Chemezov formed Russian Technologies (Rostec), an armaments company, whose chief executive he remains. All nuclear facilities were transferred to the newly founded state corporation Rosatom, which re-created the old Soviet Ministry of Atomic Energy. The old Soviet foreign trade bank, Vnesheconombank (VEB), was a third important state corporation. The other three were Olimpstroi, responsible for the construction of the Sochi Olympics, the Communal Services Reform Fund, and the Russian Corporation for Nanotechnologies (Rusnano), which was later transformed to an ordinary state-owned open joint-stock company. For the rest, ordinary state-owned companies prevailed.27
Curiously, Putin hardly said anything in public about state corporations, as if his closest men were doing this on their own initiative, although Putin undoubtedly drove this development. He holds about one publicized individual meeting with each of the heads of the big state enterprises every year.
The governance of both the state companies and state corporations changed. Overtly, the Kremlin’s aim was to improve corporate governance and make these enterprises autonomous from the ministries, but in reality Putin secured direct control. He appointed the supervisory boards of both state corporations and state companies and their chief executives were his men, answering only to him. Ministers and senior presidential administration officials dominate their boards, but the president appoints them. An apparent series of accidents bred state capitalism, but tacitly Putin has pursued a policy of deliberate renationalization.28
The real aim of state corporations appears to be twofold. First, they concentrate political and economic power into the hands of Putin and his trusted friends. Second, the state corporations are also supposed to enrich this circle of friends, as will become evident in the following chapters. Surprisingly, neither competitiveness nor economic efficiency appears important. Thanks to substantial defense expenditure, the national champions were supposed to promote technological development. By contrast, the old Soviet military-industrial complex had insisted on competition, for example, among half a dozen sophisticated airplane producers.
President Dmitri Medvedev clearly opposed the state corporations. In August 2009, he asked the prosecutor general to investigate them. In November, he daringly issued an instruction to Prime Minister Putin to present proposals on the reform of state corporations “after the audit of state corporations’ activities showed that the current legislation does not set common criteria for defining a state corporation as a form of legal entity’s incorporation. In a number of cases, the lack of proper oversight of state corporations’ activities has led to them making ineffective use of the state assets transferred to their control.”29
Evidently, Putin refused to follow this instruction. In March 2011, Medvedev challenged Putin’s scheme more specifically, prohibiting state officials from sitting on the boards of state corporations. Instead, Medvedev promoted independent directors, particularly university professors. He encountered loud resistance from disadvantaged officials, notably Sechin. Medvedev’s initiative would have undermined Putin’s power structure. This might have been a major reason for Putin’s decision to return to the presidency half a year later. Surely this was far more important to Putin than Medvedev’s stand on Libya in the United Nations Security Council, which has widely been seen as the tipping point because Putin complained about it publicly.30
The renationalization has been a gradual and drawn-out process. Usually, state corporations have bought big, good private companies when they have come up for sale. Many business leaders who made their fortunes in the 1990s saw themselves as opportunistic private equity investors rather than industrialists. One of them quipped to me: “We are prepared to sell everything apart from our family silver, if the price is right.” They were more interested in money and a good life than in what their enterprises produced. Many of Russia’s billionaires have quietly sold out their assets in Russia and emigrated to London, France, or Monaco.
Roman Abramovich is an extreme example. Coming from a poor family, he became an orphan before he was four. He made an early fortune on oil trading and managed to develop close relations with the Yeltsin family and later Putin. As a favored insider he made it big through the privatization and restructuring of the oil company Sibneft, in which he acquired a majority, together with Boris Berezovsky, in the loans-for-shares privatization in 1995 for $100 million. In September 2005, Gazprom bought the private Russian oil company Sibneft from Roman Abramovich and his partners for $13.1 billion, according to the Financial Times. This was seen as a high price by market commentators. At the advanced age of thirty-eight Abramovich retired to the pleasures of London, where he had bought the Chelsea Football Club. Abramovich is rumored to have been one of five people who picked Putin.31 In 2018, Abramovich failed to renew his UK residence permit in time, so he adopted Israeli citizenship.
