Petrostate:Putin, Power, and the New Russia

by Marshall I. Goldman

  FIGHTING OVER THE SPOILS

  Yet by no means is everything in the Russian energy sector is going well. Below the surface, major battles are being fought. When there is so much wealth up for grabs, there are bound to be major battles over who should control it. Certainly Russia is not unique in this respect, but since the state is so deeply involved and since the struggle for control is far from settled, the fight in Russia has some unique features—what I have called “The Russian Disease.”38

  TABLE 7.2 Russian Natural Gas and Petroleum Available for Possible Export

  Unlike the Dutch Disease, which, as we noted in the Introduction, is shorthand for the negative impact on a country’s manufacturing competitiveness that is a consequence of a major discovery of natural gas or oil, the Russian Disease has more to do with the greed and the jockeying for control and ownership that hit Russia during the privatization process. It was a particularly acute problem because Russia lacked what the Wellesley College economist Karl Case has called a “moral infrastructure” where there are few of the firmly rooted commercial laws or informal moral codes that are taken for granted in long-established market economies. The “rule of law” becomes the “the law of rulers.” As a result, when a country like Russia suddenly decides to privatize its valuable energy assets, the law of the jungle will almost inevitably take over and lawlessness and chaos will ensue. A blatant instance of this occurred when Putin formally announced that Gazprom would take over stateowned Rosneft. In what later turned out to be an embarrassing publicly televised announcement, on March 2, 2005, Alexei Miller, the CEO of Gazprom, appeared together at Gazprom headquarters with Sergei Bogdanchikov, the CEO of Rosneft. They used the occasion to congratulate each other on reaching an agreement to merge Rosneft and Gazprom under Gazprom leadership.39 Yuganskneftegaz, Rosneft’s largest producing unit, had just been seized from Yukos, and the announcement was that it would become a separate state-controlled entity. The rest of Rosneft was to be incorporated as part of Gazprom. With Bogdanchikov at his side, Miller confirmed that “a final decision on the procedure to join [unite] Rosneft with Gazprom has been made and the state will receive a controlling stake [more than 50%] in Gazprom.”40 In a bow to Putin’s determination to create national champions, Miller added, “Integration of the assets of Gazprom and Rosneft strengthens Gazprom’s presence in the oil sector [where it previously had almost no production] and allows the company to become, in the very near future, one of the biggest gas, oil, and energy companies in the world.”

  Bogdanchikov, however, evidently had some reservations. While he sat smiling throughout the TV presentation, he pointed out, in a somewhat off message aside, that he would head up Yuganskneftegaz as a separate entity outside of Gazprom. This seemed to contradict Miller, who insisted that the “de facto consolidation” of the two companies would take place “in the near future” and that Yuganskneftegaz would be incorporated as part of Gazprom. This had been the original intention when Yukos was seized by the government in December 2004. The reason Yuganskneftegaz was not immediately absorbed into Gazprom was concern that disgruntled Yukos stockholders would soon launch a lawsuit in an attempt to seize some of the many Gazprom assets located outside of Russia. As soon as the likelihood of such a Yukos stockholder lawsuit faded, Yuganskneftegaz would then also become part of Gazprom. This would be another step toward enhancing Gazprom’s role as a national champion. But with or without Yuganskneftegaz, it seemed clear that Miller and Gazprom would soon assert control over Rosneft and perhaps eventually Yuganskneftegaz.

