Petrostate:Putin, Power, and the New Russia

by Marshall I. Goldman

  Despite Miller’s success with ITERA, Gazprom would not become a transparent corporation overnight. As we shall see shortly, Gazprom’s dealings and interactions with the state and other companies remained almost as opaque as before.

  GAZPROM, THE HOLY OF HOLIES

  Repeatedly, Putin has signaled how central Gazprom is to him and the role it must play in Russia’s emergence as an energy superpower. He has referred to it elsewhere as this “holy of holies.”14 Given Gazprom’s role in his thinking, it is not surprising that in his May 2006 state of the nation speech, Putin took time to boast that Gazprom had just become the world’s third largest corporation as measured by the total value of its stock. At the time, only Exxon-Mobil and General Electric were larger. (Microsoft subsequently increased in value to push Gazprom to fourth place, and it in turn and even Exxon-Mobil were displaced by a set of Chinese corporations when an index of Chinese stocks more than doubled in 2007–2008.) Admittedly, such information would be of interest primarily to readers of business newspapers, but it is unlikely that many other world leaders (except those fighting an inferiority complex) would choose to emphasize such a fact in their state of the nation speech. By including it in his presentation, Putin signaled its importance to him. Yet Putin and those around him have even higher ambitions. Putin’s ultimate goal is to see Gazprom overtake and surpass (Nikita Khrushchev’s favorite way of comparing the USSR and the USA) Exxon-Mobil to become the corporation with the largest capitalized value in the world. Moreover, as he has put it, he sees no reason why some day the value of Gazprom’s stock should not rise from $300 billion to $1 trillion, overtaking Exxon-Mobil along the way.

  In Putin’s mind, Gazprom’s emergence as a dominant international corporate player was no accident. In that same 2006 state of the nation speech, he went so far as to claim this was “the result of a carefully planned action by the state.”15 While patting himself on the back for bringing to life this national champion, Putin somehow ignored that perhaps the post-1998 increase in world energy prices might have had a little to do with that surge in the price of Gazprom stock. Putin is not the only Russian official who associates the turnaround in Russia’s fortunes with whether Gazprom is thriving. As we noted in the Introduction, Alexander Medvedev, deputy CEO of Gazprom and general director of Gazexport, its export affiliate, frequently seeks to reassure foreign audiences by insisting that what is good for “a strong Gazprom is good for the world.”16

  Given the symbiosis between Gazprom and Russia, Putin and his colleagues do not take kindly to those who question how Gazprom is run. William Browder, the grandson of the long-time head of the U.S. Communist Party, Earl Browder, is a good example. As the founder and director of the $4 billion Hermitage Capital Management investment fund, Browder the younger has been an outspoken advocate of investing in Russia. However, Browder has criticized not only the original Gazprom executives but Putin’s subsequent appointees. Browder concedes that such Putin initiatives enhance the glory of Russia, but they are not in the best interests of the company’s stockholders and a higher return on their investment. Browder soon discovered that while it may be okay for Putin to criticize Gazprom’s previous management, Putin and his subordinates in the Kremlin are not eager to have others, especially foreigners, do the same. To register its displeasure with Browder and alert others that there are limits to criticism of this “holy of holies,” the Russian government canceled Browder’s Russian visa and prevented him from returning to his home in Moscow when he left Russia in 2006.

  As the Browder incident illustrates, it is hard to tell where Putin begins and Gazprom ends. Alexander Medvedev, deputy chairman of Gazprom’s management committee, insisted in a presentation in St. Petersburg on June 21, 2007, that to the contrary, Gazprom operates free of interference from the Kremlin. As he put it, “We don’t get hourly calls from the Kremlin. We get none at all.” That would seem to overlook not only Putin’s assertion about his successes with Gazprom and some of the other national champions but also Putin’s actions and unwavering advocacy and support for Gazprom’s initiatives. As the wags have it, Russia or “Gazpromistan” is run by its president and spiritual leader, Gazputin, an obvious play on the gas-rich countries of Central Asia, as well as Rasputin, the mad monk favorite of the last czar’s wife, Czarina Alexandra.17

  Putin’s new appointees, Chairman Dmitri Medvedev and particularly Alexei Miller, moved quickly to stop the asset stripping. It was not easy to repair all the damage, but as a minimum, they put an end to further dismantlement.

