50 ownership structure seems too complicated. This is, in fact, true – it is very hard to manage a company with this particular structure. When representatives of TNK and BP met with the Russian president, Vladimir Putin, to brief him about the upcoming merger and receive the go-ahead from him, Mr. Putin asked how the company would be managed given its proposed 50-50 structure. So far, however, TNK-BP has been coping well with its ownership structure, and Dr. Vekselberg expressed the belief that it will be able to overcome problems that may arise in the future.
The top management positions in TNK-BP have been apportioned between Russians and Westerners on an almost 50-50 basis, without the express aim of doing so. In this management structure, TNK sees a harmonious combination of the advantages of both sides in this alliance. BP has an advantage in technology, international market experience, as well as accounting and financial control. Thus, BP representatives took these positions in the TNK-BP management. However, for the company to be successful in Russia, it needed expertise in law and relations with federal and regional government authorities, so these functions went to TNK staffers. Russia is not reinventing the wheel of oil production, but merely following a path that has already been taken by many countries. Many TNK-BP managers have experience of working in other oil-producing countries. This combination of knowledge, experience and intellect will allow TNK-BP to build a highly capable management team.
In the future, TNK-BP would like to see Slavneft completely integrated into it. TNK-BP is not far behind YUKOS and LUKOil in terms of production, and would like to overtake its competitors. At the same time, it has the strategic goal of building the “best oil company in Russia” in terms of quality.
Last year, TNK-BP increased its production by 14 percent, which is above the industry average, and in the first quarter of 2004, it enjoyed the highest production growth in Russia. Further, the supposedly “inevitable” job cuts that follow a merger did not take place in the case of TNK-BP. The company also boosted exports to 52 percent of production in 2003. Most importantly, however, TNK-BP has reworked its priorities. Royal Dutch Shell’s reassessment of its reserves has led to a 20 percent drop in its share price. In contrast, TNK-BP is very careful regarding reserves, and is planning to reach a reserve replacement rate of 75 percent of current production this year, and perhaps 100 percent in the longer term.
Despite such aggressive growth and restructuring, TNK-BP continues to work
efficiently and profitably. All three rating agencies have raised the company’s
rating, which is now the highest among Russian oil companies.
TNK-BP has recently developed a five-year strategy, which outlines the main
priorities and investment plans for the upcoming period. Planned annual investments
are at least $1 billion on average. This figure only includes investment in
organic growth, and may be supplemented by inorganic growth through acquisitions.
The five-year strategy shows that TNK-BP’s Russian and Western shareholders share a common vision about the company’s future development. However, the creation of the strategy also points to a more stable business environment in Russia. Whereas Russian tax and tariff laws used to change often, making planning very difficult, today one can engage in long-term planning.
The company also has several major investment projects. Dr. Vekselberg emphasized the development of the Kovykta gas field in Eastern Siberia, where reserves total 73 trillion cubic feet. The gas field is almost ready for development, and TNK-BP is planning to export Kovytka gas to East Asia, especially China and South Korea, using new pipelines. While understandings have been reached with these two countries, TNK-BP is still waiting for support from the Russian government, and the gas monopoly, Gazprom. TNK-BP is planning to invest $18 billion in the project, $12 billion of which would be invested on Russian territory. It is hard to overemphasize the importance of this project, according to Dr. Vekselberg. President Putin recently expressed the ambition of doubling Russia’s GDP by 2010, and the Kovykta project could contribute 5 to 10% of Russia’s GDP growth over the next five years.
Dr. Vekselberg pointed out that the infrastructure in Eastern Siberia is extremely underdeveloped, and the project would not only bring gas to households around Lake Baikal, but would also contribute to the improvement of the region’s infrastructure in general. At the same time, he expressed the hope that TNK-BP would not ruin the natural beauty of the area.
The other area where TNK-BP is planning major investments is in oil exports. Pipeline capacity still lags behind production growth. Transneft has taken some steps to increase pipeline capacity, but it has limited itself to the Baltic Pipeline System, the Primorsk terminal on the Gulf of Finland, and the Druzhba-Adria project. The pipeline issue is critical for Russia. The oil sector constitutes a major portion of Russia’s GDP. Thus, if Russia does not solve the problem of limited pipeline capacity, it will meet considerable difficulties in the future.
