Petrostate: Putin, Power, and the New Russia

IT WAS NOT THE BEST OF TIMES

It was not an auspicious beginning for the new prime minister. Having been the head of the FSB (the modern day KGB), Vladimir Putin certainly was aware of the problems confronting his country, but awareness of problems is not the same thing as coping with them. And Russia had problems. In August 1999, it was still reeling from the financial bloodletting of August 17, 1998, twelve months earlier. In the wake of the government default on its debt, most of the country’s larger private commercial banks had shut their doors—some, such as Togobank, forever. Millions of Russians lost their savings, including former president Mikhail Gorbachev and the director of the Marinsky Opera of St. Petersburg, Valery Gergiev.

For the Marinsky, this was nearly catastrophic. Gergiev had set aside $2 million in his bank to pay for the ensemble’s trip to China. Now the bank was closed and its money gone. Had Phillips Electronics of the Netherlands not come to the rescue with $1 million, the famed St. Petersburg ensemble would have been forced to cancel its tour. Others without such a fairy godcorporation to turn to were not so fortunate. Businesses closed down, staffs were fired, and the whole concept of a market economy was cursed.

Investors fared no better. They watched helplessly as their portfolios went to zero. The RTS index (the Russian counterpart of the Dow Jones Index of Russian stocks) had been one of the world’s best performing indices prior to October 1997. But that was then. As we saw, from a high of 571, the index fell to 39 by October 1998, a mere twelve months later.

It was not only the well-off who suffered. As industrial output declined and unemployment increased, the number of Russians below the poverty level, which had fallen to 21 percent in 1997, suddenly soared to 33.3 percent, a new high. Western companies exporting to Russia were also hit. With the devalued ruble, few Russians could afford the cost of imported dollar- or euro-denominated products.

If it was not a good time to be in business, neither was it a good time to be in government. Within the subsequent twelve-month period, President Boris Yeltsin went through four prime ministers. Looking for a scapegoat, a week after the crash on August 23, 1998, Yeltsin fired Sergei Kiriyenko, a financial specialist and the presiding prime minister at the time. He was replaced with Evgeny Primakov, who lasted eight months—until May 1999. Yeltsin then appointed Sergei Stepashin. After barely three months in office, Stepashin was also pushed aside. His replacement was Vladimir Putin. Unlike Primakov and Stepashin, both of whom had also headed the FSB, as the KGB subsequently became known, Putin apparently was more amenable to ensuring Yeltsin that he and his ambitious daughters would be guaranteed legal immunity from any future investigation into contract kickbacks. From all reports, they needed such protection. It was widely rumored that the daughters had pocketed tens of millions of dollars from Swiss companies that had won contracts to refurbish the Kremlin and the Russian White House, among other projects. Reflecting the temper of the times, jokesters enjoyed recounting what happened to the Moscovite who one day drove his car into the Kremlin compound and parked it. Immediately a policeman ran up to him shouting, “You can’t park your car there. That’s right underneath Yeltsin’s window!” “Don’t worry, don’t worry,” calmly replied the driver. “I’ve locked the car.”

One month after his appointment as prime minister, Putin moved immediately to tighten control. He ordered government troops to return to Chechnia to reassert Russia’s authority there. This was done in response to the bombing of some Russian apartment houses by what appeared to be Chechen terrorists as well as the incursion into the adjoining province of Dagestan by a Chechen group led by the Chechen leader Shamil Basayev. Who actually bombed the apartment building remains in dispute. Some, such as the one-time oligarch Boris Berezovsky now in exile in London, insist that the available evidence implicates the FSB, not the Chechens. Whoever the actual bombers were, Putin used the apartment bombing, as well as the Dagestan invasion, to justify stronger measures from the Kremlin. By doing so, he put an end to dreams of any other secessionist malcontents in the regions who might have entertained similar notions of establishing an independent country.

THE ECONOMY RECOVERS

Putin’s determination to reestablish Moscow’s dominance over some of Russia’s restless regions was enhanced by the fact that five months before his appointment the economy began to improve. As Table 5.1 shows, in September 1998, industrial production was 15 percent below production of September 1997, but by March 1999 it once again began to grow.

By August 1999, when Yeltsin made Putin prime minister, industrial production was already roaring along. In May 1999, for example, industrial output exceeded that of the previous May by 6 percent. Fortunately for Putin, he took office just as the Russian economy began to benefit from the recovery in Southeast Asia, the region that had triggered the economic downturn the year before. In all fairness, if anyone deserves the credit for the economic upturn, it should be Primakov because the improvement began in early spring 1998 when he was prime minister. But more than the actions of any one prime minister or Kremlin official, the best explanation for the recovery is that the recovery in commodity prices, particularly petroleum prices, made the difference.

Because of the increase in oil prices, Russia’s rebounding economy would make whoever was in office at the time look like an economic genius. To his credit, Putin did nothing to hamper economic growth. On the contrary, he brought in some of his talented associates from St. Petersburg, such as German Gref and Alexei Kudrin, and put them in charge of reviving the economy. They had previously worked with Putin on economic and financial matters in the St. Petersburg governor’s office and were regarded as competent technocrats. (We can include them as “FOP,” Friends of Putin.) Following their advice, Putin introduced a flat 13 percent income tax and proposed a series of other initiatives, including a program to simplify and reduce the bureaucratic maze that entrepreneurs had to fight through before they could open a new business.

While the benefit of a flat tax as a stimulus to economic growth is hotly debated in the United States, it appears to have done little damage when it was introduced in Russia; to the contrary, based on the way Russian GDP grew, it seems to have had a positive impact. Previous to its passage, the maximum tax rate was set at 30 percent. Few Russians were paying any tax, much less their required share. Clearly, a low tax was better than no tax. With the rate at only 13 percent, Russians had less incentive to cheat.

