by Tom Bower
Chapter Seven
The Oligarchs
IN 1996, THE FATE of Russia’s oil and natural gas, and of the state itself, had become entwined in the ambitions of seven bankers aspiring to become oligarchs.
Boris Yeltsin’s prospects of reelection were endangered by the country’s imminent financial collapse. Inflation was 200 percent a year, the ruble was weakening and the government was in danger of defaulting on repayment of its foreign loans. Scornful of Russia’s nationalists, the pro-Westerners around Yeltsin feared that any impression of arbitrariness and paranoia would encourage Western companies to invest in Kazakhstan and other former Soviet republics, and ignore Russia. Based on advice by Boston Consulting and McKinsey, the Kremlin agreed to privatize Rosneft, Lukoil and Yukos, starting with the gas stations in Moscow. Gazprom, controlling about 25 percent of the world’s natural gas, would also be partially privatized and become a quoted company. With 53 trillion cubic meters of gas reserves and 140,000 miles of pipelines crisscrossing Russia and crossing Ukraine and Belarus into Europe, Gazprom’s value was incalculable — either worthless or invaluable depending on a market established by former outcasts, mostly Russian Jews and Western banks. Western analysts’ estimates of its value ranged from $125 billion to $740 billion. The privatization was an invitation for the enrichment on a gargantuan scale of a small group of outsiders.
At the end of 1994 the seven bankers had hatched a plan to lend the government billions of dollars to stave off Russia’s bankruptcy. As collateral they would receive shares in the companies owning Russia’s natural resources. The plan’s architect was Vladimir Potanin, a former employee at the ministry of foreign trade. Born in 1961, Potanin presented himself as a member of the Soviet elite who had been transformed into a cultivated banker akin to J.P. Morgan. His commercial career had been similar to those of the other aspiring oligarchs: he had started by consulting on import and export transactions after the collapse of the Soviet Union and had progressed to creating Onexim, or the United Export Import Bank, to broker export-import operations. His principal interest was Norilsk Nickel, a huge mineral conglomerate, but he also targeted a stake in Sidanco, Russia’s third-biggest refining and oil-producing company, which owned oilfields across western Siberia, including the huge Chernogorneft field. He offered a third of the stake in Sidanco to Mikhail Fridman for $40 million.
Born in 1964 in Lvov in Ukraine, Fridman had been barred from Moscow’s best scientific colleges because of his Jewishness, and was assigned to the dour Institute of Steel and Alloys to study metallurgy. In his free time he sold theater tickets, operated a courier service, imported photocopiers, sold Siberian wool shawls, and produced brushes to wash windows. Before ending college he was importing Western luxury goods and computers. Having mastered the Soviet bureaucracy, he graduated to profiting from the privatization of Russian industries. His Alfa Bank, opened with $10,000 in capital in 1990, earned millions of dollars trading the vouchers issued by acting prime minister Yegor Gaidar’s government to the public to be exchanged for shares in Russia’s major industries. In the rawness of the post-Soviet era, Fridman’s $40 million commitment was recorded on one sheet of paper. “I trusted Potanin,” he would explain. The shares, the two agreed, would be registered in Potanin’s name.
Mikhail Khodorkovsky was the third putative oligarch plotting to keep Yeltsin in power. Born in 1963, like Fridman, as a Jew he had been denied a place in prestigious engineering colleges despite being top in his class at school. After a short career as a black-market trader he had created the Menatep bank to broker payments between government ministries, regional governments and industries. His ambition was to buy Yukos, the oil company. At the last moment two other aspirants, Boris Berezovsky and Roman Abramovich, combined with Yeltsin’s approval to create Sibneft, to loan money to the government in return for shares in oil wells and a refinery. Two others made similar bids. Alone among the seven businessmen who sought a share of Russia’s natural resources, Potanin was not Jewish.