  The next step was more controversial and most likely another example of a Putin-initiated action. For many years, Gazprom, like the Ministry of Gas before it, intentionally held down the price of natural gas it sold within the boundaries of the former USSR, far below comparable market prices in the West. This was done to facilitate Soviet industrialization. But it also had the effect of encouraging the wasteful overuse of all raw materials, particularly oil and gas. Because the price was so cheap and because there always seemed to be more oil and gas available, there was no need to worry about conservation. This policy continued for several years after the breakup of the USSR. Prices were kept below world prices not only within Russia but also in the other republics that made up the USSR.

  UKRAINE IS TOLD TO PAY THE MARKET PRICE

  It was easy to ignore these hidden subsidies that came from being a part of the USSR, but they were substantial. Shortly after assuming the role of president of Ukraine in January 2005, Victor Yushchenko adopted a noticeably cooler attitude toward Russia. At the same time, he drew closer to the West, including the United States. In reaction, pushed by Putin, Gazprom began to warn that a looser alliance would lead to an end to gas export subsidies. If Yushchenko wanted a closer relationship with the West, he should also be prepared to pay prices closer to those paid by Western customers. As Putin told a group of us in September 2004, Yushchenko was welcome to seek a closer alliance with the West and turn his back on Russia, but he should understand that if he did so, Russia was under no obligation to continue to subsidize its energy exports to Ukraine. Ukraine was paying as little as $50 per 1,000 cubic meters while the market price in the West at the time was $150 per 1,000 cubic meters, so paying the higher price would cost Ukraine $3–5 billion a year. Since the United States was providing Ukraine only about $150 million in aid at the time, turning its back on Russia would be costly. So in Putin’s words, “Ukraine should think twice about any such embrace of the West.” By contrast, Belarus, which was then a close Russian ally, was charged less than $50 per 1,000 cubic meters for its deliveries, not much different from what users within Russia itself had to pay in 2006.

  Warning that it was prepared to take extreme measures, on January 1, 2006, Gazprom demanded that Ukraine pay $150 per 1,000 cubic meters, a threefold increase from the earlier charge. Refusing to be intimidated, Ukraine insisted on paying the lower fee, arguing that this lower price had been agreed to during previous contracts. Any reduction or cessation of gas deliveries through the pipeline by Gazprom would be a contract violation. In response, Gazprom insisted that the contract had expired and proceeded to reduce the flow of gas, sending through just enough to meet its contract obligations to its customers in Western Europe. Ukraine, however, continued to withdraw the same amount of gas from the pipeline that it had prior to December 31, 2005. Like Belarus, it felt entitled to pay for those deliveries at the lower price. The Russians then reduced the flow to Ukraine. Claiming Gazprom had broken its contract, Ukraine provided first for its own needs and only then sent what gas was left on through the pipeline to the West.

  Gazprom and Putin, however, used an economist’s arguments, pointing out that Russia was only asking Ukraine to adhere to market practices and prices. In the long run, this would be good for Ukraine. Gazprom was only helping Ukraine wean itself away from distorting subsidies. Isn’t that what the United States and the West Europeans had been urging Russia to do? Accordingly, when the flow of gas was reduced, Gazprom sp
okesmen repeatedly insisted that none of this pressure on Ukraine was political. The flow of gas would be resumed once the Ukrainians agreed to pay the market price, with the emphasis on market price. To the contrary, it was not Russia that was at fault but Ukraine. By diverting the gas intended for Western Europe to itself, the Ukrainians were simply stealing Europe’s gas.

  THE USE OF INTERMEDIARIES—WHO IS THE REAL OWNER?

  To Russia’s surprise, however, most Europeans turned out to be more sympathetic to Ukraine than to Russia. It was January, after all, and cold, and turning off the gas was not a nice thing to do. Moreover, there was widespread suspicion that executives of the gas companies in both Ukraine and Russia were using the crisis to stuff their own pockets with kickbacks. These suspicions arose because the final agreement did not involve a direct and transparent contract between GazpromExport (Gazprom’s export division) and its Ukrainian counterpart. Instead, GazpromExport agreed to deliver gas from Russia and Turkmenistan to a mysterious company called RosUkrEnergo (RUE), which in turn sold it to UkrGaz-Energo, the Ukrainian utility that delivers it to Naftogaz, which ultimately delivers the gas to the actual Ukrainian consumers.18 Setting up these different entities was designed to confuse outsiders and, as we shall see, those in charge succeeded brilliantly.

