Petrostate: Putin, Power, and the New Russia

THE USSR IS NO MORE

The disintegration of the Soviet Union unleashed a cascade of centrifugal forces, both political and economic. In 1992, after the USSR broke up into fifteen independent and occasionally hostile countries, a Moscovite traveling to Kiev or Minsk could do so only if he had a passport for foreign travel. If that Moscovite tried to ship goods to Ukraine, Belarus, or Uzbekistan, he would have to send them through customs, pay a tariff, and accept payment for his goods in something other than rubles. None of this had been necessary before when they were all brother republics within the USSR. Equally disquieting, Boris Yeltsin, the hero in putting down the August 1991 coup attempt and the duly elected president of Russia, had serious drinking and health problems (both physical and mental). This made it impossible for him to focus properly on matters of state. Yeltsin had no problem forcing the breakup of the USSR and spinning off the other fourteen republics (including Ukraine and Belarus that were Slavic), which before the revolution were provinces of the Russian empire. But in an action that haunts Russia today, Yeltsin decided that Russia would not let anyone else split off from Russia and so ordered his troops to put down an insurrection in Chechnia, a relatively unimportant but problematic region within Russia’s boundaries. Unlike Ukraine and Belarus, which share Slavic ties to Russia, Chechnia is a Moslem rather than a traditionally Slavic region. It was forced into the Russian empire in the late nineteenth century. If instead Stalin had decreed that Chechnia was an independent republic like its neighbor Georgia, it too might have been spun off as a newly independent country and no one would have complained.

In addition to the political fragmentation, the breakup of the country and the disappearance of that unified economic space hit Russia very hard and pushed it toward bankruptcy. While the CIA in the 1980s once estimated that the Soviet Union’s gross domestic product (GDP) was about half that of the United States, by 1992 the agency concluded that the Russian GDP had fallen to about 10 percent of the U.S. GDP. Some economists such as Simon Johnson, Daniel Kaufman, and Andrei Shleifer suggest that this is an understatement. They argue that the official statistics do not reflect the full growth of the just legitimized private sector.¹ Given the turmoil of the times, that may be true, but there is little doubt that most of the traditional industrial sectors suffered badly. By 1996, for example, petroleum production, the country’s crucial sector, was off 47 percent from 1987. Some of the decline was due to poor production practices of the sort described earlier by the CIA. But even more important, the rivalry to privatize the various oil fields, refineries, and pipelines was at its peak and inevitably very disruptive. Equally discouraging, with oil prices in the mid-1990s hovering around a low $20 a barrel (in 2005 adjusted prices) there was not much incentive to increase productive capacity.

Virtually no Russian petroleum company increased production from 1990 to 1999. For many observers, it appeared that petroleum production was declining, almost as the CIA had predicted. Much of the industry was privatized in the mid-1990s and almost all the new owners seemed more interested in stripping and sending assets outside the country while they could still do so and before what many assumed would be a violent and far-reaching reaction. Capital flight from the country as a whole was thought to be on the order of $1 billion a month. To top it off, the country was racked with inflation (prices rose twenty-one-fold in 1992) and the government budget was running serious deficits because few of those who should be paying taxes did so.

The failure to pay income tax typified the problems encountered in the transition to a market-type economy. Private ownership became the new model, replacing central planning and state ownership of the country’s factories, stores, and farms. In the Soviet Union, state taxes were levied as a turnover tax included as part of a product’s retail price and so unnoticed by the buyer. The income tax that everyone paid also went unnoticed, having already been deducted from workers’ cash envelopes before they received them. In the same way, the enterprise income tax was also automatically withheld by the state. Consequently, there was no need to file an income tax form nor send in an individual tax payment. As a result, only a few economists were aware that the Soviet Union even had taxes. That is why it was common for Russians to insist that the Soviet Union was superior to the United States not only because it had no unemployment or inflation but because it had no taxes.

