A CHRISTMAS-NEW YEAR IN EASTERN EUROPE

In Orthodox societies, Christmas and New Year are celebrated differently. In the former Soviet republic of Ukraine, for instance, Christmas (December 25th) is a non-event. Christmas is celebrated on January 7th instead. The country works through December 31st and then goes on holiday from January 1st to the 7th.

First, a country background. Ukraine is ancient. It lies along the many routes of conquerors and the conquered. From the north came the Vikings and the ancient Germanic tribes. From the west came the Romans, from the south, the Turks. And from the east came the Mongols. As can be expected, its people are a varied lot. Ukrainians share their Slavic roots with people of the surrounding regions—the Russians, Poles, Serbs, and Macedonians—to name some of them. The Slavic heritage, in turn, comes from the Vikings. Around 1000 AD, Ukraine, specifically its capital—Kyiv—was the seat of a kingdom called Kyivan Rus. The seat of this kingdom eventually migrated north, to present-day Moscow, to form the offspring that we now call Russia.

Second, a political background. Ukraine has a tortured past. Its national anthem, for example, can be translated as “Ukraine is still standing" or "Ukraine is not yet dead.” While it implies heroism, it also conjures an image of desperate bravery. In fact, with the major exception of Kyivan Rus, Ukraine has always belonged, in whole or in part, to more powerful kingdoms. After the Nazi occupation, it became an important cog of the defunct USSR. The Soviets exploited Ukraine to the hilt. It was simultaneously its “breadbasket” as well as its heavy metal (steel) source. In addition, many of the USSR’s engineering talent had Ukrainian origins. Most of the USSR’s navy was built in Ukraine. Its space program was based in Ukraine as was its nuclear missles. Indeed, after the USSR’s collapse in 1991, Ukraine suddenly found itself with the world’s third largest nuclear arsenal (after Russian and America). One of the longest-lived Soviet leaders, Leonid Brezhnev, was Ukrainian by birth although he did not bestow any special benefits to his native land during his era. Today, Ukraine is divided. Its president is pro-West and has been driving his country towards membership in NATO and the European Union. Ukraine’s prime minister, on the other hand, prefers the status quo and stay close to Russia. The division divides Ukraine along nearly geographic lines. With Kyiv in the center, the eastern half—the one adjacent to Russia—is pro-Russian. And it can literally be heard on the streets. The dominant language is Russian. The western half, by contrast, is more nationalistic if not pro-West. Similarly, Ukrainian is the lingua franca.

Dnipropetrovsk

Dnipropetrovsk, “Dnipro,” as the locals call it, is Ukraine’s third largest city (1.1 million). It’s in the eastern half and lies along the banks of the great Dnipro river (known in Russian as the “Dnieper”). During the Cold War, it was a “closed city.” Admission into and out of Dnipro was tightly controlled. Among other things, most of the USSR’s InterContinental Ballistic Missles (ICBMs) were produced there. So tight was its security that this city of 1 million did not officially exist in any map.



Padlocks seal the new marriage

People practice different customs in their part of the world. In Ukraine, newlyweds carry on a cute tradition. A bridge connects the city center (downtown) to an island on the river.



This island, Monastyrskiy, contains the earliest evidence of human inhabitation in the area. Today, the island houses a rebuilt cathedral and one of the tallest statues of Ukraine’s most heroic figure, Taras Schevchenko. A transplanted New Yorker, Michelle, explained a custom that newlyweds engaged in after getting married. They lock a padlock to the bridge’s rails. As you can see, the city has had many newlyweds.

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A BIG BET ON RUSSIA: BP's PREDICAMENT

BP—formerly known as British Petroleum—is currently facing the largest crisis in its storied 99-year history. The crisis is full of superlatives. By any measure, it’s enormous. It involves tens of billions of dollars and the direct employment of almost 100,000 Russians. It’s being closely watched as a harbinger of Moscow’s real intentions—economically and militarily. It has the potential to bring down a giant company. And it involves numerous ethical and legal issues.

Befitting the largest British company, BP shares trade primarily at the London Stock Exchange. Energy is currently a hot industry. Last year, BP was the fourth largest company in the world measured by revenue, preceded only by Exxon-Mobil and Royal Dutch Shell.

In 2003, BP bet big. For starters, it invested $6.15 billion for 50% ownership in a joint venture called TNK-BP. This was just for starters. BP took this gamble not only because of the enormous potential of Russia’s Siberia but also because it’s traditional haunts in the North Sea, Gulf of Mexico, and Alaska had become prohibitively expensive, its proven reserves were perilously low, and its global oil production (on which its revenue depended upon) was declining. In short, BP was desperately looking for new fields (literally) to mine.

But why Russia? Virtually all the other oil majors, with the exception of Royal Dutch Shell, had steered clear of it. BP’s peers had concluded (and it appears, rightfully so) that Russia’s legal fabric was still unproven. Why is its legal fabric so important? Russia has historically been an autocratic state. Its recent behavior in Georgia is indicative of the way the Russian government pursues its objectives. It shoots first and then presents the world with a fait accompli.