  To the shock of many observers, however, the very next day Bogdanchikov insisted that no, he had not agreed to merge Rosneft into Gazprom. In fact, a press release issued by Rosneft flatly contradicted Miller. “These statements [about the merger] do not reflect reality and they seem to be seen exclusively as the Gazprom CEO’s personal opinion.” (But what did we hear the day before on television?) In response, Gazprom’s press office described the Rosneft assertion as “a technical mistake”—in other words, a lie! Continuing the soap opera, the Kremlin then issued a statement announcing that Rosneft had retracted its statement, which in turn provoked Rosneft to deny it had done any such thing.41 This event provided an unprecedented look at the bureaucratic cat fight then going on within the Kremlin and evidence that even Putin was unable to impose a coherent policy. There were then allegations by Rosneft that in the original TV presentation, Bogdanchikov had in fact insisted that Gazprom and Rosneft would indeed remain two separate legal entities, but that the segment shown on TV omitted that portion of the announcement. The Rosneft spokesman pointedly explained that the TV station reporting the announcement was owned by Gazprom and had deliberately sought to mislead the public. Shocking! Seeking to defend Rosneft, the spokesman went on to say, “Why this happened is a question for Miller.” (Who is in charge here?)42 In the end, Rosneft did remain a separate company and did hold on to Yuganskneftegaz, the prime cherry in the orchard.

  The fact that Rosneft and Bogdanchikov, along with Igor Sechin, who sat both as chairman of Rosneft and deputy head of the Kremlin administration, dared to defy Gazprom and Miller reflects how determined the senior executives of Rosneft were to hold on to their priceless perquisites. This case study in the Russian Disease displayed a remarkable show of self-confidence by Rosneft senior executives. It was a display as bold and disrespectful as anything Khodorkovksy ever did and suggestive of the fight over the spoils that seemed to be taking place once it looked as if Putin would soon be leaving the office of president.

  THE ST. PETERSBURG “MAFIA”

  The difference in response to such insubordination is due to the fact that unlike Yukos and the outsider Khodorkovksy, Rosneft is controlled by a special group of insiders, what the Russians have come to call “siloviki.” There is no exact equivalent for the phenomenon in the United States and Europe, and so no word for it exists in English. The Russian word “sila” means strength, so perhaps the best way to convey the concept is to translate it as “law and order veterans.” Russians use the word to refer to former members of the KGB and to a lesser extent senior military officers and police. Given Putin’s own background as a lieutenant colonel in the KGB, it is not surprising that he has brought such people into his government.

  Olga Kryshtanovskaia, a sociologist who specializes in the backgrounds of senior government appointees, has compared the number of siloviki in the senior ranks of the Gorbachev, Yeltsin, and Putin governments.43 She found that the number of siloviki in the national leadership rose from about 5 percent in senior positions under Gorbachev to 58 percent under Putin.

  Balancing off these law and order types, Putin has also brought in a substantial number of technocrats, former colleagues who worked with him in Mayor Anatoly Sobchak’s St. Petersburg office, where Putin headed the Department of Foreign Economic Relations. This included Viktor Zubkov, Sergei Ivanov, Viktor Ivanov, Dmitry Medvedev, Igor Sechin, Sergei Naryshkin, Minister of Finance Alexei Kudrin, and Minister of the Economy German Gref (see Table 7.3). These FOP (Friends of Putin), called by others the St. Petersburg “mafia,” are similar to the Texas “mafia” brought to Washington by President George W. Bush and the Arkansas mafia that came in with President Bill Clinton.

  So ubiquitous are these outsiders from St. Petersburg that they have become a source of humor among Moscovites jealous of these officials from the provinces who have taken over their city. Resentful Moscovites tell the story of a local man riding the Moscow subway. Without warning, the man next to him steps on his foot. After five minutes, the Moscovite, in pain, works up his courage. “Excuse me, sir,” he says. “Are you in the KGB?” “No,” answers his neighbor. “Then are you from St. Petersburg?” “No,” again comes the answer. “Then tell me, why are you standing on my toes?”

