International Partnership in Russia James Henderson and Alastair Ferguson March 2014
Structure A history of oil and gas partnership in Russia Some joint venture and bargaining theory Practical experiences from the 1990s An objective view of joint ventures in Russia Russian Business environment today Managing Risk and Protection A Russian Engagement Model 7Rs Conclusions for foreign partners in a weak state environment 2
A short history of IOCs in Russia Soviet Period Privatisation Corporatisation Consolidation Increased State control 12.0 10.0 8.0 Competition for ROC equity IOCs not wanted Technology and finance needed - Offshore and tight oil JVs mmbpd 6.0 4.0 2.0 Technology and finance needed JVs and initial PSAs Major governance issues and economic crisis IOCs not interested Consolidated ROCs - Limited equity sales to IOCs 0.0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 3
Russia s oil production outlook 14 Black Sea and Barents Sea Arctic offshore 12 Prodction (mmbpd) 10 8 6 4 Enhanced recovery at existing fields East Siberia Tight Oil 2 0 2010 2013 2015 2020 2025 2030 General Scheme (High) General Scheme (Low) EIA Source: Ministry of Energy, General Scheme of Development of Oil industry to 2020, EIA International Energy Outlook 2013 Maintaining Russian oil production above 10mmbpd is becoming more challenging IOCs will be important contributors of technical experience, management expertise and financing for difficult projects Partnership is vital to the future of Russia s oil (and gas) sector 4
Theoretical context for FDI in a weak state environment Joint Venture Theory Foreign Partner Ownership FDI in Resource Sector Theories Domestic Partner Local Knowledge Internalisation Weak State / Local Knowledge Theories Location Host Country Bargaining Theories 5
Key Themes from Case Studies and Interviews Key themes from 1990s included: Foreign partner brought a combination of technology, management skills and money Domestic partner brought access, assets and local knowledge Transfer of knowledge tends to be a one-way process DP local knowledge is an asset to a JV but also a key risk for the FP In any conflict over JV issues the DP normally wins Interviews from 2000s confirmed that: The business environment for international partnerships in Russia has not changed dramatically over the past decade Institutions remain weak and dominated by key individuals Business outlook remains relatively short-term as faith in reliability of laws and regulations remains low Status quo unlikely to change soon, as it benefits the domestic elite Local knowledge and influence remain vital commodities International skills and work-force not always welcome, which can undermine foreign partner position 6
Survey of partnerships provided objective confirmation FP initial and final control Foreign partners in 33 joint entities surveyed Confirmed that domestic partner learning took place and was encouraged FPs learning identified through change of control over key responsibilities No significant change identified Remained strong in original areas, made no progress on local knowledge issues No gain in confidence either Related to internal partnership issues as no change in external environment However, there was a range of FP performance around this average FP control and confidence 7
More local knowledge = more success Overall Model explains 61% of FP success FP success = K + (0.46 x Increase in Local Knowledge) + (0.32 x DP Success) (0.31 x State Influence) For every 25% increase in FP Local Knowledge his chance of success goes up by 12% Joint Venture Model explains 58% of FP success in JVs FP success = K + (0.63 x Increase in Local Knowledge) + (0.31 x DP Success) For every 25% increase in FP Local Knowledge his chance of success goes up by 16% The Corporate Model makes a significant contribution to FP success on its own Joint entities using a corporate model are statistically more successful than normal JVs, but no other factor makes a significant contribution 8
Russian Business Environment The Triangle of Tension Politics Business Managed Tension Vested Interests 9
Russian Business Environment characterised by complexity and ambiguity: Factional and fragmented; managed tension between factions; trade offs but not always connected business and interests Tenacity determined and persistent Confrontational and aggressive Conflict and mistrust are the norm Unconventional business model not linear and not transparent Win lose is preferred outcome..the partnership model in Russia is competitive - specifically competition for knowledge 10
Managing Risk and Protection - Principles What you see is not what you get What is really happening vs. what you are being led to believe Understand interfaces and motivations the real drivers Always triangulate politics, business and vested interests to build an integrated picture (better than 75%).and develop a response Persistence is key to protecting yourself Bottom line: Difficult to manage and/or negotiate if you don t understand the drivers and what is really motivating a decision 11
Managing in this environment Develop an engagement strategy with Govt., JV and partners Strong asset (shareholder) team Who can identify and focus on the right issues With forensic commercial capability Comprehensive stakeholder analysis to help build the picture (politics, business and vested interests) Advisory team who can interpret important to have send and receive capability Develop a senior cadre of Russian staff Learn to manage conflict persistence 12
Foreign Entities in Russia Common Mistakes Over-reliance on intermediaries who promise understanding of, and access to, key decision makers but who cannot deliver Overconfident senior leadership who underestimate the level of complexity and ambiguity Misunderstanding/ misinterpreting the signals due to poor intelligence send and receive capability Quality of human resources you have on the ground in Russia do they really have insight into what is happening? Lack of persistence in protecting and defending yourself Complacency and arrogance once you have established a foothold 13