In a departure from the propaganda of the Soviet era, Putin also insisted on acknowledging the seriousness of the country’s economic condition. While Russia may have thought of itself as an economic superpower in the Soviet era, by 2000, Russia’s per capita income was actually lower than Portugal’s, then the poorest member of the European Union. Putin acknowledged that if Russia were ever to catch up, it would have to double its GDP in ten years. It could do this, however, only if it increased its GDP by at least 7 percent a year, a goal that he set for the country. Except in 2001 and 2002, Russia did come close to this although its growth was consistently due to high world energy prices more than a revitalized manufacturing sector (see Table 4.1).

The improvement in Russian GDP certainly added to Putin’s popularity. Yet the GDP is still not large enough to provide for a superpower’s military force, at least not one that would measure up to previous Soviet standards. Nonetheless, Putin has substantially increased the size of Russia’s military budget, by 27 percent in 2005 and 22 percent in 2006. But unless he severely curbs consumption, Russia will not be able to afford the large funds needed to support its superpower military ambitions.

A ROAD MAP TO SUPERPOWER STATUS

Putin’s concern for Russia’s struggling economic and lost superpower status long predates his appointment as prime minister. In a dissertation submitted in June 1997 to the St. Petersburg Mining Institute and in a subsequent article “Mineral’no-syr’evye resursy v strategi razvitiia Rossiiskoi ekonomiki,” published in Zapiski Gornogo Instituta in 1999 and translated by Harley Balzer in Problems of Post-Communism in January 2006, Putin outlined a plan, a sort of “owner’s manual” for Russia’s recovery and return to economic and political influence. The thesis itself was probably written just before and after his boss Anatoly Sobchak, governor of St. Petersburg, lost his reelection in 1996. Since Putin worked for Sobchak, this loss meant that Putin was also without a job.

In his dissertation Putin called on the Russian government to reassert its control over the country’s abundant natural resources and raw materials. “The process of restructuring the national economy must have the goal of creating the most effective and competitive companies on both the domestic and world markets.” He viewed this as probably the best way to reestablish Russia’s status as a superpower, an energy superpower. Instead of allowing the country’s oligarch-controlled corporations to focus exclusively on making a profit, Putin proposed that they should be used instead to advance the country’s national interests. To reclaim some of the assets spun off to private interests under Yeltsin, Russia should commandeer these companies and once again integrate them vertically into industrial conglomerates so they could compete better with Western multinational corporations such as Exxon-Mobil and Shell. In Putin’s words, “Regardless of who is the legal owner of the country’s natural resources and in particular the mineral resources, the state has the right to regulate the process of their development and use. The state should act in the interests of society as a whole and of individual property owners, when their interests come into conflict with each other and when they need the help of state organs of power to reach compromises when their interests conflict.”¹

In Putin’s thesis, he acknowledged that Russia would have a hard time becoming a competitive manufacturer. In a subsequent article, he also warned that if Russia’s economy continued to be isolated too long from world markets, its technology would never be competitive.² Even in 1997, when the economy seemed to be booming, it needed large injections of capital to help develop those resources. To attract that capital, he proposed that Russia open its heretofore closed doors to foreign direct investment. Russia should welcome the infusion of foreign capital investments, but those investors must understand that Russia would retain operating control, investment or no investment. He stressed, however, that no matter who legally came to own Russia’s commodity-producing companies, whether private parties or foreign corporations, the state should coordinate and regulate their activities. As he saw it, if left on their own, private owners become too absorbed in pursuing their own interests and are more interested in damaging their competitors than helping the state. They become so self-centered they ignore legitimate state interests. He insisted that it is a mistake to rely on the private owners and markets alone.³ When Russia did that in 1991, the country’s production suffered badly. Moreover, private monopolists obstruct innovation.⁴ By redeclaring control if not ownership, particularly of these resource-based companies, Russia, he argued, has the potential to emerge “from its deep crisis” and restore “its former might.”⁵

NATIONAL CHAMPIONS

This thesis was written considerably before Putin became head of the FSB. No one, including Putin, could have dreamed in 1996 or 1997 that he might someday be appointed prime minister as he was in August 1999, much less acting president five months later. In this thesis, Putin emphasized the concept of what he and others have come to call “national champions.” But Clifford Gaddy of the Brookings Institution, has found that this notion of “national champions,” which became so important during Putin’s presidency, actually did not originate with Putin. In a remarkable piece of textual detective work, Gaddy and his Russian assistant, Igor Danchenko, discovered that almost sixteen pages of Putin’s dissertation, “The Strategic Planning of the Reproduction of the Resource Bases,” were copied almost intact from an earlier 1978 study entitled, “Strategic Planning and Policy,” written by two University of Pittsburgh analysts, William King and David Cleland.⁶ Their book was subsequently translated into Russian and Putin includes it in his bibliography, but there is only a single citation of it in the text.⁷

Regardless of whose idea it was originally (Charles de Gaulle advocated something similar when he was president of France in the 1950s), as soon as he became president, Putin took it as his own and began to create his own national champions. As he envisaged it, these national champions would put promotion of the state’s interest over profit maximization. At home that might mean keeping energy prices low as a form of subsidy for the public. Outside Russia, it might mean suspending deliveries to countries that refuse to support Russian foreign policy or advance its interests. These national champions would most likely be more than 50 percent owned by the Russian government. But with the right type of guidance and pressure, there was no reason that predominantly private companies could not also serve as national champions. Should there be times when a private company might decide to rebuff state guidance, the state should use its powers to induce compliance. That might involve sending in state tax auditors or inspectors from the environmental agencies to check for wrongdoing. In the case of petroleum or gas producers, refusal to go along with the state or advocating undesired initiatives could be remedied by refusing such mavericks access to Russia’s oil and gas pipeline monopolies that control shipment to both domestic and foreign markets.