Unlike his former partner Boris Berezovsky, Abramovich avoided the limelight and was unknown to the Russian public until 1998. No political statement of his has ever been published. From 2000 to 2008, he was governor of the northeastern region of Chukhotka, where he spent vast amounts of money on charity to develop the region. Stephen Fortescue has shown that his Sibneft benefited from even more aggressive tax planning than Yukos. Presumably thanks to his close relations with Putin and complete discretion, the Kremlin raised no objection. The discreet Abramovich lives seemingly happily in outstanding luxury with four giant yachts and one large private jet. Renamed Gazprom Neft, Sibneft remains one of Russia’s best oil companies, just as the recently renationalized Yukos and TNK-BP are excellent parts of Rosneft.32
As the biggest gas producer in the world, accounting for 11 percent of global production, Gazprom is the gift that keeps on giving. It is a highly profitable cash cow, extracting Russia’s plentiful gas in Western Siberia at a low cost. In 2011, Gazprom recorded the highest net profit of any company in the world. Even so, its market valuation is small and its free cash flow is minimal, because its large energy rents are sunk into not very profitable capital investments such as pipelines. Arguably, Gazprom is the worst-managed big company in the world. In 2012, the still-private Moscow investment bank Troika Dialog stated: “Over the past five years, Russia’s Gazprom has indeed been the worst stock in the sector globally.” It has deteriorated further since then.33
Gazprom was formed out of the old Soviet Ministry of Gas Industry, whose last minister was Viktor Chernomyrdin. From 1985 until 2001, Chernomyrdin and his associates controlled Gazprom. Its legal status changed in 1989 from a Soviet ministry to an industrial association, and from 1993 on, it was gradually partially privatized. Gazprom maintained ownership of all the ministry’s assets, including production, transportation, distribution, sales, and regulation. It has persistently been a state in the state. It has fulfilled many functions—gas production, transportation, domestic supplies, and export sales—but it has also had many social responsibilities, such as delivering gas without being paid to poor people, regions, and enterprises.34
Gazprom’s unique position arises from its old boss Chernomyrdin, who was prime minister from 1992 to 1998, and from the nature of the gas industry. Chernomyrdin carried out the corporatization and partial privatization of Gazprom from 1992 to 1994. In November 1992, he transformed Gazprom into a joint stock company by presidential decree. The company was partially privatized in a unique fashion in 1993–1994. Its management used voucher auctions to privatize almost 40 percent of Gazprom shares for an implied price of about $100 million. Of all Russian privatizations, this was by far the biggest giveaway, as its market capitalization peaked at $369 billion, almost four thousand times more, in May 2008.35
After Chernomyrdin was ousted as prime minister in April 1998, he and Gazprom’s CEO Rem Vyakhirev allegedly indulged in gross asset stripping, transferring large assets to their children. The Washington Post reported: “Two sons of former prime minister Viktor Chernomyrdin are major shareholders in Stroitransgaz, as is the daughter of Gazprom’s chief executive, Rem Vyakhirev. . . .