Potanin, Fridman, Khodorkovsky and Berezovsky met regularly to pursue their conspiracy. In their agreements with the state, the former black-marketeers and traders undertook to auction the shares allocated to them as collateral for their loans. The highest bidder would have the right to manage the oil companies on the state’s behalf until September 1996, when the state would be entitled to redeem its shares by repaying the loans. If it was unable to do so, the successful bidder for the shares became their legal owner. Since the country’s finances were wrecked, Potanin and his collaborators anticipated that the state would be unable to repay the loans and recover the shares. Viktor Chernomyrdin, the prime minister and former minister of the gas industry and head of Gazprom, signed the agreement with the bankers in the Kremlin on March 30, 1995. Potanin’s cool professionalism had persuaded him that the loans would finance the government and prevent the communists returning to power. Yeltsin gave his formal approval on August 31. Both the president and the prime minister were unaware that Potanin had inserted incomprehensible complexities into the documents in order to confuse potential rivals, beguiling even The Economist into commenting that the bankers “will not be allowed to sell shares to themselves on the sly.” In reality, that was precisely their plan. Using rigged auctions, they intended to transfer the nation’s wealth into their personal ownership.
Unseen by government officials and journalists, the auctions for 29 state companies on September 29, 1995, were bogus. Bidders found their access to the bankers’ offices barred, or their bids rejected on technical grounds. Boris Berezovsky, a friend of Yeltsin, bought Sibneft for $100.3 million; Mikhail Khodorkovsky bought Yukos for $309 million — it would soon be worth $5 billion; Potanin become the owner of Norilsk Nickel for a pittance, and bought Sidanco for $130 million — two years later, Sidanco was valued at $5.3 billion. The IMF estimated that Russia’s oil companies, actually worth $17 billion, had been sold for $1.4 billion. Gazprom was worth $119 billion, but in the sell-off the government received $35 million for 60 percent of its shares, one twentieth of 1 percent of their true value.
The new owners became masters of the system. Underhand means, including pliable local judges, were used to secure ownership of the oilfields. Ambitious to rank among the world’s oil titans, Khodorkovsky began searching for Western experts to modernize his corporation. Vagit Alekperov, one of the seven and the new owner of Lukoil, with estimated reserves of 16 billion barrels, 15 percent of Russia’s oil, had similar ambitions to end his company’s stagnation and attract Western shareholders. Arco became the first Western corporation to buy a stake in a Russian company, taking a 6.3 percent stake in Lukoil (which was valued at $10 billion by Alekperov, and $850 million by Western banks) for $250 million, and pledging to invest $5 billion.
In those early days, the emergence of the oligarchs was less newsworthy than the success of their plan. On July 3, 1996, Yeltsin was reelected president. The Russian economy boomed while ex-communists, KGB officers and Soviet managers jockeyed to appropriate the country’s major industries, criminalizing the country. Western bankers provided loans to the new owners of Russia’s natural resources. Potanin, as a deputy prime minister in a government overtly helpful to the new businessmen, helped his co-conspirators in the loans-for-shares plot to divide the spoils. At every level, from the Kremlin down to the oilfields’ managers in Siberia, insiders snatched a share, sometimes using violence, tipping the fledgling democracy beyond Yeltsin’s control.
The chaos was broadly welcomed in Washington as providing an opportunity to replace Russia’s historic control over the estimated 200 billion barrels of oil and gas around the Caspian Sea. Baku had become a boom town filled with Tex-Mex food, nightclubs and Texans smelling big money. “This is about America’s energy security,” announced Bill Richardson, the energy secretary. “It’s also about preventing strategic inroads by those who don’t share our values.” Ignoring Russia’s antagonism and the region’s recurring wars over control of the Caspian, Richardson a
dded, “We’re trying to move these newly independent countries towards the West. We would like to see them reliant on Western political and commercial interests rather than going another way.”
Foreign investors occasionally found difficulty identifying the right person to bribe, because there were so many. Officially, the Western oil majors repudiated kickbacks, but circumstances made refusal difficult. Many key officials in the food chain in Russia and around the Caspian asked contractors to pay for “services” supplied by intermediate companies especially established for skimming. The service fees were deposited in offshore bank accounts, especially in the Cayman Islands. While Statoil of Norway had been caught and expelled from Iran for bribing the son of President Rafsanjani, there were no supervisors in Russia or around the Caspian likely to cause such embarrassment. Nor was Washington complaining. Corruption was tolerated for the sake of democracy’s future. Once Russians and the Caspian managers became property owners, Washington’s reformers believed, the property rights of foreign investors would be protected. In that atmosphere, the CPC pipeline for Chevron’s oil, running from Tengiz to Novorossiysk on the Black Sea, was finally approved, with completion set for March 2001 — but, to President Clinton’s irritation, on Moscow’s terms. Obtaining Caspian oil without Russian interference preoccupied Clinton. He wanted the oil companies to build a 1,080-mile pipeline, avoiding Russia and Iran — from Baku to Azerbaijan and then through Georgia and Turkey to Ceyhan, a Mediterranean port. One obstacle was the estimated cost, $3.7 billion.