There are several options for increasing Russia’s oil export capacity. One is to build a pipeline to Murmansk, and export oil from there to the United States using supertankers. In Dr. Vekselberg’s view, this is one of the most promising projects. The construction of a pipeline to the Far East would also allow Russia to broaden its narrow export market. While an eastward pipeline would be a good idea in general, the YUKOS project for a pipeline leading to China took the wrong approach. Not only would it have catered to a single buyer, weakening Russia’s geopolitical position and limiting its access to world markets, but it would also not allow the development of oil fields in the north of the Irkutsk Region, the east of the Krasnoyarsk Territory, or the south of Yakutia.
Discussing what needed to change within the company, Dr. Vekselberg noted that the problem of cultural integration was “issue number 1.” Russian TNK-BP executives need to learn to listen to their Western colleagues, while the latter must not act like “missionaries” or “preachers of the truth.” Russian and Western executives not only speak different languages and are used to different standards, but also have entirely different mentalities. The company has been trying to overcome this serious problem by instituting various measures to bring the two sides together. Every Western executive is shadowed by a Russian, so that the two can informally discuss issues affecting the company. At work, disagreements between Russian and British specialists can lead to shouting matches, and so the company arranges informal outings where the two sides can interact in a more relaxed atmosphere.
The second priority for TNK-BP is to incorporate world standards in environmental protection and working conditions. Russians are not having an easy time adopting these standards, and the top management has to force them on the company.
The company spent three months at the end of 2003 discussing a business strategy for 2004 at various levels. The BP management thought that general goals were enough, whereas Russian managers insisted on putting numerically exact plans in front of every subordinate, their belief being that without such plans, the company’s goals would not be achieved. In the end, a “painful compromise” was achieved, showing the effect that cultural differences can have on seemingly simple issues. Dr. Vekselberg pointed to an organizational chart that showed Russian and Western managers in different colors. He observed that at every point on the chart where the different colors meet, clashes occur everyday. While this may seem funny to the audience, it almost drives TNK-BP managers to tears. The company’s goal is to achieve a common corporate culture, so that these clashes can be eliminated.
Dr. Vekselberg called corporate governance the “issue of issues.” TNK-BP needed to make sure that investors did not worry about putting their money into the company, while shareholders felt safe that their assets were being managed properly. Long-term incentives are difficult to introduce into Russia’s corporate culture, because managers and workers prefer lower bonuses today to higher, performance-tied bonuses several years down the road. For BP managers who have come to live and work in Russia, however, long-term incentives are natural. They have thus been adopted across the board in TNK-BP without significant problems. This was achieved not just because of the influence of BP, but also because TNK-BP employees are confident about the prospects of their company, and more confident about Russia than they were before.
Another aspect of corporate governance that TNK-BP has tried to strengthen is ethics. Russian business in general hardly pays any attention to conflicts of interest, such as managers at various levels giving business preferences to their friends or relatives. TNK-BP managers now have to provide full disclosure of the business deals they handle.
Dr. Vekselberg expressed his confidence that the 50-50 ownership structure of TNK-BP will ensure progress, because one cannot move towards the achievement of serious goals without a dialectical battle of opposites.
On the subject of social responsibility, the speaker noted that different people understand the concept differently. For instance, the Russian finance minister, Aleksei Kudrin, said at the World Economic Forum in London that paying taxes is the main social responsibility of business. Dr. Vekselberg explained his understanding of the social responsibility of business using the example of the Siberian-Urals Aluminum company. Five years ago, SUAL set up a “non-commercial social partnership”, bringing together the mayors of cities where large SUAL plants were located, as well as the managers of those plants. The aim was to tell the mayors what SUAL was doing, and hear from them how they were spending tax money. The meetings of this partnership framework showed that the mayors seriously lacked accounting expertise. SUAL then helped the mayors with financial planning and accounting by providing them with training on these matters. At the same time, SUAL carries out charitable work, and the partnership with mayors has allowed it to channel funds where they are most needed.
