Oil

by Tom Bower

  By this time Fridman and his Alfa Bank had forged a partnership with two aluminum oligarchs: Renova chairman Viktor Vekselberg, who was worth an estimated $10.5 billion; and his partner Len Blavatnik, who had emigrated penniless from Russia at the age of 20 to the USA. After obtaining an MBA at Harvard, Blavatnik had worked for the accountancy group Arthur Andersen before founding Access Industries, based on Fifth Avenue. He had invested with Vekselberg in Russia’s aluminum industry. Their joint company with Fridman, the Alfa-Access-Renova Group (AAR), had in June 1997 paid $800 million in an auction for 40 percent of the Tyumen oil company (TNK). Fridman, using the $130 million he had received from Potanin, had bought half of this, while Vekselberg and Blavatnik bought one quarter each. They would buy the remaining 60 percent of the company for much less in 1999. TNK’s oilfields in western Siberia were adjacent to Sidanco’s, and as the financial crisis developed during 1998, TNK’s executives heard complaints from Sidanco’s creditors about Potanin’s attempts to avoid paying his debts by starting bankruptcy proceedings. In Moscow they also heard that Potanin, beleaguered by conflicting advice and complaints from Browne, Soros and Lewis, was struggling to survive. Still outraged by his double-crossing at the hands of Potanin, Fridman sought revenge.

  Without Potanin’s knowledge, he began buying Sidanco’s debt at a huge discount. Besides all the Russian suppliers, he also persuaded the Westdeutsche Landesbank and other Western banks to sell Sidanco’s debt to TNK for 10 cents on the dollar. Next, he applied to the bankruptcy court in Nizhnyvartovsk in Siberia to recover a notional $20,000 from Sidanco. The court agreed. Browne found himself caught in the cross fire. TNK, he discovered, was not seeking to recover just $20,000, but to strip Sidanco of all its assets, including the Chernogorneft oilfields. He also discovered that the judge in Nizhnyvartovsk was not inclined to protect BP’s interests. On the contrary, Russia’s bankruptcy laws allowed TNK to buy Sidanco’s oilfields for a pittance, and to authorize the company to manage Sidanco’s wells. Just one year after buying a stake in Sidanco, Browne embarrassingly reduced the value of BP’s investment to $200 million, although in reality it was worthless. By summer 1999, Sidanco was an empty shell. TNK had become a substantial oil company. Outmaneuvered by Fridman, BP was regarded by rival oil companies as naïve and careless, while Browne was mocked by Fridman’s manager for his unwillingness to cooperate.

  Momentarily, Browne considered telephoning Fridman, but instead he prepared his retaliation in London and Washington. First he asked Tony Blair to dispatch a warning to the Kremlin. On September 7, 1999, the prime minister wrote to Yeltsin: “BP fears that what should and could be a healthy and profitable company will be manipulated into bankruptcy and collapse.” He asked Yeltsin to “give this case your close personal attention,” because “the case is being closely followed by other major investors in Russia.” Browne’s more important retaliation was in America. To finance its nascent oil business, TNK had received preliminary approval for a $489 million loan from the US Export-Import Bank. The money would buy equipment and technology from Halliburton to refurbish the Ryazan refinery near Moscow and to rehabilitate Samotlor, a giant oilfield in western Siberia. BP hired Patton Boggs, a firm of lobbyists, to persuade the bank to withhold the loan. Under pressure from Dick Cheney, the chief executive of Halliburton, James Harmon, the head of the Export-Import Bank, refused Browne’s request “for the time being.” The oligarchs were not surprised. “Jim’s a good friend of ours,” said one of TNK’s owners, anxious to establish the company’s credibility in America. In Moscow, Fridman was nevertheless concerned. TNK needed the money, and the company needed credibility in Washington. Repeatedly he tried to contact BP’s representatives in Moscow, and Browne in London, to explain the story of his battle with Potanin, but his telephone calls were rejected. “There is nothing to talk about,” Browne told an intermediary. Fridman sought the help of Andrew Wood, the British ambassador in Moscow, but was told, “BP doesn’t want to talk to you. They say you’re a hostile player.” In London, Browne was ratcheting up his vengeance. The Republicans in the US Congress were protesting about soft and pointless loans to Russia. Browne joined the chorus, urging Al Gore and Madeleine Albright, the secretary of state, to order Harmon to abort the loan to a “criminal” company. In the battle of nerves, Browne feared he was losing — until Fridman blinked.