The 7 Rs Engagement Strategy Protection Proactivity Reality Renewal Relationships Relevance Resourcing Rigour Reciprocity Everything revolves around Foreign Partner Relevance 14
Defining the Engagement Model Relevance Reality Relationships Rigour Renewal Reciprocity Resourcing What you bring to the table and what you understand about the business environment Establishing a clear and accurate picture of what is going on and being honest about your own position Maintaining the right contacts and personal relations with relevant and influential individuals Working on comprehensive stakeholder analysis and relationship monitoring Constant review of your position in a partnership and assessment of what needs to be done to refresh it Development of reciprocal interests for mutual benefit and closer cultural connection Adopting a proactive strategy to provide high quality expat staff and develop senior national staff 15
As the gas market becomes more globalised and LNG becomes more important, will partnership become more important for Russia? Shtokman Gazprom Partners:?? Leningrad LNG Gazprom Pechora LNG Gazprom Yamal LNG Novatek Partners: Total CNPC Chayanda Rosneft JV in East Siberia with CNPC Power of Siberia Sakhalin 1 Rosneft Partners: ExxonMobil SODECO ONGC Sakhalin 2 Gazprom Partners: Shell Mitsubishi/Mitsui Kovykta 38bcma to China? S-K-V Vladivostok LNG Gazprom Gazprom Novatek Rosneft A struggle for political and commercial influence is underway as Russia debates its LNG strategy and its need for international co-operation The ending of Gazprom s monopoly on LNG exports signifies government support for 3 rd party exporters Rosneft and Novatek are actively competing with Gazprom for customers and are exploiting partnership to do it In this scenario all 7 dimensions of the engagement model are in play
Conclusions Never underestimate the degree of complexity and ambiguity or be complacent Russians have a strong sense of when and where a partner is weak and they will fully exploit it Russian partnership model is competitive, specifically competition for knowledge In a weak state environment balance can only be maintained if a FP gains local knowledge It is vital to understand the business and political environment and your partner s key drivers as fully as possible This requires an integrated engagement strategy 7Rs Model to ensure continuing relevance and balance in the relationship 17
Appendix 18
Practical experience inside a JV Feudal system with absolute power and control Parallel track and process Duplication of roles Control of key functions e.g. security, legal, Govt. & External Affairs Create chaotic environment - uncertainty and unpredictability Confrontation and conflict are the norm
Key Moments in the History of TNK-BP BP buys 10% in Sidanco BP increases Sidanco stake to 25% TNK-BP formed BP participates in Rosneft IPO Shareholder dispute resolved and TNK-BP stabilised Strategic Alliance with Rosneft announced Strategic Alliance with Rosneft lapsed Rosneft purchases 100% of TNK- BP from AAR and BP for $55bn 1997 2001 2003 2006 2007 2008 2010 2011 2012 2013 Sakhalin exploration agreements with Rosneft Arctic Cooperation Agreement with Rosneft Shareholder dispute with AAR at TNK-BP Bob Dudley leaves Russia TNK-BP buys BP Intl assets (Vietnam/ Vzla) AAR / TNK- BP minorities litigation BP announces potential sale of its 50% stake in TNK-BP
Identifying The Key Actors Decision Maker Advisors Gatekeeeper Associates Very important to accurately identify the key players and their potential impact on a partnership / decision process 21
Managing the relationship Identify and Test Positive Outcomes Identify Actors and Their Roles Determine Levels of Actor Influence Identify and Analyse Responses from Actors Identify Red Flags / Areas of Uncertainty Determine Positive Outcomes for Key Actors An intense iterative process of identifying key relationships, reassessing initial assumptions and addressing areas of uncertainty 22
Monitoring the relationship A constant process of updating relationship status A means of highlighting key changes and continuing areas of uncertainty A tool for ensuring that knowledge becomes embedded in foreign partner organisation 23
Some Theoretical Context (1) Dunning s OLI paradigm provides context for examining FDI in Russian Oil Sector IOCs bring O advantages - managerial bureaucracies, technology skills and financing Russia has L advantage of huge reserves amid a limited global opportunity set Obsolescing bargain emphasizes need for IOCs to internalise (I) in order to maintain bargaining strength How can IOCs reap benefits of I advantages in a weak institutional environment? Domestic partners needed to help gain internalisation advantages Russia is a weak state environment because its institutions can and have been undermined by powerful vested interests Strategy of state capture has complicated bargaining process for foreign investors Real power in informal, not formal, practices, within sistema governance structure Entrepreneurs with local knowledge can flourish through informal links with powerful individuals Substantial literature argues that this is as true today as it was in the 1990s Local knowledge is based on an understanding of the informal practices that allow business and politics to operate in a weak state environment Ledeneva these practices are the know-how of post-soviet Russia Understanding the rules of the game and exploiting them Establishing key relationships to allow a business to prosper Generally a core competence of domestic investors in the 1990s and the 2000s
