Petrostate:Putin, Power, and the New Russia

by Marshall I. Goldman

  Arrested he was on October 25, 2003. Masked police with submachine guns raided his private jet as it was refueling in Novosibirsk. He and Yukos were charged with tax evasion, grand theft, fraud, forgery, embezzlement, and extortion. He was found guilty and sent to prison in Krasnokamensk in Siberia. The initial sentence was for eight years, but additional accusations made in 2007 could result in another fifteen years.38

  In his frenzy to punish Khodorkovsky and destroy Yukos, the prosecutor general not only arrested Yukos’s senior executives but he also went after anyone remotely associated with Yukos, including its lawyers and junior staff. While the list is incomplete, Table 5.3 lists over two dozen people associated with Yukos who have either been jailed or have fled into exile. The case of Svetlana Bakhmina stands out. The mother of two little boys aged two and six at the time of her arrest, she was only a middle-ranking member of Yukos’s legal department. She was taken from her home at 5:00 in the morning, refused bail, and prevented from seeing her children for more than sixteen months. She was found guilty of embezzling $290 million from a Yukos subsidiary and sentenced to seven years in a maximum security prison, a sentence almost as long as Khodorkovsky’s. If her sentence had been one year less, she would have been freed from prison under an amnesty issued for mothers sentenced to six years or less. In her defense, her lawyers argued that as she lived in a two-room apartment, the charges that she had stolen so much money were absurd.39 The real reason for her arrest, claim her lawyers, was that the prosecutor was holding her hostage to force her former boss, the general counsel of Yukos, Dmitry Gololobov, to return to Moscow from his London exile.

  This was typical of the way the courts treated the Yukos defendants. Undoubtedly many of the charges, at least against the company’s senior executives, had some merit, but the courts’ assault on mid-level Yukos employees was needlessly harsh. Like Bakhmina, most of those charged were denied bail. By comparison, those charged in the Enron case in Texas were allowed out on bail until they were found guilty. For that matter, Khodorkovsky’s lawyers argued that under the Russian Constitution, “pretrial detention is basically not permitted in a white-collar trial.”40 Moreover, Yukos lawyers were also harassed, their homes and offices raided, and evidence withheld.

  Khodorkovsky’s lawyers have complained that there was remarkably little effort by either the judges or the prosecutor general to adhere to legal precedents or procedures.41 Khodorkovsky’s lawyers also pointed out that some of the charges against Lebedev and Khodorkovsky in the fertilizer company case had been heard eighteen months earlier at a civil hearing. After negotiations the dispute was resolved to the satisfaction of the prosecutor general, who subsequently reversed his decision. To bring up the issue again was a form of double jeopardy.

  TABLE 5.3 Yukos Senior Executives, in-house or outside counsel and accountants; left the country or arrested, in prison or under house arrest or wanted for questioning

  THE PLUNDERING OF YUKOS

  As for Yukos itself, it was treated just as harshly. By the end of the trial it was accused of failing to pay $33 billion in back taxes.42 Undoubtedly Yukos owed money for back taxes unpaid in its earliest years, but the government seemed unbothered by the fact that in some years the alleged tax bill exceeded total revenue earned.43 As punishment, in December 2004 Yukos’s most valuable asset, Yuganskneftegaz, was sold at yet another rigged auction for $9.35 billion to an obscure and heretofore unknown entity called the Baikal Finance Group, which turned out to be a front for Rosneft. Several outside appraisers insisted that the price was less than half of what such an auction should have yielded.44

  To protect themselves and prevent further plundering of Yukos, in December 2004, some of the American executives working for Yukos sought Chapter 11 bankruptcy protection in a Texas federal bankruptcy court. This action frightened off some prospective purchasers, including Gazprom, which feared that if Gazprom seized Yukos property, their assets might in turn be seized by European or American courts. Hence the sudden appearance of the Baikal Finance Group, which was used to launder the assets so that they could then be sold to Rosneft. If Rosneft itself had entered such a bid at the auction, it might also have been threatened with a lawsuit in a European court. Ever since, both Gazprom and Rosneft have used straws to do the initial bidding on properties being stripped off of Yukos: Neft Aktiv for Rosneft and Unitex for Gazprom.45

