Petrostate:Putin, Power, and the New Russia

by Marshall I. Goldman

  THE GAS INDUSTRY IS KEPT WHOLE

  The case of the Ministry of the Gas Industry was different. Senior officials in the ministry fought hard to retain all the various properties within the confines of the ministry. They succeeded and in August 1989, the Ministry of the Gas Industry transformed itself intact into a corporation called Gazprom. This move kept the assets of the Ministry of the Gas Industry as a whole, ensuring that they would not be parceled out to various promoters—unlike the Ministry of Petroleum, which privatized what had been its wholly controlled producing fields, refiners, and pipelines. Initially the state owned all of Gazprom’s stock but gradually sold some of its shares to private parties. Nevertheless, because the state remained the dominant share owner, the minister of the Gas Industry, Viktor Chernomyrdin, made himself president and CEO of this entity.

  Chernomyrdin had served a long apprenticeship in both the energy sector and the government. He spent his early years working at the Orsk refinery, which is located not far from Orenburg in the Urals. Then after his army service, he studied at the Kuibyshev Polytechnical Institute.3 From there he went to work for the Communist Party in Orsk and stayed until 1973 when he took a job as deputy engineer at the natural gas processing plant in Orenberg, near where he was born. He became director of that plant in 1978. His next move was to Moscow where he became an instructor for the Central Committee of the Communist Party. This trajectory put him in line to become deputy minister of the Ministry of the Gas Industry in 1982 and then minister in 1985.

  This was also the year Mikhail Gorbachev became General Secretary of the Communist Party. Gorbachev began the reform process that ultimately led to the end of central planning and the state ownership of all the means of production. Anticipating the changes that were yet to come, in August 1989, Chernomyrdin transformed the Ministry of the Gas Industry into Gazprom, which became the country’s first state-corporate enterprise. The state was still in control but now this control was exercised through shares of stock, 100 percent of which were initially owned by the state.

  This was an early indication of what was to happen in the future. But the mass privatization program did not begin until mid-1992 after Boris Yeltsin had taken over as president. In November 1992, Yeltsin authorized the conversion of Gazprom from a wholly state-owned joint stock company into a private joint stock company whose shares could be owned by both the state and private parties. In February 1993, Gazprom began to sell its stock to the public and by 1994, 33 percent of its shares had been purchased by 747,000 members of the public, most of whom were able to obtain a Gazprom share of stock in exchange for one of the vouchers the state had issued to every Russian citizen as part of the privatization process. Fifteen percent of the stock was also purchased and allocated to Gazprom employees. For the time being, the state retained 40 percent of the shares (although this was gradually reduced to about 38 percent).

  Given Chernomyrdin’s success with Gazprom, in May 1992 Yeltsin chose him to be his deputy prime minister. He was promoted again in December 1992, this time to the top position as prime minister, a post he finally relinquished in March 1998, shortly before the financial crash of August 17, 1998.

  When Chernomyrdin returned to a formal government position in May 1992, his deputy, Rem Vyakhirev, who had been deputy minister and then followed him to become vice chairman after Gazprom had been established, moved up again and took Chernomrydin’s place as both chairman and CEO.

  Like Chernomyrdin, Vyakhirev also came with considerable experience as a natural gas and petroleum specialist. He was also a graduate of the Kuibyshev Polytechnical Institute. After stints in Samara (called Kuibyshev at the time) on the Volga and Orenburg and Tiumen in West Siberia, in 1983 Vyakhirev was appointed first deputy minister of the Ministry of the Gas Industry under Deputy Minister Chernomyrdin, who would himself be promoted to minister two years later.

  With Chernomyrdin as prime minister and his old deputy as CEO and chairman of Gazprom, the state did not closely regulate Gazprom. Taking advantage of this, Gazprom paid very little in the way of taxes or dividends to its principal shareholder (the state). Not only did the state see little in the way of taxes or dividends from Gazprom while Vyakhirev was in charge, but many of Gazprom’s gas-producing wells, pipelines, and distribution entities were freely parceled out in unrestricted fashion to a wide collection of Gazprom executives’ wives, children, and mistresses. Some of the largest spin-offs were transferred to ITERA, a company relocated from Russia to Jacksonville, Florida.