FROM BLUEPRINT TO ACTION

As a first task in initiating his national champion program, Putin staffed Russian state-owned companies with leaders who would be more amenable to doing his and the state’s bidding. This meant that he had to remove some of Russia’s more notable and powerful oligarchs from their only recently privatized companies. As an indicator of Putin’s success in reclaiming the state’s ownership of the country’s oil output, when he took over as president in 2000, the state’s share of total crude oil production was 16 percent; by late 2007, it had increased to about 50 percent.⁸

Almost immediately after his election as president in March 2000 Putin set to work. Just three months later in June 2000, he forced Viktor Chernomyrdin out of his sinecure as chairman of Gazprom’s board of directors, a post he had acquired only a year earlier in mid-1999 (see Table 5.2). In the Soviet era, Chernomyrdin had been minister of the Gas Industry. In 1989, only two years before the collapse of the Soviet system, he took the initiative in transforming his ministry into “Gazprom Konsern,” making himself its president in the process. In late 1992, Gazprom Konsern was carried one step further and became the Russian joint stock company, Gazprom (RAO Gazprom).⁹ Described by Jonathan P. Stern as the “partly privatized joint stock company,” RAO Gazprom in February 1993 was in turn transformed into OAO Gazprom, an Open Joint Stock Company.¹⁰ As we saw in Chapter 4, until mid-2005 when Putin arranged for the state to buy 50 percent plus one share of Gazprom’s stock, the Russian government held only 35–40 percent of the company’s shares.¹¹

Appointed by Yeltsin as deputy prime minister of Russia in mid-1992, Chernomyrdin made sure that in his absence Gazprom was well provided for. Rem Vyakhirev, who had served under Chernomyrdin as vice chairman of the Ministry of the Gas Industry, succeeded Chernomyrdin at Gazprom and in mid-1992 became its CEO. A few months later Yeltsin promoted Chernomyrdin to the post of Russia’s prime minister. Given the incestuousness of all these arrangements, it was not much of a surprise to learn that Gazprom under Vyakhirev became one of the largest financial angels backing Chernomyrdin’s party in the December 1995 election for the Duma. It did the same a few months later in June 1996 when Yeltsin ran for reelection as president. Reflecting the closeness of their relationship, wags transformed Chernomyrdin’s party slogan, “Nash Dom, Vash Dom (Our Home, Your Home),” into “Nash Dom, Gazprom (Our Home, Gazprom).”

By March 1998, Yeltsin had begun to suspect that Chernomyrdin was taking his job for granted and on a growing number of occasions had begun to act as if he were president, not Yeltsin. Consequently, Yeltsin removed him as prime minister. To soften the blow, Yeltsin made Chernomyrdin chairman of Gazprom, a homecoming of sorts. That was all pre-Putin.

The care and feeding of the Gazprom executives that characterized the Yeltsin and Chernomyrdin years changed abruptly in June 2000 after Putin won election as president. At the time it did not seem as though Putin was accomplishing very much, but looking back at his first year in office, the firing of Chernomyrdin that June was just the kickoff of a concerted campaign.

During the same month, Putin also went after the first of the “upstart” or non-”nomenclatura” oligarchs (see Table 5.2). For the most part, these were newly rich oligarchs who in Soviet days had never been included in the party or government hierarchy, officially referred to as the nomenclatura. In fact, most had one non-Russian parent and in some cases should not have been listed as Russian on their internal passports, an important prerequisite for anyone in Russia seeking inclusion on the nomenclatura list that identified who was important in the Soviet Union. And as we saw, many had also been involved in private or black market activities—what the Soviet Union classified at the time as “economic crimes.”

RECLAIM THE TV NETWORKS

One of Putin’s first targets among this group was Vladimir Gusinsky. He headed Media-Most, a media company that encompassed NTV, the country’s largest private TV network, as well as several newspapers and magazines. Gusinsky had created that media empire in just a few years. To a Kremlin unused to a TV network that was not controlled by the state, Gusinsky had a well-deserved reputation in the Kremlin as “a pain in the neck.” Yeltsin was the first to feel his bite. Gusinsky’s NTV was particularly critical of the Yeltsin government’s 1994 war with the Chechens. In retaliation, in December 1994 Yeltsin’s bodyguards, led by Alexander Korzhakov, physically attacked Gusinsky’s bodyguards, forcing them to lie in the snow outside Gusinsky’s office in what became known as “the faces in the snow” incident. But as angry as Yeltsin and his family were over the way they were criticized and satirized by NTV, particularly in Kukely, a weekly puppet television show, Yeltsin never moved to close Gusinsky’s company or jail him.

As Gusinsky would soon learn, Putin had a much thinner skin. After Putin sent troops back into Chechnia in 1999, NTV resumed its criticism—only this time Putin, not Yeltsin, was the target. Gusinsky understood there was a change in leadership and understood there was a risk to him and his media empire. In a conversation in Moscow in March 2000, the week before Putin was elected president, Gusinsky acknowledged to a group of us from the Jamestown Foundation that such outspoken criticism of Putin might cause problems for him, his staff, and his network. But he and one of his senior assistants insisted at a late-night dinner before Putin’s expected victory that they would not pull their punches.

Perhaps they should have. Three months later in June 2000, only just installed as president, Putin had Gusinsky arrested on charges of embezzling funds from a St. Petersburg company.

STAY OUT OF POLITICS

In contrast to Yeltsin’s tolerance of criticism, Putin summoned twenty-one of the country’s new oligarchs to a Kremlin meeting convened the next month on July 28, 2000. Neither Gusinsky nor Berezovsky was invited. Had they been there, they would have heard Putin tell those in attendance that if they kept out of politics, he would leave them alone and not question how they had managed to accumulate so much wealth so quickly. His message was an implicit warning to avoid Gusinsky-type attacks in the media and interference with Putin’s policies in the Duma. Most of the oligarchs got the message and paid heed to Putin’s warnings.

