Berge, Andrea MGMT 485W Spring 2013 Case Study: TNK-BP (Russia) INTRODUCTION “This case portrays the highly uncertain scenario facing BP in Russia at the end of 2007. In the midst of unraveling relations with its cooperative partner and undesirable host government practices, ideal strategic conditions are implausible. In order to maximize outcomes under such imperfect circumstances, BP’s senior management needs to fully assess the situational risks, understand the dynamics and motivations driving stakeholder behavior, and establish a plan which can appeal to all interested parties.
TNK-BP is a joint venture established in February 2003 by BP and Alfa Access/Renova (AAR). The two companies combined their resources in Russia to create the country’s third-largest oil and gas business. Each party holds a 50 percent stake in the joint venture. RISKS Globalization, the flow of goods, capital, and services across international borders, is leading to increased economic interdependence. Globalization increases the available opportunities for firms; it has led to higher performance outcomes, including quality, cost, and productivity.
Although globalization offers potential benefits, there are related risks. These risks are collectively known as the “liability of foreignness. ” (p. 10) Political and Economic Risks Political risks can be defined as the “probability of disruption of the operations of multinational enterprises by political forces or events. ” (p. 246) Examples include uncertainty caused by government regulations, legal issues, corruption, and political instability. Economic risks can be defined as “fundamental weaknesses in [an] … economy with the potential to cause adverse effects on firms’ efforts. (p. 247) Political risks and economic risks are interdependent. In Russia, BP faced an enormous amount of political and economic risk. Russia’s institutional instability combined with a weak legal system and high levels of government corruption made foreign diversification in Russia a questionable investment. BP, the world’s third largest gas and oil company, analyzed the level of risk and, beginning in 1997, began investing in the Russian oil and gas industry. Within the oil and gas industry, competitiveness is based on increasing oil and gas production and replacing reserves.
Reserve replacement is becoming increasingly difficult as most of the “easy” oil and gas discoveries were already claimed. Russia with its proven reserves and production capabilities was an opportunity for BP to expand. BP was trying to match the financial performance of the top two firms in the global market – ExxonMobil and Shell. The TNK-BP joint venture was an attempt to secure access to the oil and gas resources within Russia. But, despite the size and importance of the raw materials found in Russia, production was declining.
In 2008, the Russian oil industry was facing a combination of problems: (1) aging oil fields and poor maintenance policies; (2) a confiscatory tax and regulatory regime; (3) a lack of Russian and foreign investments in exploration and development. Of specific concern to BP was the confiscatory tax and regulatory regime. Russian leaders had been accused of using oil and gas exports as a means of achieving foreign policy objectives. The majority of the industry in Russia was comprised of six large firms: TNK-BP, Lukoil, Gazprom, Rosneft, Surgutneftegaz, and Tatneft.
Four of these firms were government controlled. Only TNK-BP and Lukoil remained independently owned. Of these two, only TNK-BP had major foreign ownership; British-owned BP had a 50 percent stake in the organization. Lukoil’s largest shareholders were two Russian oligarchs with a 25 percent stake and Conoco-Phillips with a 20 percent stake. Regulatory changes made between 2003 and 2008 were also limiting BP’s ability to prosper within Russia. Laws limiting foreign investment in strategic industries made the future of foreign investment unclear.
New laws prohibited firms with less than 50 percent Russian ownership from bidding for strategic fields. Russia’s legislature approved the forced transfer of certain fields to government-controlled firms. In 2006, Shell was forced to transfer an expansion project to Gazprom. That same year, concern over the possible revocation of the license to the Kovykta gas field and Gazprom’s ability to block construction of a pipeline to China, forced TNK-BP to sell its stake in the field. Gazprom purchased the stake for less than a third of its real value.
The Russian government had also been known to both privatize or nationalize firms and rig auctions in order to favor government-controlled corporations. Competitive Risks The very nature of a joint venture lends itself to competitive risks. Competitive risks include: (1) opportunistic behavior; (2) misrepresentation of competencies; (3) failures to make resources and capabilities available; (4) failure to make alliance investments. The TNK-BP joint venture must deal with opportunistic behavior. Labor laws designed to limit the number of foreign nationals in top positions in natural resource companies are being exploited by TNK-BP.