American oil companies, wary of low oil prices and endless political shenanigans, wanted US government money to reignite their enthusiasm for the Caspian. Clinton refused, but dispatched Al Gore to Moscow to lobby for more favorable treatment. As Gore traveled, a stream of veterans including Henry Kissinger, James Baker, Dick Cheney, and two former national security advisers, Brent Scowcroft and Zbigniew Brzezinski, now a consultant for Amoco, elevated the fate of Caspian oil into a new post–Cold War cause. Russia was condemned for seeking to control the region as part of the new Great Game. The US administration, they urged, should support the Caspian nations against Russia. Several of those experienced Americans were retained by the Caspian governments to promote their cause in Washington. Caspar Weinberger, Ronald Reagan’s hawkish former defense secretary, spoke for the imperialists in May 1997 by decrying Russia’s attempts to “achieve strategic victory of its own: dominance of the energy resources in the Caspian Sea region. If Moscow succeeds, its victory could prove more significant than the West’s success in enlarging NATO. The stakes in the Caspian are enormous.” America’s self-interest to develop alternative oil supplies from the OPEC countries was unconcealed. “Open access to the Caspian,” continued Weinberger, “is critical if the United States is to diversify its energy sources and reduce its dangerous reliance on Middle Eastern supplies.” Ignoring a thousand years of regional history, Weinberger, echoing Clinton’s opinions, portrayed Russia as meddling in a distant regime by supplying weapons to Armenia, forging an alliance with neighboring Iran. He demonized Iran for its hostility toward Azerbaijan. “If Russia and Iran succeed in their designs on the Caspian,” said Weinberger, “they will have potential leverage over Western economies, which will be left to rely on the unstable Persian Gulf region for oil.” The first step toward defeating Russia, he advised, required Clinton to negotiate better terms for Azerbaijan from Congress. “Our long-term security interests are at stake,” he concluded. Instead of the American oil companies engaging in a dialogue with Russia’s politicians, they were encouraged by the White House to embarrass the Kremlin.
Clinton responded positively to Weinberger’s exhortation. Eduard Shevardnadze, the president of Georgia, was welcomed to the White House on August 4, 1997. His visit had been preceded three days earlier by that of President Heydar Aliyev of Azerbaijan. The former KGB boss was scheduled to spend 30 minutes with Clinton, but their discussion was extended to two hours. Azerbaijan’s relations with America had been complicated by an official trade embargo forbidding loans to the country, imposed after an uprising in 1988 by Armenian Christians seeking self-rule in Nagorno-Karabakh, an enclave inside Azerbaijan created by Stalin. Aliyev also met William Cohen, the secretary of defense, to discuss “the development of strong US–Azerbaijani defense cooperation.” The news footage beamed back to Moscow was calculated to incense Russia’s nationalists and conservatives. The festering anger about the PSA agreements in Sakhalin re-erupted, with an immediate effect on all Western oil companies. Despite Russia’s oil production having fallen from 12 million barrels a day in 1987 to six million in 1997, Western money and expertise were again regarded as suspect. Texaco, Exxon, Conoco and Amoco found Russia’s unreliable and lethargic bureaucracy introducing new taxes and summarily reversing authorization for new projects. In September 1997 Al Gore, the oil industry’s champion, returned to Moscow. In response to his complaints, Yeltsin restored tax and pipeline privileges to the early investors, but rejected requests by Exxon and Amoco for more PSA agreements.
Believing that Russia was stable, John Browne announced BP’s intention to invest in its oil industry. His principal interest was Kovytka, a monster natural gas reserve near Irkutsk with sufficient gas to supply America for three years, owned by Sidanco. Browne’s plan was to pipe the gas to China. In early 1997 Browne approached Vladimir Potanin, who had resigned from the government in March along with the rest of the Cabinet of Ministers. Enjoying good relations with the Kremlin and sympathetic to the West, Potanin owned two thirds of Sidanco; the remaining third had been bought by Mikhail Fridman, a director of the company, whose stake was registered in Potanin’s name. Browne offered Potanin $500 million for a 10 percent stake in Sidanco. Since Potanin and Fridman had paid $130 million for the entire company, the offer was warmly received.