  THE PETROLEUM INDUSTRY IS BROKEN UP

  While the ultimate fate of the Ministry of the Petroleum Industry was very different, initially its privatization began in much the same way. The first step, in September 1991, was to transform the Ministry of Fuel and Energy into a joint stock company called Rosneftegaz (Russian Oil and Gas) (see Figure 4). But unlike Gazprom, which remained more or less whole, Rosneft was soon subdivided into what would eventually be almost a dozen more or less independent entities. Vagit Alekperov, acting minister of the Petroleum Industry, was one of the first to see the industry’s potential. In November 1991, before the collapse of the USSR, Alekperov used his authority to set aside the Langepaz, Urengoi, and Kogalym petroleum fields and combine them into a package, call it LUKoil, and put himself in charge as the CEO. (Much earlier Alekperov had managed the West Siberian Kogalym region).4

  The process of breaking out chunks of the former Ministry of Fuel and Energy continued and even accelerated after December 25, 1991, when the USSR split apart. In November 1992, Rosneftegaz was reduced to Rosneft. Two more companies, Yukos and Surgutneftegaz, were spun off in 1993. Vladimir Bogdanov took over as CEO of the latter, in essence the same producing combine he had supervised as a government manager under the Ministry. As for Rosneft, while bereft of LUKoil, Yukos, and Surgutneftegaz as of 1993, it nonetheless still produced more than 60 percent of the country’s crude oil output. The raids on it were far from over, but at the time it controlled twenty-six oil-producing regional associations and twenty-three refineries.5

  As questionable as it may have been to allow two senior ministry executives to seize ownership for themselves of the billion dollar assets they had been operating, that was almost benign compared to the way the rest of Rosneft was privatized as part of what came to be called the Loan for Shares initiative.

  FIGURE 4 The Breakup and Reconsolidation of the Ministry of Petroleum and Rosneft. Sources: Kommersant 10/23/01. Nina Poussenskova, “Rosneft as a Mirror of Russia’s Evolution,” Pro et Contra Journal 10, no. 2 (June 2, 2006); Goldman, The Piratization of Russia; Russian Analytical Digest, No. 1: Gazprom, Liberal Politics, Elections, 2006.

  LOANS FOR SHARES

  What turned out to be the biggest and most controversial transfer of wealth ever seen in history began in 1995 and evolved out of a proposal conceived by Vladimir Potanin. At the time Potanin was deputy prime minister under Prime Minister Chernomyrdin. Potanin proposed the Loans for Shares plan as a novel way to compensate for the fact that so few Russian individuals (especially those who came to be known as oligarchs) or businesses were paying their rightful share of taxes. Without the tax revenue, the state could not pay its bills. Under Potanin’s plan, several of the banks newly opened by the oligarchs would offer to lend the government money so it could pay its bills. As collateral for those loans, Potanin proposed that the state turn over shares of stock in several of the country’s petroleum companies that had not yet been fully privatized. Once the state had collected its taxes, the loans would be repaid and the collateral—that is, the shares of stock—would be returned by the bank to the state. If for some reason the loans could not be repaid, the banks, on behalf of the state, would then be authorized to auction off the collateral they were holding. After they had taken out the money they were owed, the banks would then turn the remaining proceeds over to the state.

  Given the climate of the time and the rush to seize state assets, not surprisingly, this turned out to be a massive scam. Everyone knew fr
om the beginning that there was little likelihood that the state would be able to collect the taxes it needed to repay the bank loans. How could it when the oligarchs themselves and their companies, as well as their banks, were among the largest tax delinquents? As for the auctions, almost all of them turned out to be rigged. Foreigners and most other viable bidders were excluded from the bidding. With the number of bidders sharply limited, it was no wonder that in virtually every case, the auction winner turned out to be the bank running the auction itself, or its straw or accomplice, and for a price that barely covered the amount of the loan. It was part of the Loans for Shares scheme that allowed Mikhail Khodorkovsky and his Menatep Bank to end up as the owners of Yukos that was also spun out of Rosneft, bidding a mere $309 million. (Not pocket change but cheap for even a poorly operating oil company. It soon had a market value of $15 billion.)

  In a somewhat similar pattern in July 1997, Mikhail Fridman—a colorful figure whom we will turn to shortly—used his Alfa Bank and Renova, a holding company, to win control of Tyumen Oil (TNK). Subsequently, after a very contentious legal and public relations battle, TNK joined up with its one-time rival, BP, to form the TNK-BP 50–50 partnership.