PRIVATIZATION AND CHAOS

When the state transferred ownership of all those stores and factories to private owners, all that changed. Since it no longer could make deductions automatically, beginning in the late 1980s the state had to find some way to induce the new private owners as well as individual wage earners, voluntarily on their own, to send in taxes. That was something the public had never done before. Few could be expected to do so voluntarily just because some state official said they should. Given that tax rates were 30 percent or more and that the state was ill prepared to chase after tax delinquents, it was not surprising that in 2000, even after nearly a decade of private ownership, only 3 million Russians out of the 70 million who were supposed to pay taxes actually did so.²

Similarly, after the transition, there was as yet no market mechanism in place where producers and consumers could meet, be informed, and deal with one another. In the days of the USSR, there was no need for such a market mechanism because Gosplan, the Central Planning Agency, and the various central ministries did the job, even if poorly. But after 1991, when Gosplan and the ministries lost their power to make such allocations, Russians seeking to acquire even simple things such as a mattress, a saw, or a jacket did not know where to go. Imagine then how difficult it was for a factory director in search of a ton of coal or a specialized machine tool to find what he was looking for. Russia’s retail stores had little or no experience in dealing with an independent manufacturer and supplier. Moreover, some of the supplies allocated previously by Gosplan came from factories that were now located in newly independent countries that no longer would take rubles. This was not only because it was no longer their local currency but because of the hyperinflation in Russia mentioned earlier.

For that matter, the privatization process itself was problematic. In an effort to win political support for his new bottom-up democracy, Yeltsin agreed to privatize the heretofore centrally planned, state-owned economy. The state issued every Russian citizen a 10,000-ruble voucher redeemable in newly issued shares of the enterprises being privatized. The intention was to ensure that every Russian would not only derive some benefit from the dismantling of the old system but would also have a vested interest in the success of the new market system. But after being subjected to seventy years of state propaganda against capitalism, few Russians understood why a share of stock in the new Russian companies was worth owning or had any value, especially at a time when Russia was in such a sorry economic condition. Not surprisingly, when the market value of their voucher fell to the equivalent of $25 and then $10, most Russians opted to sell their newly allocated voucher and its entitlement to a share of stock for a bottle of vodka or a few rubles. Vodka was concrete and pleasurable, rubles were tangible, but the stock was abstract and at the time little more than a piece of paper. So the vast majority of Russians had little more than a passing hangover or a few rubles to show for seventy years of communism.

Even worse, because of politics, greed, a flawed design, and corrupt implementation, a small number of investors ended up in control of most of the previously state-owned enterprises. One group of these newly rich, so-called oligarchs were former government officials. They simply took over ownership of the state properties that they had been managing as agents of the government. Another group of owners emerged from a seamier stratum of black market operators and money changers. While despised in the Soviet era for their anti-social black market activities, they nonetheless had learned how to operate in a shortage environment by mastering market practices even if they were illegal at the time. Consequently when markets and private ownership were legalized and no longer anti-social, these previously underground operators found themselves at a significant advantage. This group stood in marked contrast to the former government bureaucrats who were used to issuing decrees in the rigid world of state ownership, unconcerned by what the consumer might or might not actually want. These former bureaucrats found themselves ill-equipped to operate in a market environment where consumers had choices and could not be dictated to.

DIVIDING UP THE SPOILS

In this chaotic environment, in a short time a growing number of these newly rich oligarchs became billionaires. But that did not necessarily mean they were good managers. Certainly none were self-made men comparable to a Bill Gates of Microsoft, Edwin Land of Polaroid, Fred Smith of Federal Express, Steve Jobs of Apple, or Michael Dell of Dell Computers. Even those adept at adapting to the market derived most of their wealth from seizing what had been state assets and in a large number of cases by stripping assets from those companies. These enterprises, taken over by the new oligarchs, were spun off from previously state-owned enterprises within the country’s various ministries.

THE GAS INDUSTRY IS KEPT WHOLE

The case of the Ministry of the Gas Industry was different. Senior officials in the ministry fought hard to retain all the various properties within the confines of the ministry. They succeeded and in August 1989, the Ministry of the Gas Industry transformed itself intact into a corporation called Gazprom. This move kept the assets of the Ministry of the Gas Industry as a whole, ensuring that they would not be parceled out to various promoters—unlike the Ministry of Petroleum, which privatized what had been its wholly controlled producing fields, refiners, and pipelines. Initially the state owned all of Gazprom’s stock but gradually sold some of its shares to private parties. Nevertheless, because the state remained the dominant share owner, the minister of the Gas Industry, Viktor Chernomyrdin, made himself president and CEO of this entity.