  Fridman had been puzzled to receive a telephone call from Pinchas Goldschmidt, a Swiss national and Moscow’s chief rabbi. “I hear you’ve got a problem,” said the rabbi. “I’ve got a friend in London who knows Browne’s mother, and I’ll tell her that you’re a good man and Browne should call you.” Fridman was nonplussed. He never attended synagogue, and he could not believe that Browne would take advice about business from his mother. “Why not?” he replied with a smile. To his astonishment, two days later, Browne called from London. “People I respect tell me that you are a man of your word, that if you promise to do something you’ll do it. Is that true?” “Of course it’s true,” replied Fridman. Meekly, he pleaded, “We don’t want to harm BP. We’re not against you guys. All we want is compensation from Potanin.” “Come to London,” said Browne, “and let’s find a solution.” At the meeting three days later in BP’s private house in Hill Street, Mayfair, Fridman met Ralph Alexander, Browne’s trusted Russian expert. “It’s a big honor for us,” said Fridman, “to have a relationship with BP. We are simple people and it’s a big step in our lives.” While the negotiations continued, Browne urged Madeleine Albright to order Harmon to withdraw the loan to TNK, on the grounds that it was against US interests. On December 21, 1999, Harmon obeyed. This exercise of power impressed Fridman. “It shows strength,” he told a colleague, acknowledging BP’s importance. Just hours before the order was formalized, realizing that BP could permanently damage his reputation, Fridman finalized a settlement with the company. There was a mutuality of interests. Browne wanted a secure foothold in Russia, while Fridman needed technical help to rebuild TNK’s and Sidanco’s oilfields. Like so many Siberian oilfields, TNK’s had been damaged by bad drilling and engineering. The agreement between the two would be the foundation of BP’s activities in Russia. In return, the Export-Import Bank loan was approved. In London, the exploration section celebrated BP’s decision to stay in Russia during their Christmas dinner in Trinity House. With Russian oil, everyone agreed, BP’s growth was assured.

  In the reconstruction of Sidanco, the Chernogorneft oilfields were returned by TNK to Sidanco. Fridman and the Alfa Bank took a 25 percent stake in the new company and a single blocking vote, while BP’s interest rose to 25 percent. During the following year, the other foreign shareholders would be bought out by Fridman, and Potanin lost control of Sidanco. As a minority shareholder in TNK, BP was squeezed to collaborate with Fridman. The Russian, Browne concluded, was not dishonest, just very aggressive.

  Browne and Fridman’s peace agreement was unusual. President Clinton was encouraging the American oil companies to behave belligerently. In May 1999, six US ambassadors from the Caspian region toured the USA promising potentially huge profits for those who were “not fainthearted.” Oil & Gas, the industry’s trade journal, characterized the US administration’s stance as “aggressive meddling” and “arrogance [that is] especially troubling” in the Caspian.

  Clinton’s forcefulness had been spotted by Vladimir Putin while he was Saint Petersburg’s deputy mayor after 1992. Born in 1952 in Saint Petersburg, Putin had worked for 16 years in the KGB, including service for the First Directorate as a foreign intelligence officer in East Germany. In the gangster era in the early 1990s, he was mentioned in connection with Saint Petersburg’s murky gambling syndicates, crooked businessmen and murdered tycoons. Less well known was his thesis, completed in the mid-1990s, explaining how Russia needed to recapture control over its natural resources to restore its status as a superpower. High oil prices were crucial to Putin’s plan. His model for success was Saudi Arabia. Putin’s nationalistic agenda appealed to an unusual coali
tion.