The Russian shareholders of AAR are using the laws to limit the number of foreign managers and specialists working in Russia. The ultimate goal is to place more Russians into top positions and to use the leverage provided by that leadership to achieve AAR objectives. The main dispute revolves around whether TNK-BP should be allowed to expand outside Russia even if it would compete with BP’s own operations. The lack of foreign nationals in top management positions means that BP runs the risk of losing control of the joint venture’s operations. Risk Summary
Most importantly, most of BP’s Russian assets are involved in the cooperative alliance. The company risks losing control of their assets if the firm is nationalized or forced into a minority position within the joint venture. The company also risks the loss of nearly one-quarter of BP’s oil production, and almost one-fifth of its reserves. Losing its stake in TNK-BP would have serious financial implications for BP. In order to reduce risk, BP needed to forge stronger ties with the Russian government and improve it position within the unstable Russian and political and economic environment.
BEHAVIOR OF STAKEHOLDERS The first step to reduce risk was to understand the political, economic, and sociocultural environment. The second step was to understand the factors that motivated shareholders’ behaviors. Shareholders incentives to respond or take action relate to perceived gains and losses. The most prominent stakeholders in the TNK-BP joint venture are the capital market stakeholders, BP and AAR, and the product market stakeholder, the Russian government. BP BP is motivated by economic and competitive concerns.
Access to Russia’s oil and gas production facilities as well as Russia’s vast expanse of oil and gas reserves is critical to BP’s success. It is also critical that BP protect its prior investments in TNK-BP and Russia. Most of BP’s Russian assets are controlled by the joint venture, and TNK-BP accounted for one-fourth of BP’s oil production and one-fifth of its reserves. If the company loses control of the joint venture, BP would lose control of its assets. The company would struggle financially and may lose ground in the international competition to control the oil and gas industry.
In addition to access to Russian resources, BP was motivated by the experience and judgment in Russian government relations, legal affairs, and security provided by the leadership of AAR. AAR AAR is motivated by financial concerns. The Russian shareholders of AAR are three oligarchs motivated by monetary returns and power. They are among the wealthiest men in the world. They are motivated by the desire to maximize financial returns, which they believe will come from cutting costs and increased growth.
Critical to their beliefs about potential growth was the belief that the company must expand outside of Russia. The joint venture agreement states that “the business scope of TNK-BP is limited to oil and gas in Russia and Ukraine. ” However at the outset of the partnership, Mikhail Fridman, the lead oligarch shareholder, stated, “I’m sure that this new unique entity will play a leading role in the Russian and, later, the world oil industry. ” The desire for higher shareholder returns and increased production led AAR leadership to request the removal of TNK-BP Chief Executive Robert Dudley in May 2008.
In addition to BP assets, AAR was motivated by access to BP’s global position and reputation, intellectual property, and managerial experience. Russian Government The Russian government is motivated by economic and political concerns. Most host governments in oil-producing nations, including Russia, were seeking better contractual terms to improve their economic positions. The financial benefit gained from oil and gas reserves is substantial. For Russia, oil and gas revenues made up 50 percent of budget revenues, 65 percent of exports, and 30 percent of foreign direct investment. The flow of petrodollars … created a sense of stability, masked economic woes, and given Russia more clout on the world stage. ” The Russian government’s modernization agenda relies on the ability to attract both Russian and foreign investment. The perception of political stability and economic progress would serve as proof that Russia was “integrat[ing] with the world economy. ” However, the current problems with the TNK-BP joint venture illustrate more fully Russia’s lack of commitment to its stated policies.
The Russian government has actively decreased the involvement of foreign stakeholders in the oil and gas industry, and acted in support of political and personal economic alliances. UNETHICAL BUSINESS PRACTICES Corporate governance is an increasingly important issue in the global economy. As firms and countries seek to attract foreign investment, they must illustrate that adequate mechanisms for corporate governance are in place. Although globalization is helping to decrease regional and national differences in governance systems, the truth is that different nations have different systems in place.