Two oligarchs, Boris Berezovsky and Mikhail Khodorkovsky, did not. Even though he was not there in person, Berezovsky quickly learned of Putin’s warnings, but typical of the arrogance of the oligarchs who rose to affluence in the Yeltsin years, Berezovsky acted as if it made no difference. When Russia’s nuclear submarine Kursk sank in August the following month, ORT, the TV network Berezovsky controlled, joined with Gusinsky’s NTV (Gusinsky had been released from jail) to criticize the accident and the government’s belated response to it. ORT made a special point of interviewing the bereaved families of the dead sailors in their drab quarters in Vidyayevo, the submarine’s home port on the Barents Sea. Where, the families wanted to know, were Putin and other senior government officials? Why weren’t they at the scene of the accident? Both ORT and NTV provided the answers with video shots of Putin enjoying himself on vacation outside his home along the ritzier Black Sea. That did it. Now Berezovsky and Gusinsky were in serious trouble. Soon after, Media-Most, Gusinsky’s holding company, was seized from him (ostensibly for his failure to repay a loan). He then fled to Spain and into exile in the United States and Israel.

Berezovsky can be forgiven for thinking that he would not become a Putin target. As one of Putin’s original backers for the post of prime minister, Berezovsky evidently assumed that as a minimum, out of gratitude, Putin would not turn on him. After all, before all this trouble began, Berezovsky had even gone so far as to welcome Putin and his family as houseguests in Berezovsky’s mansion on the French Riviera.¹² Moreover, Berezovsky had been close to Yeltsin’s family and other senior officials in the Kremlin. He had become a financial supporter and confidante to Yeltsin’s daughters and their husbands. Berezovsky made one of them, Valery Okulov, the CEO of Aeroflot. That in large part explains why they, in turn, agreed to set aside Sibneft, a petroleum complex in one of the Loan for Shares auctions so that Berezovsky would emerge as the dominant owner. Berezovsky, in turn, agreed to use some of the revenue from Sibneft in an off-the-books pass-through to underwrite Kremlin expenditures and Yeltsin’s 1996 campaign for reelection.

Berezovsky’s biggest mistake, however, was that he allowed ORT to join with NTV in its various attacks on Putin. Eventually that set off rumors that Putin had put out an order for Berezovsky’s arrest. Taking the hint, Berezovsky fled to London and surrendered control of his media assets as well as his petroleum company, Sibneft, to what had been his junior partner, Roman Abramovich. Abramovich, in turn, was happy to be cooperative and graciously put them at Putin’s disposal. In a few months, state-owned Gazprom took possession of Gusinsky’s company Media Most and Berezovsky’s Sibneft, in effect nationalizing them both. Putin’s national champions were quickly beginning to take shape.

RECLAIM GAZPROM

The next year in May 2001, Putin continued his campaign by asserting firmer control over state-controlled Gazprom. He did this by using the Gazprom stock owned by the state to vote to oust Vyakhirev as CEO. With the removal of both Chernomyrdin and Vyakhirev and their replacement with Dmitri Medvedev and Alexei Miller, two younger bureaucrats who had worked with Putin in St. Petersburg, Putin was now in a position to halt the blatant asset stripping that had characterized Chernomyrdin and Vyakhirev’s almost decade-long raid on Gazprom, the company they were supposedly leading.

One of the most brazen examples of this asset stripping was the way Gazprom executives aided and abetted the formation of ITERA. This company soon became the second largest producer of natural gas in Russia. ITERA stands out because although its main business was in Russia, it was headquartered in Jacksonville, Florida. As far as is known, Jacksonville was picked because it is warmer than Moscow and because the CEO, Igor Makarov, had a Russian friend who emigrated to Florida and suggested that Makarov open an office nearby. In retrospect it was probably a safer place than Moscow for a company that on occasion (even if unfairly) has been accused of asset stripping. No one in Jacksonville seemed particularly upset that ITERA’s assets had been stripped from Gazprom nor did they seem to care that according to rumors that may have been part of a campaign of disinformation to discredit ITERA, almost all the trustees of ITERA seemed to be close relatives or mistresses of senior Gazprom executives. As of this writing, the identity of those trustees has not been published. That was nothing unusual in the Yeltsin era.

Putin’s ouster of Chernomyrdin and Vyakhirev from Gazprom plus his subsequent removal in March 2002 of Viktor Gerashchenko as chairman of the Russian Central Bank were all efforts to halt such banditry and punish what Putin saw as mismanagement and the personal pillaging of state assets. (In the case of Gerashchenko, he had been accused of misusing the powers of Russia’s Central Bank.) All three—Gerashchenko, Chernomyrdin, and Vyakhirev—had been long-serving state officials, and all had begun their careers in the Soviet era and had become members of the nomenclatura, the Soviet bureaucratic elite. With their removal, ITERA soon lost most of its contracts and in a short time it surrendered its position as Russia’s second largest producer of natural gas to another firm, Novatek.