  In August 1999, Boris Yeltsin was on the verge of dismissing Sergei Stepashin, his fourth prime minister in less than 18 months. Fearing Russia’s disintegration, Boris Berezovsky and senior KGB officers advised Yeltsin that the 46-year-old Vladimir Putin was the ideal candidate to reform the country, and on August 3, 1999, he was appointed acting prime minister. Over the following weeks he aggressively prosecuted the war against the Chechens and established his authority after two bombs exploded in Moscow, destroying blocks of flats and killing 212 people. By the end of the year, a combination of former KGB officers and Putin’s trusted officials from Saint Petersburg had steadied Russia. When Yeltsin unexpectedly resigned on December 31, 1999, Putin was appointed acting president. He immediately began executing his plan to take control of the media, to postpone elections and to appoint cronies from Saint Petersburg to key positions, especially in control of Russia’s natural resources. Several of those who knew the details of his rise to power either went into exile or would die in mysterious circumstances. Beyond his tight circle of advisers, few anticipated Putin’s intention to use the prices of oil and natural gas as levers of political influence.

  Chapter Eight

  The Suspect Traders

  FIXING THE WORLD’S oil prices had created raw hatred between Jorge Montepeque and Laney Littlejohn. Montepeque, the son of Guatemalan peasants, distrusted the oil industry. Every day, from his office in Singapore, Montepeque’s small team of reporters employed by Platts, a specialist publisher bought by McGraw-Hill in 1953, recorded the prices for which producers and traders had bought and sold crude and its refined products for shipment across the world on tankers and railways and through pipelines, and published them as a guide for the world’s oil trade. “I’m uncomfortable,” Montepeque said, “because every day some traders are stretching the truth.” Montepeque set out in 1991 to create a transparent, honest market. As the trade’s self-appointed policeman, he was regarded by most traders as a necessary evil, but Laney Littlejohn saw only evil.

  Four thousand miles to the west, within sight of the Gulf of Iran, Laney Littlejohn, an economist trained in Missouri, was employed by the Saudi government to fix the price of its oil. Littlejohn was housed in Box 8000, a three-story, reinforced building in the cramped Dhahran compound for 11,000 foreigners, and his daily routine was to collect market prices in Dubai, New York and London, estimate the amount of oil stored in ports and refineries around the world, and, after a simple calculation, inform the minister of oil the highest price customers could be charged for Saudi crude. Although Saudi Arabia supplied over 10 percent of the world’s daily consumption, and through OPEC influenced the world’s oil supplies, Littlejohn knew that his master’s power to control prices was limited. Pricing Saudi oil, Littlejohn admitted, was two thirds science and one third “How much can we get away with?” The self-confident Saudi royal family, he knew, liked to imagine they were getting the best deal for themselves. After all, they owned Ghawar, the world’s largest oilfield. Discovered in 1948, it was 174 miles long and 12 miles wide. By 1993, 34 billion barrels of oil had been extracted from it, and its unceasing production of 4.2 million barrels a day underpinned the nation’s wealth. If the government needed more money, Littlejohn’s recommended price was occasionally overruled by the minister. The extra nickels and dimes on five to eight million barrels a day were valuable. Accordingly, Littlejohn resented Montepeque’s homily that a producer could control either volume or price, but not both. “Like quantum physics,” said Montepeque, “you can’t know the speed and direction at the same time.” Oil prices, he believed, were a victim of the law of unintended consequences. Littlejohn resented anyone casting doubt about the credibility of his prices, and fumed at Montepeque’s doubts about the market’s honesty.