Chernomyrdin had served a long apprenticeship in both the energy sector and the government. He spent his early years working at the Orsk refinery, which is located not far from Orenburg in the Urals. Then after his army service, he studied at the Kuibyshev Polytechnical Institute.³ From there he went to work for the Communist Party in Orsk and stayed until 1973 when he took a job as deputy engineer at the natural gas processing plant in Orenberg, near where he was born. He became director of that plant in 1978. His next move was to Moscow where he became an instructor for the Central Committee of the Communist Party. This trajectory put him in line to become deputy minister of the Ministry of the Gas Industry in 1982 and then minister in 1985.

This was also the year Mikhail Gorbachev became General Secretary of the Communist Party. Gorbachev began the reform process that ultimately led to the end of central planning and the state ownership of all the means of production. Anticipating the changes that were yet to come, in August 1989, Chernomyrdin transformed the Ministry of the Gas Industry into Gazprom, which became the country’s first state-corporate enterprise. The state was still in control but now this control was exercised through shares of stock, 100 percent of which were initially owned by the state.

This was an early indication of what was to happen in the future. But the mass privatization program did not begin until mid-1992 after Boris Yeltsin had taken over as president. In November 1992, Yeltsin authorized the conversion of Gazprom from a wholly state-owned joint stock company into a private joint stock company whose shares could be owned by both the state and private parties. In February 1993, Gazprom began to sell its stock to the public and by 1994, 33 percent of its shares had been purchased by 747,000 members of the public, most of whom were able to obtain a Gazprom share of stock in exchange for one of the vouchers the state had issued to every Russian citizen as part of the privatization process. Fifteen percent of the stock was also purchased and allocated to Gazprom employees. For the time being, the state retained 40 percent of the shares (although this was gradually reduced to about 38 percent).

Given Chernomyrdin’s success with Gazprom, in May 1992 Yeltsin chose him to be his deputy prime minister. He was promoted again in December 1992, this time to the top position as prime minister, a post he finally relinquished in March 1998, shortly before the financial crash of August 17, 1998.

When Chernomyrdin returned to a formal government position in May 1992, his deputy, Rem Vyakhirev, who had been deputy minister and then followed him to become vice chairman after Gazprom had been established, moved up again and took Chernomrydin’s place as both chairman and CEO.

Like Chernomyrdin, Vyakhirev also came with considerable experience as a natural gas and petroleum specialist. He was also a graduate of the Kuibyshev Polytechnical Institute. After stints in Samara (called Kuibyshev at the time) on the Volga and Orenburg and Tiumen in West Siberia, in 1983 Vyakhirev was appointed first deputy minister of the Ministry of the Gas Industry under Deputy Minister Chernomyrdin, who would himself be promoted to minister two years later.

With Chernomyrdin as prime minister and his old deputy as CEO and chairman of Gazprom, the state did not closely regulate Gazprom. Taking advantage of this, Gazprom paid very little in the way of taxes or dividends to its principal shareholder (the state). Not only did the state see little in the way of taxes or dividends from Gazprom while Vyakhirev was in charge, but many of Gazprom’s gas-producing wells, pipelines, and distribution entities were freely parceled out in unrestricted fashion to a wide collection of Gazprom executives’ wives, children, and mistresses. Some of the largest spin-offs were transferred to ITERA, a company relocated from Russia to Jacksonville, Florida.