Recognizing and understanding the differences in the Russian system improves the likelihood that BP will be able to prosper in its joint venture. BP must engage in more active and effective monitoring of TNK-BP managerial decisions. Using their concentrated ownership power will help force decisions that are in the best interests of all shareholders. BP should also revisit the issue of executive compensation to ensure an effective system. An effective system of executive compensation will help produce managerial decisions that are in the best interests of shareholders.
The decisions and actions of TNK-BP’s board of directors must reinforce the desire for ethical behavior by top-level management. Establishing clear boundaries for the firm’s business ethics and values and clearly communicating them to top management and stakeholders will help to improve current and ongoing operations. Unfortunately, effective corporate governance in difficult for international companies, especially in a political climate, such as Russia’s, that is fraught with corruption and other unethical business practices. STRATEGIC OPTIONS
A strategic alliance is “a cooperative strategy in which firms combine some of their resources and capabilities for the purpose of creating competitive advantage. ” (p. 263) A strategic alliance is a good way for a firm to enter a new market, especially when faced with the high levels of risk associated with international expansion. TNK-BP is a joint venture, a strategic alliance in which two or more firms combine some of their resources to create a new legal entity. The joint venture combines resources from AAR and BP; each form holds a 50 percent stake in the joint venture.
Unfortunately, the formation of a strategic alliance does not guarantee success. Success is more likely when partners behave cooperatively. The TNK-BP joint venture has been characterized by difficulties, suspicion, and cultural differences since its formation. The conflict between the two firms resulted in threatened legal action in 2008. However, BP is financially dependent on the success of the joint venture. The “lock-in period” that did not allow either partner to sell their interests in the venture expired on December 31, 2007.
With the ongoing conflicts and the possibility of a sale of assets, the joint venture needs to restructure in order to continue as a going-concern. The new agreement should focus on providing greater value for all stakeholders. Current Obstacles The lack of growth in the oil and gas market outside of Russia is the biggest obstacle to the success of the joint venture. Any restructured agreement must allow for expansion beyond Russia and the Ukraine. Expansion goals for TNK-BP can be compared with expansion goals for BP in order to minimize conflict and gain benefits for both firms.
Additionally, BP must agree to restructure compensation packages for expatriates. As early as June 2003, the issue of bonuses and entitlements for expatriates was an issue for AAR shareholders. Management pay must be in line with Russian practices. If BP feels that in order to properly compensate top-management they must pay more than AAR is willing to invest, the funds will need to be apportioned between TNK-BP funds and BP funds. Current Strengths The strength of the current joint venture is the financial performance of TNK-BP.
TNK-BP’s 74 percent return on equity, 32 percent return on assets, and 61 percent on return on invested capital are well above the Russian average and the global average. The joint venture has clearly created a competitive advantage. But without BP’s resources and AAR’s local knowledge, the results for all stakeholders would diminish. Neither the firms nor the Russian government would be as successful at attaining their objectives without the joint venture. Protection of Investments In order to protect BP’s investments and assets, the company should restructure to allow for a redistribution of assets.
AAR control of actual raw materials and BP control of refining and marketing activities will minimize conflict with the government’s stated objectives. If BP is unable to structure a new agreement that will protect its own interests, it must consider reducing or eliminating further Russian investments. Another option would be to continue to seek alliances with other strategic partners within Russia. This would expand the company’s legal, political, and cultural presence within Russia. CONCLUSION The current operating conditions for BP in Russia are characterized by extreme risk.
The joint venture with AAR has proven increasingly difficult to manage, although financially successful. BP’s goals should be to reduce risks and provide mutual gains for all stakeholders. A successful join venture will result in a long-term relationship. The strengthen the alliance between BP and AAR, BP’s actions should encourage: (1) full disclosure and increased transparency to reduce opportunistic behaviors; (2) open and frequent communication; (3) higher levels of trust; and (4) cooperative interaction to promote the creation of competitive advantages and above-average-returns.
Cite this Case Study: TNK-BP in Russia
Case Study: TNK-BP in Russia. (2016, Sep 28). Retrieved from https://graduateway.com/tnk-bp/