  There was reason for such fears. In 1993, Noga, a Swiss trading company, had used a Western court judgment against Russian authorities to seize a Russian bank operating in Luxembourg. It did this to force payment of the overdue bills claimed by the Swiss firm. (I had served as an adviser to Noga in its effort to collect what it claimed it was owed. Noga was unaware that Russia had such assets in the West. Once alerted, they sought support from a European Court and the East-West United Bank in Luxembourg was seized as a form of collateral to force repayment.) There was every reason to believe if Gazprom or Rosneft themselves tried to buy up Yukos assets, they would suffer a similar fate. That was enough for Gazprom and Rosneft to refrain from making a direct bid. But after due consideration as to whether a U.S. court had jurisdiction in such a case, the Texas judge decided it did not.

  The company’s fate therefore was left up to Russian courts. After seeing that Yukos could not pay its debts, the Moscow Arbitration Court on August 2, 2006, declared Yukos bankrupt.46 This was despite Putin’s earlier insistence at a RIA Novosti press agency discussion that Russia would not force Yukos into bankruptcy.

  In 2007, a second batch of nearly 200 properties, including the 20 percent stake in Gazpromneft (formerly Sibneft) that Yukos still owned as well as its Tomskneft and Samaraneftegaz subsidiaries, were put up for sale to cover the rest of the back tax bill.47 Because of the increase in petroleum prices after 2004, the remaining Yukos properties were appraised at a higher level and valued at a minimum of $22 billion, and then again increased to $26 billion.48 At that appraisal, what remained of Yukos would have allowed it to sell off some subsidiaries, use the funds to pay back the taxes, and still retain at least some assets for itself. That would mean that it really was not bankrupt. To prevent that from happening, the state authorities recalculated the taxes owed by Yukos and found that they had underestimated what Yukos owed. According to their new calculation, Yukos’s total debt was in fact $26.6 billion, an amount that again conveniently exceeded the company’s newly estimated net worth.49 Former Yukos executives argued, however, that the real value of Yukos’s remaining assets was even higher at $37 billion. Whatever the fair value of the property, there was no way the former owners of Yukos would have been able to keep any of the assets. Whenever someone came up with a calculation that showed that the company’s assets were actually more valuable than indicated in earlier estimates, the tax authorities would recalculate the overdue tax debt and somehow come out with an even larger estimate.

  The charade continued. In late March 2007, Rosneft, which along with the state was the chief creditor for Yukos properties, organized an auction to sell off the assets it had seized from Yukos. The first auction involved the sale of 9.44 percent of Rosneft’s own stock that Yukos had acquired earlier. Reminiscent of the Loan for Shares auctions of the mid-1990s, Rosneft was not only the auctioneer but—to no one’s surprise—also the winner.

  To avoid a repetition of such “done deals,” after the Loans for Shares fiasco, a new requirement was put in place. All future auctions would be valid only if there were at least two bidders. Therefore, in order to lend credence to the March 2007 auction, TNK-BP agreed to enter a bid. However, TNK-BP dropped out after the opening bid raised the $7.5 billion asking price by a mere $97 million.50 The $7.5 billion was $900 million less than it would have cost to buy an equivalent amount of Rosneft stock on the London Stock Exchange. If TNK-BP had really been a serious bidder, they would not have let such a bargain pass. It was generally agreed that TNK-BP had entered a bid only to make the exchange look legitimate and so curry favor with Putin and the Kremlin in hope that nei
ther the state nor Gazprom would seize BP’s holdings in Kovykta. There was further evidence that the auction was a charade: the acting head of Yukos in Russia at the time, Eduard K. Rebgun, who earlier had agreed to discount the price of the Yukos assets he was supposed to be protecting, applied to join Rosneft’s board of directors, a blatant conflict of interest.51 Without apparently being aware of the irony in what he was saying, after the auction Rebgun boasted that the auction “went, thank God, normally.”52 For those with memories of Loans for Shares, it certainly did. Once again, however, the sale failed to generate enough to pay off what remained of the original $25 billion tax bill.

  But this was not the end of the struggle. In May 2007, the state put the Yukos headquarters up for sale. An obscure company called Prana bid an amazing $4 billion. By doing so, the total collected by the state exceeded the amount the state was owed. No matter, Yukos was still treated as a bankrupt company.