THE PETROLEUM INDUSTRY IS BROKEN UP

While the ultimate fate of the Ministry of the Petroleum Industry was very different, initially its privatization began in much the same way. The first step, in September 1991, was to transform the Ministry of Fuel and Energy into a joint stock company called Rosneftegaz (Russian Oil and Gas) (see Figure 4). But unlike Gazprom, which remained more or less whole, Rosneft was soon subdivided into what would eventually be almost a dozen more or less independent entities. Vagit Alekperov, acting minister of the Petroleum Industry, was one of the first to see the industry’s potential. In November 1991, before the collapse of the USSR, Alekperov used his authority to set aside the Langepaz, Urengoi, and Kogalym petroleum fields and combine them into a package, call it LUKoil, and put himself in charge as the CEO. (Much earlier Alekperov had managed the West Siberian Kogalym region).⁴

The process of breaking out chunks of the former Ministry of Fuel and Energy continued and even accelerated after December 25, 1991, when the USSR split apart. In November 1992, Rosneftegaz was reduced to Rosneft. Two more companies, Yukos and Surgutneftegaz, were spun off in 1993. Vladimir Bogdanov took over as CEO of the latter, in essence the same producing combine he had supervised as a government manager under the Ministry. As for Rosneft, while bereft of LUKoil, Yukos, and Surgutneftegaz as of 1993, it nonetheless still produced more than 60 percent of the country’s crude oil output. The raids on it were far from over, but at the time it controlled twenty-six oil-producing regional associations and twenty-three refineries.⁵

As questionable as it may have been to allow two senior ministry executives to seize ownership for themselves of the billion dollar assets they had been operating, that was almost benign compared to the way the rest of Rosneft was privatized as part of what came to be called the Loan for Shares initiative.

LOANS FOR SHARES

What turned out to be the biggest and most controversial transfer of wealth ever seen in history began in 1995 and evolved out of a proposal conceived by Vladimir Potanin. At the time Potanin was deputy prime minister under Prime Minister Chernomyrdin. Potanin proposed the Loans for Shares plan as a novel way to compensate for the fact that so few Russian individuals (especially those who came to be known as oligarchs) or businesses were paying their rightful share of taxes. Without the tax revenue, the state could not pay its bills. Under Potanin’s plan, several of the banks newly opened by the oligarchs would offer to lend the government money so it could pay its bills. As collateral for those loans, Potanin proposed that the state turn over shares of stock in several of the country’s petroleum companies that had not yet been fully privatized. Once the state had collected its taxes, the loans would be repaid and the collateral—that is, the shares of stock—would be returned by the bank to the state. If for some reason the loans could not be repaid, the banks, on behalf of the state, would then be authorized to auction off the collateral they were holding. After they had taken out the money they were owed, the banks would then turn the remaining proceeds over to the state.

Given the climate of the time and the rush to seize state assets, not surprisingly, this turned out to be a massive scam. Everyone knew from the beginning that there was little likelihood that the state would be able to collect the taxes it needed to repay the bank loans. How could it when the oligarchs themselves and their companies, as well as their banks, were among the largest tax delinquents? As for the auctions, almost all of them turned out to be rigged. Foreigners and most other viable bidders were excluded from the bidding. With the number of bidders sharply limited, it was no wonder that in virtually every case, the auction winner turned out to be the bank running the auction itself, or its straw or accomplice, and for a price that barely covered the amount of the loan. It was part of the Loans for Shares scheme that allowed Mikhail Khodorkovsky and his Menatep Bank to end up as the owners of Yukos that was also spun out of Rosneft, bidding a mere $309 million. (Not pocket change but cheap for even a poorly operating oil company. It soon had a market value of $15 billion.)

In a somewhat similar pattern in July 1997, Mikhail Fridman—a colorful figure whom we will turn to shortly—used his Alfa Bank and Renova, a holding company, to win control of Tyumen Oil (TNK). Subsequently, after a very contentious legal and public relations battle, TNK joined up with its one-time rival, BP, to form the TNK-BP 50–50 partnership.

Since it was Potanin’s idea, it would have been unfair if he had not been able to benefit from his own program. Not surprisingly, therefore, in addition to the modest $170 million he paid to acquire Norilsk Nickel, which once privatized became one of the world’s largest nonferrous metal conglomerates (its profits in 2000 were reported to be $1.5 billion),⁶ Potanin and his OneksimBank also won control of the oil company, Sidanko, for $130 million. This had been one of the Ministry of Petroleum Industry’s operating units located in West Siberia, and it, like the other privatized oil companies, was spun out of Rosneft.