BP was undeterred. It forged ahead. The promise of enormous gas and oil reserves, low cost, and the advantages of vertical integration—from the ground through the pipes to the consumer—was irresistible. It was willing to risk bad governance, a corrupt judiciary, venal bureaucracy, combative local partners, organized crime, and capricious legislation. It boldly proclaimed that Russia is changing for the better. Russia’s fledgling democratic society is becoming stable. Russia needs foreign investment and will give its investors at least a level playing field. It has to behave like a civilized country of laws for it to retain its status as an inviting place for investment.

It seems to have fooled itself. Whether or not it deluded itself, this is a dangerous type of managerial delusion. It puts a lot of jobs, not to mention resources, at risk—if the decision, in fact, was a product of managerial delusion.

A HISTORICAL PERSPECTIVE

I think Senator McCain, the current Republican candidate for the US presidency, said it best. In a campaign interview last month, he said:

Let me put a little bit of historical perspective on this. I think all of us had [developed] a kind of a romanticized view of the world after the fall of the Soviet Union. There was a period of time when we saw dramatic progress around the world of countries attaining democracy [referring primarily to the former vassal states of the USSR]. Many assumed that it was almost automatic that China and Russia would inexorably [follow] a path toward democratic and free societies. Then we saw Tiananmen Square, the chaos [including the attempted coup d’état] in Russia and their diminished stature in the world. Now Vladimir Putin and company are eager to reassert [their centuries-old self-image of being one of the major powers in the world].

So, in other words, great economic progress did not mean the diminishment of autocracies. I still believe that history will show that democracy and freedom go hand in hand with economic development, sophistication, and the technologies that enable the free flow of information. I think we all are realizing that progress is not going to be as rapid as we may have thought it was going to be in the halcyon days of the 1990s.

Assassination continues to be one of their tools (referring to Alexander Litvinenko), oil, brazen attacks on civilians (in Chechnya, etc.), outright attacks on the pretext of protecting its citizens (in the breakaway provinces of South Ossetia and Abkhazia in Georgia).

I don’t think we’re going to reignite the Cold War. I don’t think there’s going to be a nuclear confrontation with Russia. I do think there’s going to be a dramatically different relationship.

We should always try to maintain relations and communications with every country in the world. But never confuse national interests with personal relationships.

Comment: Incidentally, that’s what President Bush did back in 2001. His famous remark was “The more I get to know President Putin, the more I get to see his heart and soul ...the more I know we can work together in a positive way.” Sorry George, you’re very wrong on that one. Putin is a former KGB agent. What were you thinking?

Three short years later, by 2006, TNK-BP went on stream. In its 2007 Annual Report, BP announced that TNK-BP accounted for 25% of its global oil production and contributed 15% of its net income. From 2003 to 2006, BP claimed that it had earned enough dividends to recoup its initial investment. Indeed, by the third quarter of 2006, BP’s share of revenue amounted to $6.9 billion. (I’m not clear on the source or nature of these “dividends.” The term might be used generically.) Not so prominently mentioned was the fact that BP has no other major projects on stream that could take TNK-BP’s place.

The economic climate turned around in 2007. Russia had tasted the wealth and power that comes with being the major supplier of Europe’s energy needs. Now the real Russia came out.

RUSSIA MAKES ITS MOVES

In December 2006, it forced Royal Dutch Shell along with its Japanese partners, Mitsui and Mitsubishi, to sell its controlling stake in Sakhalin-2. This was a $22 billion stake. This is not an amount to trifle with—even for the oil majors. Russia was able to impose its will anyway. How? It used a government environmental agency (just like the EPA of the US government) to threaten to freeze work on the project.

Since then, Russia has focused its efforts on harassing BP. It uses a combination of tactics—the same environmental agency, the tax revenue police, the justice police, and, most ominously, the FSB (the modern-day successor of the KGB).

The results were predictable. There is no contest between one of the largest companies in the world against the largest country in the world.

By June 2007, BP agreed to sell one of TNK-BP’s prize assets—one of the world’s largest natural gas fields—to Gazprom. The latter is a Russian state company and a monopoly. The leverage used by the Russians was typical: the threat to revoke the company’s license to develop the gas field. The Russians window-dressed the transaction. Gazprom would “buy” it from BP for $700 to $900 million. BP will take a huge opportunity loss on this. Analysts estimate that the gas field, called “Kovykta,” was capable of earning between $1.5 to $2 billion. Furthermore part of BP’s compensation will be the opportunity to invest another $3 billion and form a joint venture with Gazprom.

Comment: Thank you very much. First, you force me to sell at a loss. Second, you’re generous enough to give me another opportunity to lose more money.