  TABLE 7.3 Siloviki in Business

  But the siloviki around Putin and the privileges and power they have been given distinguish them from their Washington counterparts. The Washington political appointees are
very often appointed to plum positions after they leave government service. Under Putin, they are appointed to the lucrative posts while they hold their jobs in the government. Given the way that new government officials in Russia treat their predecessors (a legacy of the USSR when predecessors were blamed for all the country’s subsequent problems—Brezhnev, Gorbachev, Yeltsin, and Stalin are good examples, not to mention Khrushchev, who was put under house arrest), Russian officials fear that once they are out of the government, they will no longer have access to such patronage. (This habit is also a source of humor. As he is about to turn over his office to his successor Vladimir Putin, Boris Yeltsin is asked by Putin if he has any words of advice. Yeltsin tells Putin that if he encounters any difficulties, he should look in his desk in the president’s office where Yeltsin will leave three envelopes. At the first sign of trouble, open the first envelope. Sure enough, Putin has trouble and decides to open the first letter. It reads: Tell everyone it was [Yeltsin’s] my fault. If the trouble continues—open the second envelope. It reads: Promise that everything will get better. If the protests still continue, prepare three envelopes.) So Russian officials have learned to take such posts and collect the fringes they bring while they can.

  DOUBLE DIPPING

  Whatever the rationale, Putin has instituted the practice of appointing his former colleagues not only to the most senior positions in the government but also to senior and lucrative posts in the business world. One Russian told me that senior Gazprom executives are reported to collect salaries that exceed $300,000 a month. (That surely would be high by past Russian standards but still less than what some senior executives in the United States receive today.) But unlike the practice in the West, the Russians hold these appointments simultaneously with their government positions. Since many of the posts are at the top of Russia’s most prosperous companies, they are following in the steps of the oligarchs, only they, unlike Khodorkovsky, Berezovsky, and Gusinsky, are protected by their benefactor, Putin. These FOP are doing very well. The Moscow Times on June 22, 2007, for example, reported that several of them have joined some of the old oligarchs in paying the $50,000 a year dues to the Burevestnik Yacht Club, Russia’s largest, which even has its own helipad. The yacht is extra.

  This was not the only glimpse into what seems to be the acquisition of great wealth by KGB veterans or what we have called the second generation of oligarchs. In an interview in the Russian paper Kommersant, Oleg S. Svartsman acknowledged that the $3.6 billion Finansgroup investment fund that he manages is a vehicle used by members of the FSB and SVR (Foreign Intelligence Service) and other high-ranking officials and their families. They use this to enhance their wealth (at $3.6 billion, this is pretty good for a relatively small group of public servants) and promote “social responsibility to the state.”44 In the words of Yevgenia Albats, the deputy editor of New Times and the author of The State Within a State, a book about the KGB, “The FSB is no longer just a police organization, it is a business.”45

  As a look at Table 7.3 shows, Putin appointees now run most of Russia’s national champions. At a meeting of the Valdai Hills group on September 9, 2006, at Putin’s home in Novo-Ogaryovo outside of Moscow, I asked President Putin if this was a good way to run both the government and these companies. “How could someone like Igor Sechin,” I asked, “the deputy head of the Kremlin administration, which is a full-time job, also do a good job as the chairman of the board of Rosneft, which is also a full-time job? More than that, how could Sechin be expected to be objective if the Kremlin is asked to mediate a dispute between Sechin’s Rosneft and an ostensibly private company like Lukoil? Wouldn’t this constitute a clear conflict of interest and open the door to criticism of corruption and abuse of power? Moreover, aren’t they likely to enrich themselves in the process, and before long end up as new entries on the Forbes Magazine list of world billionaires?”

  Putin’s response, according to the official transcript, seemed to skirt or, perhaps more charitably, miss the point. “These people only represent the state’s interests in a given company where the state holds a certain number of shares. . . . They do not manage the company and do not manage its resources. . . . Of course we could develop a system in which independent experts and lawyers represent the state’s interest. . . . For now I consider this is not realistic because at present lawyers and independent managers would at once start to engage in their own private business.” He then cited as an example of such corruption the two Harvard University advisers sent to Russia to help with the privatization effort only to be sued, found guilty, and fined $2 million each by the U.S. government for violating their work contract and insider trading. “For that reason it is natural that bureaucrats working for the state should represent the state’s interests.”46

  Whatever the reasoning, it is hard to find any other country in the world where so many senior government officials can simultaneously hold such lucrative business positions, whether in wholly or partially owned government companies. It is also hard to see how such companies can avoid patronage and other political pressures—pressures that are often difficult for even purely private companies to ward off. Inevitably, the partially private Russian companies headed by siloviki or FOP face the same political pressures encountered by wholly state-owned companies over such issues as patronage appointments, where to locate factories, pricing, wage setting, and vendor selection. In most such instances, production, productivity and profits suffer.