The foreign investors have also alleged that hundreds of millions of dollars’ worth of Gazprom assets, mostly rich gas fields, have been transferred to another fast-growing Russian gas company, Itera, either without adequate compensation for Gazprom or in questionable stock deals.”36
In the spring of 2006, I took two young investors to meet Russian ambassador Chernomyrdin in Kyiv. We had an enjoyable conversation, but then one of the young men asked Chernomyrdin: “What would you invest in in Ukraine if you had $100 million of spare cash?” Chernomyrdin grew quite upset because of a misunderstanding and retorted, “$100 million!? I have $5 billion!” That amount corresponded at that time to 5 percent of Gazprom’s market value.37
In May 2001, President Vladimir Putin sacked the Chernomyrdin-Vyakhirev group from Gazprom. Putin appointed as CEO his former assistant from the St. Petersburg’s mayor’s office, Alexei Miller, in place of Vyakhirev, and his chief of staff Dmitri Medvedev as chairman of the supervisory board. Miller, a young economist, had no experience of the energy sector. My late friend and former Russian finance minister Boris Fedorov, who was a member of the board of Gazprom from 2000 until his premature death in 2008, thought that Putin would clean up Gazprom from massive corruption. Gazprom did recover some assets, but it soon became clear that the nature of the regime had not changed, only the beneficiaries. Miller remains CEO of Gazprom, but the outstanding independent Moscow energy analyst Mikhail Krutikhin notes that “Gazprom has one manager: Putin.”38
Gazprom has a supervisory board with eleven members, chaired by Viktor Zubkov, a former prime minister and a long-standing close friend of Putin. All are Russian citizens apart from Timur Kulibayev, the billionaire son of Kazakhstan’s president Nursultan Nazarbayev. The German energy company E.on used to have one board member, Burkhard Bergmann, 2000–2011, but it sold its shares in Gazprom and gave up its board seat over disappointment with the company’s poor performance. The Gazprom board that is elected annually varies little and is dominated by its managers.39
Gazprom enjoys multiple monopolies, including on trunk pipelines, exports through pipelines, development of new offshore fields, and the regulation of pipeline transportation. It decides independently whether another company will be allowed to transport gas through its pipelines, compelling a large share of Russia’s gas to be flared.
Gazprom is profoundly conservative. Its international business is traditionally to export natural gas on long-term contracts to Europe through pipelines, and it has resisted novelties of all kinds, such as liquefied natural gas, shale gas, spot sales, and exports to China and the Far East. It probably opposes shale gas for good commercial reasons, since it has ample supplies of cheap ordinary gas, but it has been conservative also in its contract policy, insisting on decade-long contracts with prices fixed to oil prices and specific volumes. Customers have been compelled to pay even if they have not taken delivery of contracted volumes, so-called take-or-pay conditions.
In spite of its administrative clout, Gazprom has lost out to two competitors on the domestic market, the privately owned and far more efficient Novatek and Rosneft. Russia’s gas production has been roughly constant since the late 1980s (fig. 4.1), whereas Gazprom’s production of natural gas has fallen steadily by 25 percent from 562 billion cubic meters (bcm) in 2009 to 419 bcm in 2016, and its share of Russia’s gas production has fallen from 85 percent to 65 percent. In 2017, however, Gazprom managed to reverse this trend by increasing its production by 12 percent to 472 bcm, thanks to larger sales to Europe. Unable to sell at capacity, Gazprom is considered to have a monumental surplus of some 100 bcm annually. In 2014, Gazprom lost its export monopoly on liquefied natural gas when Rosneft and Novatek gained the right to export the gas. Novatek is a crony company, in which Putin’s friend Gennady Timchenko owns 23 percent, while Putin’s close associate Sechin runs Rosneft.40
Fig. 4.1 Oil and gas production, 1989–2016. Source: BP historical data (2018)
Gazprom’s first liquefied natural gas project was the Sakhalin II development, initiated by a group of foreign companies led by Royal Dutch Shell independently of Gazprom. In 2007, Gazprom imposed itself on this project, taking over 50 percent at a price set by Gazprom. The first liquefied natural gas plant was commissioned two years later. Beginning in 1997, the reform of Russia’s public utility UES was a welcome improvement, but Gazprom reversed the attempt to establish an electricity market after it had purchased a large share of Russia’s power assets.41
Before December 2005, the trade in Gazprom shares was highly restricted even on the domestic market, but that month Putin issued a decree permitting foreigners to trade freely in Gazprom stocks. The price of Gazprom stocks multiplied. The government kept state ownership of 50 percent plus one share, allowing the rest of the stocks to be traded freely. Gazprom shares are mainly traded in London. For a couple of years, international investors loved Gazprom, driving its market capitalization to $369 billion in May 2008. Since then, it has slumped precipitously by 86 percent, lingering around $50 billion for the past couple of years. By contrast, the market capitalization of other international oil majors has fallen only moderately with lower oil prices.42