  Since it was Potanin’s idea, it would have been unfair if he had not been able to benefit from his own program. Not surprisingly, therefore, in addition to the modest $170 million he paid to acquire Norilsk Nickel, which once privatized became one of the world’s largest nonferrous metal conglomerates (its profits in 2000 were reported to be $1.5 billion),6 Potanin and his OneksimBank also won control of the oil company, Sidanko, for $130 million. This had been one of the Ministry of Petroleum Industry’s operating units located in West Siberia, and it, like the other privatized oil companies, was spun out of Rosneft.

  The duo of Boris Berezovsky and Alexander Smolensky were more devious in their efforts. Berezovsky, who at the time had close relations with the Kremlin, particularly one of Boris Yeltsin’s daughters, was behind the August 29, 1995, Presidential Edict which spun off Sibneft from the Ministry of Energy and Rosneft. Alexander Korzhakov, Yeltsin’s one-time bodyguard, claims that as part of the deal, Berezovsky promised Yeltsin that if he were given ownership of Sibneft, he would then see that ORT, the TV network Berezovsky controlled, did all it could to back Yeltsin in the 1996 campaign for reelection as president. Not surprisingly, the bidding process for Sibneft was even more opaque than normal. In a December 1995 Loans for Shares auction, a heretofore unknown company FNK (Finansovaia Neftyanaia Kompaniia— Financial Oil Company), acquired 51 percent of Sibneft shares for a paltry bid of $100 million, plus the promise that more money would be invested subsequently.7 FNK turned out to be a front for Alkion Securities, which turned out to be 100 percent owned by SBS/AGRO, which— surprise, surprise—was run by Alexander Smolensky in partnership with Berezovsky. As a further indicator of how rigged the whole process was, the auction for Sibneft was conducted by the Neftyanaia Finansovaia Kompaniia or NFK (note the similarity in name and initials), which turned out to be controlled by Berezovsky.8

  The owners of the two already privatized petroleum companies— Vladimir Bogdanov, the CEO of Surgutneftegaz and Vagit Alekperov of LUKoil—also used Loans for Shares to enhance their personal stock holdings. But at least they had spent many years working out in the oil fields and managing petroleum production. By contrast, almost none of the future owners of the other oil companies, that is, Potanin, Fridman, Berezovsky, and Smolensky, had had much prior experience in the petroleum industry. Khodorkovsky had spent several months as a deputy minister of Fuel and Energy in 1993. But after he took over Yukos and went to look over his company’s newly acquired oil fields in Nefteyugansk to “learn how the drilling process works,” his host Vladimir Petukhov, the mayor of Nefteyugansk and an oilman with a doctorate in oil technology, was appalled to discover that Khodorkovsky, despite that stint in the Ministry of Fuel and Energy, had never seen an oil field before.9

  EVERYONE WANTS TO BE A BANKER

  To understand how Potantin, Berezovsky, Smolensky, Fridman, and Khodorkovsky managed to be in a position to bid for these large petroleum companies, it is necessary to detour a bit and explain how they came to establish their own banks. After all, only a few years before, none of them had any net worth to speak of.

  With so little to begin with, how did they manage by 1997 to become billionaires? The explanation is that all five were able to take advantage of the Russian public’s enormous hunger for consumer goods they had been denied for more than seventy years under Soviet central planning. The demand for personal computers (then a relatively new invention and in any event rare in Russia) was particularly intense. It also helped that when it became legal to establish private commercial banks for the first time in 1987, the capital requirement was the ruble equivalent of only $750,000. As trivial as this was, because of inflation by 1990 the equivalent in rubles amounted to as little as $75,000 in real terms.