Putin’s purge of Gusinsky and Berezovsky was of a different nature. Both were viewed as upstarts from the murkier side of the street. Unlike Chernomyrdin, Vyakhirev, and Gerashchenko, neither Gusinsky nor Berezovsky had served as a senior government official in the Soviet era. Nor were Gusinsky and Berezovsky ethnic Russians. Although Berezovsky had an advanced degree in economics, like so many upstart oligarchs he began building his wealth as a trader. Gusinsky emerged from the black market of the Soviet era—an economic criminal by Soviet standards. Berezovsky had been closely involved with criminal groups as well. Neither would ever have been allowed into the upper ranks of the Communist Party. They had not come up through the system like Chernomyrdin, Vyakhirev, and Gerashchenko. Gusinsky and Berezovsky were both at least partly Jewish and were not “ole boys” or part of the Soviet nomenclatura. Both sets of men had enriched themselves at the expense of the state, but somehow the excesses of Chernomyrdin and Vyakhirev at Gazprom and Gerashchenko at Gosbank were not regarded as venal and therefore not punishable with imprisonment or exile (apparatchiks will be apparatchiks, and besides, they are ours). Conversely, Gusinsky and Berezovsky—most definitely not “ours”—were both either imprisoned or threatened with imprisonment.

THE ATTACK ON YUKOS

This distinction about status in the Soviet era, even if subtle, also helps explain the arrest of Mikhail Khodorkovsky. The attacks on Yukos and Mikhail Khodorkovsky highlight Putin’s determined effort to reign in these upstart oligarchs and at the same time renationalize and refashion their property into state companies and his vaunted national champions. By 2003, with the earlier arrests and firings, it should have been clear just what Putin was attempting to do. Yet Khodorkovsky, by his actions and his hubris, acted as if he were invulnerable. At the time, Forbes Magazine estimated that his net worth amounted to $15 billion, which made him the richest man in Russia. This may have warped his judgment and made him think he was indeed invulnerable.

Khodorkovksy’s rise to fortune and infamy began when he was a student at the Medeleev Chemical Technical Institute. Taking advantage of the new 1987 Gorbachev-era reform authorizing the creation of private businesses, Khodorokovsky, along with twelve classmates, opened a cooperative coffee house and discotheque, which they called Menatep (this stood for Intersectoral Center of Scientific Technical Progress). They soon expanded their activities to sell consumer goods such as computers and other products that were in short supply. Trading proved to be very profitable, and all the cash they had accumulated allowed them to open their own bank the following year. This was made possible in 1987 by another Gorbachev reform that authorized the formation of private banks, the first time since the Revolution. Eventually, they named the bank Menatep, the same as their cooperative.

As one of the first private commercial banks in Russia, Menatep was in a key position in 1992 to buy up the vouchers that President Boris Yeltsin decided to issue to every Russian. The vouchers, in turn, could be exchanged for shares of stock in the thousands of heretofore state-owned enterprises that were then being privatized. The intent was to make every Russian a stockholder, a true case of people’s capitalism. The hope was to involve each Russian in the privatization process and so give each one a stake in the new market system.

But as we saw, few Russians had any appreciation for the value of their vouchers. The voucher system, however, was made to order for economic sophisticates like Khodorkovsky and his banking associates who understood the potential of the vouchers. They quickly bought up as many as they could. In a few months, their vouchers enabled them to accumulate a large corporate empire.

Khodorkovsky’s biggest acquisition, however, came when he managed to gain control of the oil company Yukos. This was a by-product of the Loans for Shares scheme described in Chapter 3. To help the government pay its bills, Khodorkovsky’s Menatep, along with several other banks, offered to lend the government the money it needed. As collateral for its loan, Menatep agreed to take the government’s stock in Yukos, a petroleum company that had been spun out of Rosneft in November 1992. Incidentally, the name “Yukos” reflected the merger of the Production Association Yuganskneftegaz (Yu) with the refinery KuybyshevnefteOrgSintez (Kos).¹³ When the government could not pay back its loan, Menatep proceeded to auction off its collateral, as it was allowed to do. The assumption was that a fair auction would fetch a price high enough to provide the state with funds not only to repay the loan to Menatep but also to generate additional income for the government. What happened, of course, was that the December 8, 1995, auction was rigged. As with the other auctions, viable competitors were prevented from bidding so that the winner was, in fact, a “straw” put up by Menatep, which conducted the auction. This way, despite higher bids from Alfabank, Inkombank, and Russian Credit Bank, all of which Menatep had ruled out on a technicality, Khodorkovsky was able to pay only a bit more than $350 million, the required minimum price for control of 88 percent of Yukos stock. A few months later Yukos would have a market value of $3–5 billion.¹⁴

It was disturbing enough for the public to learn how these one-time state properties had been acquired by Khodorkovsky and a dozen or so other oligarchs at a fraction of their value, but to make matters worse, it happened at the same time the Russian economy was all but disintegrating. Between 1990 and 1998, as the country moved into shock therapy and simultaneously closed down much of the military-industrial complex, the GDP shrank by 40–50 percent. Not only were a few oligarchs taking out a gigantic piece of the economic pie for themselves but the pie itself had shrunk to barely half of what it had been before Yeltsin rose to power. That is why by 1998, more than one-third of the population found itself below the poverty line.

This was not the only controversial action taken by Khodorkovsky and his associates on their way to control of Yukos. Khodorkovsky and Menatep did not control all the stock in Yukos nor in the Yukos subsidiaries that produced the oil. Other investors had also purchased vouchers and exchanged them for shares, which they now owned. One of the most adventurous investors was a foreigner, Kenneth Dart, an American who was an heir to the Dart Cup business. He put in approximately $2 billion to purchase shares in Yuganskneftegaz and other subsidiaries of Yukos. Khodorkovsky wanted Dart out. Consequently, Khodorkovsky stripped Yuganskneftegaz of its value in the expectation that Dart would conclude he should sell out while there was still some value to his investment. To nudge him along, Khodorkovsky ordered that the petroleum produced by Yuganskneftegaz should be sold at below or close to cost to another subsidiary more closely controlled by Khodorkovsky. This second subsidiary would then sell the petroleum at the higher market price and thereby capture all the profit. This so-called transfer pricing is a common way to squeeze out minority shareholders (it is also a way of trying to reduce taxes for the first subsidiary) such as Dart, even if it means bringing a company like Yuganskneftegaz to the brink of bankruptcy. Subsequently, Dart initiated a series of lawsuits in an effort to recoup his investments. Despite some success, Dart estimates he lost over $1 billion.¹⁵

Something similar happened after Menatep closed its doors in the wake of the financial crisis of August 17, 1998. Those with deposits in Menatep as well as the foreign companies and banks that had provided loans to Menatep lost almost all their money. But while outsiders were left with little or nothing, Khodorkovsky, as we saw, transferred the bank’s assets that still had value to another, but independent, subsidy in St. Petersburg called Menatep St. Petersburg.