  In an effort to salvage something more from the bankruptcy, some former Yukos stockholders have threatened lawsuits against what they claim has been the illegal expropriation of Yukos. The lawsuit was intended to deter Western companies from bidding and Western banks from lending money to Rosneft so they would not have the funds they needed to bid for Yukos properties. It is also why Rosneft itself did not bid in the auction. Instead, yet another straw called RN-Razvitiye, patterned on the Baikal Finance Group model, did the bidding and won. This was to protect Rosneft from a Western lawsuit. Like Baikal Finance Group, RN-Razvitiye came out of nowhere in January 2007, three months before the auction.53 It clearly was created just for the purpose of bidding on Yukos. It turns out that at the time that RNRazvitiye was capitalized at only $385. Nonetheless, it easily and quickly managed to borrow the $9 billion it needed to bid in the auction, something I wish my banker would let me do.

  Taking no chances, Russian authorities also sought to discredit Yukos’s financial reports. It sued PricewaterhouseCoopers (PWC), Yukos’s accounting firm, claiming that PWC misrepresented Yukos’s earnings. Initially a lower Russian court found PWC guilty and ordered that it pay $15 million in back taxes. Under pressure PWC did the state’s bidding and disassociated itself from ten years of its own audits of Yukos (not something to be proud of). This move undermined Yukos’s argument that it had fully paid its taxes.54

  While the Yukos case has to be an embarrassment for those who insist that Russia is “a normal country” that is coming to embrace the concept of “rule of law,” it did accomplish what Putin wanted—the removal of Khodorkovsky from the economic and political stage, the dismemberment of Yukos, and its effective renationalization and redistribution to state-controlled entities like Rosneft. More than that, by transferring ownership of most of Yukos to Rosneft, Putin prevented Yukos and its petroleum reserves from falling in the hands of Exxon-Mobil or any other foreign entity. At the same time, Putin enhanced the role and capabilities of another one of his designated national champions by putting another 11 percent of the country’s petroleum output back in the state’s hands.55

  SIBNEFT’S TURN

  Having reined in Yukos, Putin’s next target was Sibneft. Its takeover was done so quietly hardly anyone noticed. As we saw, when threatened with jail, then chief owner Boris Berezovsky hastily fled to London. On his way out, he sold off his share of various properties to his one-time protégé, junior partner, and erstwhile sportsman Roman Abramovich, who in turn was happy to relay most of his new possessions on to the state. Among other properties, Berezovsky transferred control to Abramovich of the aluminum company Rusal, the TV network ORT, and, most important, the petroleum company Sibneft. This undid an earlier merger between Yukos and Sibneft agreed to in April 2003. At that time, Khodorkovsky had paid $3 billion for a 26 percent share of Sibneft stock. After Khodorkovsky’s arrest, Abramovich put the merger on hold but neglected to refund the $3 billion.

  For a time, Abramovich also flirted with the subversive idea of selling half of his share of Sibneft to a foreign company. He considered offers from Chevron-Texaco, Shell, and Total.56 But after the inevitable visits from the Russian tax authorities and significant claims of some $1.4 billion in tax arrears, in September 2005 Abramovich agreed instead to sell his 72 percent stake in Sibneft to Gazprom for $13 billion.57 Renamed Gazpromneft (Gas Industry Petroleum), this gave state-dominated Gazprom a major stake in the petroleum sector for the first time. With the transfer of Sibneft to state ownership, the state once again gained control of 30 percent of Russia’s total oil output.58

  Don’t shed any tears for Abramovich. By working with the state and Putin, he was able to sell Sibneft at a price that made him Russia’s richest man with a net worth estimated by Forbes Magazine at over $18 billion. This leapfrogged him over the now jailed Khodorkovsky, whose earlier $15 billion had been mostly in Yukos stock. After the company’s bankruptcy, it was worth only a fraction of what it had been.