The duo of Boris Berezovsky and Alexander Smolensky were more devious in their efforts. Berezovsky, who at the time had close relations with the Kremlin, particularly one of Boris Yeltsin’s daughters, was behind the August 29, 1995, Presidential Edict which spun off Sibneft from the Ministry of Energy and Rosneft. Alexander Korzhakov, Yeltsin’s one-time bodyguard, claims that as part of the deal, Berezovsky promised Yeltsin that if he were given ownership of Sibneft, he would then see that ORT, the TV network Berezovsky controlled, did all it could to back Yeltsin in the 1996 campaign for reelection as president. Not surprisingly, the bidding process for Sibneft was even more opaque than normal. In a December 1995 Loans for Shares auction, a heretofore unknown company FNK (Finansovaia Neftyanaia Kompaniia— Financial Oil Company), acquired 51 percent of Sibneft shares for a paltry bid of $100 million, plus the promise that more money would be invested subsequently.⁷ FNK turned out to be a front for Alkion Securities, which turned out to be 100 percent owned by SBS/AGRO, which— surprise, surprise—was run by Alexander Smolensky in partnership with Berezovsky. As a further indicator of how rigged the whole process was, the auction for Sibneft was conducted by the Neftyanaia Finansovaia Kompaniia or NFK (note the similarity in name and initials), which turned out to be controlled by Berezovsky.⁸

The owners of the two already privatized petroleum companies— Vladimir Bogdanov, the CEO of Surgutneftegaz and Vagit Alekperov of LUKoil—also used Loans for Shares to enhance their personal stock holdings. But at least they had spent many years working out in the oil fields and managing petroleum production. By contrast, almost none of the future owners of the other oil companies, that is, Potanin, Fridman, Berezovsky, and Smolensky, had had much prior experience in the petroleum industry. Khodorkovsky had spent several months as a deputy minister of Fuel and Energy in 1993. But after he took over Yukos and went to look over his company’s newly acquired oil fields in Nefteyugansk to “learn how the drilling process works,” his host Vladimir Petukhov, the mayor of Nefteyugansk and an oilman with a doctorate in oil technology, was appalled to discover that Khodorkovsky, despite that stint in the Ministry of Fuel and Energy, had never seen an oil field before.⁹

EVERYONE WANTS TO BE A BANKER

To understand how Potantin, Berezovsky, Smolensky, Fridman, and Khodorkovsky managed to be in a position to bid for these large petroleum companies, it is necessary to detour a bit and explain how they came to establish their own banks. After all, only a few years before, none of them had any net worth to speak of.

With so little to begin with, how did they manage by 1997 to become billionaires? The explanation is that all five were able to take advantage of the Russian public’s enormous hunger for consumer goods they had been denied for more than seventy years under Soviet central planning. The demand for personal computers (then a relatively new invention and in any event rare in Russia) was particularly intense. It also helped that when it became legal to establish private commercial banks for the first time in 1987, the capital requirement was the ruble equivalent of only $750,000. As trivial as this was, because of inflation by 1990 the equivalent in rubles amounted to as little as $75,000 in real terms.

The case of Mikhail Fridman is typical. The son of an academic father, Fridman, after graduating from the Moscow Institute of Steel and Alloys, worked in a steel mill for two years from 1986 to 1988.¹⁰ Although trained to work in a Soviet state-owned factory, even as a student, Fridman began to take odd jobs on the side. Among other chores he washed windows, organized a discotheque, and did construction work. In 1987, when it became legal to set up a private or cooperative business, he opened Kuryer, a cooperative that offered such services as package delivery, window washing, and assistance with apartment rental. None of these activities required much in the way of startup capital—all they needed was labor. But as he began to accumulate a little capital, he began importing sought-after Western consumer goods, including cigarettes, perfume, computers, and even Xerox machines. He also opened up a network of photo labs. Then in a very distinct departure from such retail operations he opened a commodity trading firm. In January 1991, while Gorbachev was still president of the USSR, Fridman took his newly accumulated capital and established the first office of Alfa Bank. To do this, he needed 6 million rubles which at the time was the equivalent of $100,000, a relatively small amount for the capital of a bank.¹¹ It was through Alfa Bank that in July 1997 Fridman, in partnership with Access Industries—a company established in the United States by Leonard Blavatnik, a Russian émigré—was able to purchase 40 percent of Tyumen Oil Company’s shares for a bid of $810 million. In doing so Fridman and Blavatnik became the effective owners of the company in much the same way Alexander Smolensky began to build his fortune by performing similar odd jobs. They too required little in the way of capital, but if such services were to be performed legally through official Soviet central planning channels, the customer would have had an enormous wait, sometimes months if not years. There seemed to be shortages of almost everything, including plumbers, carpenters, and general repairmen. For that reason, many Russians were willing to pay something extra under the table to have the work done right away. To illustrate how bothersome the shortages and delays were, the Russians delighted in telling the story about Ivan. He had been waiting and waiting for six or seven years to buy his own automobile. After waiting all that time, he finally was notified to appear July 1, 1980, at the regional office of the Ministry of Trade.