As troubling as such behavior is, it was the physical violence, including murder, allegedly carried out by several Yukos officials that was the most disturbing. That at least was what the judges decided in March 2005 when they found Alexei Pichugin, head of Yukos security, guilty of murder and sentenced him to twenty years in prison. (In August 2007 the sentence was extended to life in prison.) In addition, Leonid Nevzlin, one of Khodorkovsky’s closest associates who is now exiled in Israel, was also charged with being Pichugin’s accomplice in similar crimes.¹⁶ Given how dependent the judges in the Yukos case were on Putin, there is reason to question just how impartial the judges could be. Khodorkovsky’s lawyers, in fact, claim that one of the judges would excuse herself periodically to seek advice from the Kremlin about how to rule.

While both men deny any guilt, the circumstantial evidence is hard to disregard. The Russian procurator general claims that Pichugin and Nevzlin organized an assassination attempt in 2003 on Yevgeny Rybin, then the managing director of the E Petroleum Handesges oil company. Nevzlin was also accused of ordering Pichugin to murder Sergei Kolesov and Olga Kostina; the latter had been director of the public relations department of the Moscow Mayor’s office and for a time was an adviser to Khodorkovsky. Pichugin was also charged with the 2002 murder of Sergei and Olga Gorin, a businessman from Tambov and his wife, both of whom were rumored to be blackmailing Nevzlin and Valentina Korneyeva. Until her death, Korneyeva was the director of Feniks, a Russian commercial trading company.¹⁷

Those accusations involved not only Pichugin and Nevzlin but also Khodorkovsky. After Khodorkovsky’s Menatep and his investment group won control of Yukos in 1995–1996, Vladimir Petukhov, mayor of Nefteyugansk—the city where Yuganskneftegaz, Yukos’s chief producing unit, is headquartered—began to complain about the failure of the new management to pay its taxes.¹⁸ With weak oil prices, all the petroleum companies were under enormous financial pressure. For that matter, few companies were paying their workers on time. When they were paid it was often with goods in kind, not rubles. But as we saw in Chapter 3, when we noted Mayor Petukhov’s surprise that Khodorkovsky had never visited an oil field until he gained control of Yukos, the mayor was very outspoken. An oil man himself, Mayor Petukhov fought bitterly to pressure Yukos, by far the region’s chief taxpayer, to pay its taxes and other bills and to refrain from massive worker layoffs. In addition, he launched a campaign to embarrass Yukos over its effort to write off a 450 billion ruble debt to the city that had accumulated before Khodorkovsky took control. On June 16, 1998, Petukhov had the audacity, not to mention poor judgment, to write a public letter to Yeltsin as well as Prime Minister Kiriyenko that criticized Yukos for its failure to pay its share of taxes to the city. He also wrote to Duma leaders charging that Yukos was guilty of criminal acts for “concealing taxes in large quantities from 1996 to 1998.”¹⁹ To dramatize the city’s case, he organized a public protest outside Yuganskneftegaz’s headquarters during its annual stockholders’ meeting on May 27, 1998. A month later, he was shot. The prosecutors charged it was more than coincidence, and so the guilty sentence for Pichugin.

As the mayor’s experience suggests, Yukos officials did not take criticism lightly. A reporter for the Wall Street Journal in the Moscow bureau told me he had been warned that if he knew what was good for his health, he would stop writing negative articles about Yukos. I take such reports seriously; after having read a draft of what I planned to write about Yukos in my previous book, a senior official of Yukos agreed that I had every right to publish it, but if I did, I should expect to be sued for libel. Nonetheless, I went ahead and published it. So far there has been no such suit, probably because shortly after my book was published, Khodorkovsky was arrested and jailed. Understandably, since then, he probably has been distracted from such a frivolous pursuit as a libel suit against some hapless American professor (at least my wife hopes so).

Even though it may seem like piling on a man who is serving a long sentence in jail, there probably is a case for suggesting that Menatep and those associated with it had shady reputations. As early as 1994, the CIA issued a classified report warning that “the majority of Russian banks are controlled by the dreaded Mafia.” According to those who have seen the report, the only bank mentioned by name was Menatep.²⁰

As sordid as all this was, Khodorkovsky and Yukos were not the only ones to have pushed the law to its limits and on occasion beyond. The struggle for control of the aluminum industry, for example, was even more violent. Nearly a dozen executives involved with aluminum finance and production encountered various forms of bodily harm. And as with Yukos, I was personally warned to avoid criticism of some of those more colorful executives in the aluminum industry. In another instance, one of the leading personalities in the aluminum business offered me a bribe. Of course, not all the oligarchs engaged in such tactics, but it was a tough time and those who were not prepared to cut a corner now and then quickly fell from power.

What makes Khodorkovsky unusual among the oligarchs is that having survived as the fittest, he suddenly decided in 1999 to embrace reform and transparency. This often happens once someone attains a hard-fought goal. “I have made it into the subdivision; now let’s raise the zoning requirements.” In other words, even if I acquired my property by questionable tactics, I have something of value (Yukos), and we need proper rules and regulations so no one can steal it from me.