  Abramovich was not only Russia’s richest man. Since he had effectively moved to London, he also became Great Britain’s richest man. One of his new homes was a 440-acre estate in Sussex, the other a mansion in London’s exclusive Belgravia district. His other purchases included two of the world’s largest yachts and the Chelsea soccer team for which he paid $250 million—not bad for a poor boy with a murky background who started out in 1996 as a junior oil trader and office manager at Sibneft.59

  FRIENDLY PERSUASION

  No company can assume it is immune from harassment by the state, particularly if that company fits in nicely with Putin’s notion of national champion. Mikhail Gutseriev, for example, who formed Russneft in 2002 by building on assets acquired from Slavneft, until then a state company, claimed that because of pressure from the police and federal tax authorites, he was being forced to sell his company to Oleg Deripaska. It was clear Deripaska was acting on behalf of Putin. At the time in 2007, Russneft had become Russia’s seventh largest oil company, producing 16 million tons of crude oil a year. Gutseriev later denied that he had come under pressure but there were rumors that he had angered Putin when Gutseriev attempted to buy up Yukos assets, thereby making it hard for state-owned Rosneft to do so.60 Other companies that have in effect been similarly renationalized include VSMPO-AVISMA, a titanium producer that was purchased by state-owned Rosoboronexport, a military arms exporter, and Nortgaz, all of whom have been forced to become national champions.61

  With state ownership restored over what used to be Yukos and Sibneft, among the larger companies, the state lacked a majority share of the stock only in Surgutneftegaz, LUKoil, and TNK/BP. As for Surgutneftegaz, this was not a problem. For all intents and purposes, Surgutneftegaz behaved almost as if it were under state control, and as such, a national champion. Rarely if ever did the company deviate from state policy or face complaints or even allegations about law violations, environmental abuse, or tax delinquency. The CEO, Vladimir Bogdanov, was an “ole boy” uninterested in the high life who preferred living in Siberia rather than in that fleshpot Moscow. He also saw nothing wrong in keeping his corporate operations as secretive and opaque as possible. Bogdanov and his staff controlled more than 50 percent of the company’s stock, which they held very closely.62

  This close control does not mean that Surgutneftegaz has managed to avoid all controversy. After being praised in 1998 and 2004 for the way its workers were treated (this was in sharp contrast to those working for Yukos, who complained about being underpaid and harassed), those same workers at Surgutneftegaz nonetheless went to the streets in a May Day protest in 2006 to demand higher wages and an end of the arbitrary awarding of bonuses to management favorites.63 Similarly, at the other end of the ownership pyramid, outside minority stockholders have complained about insider self-dealing and the lack of transparency. The Harvard Management Company, which manages Harvard University’s $34.9 billion endowment (as of June 2007), filed a claim against Surgutneftegaz with the American Arbitration Association in New York. It charged that Surgutneftegaz’s management withheld $400 million in dividends that were
hidden by senior management but should have been paid to minority shareholders, including $3.7 million which it said was owed to Harvard.64 That publicity and subsequent legislation by the Russian government induced Surgutneftegaz to pay out an acceptable dividend return to its stockholders, although as of early 2007 it had not agreed to make up for the missed dividends of the past.65

  LUKoil’s willingness to adapt to state policy was not quite as swift as Surgutneftegaz’s, but only rarely has it or its CEO, Vagit Alekperov, overtly challenged the state or Putin’s policies. How LUKoil and the state have generally worked in tandem was highlighted in September 2003 when President Putin joined with Alekperov to inaugurate a LUKoil filling station in Manhattan. Why not? Establishing Russian beachheads in the center of New York City and New Jersey is just what “national champions” are supposed to do, whether they be state or privately owned. Like any good multinational corporation, LUKoil, as we mentioned earlier, bought into the U.S. market by acquiring Getty Petroleum Marketing Limited in 2000. This brought it 2,000 stations stretching from Maine to Virginia, and it bought another 1,000 from Mobil. It expects all these stations to be converted into LUKoil outlets by 2008. This will give LUKoil 7 percent of the market in its territory but as much as 24 percent in New Jersey and Pennsylvania (where it is concentrated).66 Initially, these stations were supplied with crude oil from the Middle East, which was then refined in the United States. LUKoil plans, however, to replace that Middle East oil with its own crude from Russia in 2008. Reducing our reliance on Middle East oil would be very much in the U.S. national interest, but given how Russia uses its petroleum exports for political purposes, there is no guarantee that future imports from Russia will not at some time be used in a similar way.