“I have good news for you,” said the clerk. “Your car will be delivered to you five years from now on July 1, 1985.”

“Wonderful!” Ivan replied. “But will it be in the morning or the afternoon?”

“What difference does it make?” asked the puzzled clerk. “That is five years from now.”

“Well, I have to be home that morning because it’s the only time I could arrange for the plumber to come.”

Smolensky began to build up his fortune by specializing in construction work. The Russians had a special term for such private work crews—they were called shabashniki. While it was difficult enough to find anyone willing to do such work, it was more difficult to find work tools and construction supplies, even such simple things as two-by-four lumber and hammers and nails. Recognizing an opportunity, Smolensky began to buy up such products where he could and on occasion even manufactured these items and sold them to other moonlighting entrepreneurs.¹² All such private activities were illegal and classified as economic crimes. Eventually Smolensky was found guilty of using government printing presses to sell Bibles for private profit and sentenced to jail for two years for just such an economic crime. In 1987, when Gorbachev finally made such activities legal, Smolensky set up the Moscow No. 3 Constructive Cooperative. On February 14, 1989, two years before Fridman did the same thing, Smolensky took the rubles he had accumulated and established what he called the Stolichny (Capital) Bank. He later expanded the bank by buying up Agroprombank, which had been a state-owned bank designed to provide banking services to rural areas. Combining the two banks, he changed the name to Stolichny Bank Savings/Agro or SBS/Agro. Together with Boris Berezovsky, in December 1995 and then again in September 1996, the two men won majority control of Sibneft in one of the Loans for Shares auctions discussed earlier (see Figure 4). The SBS/Agro bid for control of Sibneft was only $100.3 million. Not bad for an asset worth upward of $10 billion.

In the case of Vladimir Potanin, he managed to build up his OneksimBank not so much by using his own labor but by subverting government agencies to his own personal ends. Like his father, Potanin worked for a Foreign Trade Organization (FTO) under the Ministry of Foreign Trade. These FTOs were set up to import and export goods on behalf of the state and to act as agents of the various state enterprises which themselves were not authorized to engage in foreign trade. Only the FTOs were allowed to have foreign currencies. In Vladimir’s case, his FTO was Soiuzpromexport and it specialized in the export of nonferrous metals.¹³ After he saw how others were enriching themselves with their newly created cooperatives, Potanin decided to capitalize on his own specialization by creating a cooperative that would do privately what he had been doing on behalf of the government. Leaving the government, he created a cooperative called INTERROS that began to trade in nonferrous metals. Next he decided he needed his own bank. To generate the capital he needed, he took advantage of his former government connections and supplemented his own money with borrowed funds from Vneshekonombank, the state-owned foreign trade bank. Once he had the required capital he used it to open OneksimBank, yet another in the series of personal banks established by these newly rich oligarchs.