By the time of his arrest, Khodorkovsky had become one of Russia’s most outspoken supporters of good corporate governance. Undoubtedly, the fact that by 1999 oil prices had risen from $10 and were on their way to $30 a barrel and beyond was a factor in his conversion. Khodorkovsky quickly realized that despite its shady past Yukos could become a much more valuable property if oil prices kept increasing. If Yukos looked as though it had become more transparent, it might become attractive to foreign investors.

Transparency, however, did not come easily. To begin with, it required a change of cultures, something the existing Russian management would probably have been incapable of doing by itself. Therefore, in a bold move for the time and culture, Khodorkovsky decided to bring in experienced Western managers. He appointed Bruce Misamore, formerly an executive for twenty-three years at Marathon Oil and PennzEnergy, as Yukos’s chief financial officer. Misamore’s task was to introduce international accounting standards and bring in Western accountants. This was not easy, but when I interviewed him, Misamore insisted that whenever he met resistance from others in Yukos, Khodorkovsky provided the necessary support. Similarly, Khodorkovsky hired Steven Theede, formerly an executive at ConocoPhillips, as his chief operating officer. Going even further, he decided to staff the board of directors with foreigners and appointed Sarah Carey, a Washington lawyer; Raj Kumar Gupta, a former vice president of Phillips; Bernard Loze of France; Jacques Kosciusko-Morizet, a former vice president of Credit Lyonnais; and Michel Soublin, the treasurer of the oil service company Schlumberger to his board. He also set up a philanthropic foundation with a blue ribbon international board, which provided grants to Russian and foreign groups, including the U.S. Library of Congress.

Khodorkovsky’s embrace of transparency, while far ahead of his peers’ behavior, was not beyond criticism. In 1999, for example, he suddenly relocated a stockholders’ meeting without bothering to notify stockholders who were not part of management. He was also accused of stripping assets from one of his subsidiaries, the Eastern Oil Company.²¹ Nonetheless by the year 2000 there were fewer such accusations, and Yukos seemed to be on its way to becoming the model of good governance in Russia. In recognition of these reforms, shares of its stock were listed on the London Stock Exchange.

Yukos also seemed to be setting high production standards.²² Output increased by as much as 12 percent a year. Some critics complained that this was a result of over-pumping, not new exploration. In any case, by 2004, Yukos was Russia’s largest producer and Khodorkovsky had become a major presence at international oil conferences. Yukos even sent oil tankers to Houston as a forerunner of what Khodorkovsky said was Yukos’s willingness to become a major supplier to the United States. As part of that effort, he, along with some of the other oil company oligarchs, called for the construction of an oil pipeline to Murmansk on the Barents Sea. This would provide larger deepwater tankers with easy access to Russian oil, which would make it profitable to ship petroleum to the United States. It was, however, a direct challenge to Transneft, a state-owned company that had monopoly ownership and control of all of Russia’s crude oil pipelines, including those used for crude oil exports.

Not only did Khodorkovsky decide to take on Transneft by threatening to end its monopoly in the European part of Russia but he also began a campaign to build a pipeline through Siberia to China. Yukos, on May 28, 2003, even signed a twenty-year oil-delivery contract with China. This committed Yukos to deliver 20 million tons of oil annually by 2005 and 30 million tons a year by 2010.

What arrogance. Khodorkovsky and Yukos were acting as if they were sovereign powers. Here they were, making foreign policy with China, something Putin regarded as the state’s and his, not an oligarch’s, prerogative. Khodorkovsky also let it be known that he was on the verge of selling off a substantial portion of Yukos to either or both Chevron and Exxon-Mobil.²³ In fact, a protocol of understanding agreeing to the sale was signed between Yukos and Exxon three weeks before Putin had Khodorkovsky arrested in October 2003.²⁴ An employee of Exxon has acknowledged to me that the American company had completed its due diligence study and was prepared to become a Yukos partner, much as BP had just arranged that September with TNK.

Except for a detail or two, Exxon’s purchase of Yukos stock, possibly more than 50 percent of it, awaited only the signing of the contract. The CEO of Exxon, Lee Raymond, arranged to meet twice with Putin in September 2003 (once in New York and once in Moscow) to discuss the purchase. He left Putin’s office under the impression that the government would not object. Early in October 2003, Raymond spoke at a business conference in Moscow on a panel with Khodorkovsky the same morning that Yukos announced its planned merger with Sibneft, the oil company Berezovsky had turned over to Roman Abramovich. Raymond and Khodorkovsky both refused to confirm news reports that Exxon was about to buy at least 40 percent of Yukos, but nonetheless officers of Exxon reported they were close to a deal.²⁵

That Khodorkovsky was also close to an agreement with Chevron is confirmed indirectly by Khodorkovsky’s lawyers who have filed a suit to subpoena Chevron to release its due diligence materials prepared before its intended purchase. These materials, the lawyers say, will show that Chevron had determined that Khodorkovsky had not stripped the company of its assets nor laundered money as the state contends. But this is also a fairly good indication that from Chevron’s point of view, such a sale was all but ready to be made.

But while all these negotiations were under way, there were also ominous signs. Shortly after his and Lee Raymond’s presentation at the Moscow conference, Khodorkovsky’s wife called him in panic to report that the police had just surrounded their house and were searching documents and computers in a nearby home and a boarding school funded by Yukos. The police claimed that Yukos had donated some of its old office computers to the school and that incriminating records could be found on the hard drives. Furious that his home and family had been subject to such intimidation, Khodorkovsky called a press conference. Apparently feeling invulnerable, he dared the police to go after him. “If the goal is to drive me from the country or put me in jail, they had better put me in jail.”²⁶ A few days later, on October 25, 2003, they took him at his word.