  Saudi Arabia’s finances had been crushed in 1986 by the collapse of oil prices, which had been unexpected by the Saudis, but with hindsight was inevitable. Until then, Sheikh Zaki Yamani, the internationally recognized oil minister, had given the impression that OPEC had replaced the Seven Sisters as undisputed price fixers. Littlejohn had been amused when Henry Kissinger mentioned a “fair price” for oil: “I thought Thomas Aquinas was the last person to talk about ‘fair price,’” he said. The Saudis had assumed that the West was powerless to influence prices after Occidental’s oilfields had been gradually nationalized by the Libyan government after 1970 and the oil majors had been restricted under US antitrust laws to collaborate and mitigate the damage. The Saudis and all the other OPEC countries concluded that the oil majors were vulnerable. But during the early 1980s oil supplies from the North Sea and Russia had overturned their assumptions. Fixed prices had been wrecked by the perception that the oil nations were producing between six and eight million more barrels of oil every day than required. Spare capacity and Saudi Arabia’s subterfuge in undercutting other OPEC members wrecked price-fixing. Littlejohn’s former practice of confidently quoting the price of the sulphurous Saudi crude by checking the bids for West Texan Intermediate light on Nymex was wrecked as prices started falling from $26 a barrel during the last weeks of 1985. “The market’s going to hell,” Littlejohn told his confidants. “It’s going down.” His warnings were ignored by Saudi Arabia’s rulers. Sheikh Yamani was unwilling to accept that the free market was destroying OPEC’s cartel.

  The disintegration had started in Nigeria. For nearly 20 years, the Nigerian government had sold light crude at fixed prices, until in the early 1980s its production was priced by traders against Brent oil. When North Sea oil unexpectedly became cheaper in 1985, Nigeria’s crude was too expensive, and traders canceled their contracts. Simultaneously, the price of Dubai crude fell to $10. Tankers were sailing empty from Saudi terminals after American refineries refused to buy sour crude for high, fixed prices. King Fahd of Saudi Arabia was baffled. He had assumed that if Saudi Arabia produced six million barrels a day, the price would be $17.52. Neither he nor his entourage understood how international markets operated. John Kalberer, Aramco’s chief executive, and Littlejohn explained to him that fixed prices and a fixed quota were inconsistent with a free market. Even Yamani spoke about the inconsistency of OPEC simultaneously pursuing higher output and higher prices. Troublemakers seeking to remove Yamani contradicted the Americans. Saudi Arabia, they insisted, could continue to produce six million barrels a day and sell it for around $18. “On Wednesday I was talking to Yamani,” recalled Littlejohn, “and next day he was gone. I had no inkling. Those ambitious people who pushed him to the wall were fooling themselves about the formula. No one wanted to listen to me.” Combining ignorance with the need for a high income, the OPEC countries refused to reduce production below 12 million barrels a day. “Sell my quota,” Sheikh Hisham Nazer, Yamani’s successor, told Kalberer. Obediently Aramco sold one cargo to Chevron for less than $5 a barrel. The company agreed not to reveal the price, but Aramco had no choice but to sack staff and produce less oil. Seven months after the crisis started, Littlejohn persuaded the new oil minister that the existing pricing formula was redundant. At the OPEC meeting in September 1987, the producers agreed to adjust to the new world. Rather than dictating prices, Littlejohn would discuss his new pricing formula with the “lifters” — his customers.

  Like wine and cheese, the quality and value of crude oil varies significantly. The difference in price depends on factors including the amounts of sulphur and asphalts within the oil, and the distance from the oilfields to the refineries equipped to process that specific crude. Three principal locations determined the price. The first was Cushing, Oklahoma, the delivery point for WTI; the second was the North Sea, the pricing location for Brent, West African and Russian crude; and the third was Dubai, the pricing reference for oil produced in the Middle East for delivery to Asia. By 1989 a major distinction had arisen between buying oil in the future, speculating on paper, and trading actual cargoes of crude oil and products on “spot” — the sale of a single cargo, right here, right now, for cash, sometimes at a fixed price but
often linked to an index published by Platts or Argus, a smaller British rival. In 1990, one third of oil traded was “spot” — for instant or future delivery for cash. Increasingly those “spot” trades were sold over the counter, or OTC, which meant they were unregulated in any market (only the futures market would be regulated). During the 1990s, the OTC market began to expand. By 1998, $80 trillion of oil was traded as OTC, compared to $13.5 trillion in exchanges. Each trade of the 120 types of other crude oils extracted in the Middle East, Russia, Africa, South America and elsewhere was determined by referring to the differential of the price of WTI or Brent, on Nymex and on the International Petroleum Exchange in London. Sixty to 70 percent of all crude oil trades were priced every day, reflecting the crude’s quality against Brent, and the transport costs.