Browne’s proposed investment in Sidanco, and an alternative invitation to invest in Sibneft, were discussed at a quarterly meeting of BP’s executives in New Orleans. Like Exxon and Shell, the corporation had been invited to invest in Russia during the 1980s, but the experiences had been frustrating. Secretive and suspicious, the Russian oilmen had refused to reveal any information. Now, Browne explained, it was different. He accepted the common wisdom that Russia would develop into a Western-style economy. The critics’ argument during the meeting was familiar: the Russians considered the country’s natural resources as their birthright, and would prevent capitalists profiting from their minerals. Browne’s confidence in Potanin was shared by only a few, including David Jenkins. “It’s a $500 million learning experience,” said Jenkins, “and you’ll love it.” Browne understood the reasons for some of the reservations. The due diligence process to assess Sidanco’s true worth would be imperfect, and BP, without Russian-speaking experts, would be unable to influence the company’s management. Nevertheless, he trusted Potanin and agreed to pay $571 million (£389 million) for 10 percent of the company. Any doubts were swept aside by Potanin’s sale of another 10 percent stake for about $550 million to the Sputnik Fund, financed by George Soros, the Hungarian-born financier, and Joe Lewis, a British currency trader based in the Bahamas. None of these foreign investors, including Browne, knew about Mikhail Fridman, or understood the background to Potanin’s sale of 20 percent of Sidanco’s shares.
Ever since the loans-for-shares deal had expired at the end of 1996 and Sidanco’s shares had been auctioned by the government to the Onexim bank, Fridman claims that Potanin had tried to persuade him to sell his 33 percent stake, although Potanin denies this. Fridman had always refused, but Potanin eventually invoked his influence in the Kremlin, which Fridman says changed his mind. “He’s the big boss,” conceded Fridman, and accepted $130 million, a profit of $70 million, as compensation for the squeeze. Those shares were sold to BP and Kantupan Holdings. Unaware of the background, Browne asked Tony Blair to celebrate the deal at a reception in Downing Street. On November 18, 1997, the prime minister applauded while Browne and Potanin shook hands, and heard Browne
announce that the venture was the precursor to investments totalling $3 billion in Russia over the next decade. Browne’s optimism was based on the assurances of BP’s political advisers that Russia was stable. No one realized that Russia’s budget deficit was edging beyond the Kremlin’s control.
Officially, Russia’s crisis started in May 1998. Falling oil prices were wiping out profits and the collateral for Russia’s foreign loans. Oil production was again falling, and crude was being traded inside Russia by barter and cash. On the international market, the cost of extracting Russian oil was too high — $8 to $10 for a barrel of Siberian oil compared to $2 in Saudi Arabia — and since 40 percent of Russia’s exports was oil, the country’s financial plight was dire. Viktor Chernomyrdin had been fired as prime minister two months earlier. “Where there’s oil, there is blood,” he quipped, complaining about the oligarchs’ control over the industry and their destabilization of the government. To avoid the humiliation of defaulting on international debts, Sergei Kiriyenko, the new prime minister, wanted to raise $10 billion, partly by selling 75 percent of Rosneft, Russia’s last wholly state-owned energy giant. The initial price was $2.1 billion. After Western companies shied away, blaming low oil prices, high taxes and turmoil in Russia, the price was reduced to $1.6 billion, and finally to $470 million. On auction day in May 1998, BP and Shell, the last prospective buyers, refused to bid at any price, blaming Russian instability and the plunge of oil prices. Mortified that Russia’s financial structure was melting, Yeltsin appealed to Clinton for help. In July, the White House arranged for the IMF to grant Russia a $22.6 billion loan, but it was too late. In August, following an economic crisis in Asia, oil prices fell to $15, and then toward $10. On August 17 the Russian government defaulted on $40 billion of loans. Amid soaring unemployment and bank failures, Yeltsin agreed to devalue the ruble. Facing financial ruin, Russians lost their trust in the government and the banks. On August 23, five months after his appointment, Sergei Kiriyenko was fired and replaced as prime minister by Evgeny Primakov, a patently temporary appointment. Among the casualties as the oligarchs struggled to save their assets was Sidanco, which was on the verge of bankruptcy. John Browne was embarrassed, not least because Vladimir Potanin had disappeared. Deploying his presentational skills, Browne could have glided over the discomfiture of explaining the loss to BP’s shareholders, had Mikhail Fridman not intruded into his grief.