To ensure the continuation of the privatization process, Potanin along with most of the other oligarchs used his bank to finance Yeltsin’s presidential campaign effort. They all worked together to defeat Yeltsin’s main rival and critic of the privatization process, Gennady Zyuganov, head of the Communist Party. As a reward for his support, in August 1996, after the election, Yeltsin appointed Potanin first deputy prime minister. After a short time, however, Potanin left office in March 1997 to go back full time into business. He did not return empty-handed. With the help of his Loans for Shares program, Potanin ended up owning twenty former state enterprises. These included not only the petroleum company Sidanko, which in late 1997 joined in a partnership with the British firm BP, but in an equally good deal, he won ownership of Norilsk Nickel, a company that produces one-fifth of the world’s nickel, two-thirds of its palladium, and one-fifth of its platinum. As the profits of his company INTERROS began to grow, he expanded it into foreign markets, including the United States. There it bought up the QM Group, a nickel-producing company in Cleveland, and Stillwater Mining, a palladium and platinum producer in Montana.¹⁴

Given how low the price of petroleum and ferrous and nonferrous metals was in the 1990s, ownership of these Russian companies did not always look like the bargain it would become once commodity prices began to rise and oil prices hit $30 a barrel or more. Yet even in the mid-1990s, when prices were low, there was a growing awareness that the Loans for Shares scheme benefited an opportunistic and unscrupulous few at the expense of the state. More than that, the victors frequently quarreled among themselves and on occasion settled their disputes with mayhem and occasionally murder.

PLAYING HARDBALL

None of the oil oligarchs was willing to give a potential challenger the benefit of any doubt. TNK (Tyumen Oil) was particularly aggressive. In one instance that was not widely publicized, NOREX Petroleum of Canada charged that in June 2001, TNK and its parent bank, Alfa, sent in “machine gun-toting guards” to seize the production facilities of Yugraneft in Siberia. NOREX insists that at the time, it owned 60 percent of the shares of the company and that it, not TNK, was the governing partner in their joint venture.¹⁵ TNK has justified its decision to send in its armed guards by claiming “that NOREX’s capital contribution in the form of ‘know how’ had been improperly valued.” In other words, NOREX did not own as large a share of the joint venture’s capital as it claimed. Using that as a justification, TNK argued that NOREX was obligated to surrender its operating control of Yugraneft.¹⁶ Since NOREX refused to yield control, TNK says it had no choice but to send in its armed persuaders.

In much the same spirit and in another equally brazen move, TNK also decided to take over ownership of the Chernogorneft oil fields in West Siberia. TNK wanted these fields because they were adjacent to TNK’s big Samotlor Field. It made sense to combine these two fields to prevent one company from attempting to draw oil from underneath its neighbor’s reservoirs. When that happens, the pressure is reduced and output in both fields is less than it otherwise would be. At the time Chernogorneft was owned by Potanin’s Sidanko and Potanin’s new junior partner, the U.S. oil company, Amoco, to which he had sold a 10 percent interest. Amoco in turn was purchased a short time later by BP.¹⁷

To gain control of Sidanco and its Chernogorneft fields, in October 1998 TNK arranged for a minor creditor to sue Chernogorneft in a provincial court for an unpaid bill of only $50,000. Two months later the local bankruptcy judge declared that because it had not paid this bill, even if a trifle, Chernogorneft was indeed bankrupt. (Once a company is declared bankrupt, it is too late for the parent company to try to pay off the debt.) The judge then assigned its assets (which were more than adequate to pay off the rather trivial $50,000) to a creditor who turned out to be a front—surprise, surprise—for TNK. The suit did nothing to enhance Russia’s reputation for adherence to honest and ethical business codes, especially when it became known that the bankruptcy judge was an appointee of Leonid Roketsky, who at the time was governor of the Tyumen Region. That was not the problem. The problem was that in his off hours, Roketsky also just happened to be the chairman of TNK. Simultaneously, a straw subsidiary of TNK bought up 60 percent of Chernogorneft’s debt. By the time the judge was finished, TNK had become Chernogorneft’s effective owner. As a result, BP had to write off $200 million of its investment in Sidanco.