BP’s reaction was puzzling, to say the least. Its CEO welcomed the arrangement as the start of a new strategic partnership with Gazprom. Furthermore, in the same speech (given in Moscow, incidentally), BP’s CEO praised BP’s business progress and encouraged other companies to invest in Russia. He called the gas field dispute just “one of those bumps in the road.” Of course, this was probably smoothing the crisis on the surface. Wait and see and until then, pretend everything is going smoothly.

Thirteen months later, in July 2008, BP-TNK’s CEO was effectively ousted. Moscow’s tactic: the non-renewal of the expatriates’ work permits. Affected with the CEO were 150 senior engineers of BP. Moscow presented BP with one small consolation—the CEO was still the CEO and could continue to run the company albeit from overseas.

CAN WE DRAW SOME CONCLUSIONS?

Would you agree that the following conclusions can be drawn from this story?

1. Russia is pursuing a policy of state control. It lures Western oil companies and, over time, makes them junior partners. It needs Western investment and technology and is only intent on building its own capabilities.
2. It will not use bald-faced tactics to expropriate Western investments. Instead, Moscow uses its entire arsenal of laws and regulations to harass its foreign partners until it achieves its goals. Time and location are on Russia’s side.
3. Russia’s power elite, led by Putin, will not hesitate to apply these same tactics to domestic enemies. The former owner of Yukos, Russia’s first large oil company, dared defy Putin in 2003. Yukos was looted and eventually absorbed by Russia’s state owned oil company, Rosneft. As for the billionaire who defied Putin, he now languishes indefinitely in an obscure penal colony close to the Russian-Mongolian-Chinese border. Apart from him the other big losers were Western banks who were owed more than $1 billion.
4. It’s obvious that Russia is leveraging its power as the single largest fossil fuel producer (second after the entire OPEC cartel) to re-arm itself. Russia’s goal is to return to its place as one of the world’s superpowers. This goal can only be attained by developing its industrial and military capabilities. To this end, it is vital for Russia’s oil and gas to stay within Russia’s border until it reaches its European customers. This is a major reason for its hostility to the West and to its former satellite states for daring to build a trans-Caucus pipeline.

WHY DID BP MAKE THIS DECISION?

Why did they take such an enormous risk especially since most of their peers, save another one (Royal Dutch Shell), played it safe?

It won’t do much good to second guess the board’s decision. The agreement to go ahead was signed with much publicity. Putin even flew to London for the event. BP’s decision doesn’t seem like it was made secretively.

A clue may be found in the reported condition of BP’s board in 2001 till 2003. It seems that BP’s board was dysfunctional. The CEO, Lord Browne, led autocratically and not by consensus. He was forced out in 2007—for reasons unrelated to BP’s Russian investment. Various unflattering portraits of him can be found on the Web. Four examples are:

• The Houston Chronicle - BP is the largest investor in US energy development. Most of that is in Texas.
• USA Today
• BusinessWeek
• Wikipedia about Lord Browne

I mentioned decision-making delusions that plague executives earlier. Click here for a link to a blog entry that discusses the subject. It’s based on a critical review of a book entitled The Halo Effect.

Click here for a link to a guide for making good decisions:.

Bottom line: The shareholders (among many other observers) probably held their collective breath for the first few years. They must have been pleased, even euphoric, at the results as reported by the 2007 Annual Report. The rapidity of successive setbacks that began in 2007 to the present day must be shocking them.

I suspect the board fulfilled its responsibilities—ethical and legal—to its shareholders and to the greater society. Fortunately for management, the results from the first few years validated their decision. I wonder if any activist shareholders plan to file a derivative suit or the equivalent in the UK. But what would the suit’s legal theory be based on?

A final note about Lord Browne: he was rewarded with a parachute (a very, very modest one by US standards—it was only $4 million!) when he retired.

THE ROCKY RELATIONSHIP BETWEEN THE US AND RUSSIA

The relationship of the US with Russia has always been rocky. The US helped Russia beat back the Nazi onslaught. It wouldn’t be an exaggeration to say that without the help of the US, Russia would’ve fallen.

After the USSR fell in 1991 and the US poured billions into assisting the former adversary, I wondered what the heck was going on. I could understand our assistance in so far as the USSR’s former nuclear arsenal was concerned; we certainly don't want any of those weapons to fall into the wrong hands. Unfortunately the technology, i.e., the skills, is more difficult to control. Witness the rogue Pakistan physicist who shared his knowledge with countries whose relationship with US is currently on edge (North Korea, for example).

WHAT NEXT?

In retrospect, it appears that BP was reckless (or bold, depending upon how things would turn out) in investing in Russia. A capitalist-based economy is still new to them. The majority is not used to democracy or freedom. Their present system is merely a continuation of the corrupt system of Communism.

A badly skewed socio-economic system invites corruption on a massive scale. Russia’s entire wealth is concentrated in the hands of about 100 families. It has a population of almost 150 million and a GDP of about $2 trillion. There is a very thin middle class. In many ways, despite its imposing military, Russia is a third country. (National Geographic, 2008)

So returning to BP and its current predicament, it’ll be interesting to see what happens in the next 24 months.