  RUE first began to supply UkrGaz-Energo in 2005. The use of intermediaries, however, dates back to the 1990s when ITERA, that opaque Florida-based company, stepped in to deliver gas from Turkmenistan to Ukraine. ITERA was created by Igor Makarov. A native of Turkmenistan, Makarov was a poor boy who became a world-class bicycle racer, bringing glory to Turkmenistan and becoming a local hero. As a result he was befriended by the Turkmen president, the President for Life or Turkmenbashi, as he called himself, Saparmurat Niyazov. (Except that he was president of Turkmenistan and not Kazakhstan, Niyazov could have served as a model for the movie Borat.) After the collapse of the Soviet Union, Turkmenistan found itself with almost no convertible currency and as a result, in serious need of basic consumer goods. Through his friendship with Niyazov, Makarov was given access to Turkmenistan’s natural gas, which Makarov was then allowed to use to barter for food and other consumer goods. To do all of this, of course, Makarov also had to convince Rem Vyakhirev of Gazprom to grant him access to Gazprom’s pipeline network. Gazprom was not interested in bringing gas into Russia to compete in its own domestic market but it was willing to transport Turkmen gas to Ukraine, which it did beginning in 1994. This earned ITERA a handsome profit (and who knows what for Vyakhirev), at least until the financial collapse of August 1998. The market collapse, while bad for most businesses, including Gazprom, provided ITERA with a great opportunity to buy up some distressed Gazprom properties at an auction. Since auctions in Russia are not noted for their transparency, especially those associated with the Loans for Shares privatization of 1995–1996, it is hard to dispel the suspicion that with Vyakhirev’s blessings, ITERA ended up with valuable Gazprom assets at a cost that was low even compared with the distressed prices that prevailed in 1998. In any case, after Putin removed Vyakhirev as CEO of Gazprom, Alexei Miller, Vyakhirev’s successor, moved rapidly to repossess as much as two-thirds of the property that ITERA had acquired from Gazprom.

  It may have been coincidence, but once Vyakhirev was no longer in charge of Gazprom, ITERA lost one of its main protectors. Not only did ITERA have to return some of its assets to Gazprom but it was also squeezed out of the Turkmenistan-Ukraine trade in 2002 by a company controlled by Dmytro Firtash called Eural Trans Gas.

  Eural Trans Gas in turn held on to the franchise until 2005 when RUE took it over.

  All of these companies were opaque and regarded with suspicion.

  Ostensibly, while the companies were different, it seems that many of the principal owners of the various companies remained the same.19 Thus, Dmytro Firtash, a Ukrainian businessman who had been bartering consumer goods to buyers in Ukraine, Turkmenistan, and Russia, joined a company called Highrock Holding in 2001. Firtash insists that one of his partners in Highrock Holding was Igor Makarov, president of ITERA. Subsequently, ITERA was superseded in Turkmenistan-Ukraine trade in 2002 by Firtash’s Eural Trans Gas. According to the Financial Times, Makarov subsequently denied he ever had an economic interest in Highrock Holding.20

  That is of interest because it reflects the murkiness associated with importing natural gas and the unsavoriness of the parties involved. When Putin moved to clean up Gazprom, the new Gazprom management in turn began to apply pressure on ITERA, not only to return assets to Gazprom (as we saw) but to force it out of the transit business between Turkmenistan and Ukraine. That opened the way for Eural Trans Gas, which hardly seemed much of an improvement.21

  The U.S. Department of Justice and the FBI have been investigating whether Russian and Ukrainian mafia members have also been involved with these companies. After it became known that the FBI was investigating Highrock, its principal owner Dmytro Firtash acknowledged that he and his junior partner, Ivan Fursin, owned Centragas Holding, which owns 50 percent of RUE.22 The other 50 percent was owned by Arosgas Holding, Gazprom’s Austrian affiliate. Without meaning to deprecate Ukrainian and Austrian skills at obfuscation, this is almost but not quite as complicated as trying to ascertain who owned what of the Enron Company in Texas before it went bankrupt. Gazprom demanded part ownership in RUE for the obvious reason that its monopoly control of the gas pipelines in Russia gave it the exclusive rights to ship the gas from Turkmenistan and its neighbors through Russia to Ukraine.23