Some Theoretical Context (2) Bargains are dynamic in nature, and in joint ventures the shifts are based on the willingness of the partners to learn or acquire each other s skills Even traditional IOC / State oil industry bargains tend to shift in favour of the State over time When domestic partners are introduced, JVs become a race to learn Foreign partner skills tend to be more transferable than local knowledge of domestic partner Domestic partners and state actors incentivised to keep business environment asymmetric Also, IOCs became more reliant on Russia for access to large hydrocarbon resources FP need for local knowledge brought by DP de-stabilises traditional OLI framework Conclusions while FPs bring obvious skills to bear, they need to be prepared to maintain the value of their contribution to any joint entity they form IOCs bring widely acknowledged ownership skills to any oil industry investment State brings locational advantage of oil and gas resource Domestic partners bring the ability to manage and influence the asymmetric business environment including the state institutions that play a key role in allocating resources and allowing investors to operate profitably As joint entities are formed to balance the needs of all three parties, the most successful partner will be the one who can maintain his bargaining power for longest Crucially, the domestic partner s bargaining power is based on his local knowledge, which he is incentivised to use to his own advantage and protect from foreign partner learning
FDI in a weak state environment Domestic Partner Local Knowledge Foreign Partner Ownership Internalisation Location Host Country Foreign partner brings ownership of international skill set Negotiates with Host Country for access to assets located within its borders FP s ability to exploit its skills is undermined by the weak state environment A Domestic Partner is needed to gain local knowledge However, this local knowledge requirement interrupts the traditional bargain between FP and Host Country 26
Some experiences from the 1990s Three case studies of joint ventures from the 1990s Key themes include: Foreign partner brought a combination of technology, management skills and money Domestic partner brought access, assets and local knowledge Transfer of knowledge tends to be a one-way process DP local knowledge is an asset to a JV but also a key risk for the FP In any conflict over JV issues the DP normally wins Key conclusions: Do not expect FP appeals to international network to be successful FP should develop a local network, if only as an insurance policy Local knowledge acquisition involves cultural integration JVs often suffer from being single asset ventures with no long-term future An alternative governance structure a corporate model can create mutual incentives and encourage success for both parties 27
Some commentary from the Putin era The business environment for international partnerships in Russia has not changed dramatically over the past decade Institutions remain weak and dominated by key individuals Business outlook remains relatively short-term as faith in reliability of laws and regulations remains low Status quo unlikely to change soon, as it benefits the domestic elite Local knowledge and influence remain vital commodities Transfer of skills remains a largely one-way process International skills and work-force not always welcome, which can undermine foreign partner position 28
Some commentary from the Putin era (2) Clear necessity to build high level relationships with key individuals Deep horizontal and vertical relationship building also required within organizations and institutions Mutual learning as a tactic for relationship strengthening and cultural bonding Reciprocity can help partner alignment Commitment of senior management is vital to success Traditional foreign partner contributions are of interest in Russia once more, but IOCs need to ensure that they are not exploited and then discarded again 29
A Survey of Foreign Partners 33 partnerships surveyed What are the key drivers of FP success? Identify partner contributions and control How did learning take place and did this impact control over time? Did FP grow in confidence in areas where he was initially relying on DP? What other factors could have contributed to success or failure from the FP perspective? Partner contributions Partner control 30
Some subjective conclusions FP should develop a local network, if only as an insurance policy In the current era there is a need to build high level relationships with key individuals However, deep horizontal and vertical relationship building also required within organizations and institutions Mutual learning as a tactic for relationship strengthening and cultural bonding, which are keys to local knowledge Reciprocity can help partner alignment Traditional foreign partner contributions are of interest in Russia once more, but IOCs need to ensure that they are not exploited and then discarded again JVs often suffer from being single asset ventures with no longterm future An alternative governance structure a corporate model can create mutual incentives and encourage success for both parties 31
What are Russian Partners Looking For.. Reliable and constructive partner who will bring legitimacy Investment, technology and skills, specifically in areas which they do not have Governance, investment and portfolio management processes Minority partner who can operate and lead in certain areas, and follow when required To bring new, transformational ideas and creativity Strategic thinking and planning developing future shape of the business (and potential options) Target where these vectors come together. 32
International Oil Companies in Russia The JV Era Equity Investment Back to JVs Sakhalin 1 Sidanco Offshore, Tight Oil JVs with Rosneft Priobskoye TNK-BP Kharyaga Novatek GazpromNeft, Severenergia Yamal LNG Offshore JVs with Rosneft Sakhalin 2 Salym Baitex Shtokman Offshore, Tight Oil JVs with Rosneft 1991 c.1997 Samara c.2010 2014 Polar Lights Nafta Lukoil Rosneft Canadian Service JVs White Nights Achimgaz KMOC South Russkoye Yamal LNG Multiple Small Company JVs Udmurtneft Rosneft JV East Siberia 33 Corporate Joint Venture Gazprom Imperial Oil South Russkoye Rosneft JV Sea of Okhotsk