Dr. Vekselberg closed with a comment on the recent World Bank memorandum on Russia, according to which Russia’s high capital concentration is not benefitial for a developing economy, has negative macroeconomic effects, and stifles the development of small and medium business. While the memorandum is right in suggesting, that a high concentration of capital is a negative phenomenon in general, Russia’s capital concentration has to be seen in its proper context. Russia still has a long way to go to achieve an economy in which such a high concentration of capital is unacceptable. Today’s Russian finance-industrial conglomerates are oases of “normal, civilized culture” which will lead Russia towards new frontiers. They are places with a high concentration of young, educated and aggressive professionals, whose (often Western) education is aimed towards the achievement of serious results. They are also places where international accounting standards are already being applied. Further, they are those parts of the Russian economy that undertake large-scale investment projects.
Large enterprises often build up a network of small businesses around themselves. For example, General Electric is surrounded by over a thousand “satellite” companies. TNK-BP owns over a hundred service enterprises, which it wants to sell over two years. A competitive market will thus be created, giving TNK-BP access to better and more efficient service.
Responding to a question on Russia’s high dependence on energy exports, Dr. Vekselberg observed that the development of a country’s economy must be natural. Certain sectors, such as processing and innovative industries, can be stimulated to give rise to alternative sources of growth. Russia cannot “jump into” a diversified economy, but can gradually reach it. The speaker reiterated his company’s commitment to further exploration, saying TNK-BP’s willingness to invest in the risky search for new reserves shows its confidence. However, the company could use government support, perhaps in the form of tax breaks—which exist in “the whole world”—to encourage exploration.
Replying to a question on capital flight, Dr. Vekselberg denied that today’s business climate in Russia encourages divestment and the transfer of capital abroad. The situation today, in his opinion, is no different from six months or a year ago, and he has no plans to move his assets abroad. Russia has a large number of unresolved social problems, and the government may need to dip into the most profitable sectors to try to solve them. However, the long-term economic strategy of the government is right. It is thus important to distinguish this strategy from the large number of single cases where the government has difficult relations with particular companies.
The government currently does not have a partnership with business, and makes business decisions in the sectors under its control based on political considerations. For example, it still does not allow private capital to participate in oil or gas pipelines, which is not quite right. Russian pipeline networks would be developing much more actively if the private sector was allowed to invest in them. Yet, the government could retain some control through a regulatory system.
Asked about the sources of finance for TNK-BP, Dr. Vekselberg responded that the company’s debt ratio is only 28 percent, giving it a high degree of creditworthiness, which allows it to finance all of its planned projects. However, for a project on the scale of Kovykta, where TNK-BP is planning to invest $12 billion, several banks will have to get involved, backed by government guarantees. While Russian government guarantees are desirable, Chinese guarantees are essential to obtain financing for the project.
Regarding nationalization and re-privatization, Dr. Vekselberg noted that most countries have laws that allow the state to undertake these actions in some circumstances. However, these laws have to be “reasonable, civilized, and applied in a balanced manner.” Russia’s laws in this sphere are still under development. However, the speaker expressed the hope that a time will come when nationalization will be off the table and will no longer be used as a scare tactic.
Rosneft and Gazprom will not be privatized for at least another three years. However, Anatoly Chubais may succeed in starting the privatization of the Unified Energy System (UES). Some wholesale generating companies that are part of the utility may be put up for sale, or may at least issue a management tender. UES is burdened with inefficient expenditures which cannot be eliminated without the introduction of private ownership. The government may also replace the mining and fossil fuel tax with another form of tax, which would allow energy companies to bring unused reserves into production. This may develop a secondary market in oilfield exploitation licenses.
The existence of state interests is natural, but everyone should know what these interests are, and how they are prioritized. Gazprom bears a heavy social burden today, because consumers are not paying the real cost of gas. However, it would be impossible to raise natural gas prices to European levels overnight; that would cause the economy to collapse. What is needed is a gradual increase in prices, balanced by subsidies for certain segments of the population to enable them to pay the higher prices. Russia also has a legal system of tenders, and several ministers have promised not to give Gazprom a free ride.
TNK-BP and Sibneft have agreed in principle to divide Slavneft between them, but no legal scheme has yet been worked out to do this. De jure, 92 percent of Sibneft belongs to Yukos, but de facto, Sibneft remains under the control of Roman Abramovich. Thus, TNK-BP cannot resolve the question of dividing Slavneft until there is a real interlocutor to deal with, Dr. Vekselberg concluded.
Summary prepared by Rashed Chowdhury, Junior Fellow with the Russian and Eurasian program at the Carnegie Endowment.