Seeking revenge, BP launched an attack on TNK that eventually involved both Madeleine Albright, then the secretary of state, and Dick Cheney, then the CEO of Halliburton, the petroleum service company. In an effort to enhance its productivity in its oil fields, TNK signed a $198 million contract with Halliburton for the purchase of its services and access to more advanced technology. To finance this, Halliburton and TNK applied for a loan from the U.S. Export-Import Bank in Washington. Angry that an official agency of the U.S. government had agreed to underwrite what it viewed as the theft of its property, BP protested to Secretary of State Albright, who found a way to abort the loan. After some bitter recriminations on both sides, however, BP and TNK kissed and made up, and in August 2003, in the presence of Vladimir Putin and British Prime Minister Tony Blair, the heads of both companies agreed to form a TNK-BP 50/50 partnership that would operate TNK’s assets under BP management within Russia. BP later encountered some problems as the Russian government adopted a more hostile attitude toward foreign involvement in the Russian energy sector, especially in cases where foreigners own as much as 50 percent of the venture. Despite occasional statements to the contrary, Putin made it very clear that while he was happy to have foreign investors put their money in Russian energy companies, he did not want foreigners running them. In September 2007, he made it explicit, complaining that too many foreigners were managing Russian companies. Reflecting that same xenophobia, there were widespread rumors that Putin would arrange for the state to buy out TNK-BP’s Russian partners.¹⁸ Then once it owned 50 percent of the TNK-BP venture, the state would move to reduce BP’s share to below 50 percent or push it out completely. Dick Cheney, of course, went on to become vice president under George W. Bush. Before long, he found himself being blamed because the United States had become mired in Iraq, so neither TNKBP or Cheney has lived happily ever after.

PETROLEUM OUTPUT DECLINES

Such infighting did nothing to advance the interests of the state or petroleum production. For eight years oil production continued to decline. By 1998 it was about 60 percent of what it had been at its peak. In desperation to break out of the yearly decline and in an effort to spark new output, just as it had seventy years earlier, the Russian government grudgingly allowed foreign companies such as BP to acquire an equity in Russian energy ventures, especially as it sought to develop some of the more remote offshore and Arctic locations. To make it worthwhile for Western companies to tackle the very difficult working conditions offshore near the island of Sakhalin and in northern Siberia, fields that required technology that Russians companies lacked, the Russian government agreed to sign three Production Sharing Agreements (PSA) with foreign companies, something it had been reluctant to do earlier. A PSA is more attractive to an oil company than a regular operating agreement because it allows the oil company to recoup all of its costs before it has to share any profits with the state. For the same reason, states do not like to make such concessions because they feel they should share immediately in the resulting revenue.

One PSA was offered to the French company Total as an inducement for it to undertake the development of the Kharyaga field in Timan-Pechora. According to the geologist John Grace, no Russian company seemed to be able to work with the poor quality oil in the field. The other two PSAs were offered in an effort to attract developers to the island of Sakhalin. The first PSA was signed in June 1994 with a consortium led by Royal Dutch Shell, which agreed in exchange to work the Sakhalin II offshore oil and gas fields. Because of the extreme weather, it is impossible to work there in the winter months. Shell agreed to put up 55 percent of the equity with two Japanese partners, Mitsui, which took 25 percent, and Mitsubishi, which took the remaining 20 percent. Notice that there were no Russian partners in the Sakhalin II project. By contrast, in the Sakhalin I consortium signed a year later, Sakhalinmorneftegaz was included with a 11.5 percent equity and Rosneft with 8.5 percent. But because they too lacked the technology and experience of working in Arctic offshore conditions, it was agreed that Exxon-Mobil would serve as the lead partner with a 30 percent share. The other partners were SODECO, a Japanese company with 30 percent, and an Indian company, ONGC Videsh, with the remaining 20 percent.¹⁹

The Russian government agreed to these PSAs with great reluctance and only because the authorities were so eager to halt the slump in petroleum and natural gas production. Russian oil companies, including Yukos and its owner, Mikhail Khodorkovsky, led the opposition to PSA concessions.²⁰ He and some others viewed the offer of a PSA for a foreign company as a form of unfair competition. But with petroleum prices barely rising above $10 a barrel in 1999 and output 40 percent below its 1987 peak, the prospects for a recovery in petroleum and gas production were not very good. Thus as in times past, Russia was forced to make concessions to obtain the help it needed. However, in a repeat of history, as soon as it felt confident enough to operate on its own, it moved to invalidate those same concessions.