  The case of Mikhail Fridman is typical. The son of an academic father, Fridman, after graduating from the Moscow Institute of Steel and Alloys, worked in a steel mill for two years from 1986 to 1988.10 Although trained to work in a Soviet state-owned factory, even as a student, Fridman began to take odd jobs on the side. Among other chores he washed windows, organized a discotheque, and did construction work. In 1987, when it became legal to set up a private or cooperative business, he opened Kuryer, a cooperative that offered such services as package delivery, window washing, and assistance with apartment rental. None of these activities required much in the way of startup capital—all they needed was labor. But as he began to accumulate a little capital, he began importing sought-after Western consumer goods, including cigarettes, perfume, computers, and even Xerox machines. He also opened up a network of photo labs. Then in a very distinct departure from such retail operations he opened a commodity trading firm. In January 1991, while Gorbachev was still president of the USSR, Fridman took his newly accumulated capital and established the first office of Alfa Bank. To do this, he needed 6 million rubles which at the time was the equivalent of $100,000, a relatively small amount for the capital of a bank.11 It was through Alfa Bank that in July 1997 Fridman, in partnership with Access Industries—a company established in the United States by Leonard Blavatnik, a Russian émigré—was able to purchase 40 percent of Tyumen Oil Company’s shares for a bid of $810 million. In doing so Fridman and Blavatnik became the effective owners of the company in much the same way Alexander Smolensky began to build his fortune by performing similar odd jobs. They too required little in the way of capital, but if such services were to be performed legally through official Soviet central planning channels, the customer would have had an enormous wait, sometimes months if not years. There seemed to be shortages of almost everything, including plumbers, carpenters, and general repairmen. For that reason, many Russians were willing to pay something extra under the table to have the work done right away. To illustrate how bothersome the shortages and delays were, the Russians delighted in telling the story about Ivan. He had been waiting and waiting for six or seven years to buy his own automobile. After waiting all that time, he finally was notified to appear July 1, 1980, at the regional office of the Ministry of Trade.

  “I have good news for you,” said the clerk. “Your car will be delivered to you five years from now on July 1, 1985.”

  “Wonderful!” Ivan replied. “But will it be in the morning or the afternoon?”

  “What difference does it make?” asked the puzzled clerk. “That is five years from now.”

  “Well, I have to be home that morning because it’s the only time I could arrange for the plumber to come.”

  Smolensky began to build up his fortune by specializing in construction work. The Russians had a special term for such private work crews—they were called shabashniki. While it was difficult enough to find anyone willing to do such work, it was more difficult to find work tools and construction supplies, even such simple things as two-by-four lumber and hammers and nai
ls. Recognizing an opportunity, Smolensky began to buy up such products where he could and on occasion even manufactured these items and sold them to other moonlighting entrepreneurs.12 All such private activities were illegal and classified as economic crimes. Eventually Smolensky was found guilty of using government printing presses to sell Bibles for private profit and sentenced to jail for two years for just such an economic crime. In 1987, when Gorbachev finally made such activities legal, Smolensky set up the Moscow No. 3 Constructive Cooperative. On February 14, 1989, two years before Fridman did the same thing, Smolensky took the rubles he had accumulated and established what he called the Stolichny (Capital) Bank. He later expanded the bank by buying up Agroprombank, which had been a state-owned bank designed to provide banking services to rural areas. Combining the two banks, he changed the name to Stolichny Bank Savings/Agro or SBS/Agro. Together with Boris Berezovsky, in December 1995 and then again in September 1996, the two men won majority control of Sibneft in one of the Loans for Shares auctions discussed earlier (see Figure 4). The SBS/Agro bid for control of Sibneft was only $100.3 million. Not bad for an asset worth upward of $10 billion.

  In the case of Vladimir Potanin, he managed to build up his OneksimBank not so much by using his own labor but by subverting government agencies to his own personal ends. Like his father, Potanin worked for a Foreign Trade Organization (FTO) under the Ministry of Foreign Trade. These FTOs were set up to import and export goods on behalf of the state and to act as agents of the various state enterprises which themselves were not authorized to engage in foreign trade. Only the FTOs were allowed to have foreign currencies. In Vladimir’s case, his FTO was Soiuzpromexport and it specialized in the export of nonferrous metals.13 After he saw how others were enriching themselves with their newly created cooperatives, Potanin decided to capitalize on his own specialization by creating a cooperative that would do privately what he had been doing on behalf of the government. Leaving the government, he created a cooperative called INTERROS that began to trade in nonferrous metals. Next he decided he needed his own bank. To generate the capital he needed, he took advantage of his former government connections and supplemented his own money with borrowed funds from Vneshekonombank, the state-owned foreign trade bank. Once he had the required capital he used it to open OneksimBank, yet another in the series of personal banks established by these newly rich oligarchs.