The Gazprom stock is traded entirely on the basis of its high dividend yield, at 5.7 percent in August 2018—that is, not as a normal stock but rather as a bond. The shareholders do not consider themselves as owners but rather as subject to state decisions about the dividends. Yet the miserably low stock price does not bother the Gazprom management. In 2015, JP Morgan Cazenove concluded: “Weak corporate governance which has been a drag for Gazprom investment case is now compensated by stronger commitment to dividend and better dividend yield. . . . The looming budget deficit makes the [Russian] government much more aware of the Gazprom dividend. The minority shareholders and the state are now finally in same boat in terms of requiring higher payout.” The finance company summarized its view of Gazprom: “Owning Gazprom has been a challenging experience for investors over the last several years. The stock underperformed the market and the sector and is currently trading near a 12-year low. There are internal and external reasons for this. First, the company, which employs almost half a million people, is seen as relatively slow and inefficient in decision making. Second, Gazprom is heavily involved in political developments related to Ukraine gas suppliers.” This situation has not changed.43
Gazprom has many objectives, most of them of dubious motive, and dysfunctional decision-making. Its foremost objective is the enrichment of the Putin circle. Its second goal is Russian geopolitics. Its third aim is an array of social objectives, notably making sure that the whole country is supplied with gas, but also the support of employment in remote company towns. Last, Gazprom is not altogether oblivious of commercial considerations.44
Throughout the years Gazprom has been accused of larceny, though the nature of the accusations has changed. In the 1990s and 2000s, the main concern was privileged arbitrage between different regulated prices and nonpayments. While these concerns linger, liberalization of gas trade has limited them. Boris Nemtsov and Vladimir Milov have detailed four kinds of corruption in Gazprom: privileged procurement, asset stripping, exclusive trade agreements, and stock market manipulation.45
For geopolitical reasons, Gazprom’s overwhelming ambition has been to avoid gas transit through Ukraine by building pipelines through the Baltic Sea—Nord Stream and later Nord Stream 2—as well as Turkish Stream.
But overinvestment in no-bid contracts, or capital procurement at excessive prices, is also the most important source of overpricing or undue enrichment. In a fine analysis, Troika Dialog assessed $37 billion or 70 percent of Gazprom’s capital investment in 2011 as “value destruction.” Most of these value-destructive activities amounted to “building capacity that cannot possibly be utilized in the foreseeable future,” both production and pipeline capacity.46
Gazprom’s capital expenditures vary swiftly with net profits. The most extreme year was 2011. Initially, Gazprom had planned for $27 billion of
capital investment, but as revenues unexpectedly skyrocketed with rising gas prices, Gazprom eventually “invested” $53 billion, almost twice as much. No efficient investment planning is possible with such short notice. It is difficult to avoid the impression that the Gazprom management was just shoveling money out of the door, as one investor saw the situation.47
Gazprom has regularly overinvested in pipelines that are not commercially viable. These contracts have been awarded to companies controlled by a few close friends of Putin (see chapter 5: Arkady Rotenberg and Gennady Timchenko). The excellent Russian investigative journalist Yulia Latynina, who has been forced to flee Russia, notes that Gazprom is planning a loss of $15 billion for 2017–2019, largely to pursue overinvestment in pipelines to be built by Rotenberg and Timchenko. When Gazprom built Blue Stream in the late 1990s, Hermitage Capital Management showed that Gazprom’s cost per kilometer of pipeline was 119 percent higher than on the Turkish side. The comparative costs have risen substantially since then and appear now to be three times higher.48
In spite of poor commercial performance, Gazprom’s managers are handsomely remunerated. According to Russian Forbes, Miller’s salary alone has been $25 million a year for many years, and he enjoys plenty of fringe benefits. The eminent opposition newspaper Novaya Gazeta published photos of “Millerhof,” the palace allegedly built for Miller in the Moscow region in 2008–2009. It is so called because of its reminiscence of Peter the Great’s palace Peterhof outside of St. Petersburg. Presumably to salvage Miller from the scandal, a big businessman closely connected with the Kremlin claimed it as his property.49
Russia's Crony Capitalism Page 13