  Firtash’s role was news because for some time his involvement had been shielded from public view by Raiffeisen Investment AG, the investment arm of the Raiffeisen Bank of Austria. Raiffeisen Investment AG acted as trustee for what was thought to be the true owners. It should be noted that the Raiffeisen Bank itself has had a long history of dealing in Eastern Europe and the Soviet Union, which almost guarantees that many of its transactions will not be transparent.

  For Gazprom, a Russian company, to be involved in such convoluted corporate juggling within Ukraine is troubling enough, but what drew the attention of the FBI was the possible evidence that another “Ukrainian businessman,” Semion Mogilevich—or at least his wife— had also been involved in these machinations as a partner with Firtash in Highrock Holdings.24 Mogilevich has, as they say, been a person of interest to the FBI since 2003. Although he was found not guilty of criminal activity in one trial, he has been on the FBI’s Most Wanted List, regarded as “one of the world’s most sophisticated international criminals.”25 In January 2008, after considerable international pressure, Russian authorities finally arrested him. Among other crimes, the FBI wanted to question him about his alleged involvement in prostitution, drug trafficking, and stock fraud.26

  The shenanigans of Highrock, RUE, ITERA, Eural Trans Gas, and Gazprom illustrate the skill with which veterans of the black market in the Soviet era have learned to manipulate the market system and obfuscate their operations from even sophisticated investors. How they learned to build such a web of false fronts and hidden assets for themselves despite having grown up in a system of relatively simple central planning remains a mystery. Where did they learn such sophisticated schemes? It was not taught to them in Soviet institutions of higher learning or in Gosplan, the state central planning agency.

  Such shadowy entities linking up Russia and Ukraine cast doubt on the integrity and the transparency of the economic interactions between Russia and Ukraine. The Russians’ argument that Ukraine deserved to pay the market price for gas was weakened when it became known that at least 60 percent of the gas supplied to Ukraine actually came from Turkmenistan, not Russia. Nor did Gazprom win sympathy for itself when it was learned that at the time Gazprom refused to pay Turkmenistan more than $46 per 1,000 cubic meters while selling the same gas to RUE and Ukraine for $95 per 1,000 cubic meters. Only in February 2006 did Gazprom agree to pay a comparable amount for its Turkmenistan purchases. Gazprom control of the pipeline linking Turkmenistan with the Wes
t, a legacy of the Soviet era, allowed Gazprom to squeeze Turkmenistan this way. Gazprom agreed to raise the price to $130 in 2008, but that remained for below the $354 Gazprom expected to collect from its sales to Europe.

  What does seem odd is that Turkmenistan agreed to extend a PSA (production sharing agreement) to Russian companies engaged in energy development there. Russia has been invalidating similar PSAs it made earlier with Western companies such as Shell, Exxon-Mobil, and Total. While Russian companies have opposed extending PSAs to foreign companies working within Russia, evidently that has not prevented Russian companies from signing up for similar concessions for themselves in other supplicant states.

  What all this illustrates is that Gazprom control over the pipeline network of the one-time USSR Ministry of Gas has been one of Russia’s most valuable and strategic assets. For the time being, the only way Central Asian countries can export their gas to Europe is through Gazprom’s pipeline.

  SEEKING A WAY AROUND GAZPROM PIPELINES

  Efforts are afoot by the United States and some members of the European Union to build an alternate gas pipeline under the Caspian Sea from Central Asia to Baku. U.S. Vice President Dick Cheney made a visit to Kazakhstan in the spring of 2006 to seek support for such a bypass. That gas pipeline would then parallel the recently completed private petroleum pipeline from Baku, Azerbaijan, through Tbilisi, Georgia, which then terminates in Ceyhan, Turkey, on the Mediterranean Sea. There is some uncertainty, however, as to whether such a gas pipeline will be financially viable. To ensure that it would not be, Putin moved immediately to neutralize Cheney’s effort by making a follow-up visit to dissuade Kazakhstan from such a move.