  It may already be too late. Russian state companies have begun to appoint the children of siloviki to high corporate positions. Called “princelings” in China, their Russian equivalents are a form of a kick-back for senior leaders in the party and government. While these Russian princelings may be capable, it is clear to other employees that their appointment was due more to their parentage than their training or competence. As Table 7.4 shows, these appointments are to senior posts in state-owned entities. Nikolai Patrushev, head of the FSB (once the KGB), for example, has managed to place two sons in these companies.

  At the 2007 Valdai Hills meeting I asked Putin if appointing the children of government officials, who would probably otherwise not be regarded as qualified, would likely have a negative impact on company productivity. Putin responded that such impact would be minor and besides such practices are not unique to present-day Russia. They are common all over the world. To illustrate his point he related a joke from the Soviet era. An official is asked if it is possible for a Soviet general’s son to become a general. “Sure, why not?” “Then is it possible for a general’s son to become a marshal?” “No!” “Why not?” “The marshals have their own sons.”

  TABLE 7.4 Princelings

  While nepotism of this sort may have been commonplace under the Czar, except for the generals and the marshals there was very little of it in the Soviet era. At best the children of Politburo members would sometimes find appointments in academic institutions, although Brezhnev’s son-in-law had a senior appointment in the Ministry of the Interior. Other than a few such exceptions, when it comes to feathering the beds of the children of those close to Putin, Russia today more closely resembles China than the USSR. As such, there is a strong likelihood that productivity will be affected. For example, the Japanese economist T. Shiobara points out that it costs Gazprom $3.3 million to construct one kilometer of gas pipeline whereas the world average price is approximately $1 million.47 When asked about such disparity, Putin pointed out that Russia builds many of its gas lines in permafrost and swampy conditions and so costs should be higher. “Russia is not the Balkans,” is how he put it. Yet a threefold higher cost does seem excessive.

  There are other signs of inefficiency and waste that are most likely a consequence of state ownership. John Grace has found this to be the case in the petroleum industry. As for gas production, Michael D. Cohen, an industry economist at the U.S. Department of Energy’s Energy Information Administration, cites data from his office that in 2004, “roughly 70 billion cubic meters [or one-
third of Russia’s gas exports] either leaked in the form of methane in the course of transmission or distribution . . . or were flared,” although some of the flaring was by private petroleum companies. Cohen also noted that only 20 percent of Gazprom’s investment is directed to upstream or new projects that will result in increased production.48

  On occasion, some Russians in the private sector have been bold enough, or perhaps indiscreet enough, to warn that the state was again becoming too involved in the economy, especially in the energy sector. Vagit Alekperov, the CEO of LUKoil, did just that in August 2007. Vladimir Bogdanov the CEO of Surgutneftegaz, said much the same thing a few months later in October. Alekperov later backtracked, but it is clear there is concern that if the state is allowed to become too dominant, it will affect efficiency throughout the whole economy for all the usual reasons associated with state ownership and management of economic resources.49

  In much the same spirit, once anointed as a national champion, there is a real danger that a company like Gazprom may become a law unto itself and act as if it is exempt from the normal checks and balances that restrain ordinary corporations. Gazprom, for example, despite widespread protests, has decided to build itself a new skyscraper monstrosity in St. Petersburg at the mouth of the Okhta River across from the city center. What makes such a decision so controversial is that this new structure will be 396 meters high. Therefore, in this eighteenth-century city it will tower over the rest of the buildings, which are restricted to 48 meters.50 Moreover, once one building is granted an exception to the height restriction, it is all but certain that others will also want the same privilege and before long, the beauty that makes St. Petersburg so unique will be destroyed. Some local environmental groups as well as UNESCO have protested, but there is not much likelihood that a company as strong financially and politically as Gazprom will be prevented from moving ahead with construction.