From Putin’s point of view, Khodorkovsky was acting like a king, not a subject. In a subsequent interview reported by the Wall Street Journal, Putin expressed his pique that neither Exxon nor Yukos had consulted with him in advance about such a large transaction.²⁷ What right, Putin implied, did Khodorkovsky have to turn over ownership and control of Russia’s most valuable resource to a foreign company, and an American one at that? Evidently, Putin did not consider his September 2003 meeting with Lee Raymond to be enough advance notice. Even without such an investment by Exxon-Mobil, companies partially or substantially owned by foreign companies or investors were already producing 26 percent of Russia’s oil.²⁸ Given historic Russian xenophobia, that was too much. The failure to consult with Putin about such a matter was not the type of respect that Putin expected from his subjects.

Having become Russia’s richest man, Khodorkovsky apparently believed that he no longer needed to kowtow to political godfathers— that is, pay for a krisha or “roof,” as Russian businessmen had since the days of the czar. Nor did he take seriously Putin’s July 28, 2000, warning that if they knew what was good for them, the oligarchs would stay out of politics. In fact, Khodorkovsky seemed to think that he could create his own rival political power base. He and some of his Yukos executives became major financial supporters of several of the country’s opposition parties, including the pro-Western Yabloko Party. With the help of some financial inducements, he had lined up as many as 100 members of the Duma who would support whatever he wanted. That was one of the main reasons for the defeat of two government efforts to increase taxes and environmental restraints on the oil companies. After some financial contributions, even members of the Communist Party somehow agreed to set aside their ideology and rally to Yukos’s causes—causes somehow overlooked in the Communist Manifesto. There was even talk that Khodorkovsky had decided he would run for president in 2008 after Putin’s term came to an end.

As if he feared no one, Khodorkovsky began to challenge not only what the Russians call the “siloviki”—the law and order types in the government who had previously served in the KGB and in other higher security posts—but Putin himself. Khodorkovsky seemed oblivious to the fact that it was particularly hard for these loyal officials to accept such a reversal of roles. In the Soviet era, they ran the country and no one dared to challenge them. Now these KGB alumni and their siloviki counterparts from similar agencies found themselves having to stand by and suffer the antics of the likes of a Khodorkovsky and his highwaymen. Who did they think they were? As one insider told me, a Yukos official close to Khodorkovksy even warned a Kremlin staff member that he would be crushed if he were to dare move ahead with an effort to increase taxes.

The conflict between Khodorkovsky and the Putin government came to a head, however, when Khodorkovsky decided to criticize Sergei Bogdanchikov, the CEO of the state-owned Rosneft. On live TV in February 2003 Khodorkovsky had the effrontery to complain to Putin that Putin’s close friend Bogdanchikov had worked out a sweetheart deal at the country’s expense. According to Khodorkovsky, his rival Bogdanchikov overpaid $622.6 million for Northern Oil, a company controlled by Andrei Vavilov, an insider who was a senator in the Council of Federation and a former deputy finance minister. Khodorkovsky in effect implied that Bogdanchikov and Vavilov were in cahoots with each other and had used state funds to enrich themselves. Khodorkovsky charged that Bogdanchikov paid Vavilov double what the property was worth.²⁹ According to Khodorkovsky, this was a corrupt kickback scheme. (Since his own background had not been so stellar, such an accusation had to be a little presumptuous coming from someone like Khodorkovsky.)

Pushing his luck even further, Khodorkovsky then told President Putin, “Your bureaucracy is made up of bribe-takers and thieves.”³⁰ (Khodorkovsky had a point. Subsequently, Vavilov was charged in a Russian court of having committed fraud by selling shares in Northern Oil that he did not own.)³¹ Defending his buddies and Rosneft, Putin insisted to the contrary. Rosneft “is a state company and needs to increase its insufficient reserves,” and if anything, it is the nonstate private oil companies (Yukos) that have excessive reserves. “We still have to investigate” how they obtained them.³²

There is good reason to believe the decision to destroy Yukos as a viable company may have been triggered by that incident. During the same month that Khodorkovsky attacked Bogdanchikov, an American working for an American investment bank in Moscow had an interview with Yury Shafranik, an insider who had been the minister of Industry and Energy from 1993 to 1996. At one point in the conversation, Shafranik became very angry because the American’s firm had been recommending Yukos as an investment to its clients. “It was a mistake to promote Yukos,” Shafranik warned, “because in a year’s time, Yukos would no longer be in existence.” Then revealing the anger that such former apparatchiks of the Soviet era have for these arriviste new owners of Russia’s oil and gas wealth, he added, “Before long, there will be some real oil specialists put in charge who will know what they are doing.”³³

As Khodorkovsky became an ever more dominant and annoying presence, those around Putin came to regard Khodorkovsky as a major threat to their authority. In what is alleged to be a wiretapped conversation, the same Sergei Bogdanchikov of state-owned Rosneft (and the one Khodorkovsky accused of taking kickbacks) is heard complaining that the Yukos leader had become too uppity. “Three days in Butyrke Prison and (the Yukos leaders) will understand who is the king of the forest.”³⁴ In Bogdanchikov’s eyes, Khodorkovsky and his partners seemed to be acting as if they, not government officials, were running the country. Not only were they accusing Kremlin insiders of corruption and signing major petroleum delivery contracts with the Chinese government that had not been approved by the state, but they were also challenging the state’s monopoly control of the country’s petroleum pipeline. As if that were not enough, they were on the verge of selling some of the country’s most valuable assets, its oil fields, to an American company. Virtually all those around Putin regarded Khodorkovsky’s actions as an affront to the state’s authority and agreed that it was necessary to crush Khodorkovsky as soon as possible to abort such a sale.

The counteroffensive against Yukos began with the June 2003 arrest of its security chief, Boris Pichugin, on murder and attempted murder charges and continued with the arrest of Platon Lebedev, one of the top Yukos officials, the following month. Lebedev was accused of failing to invest as much as he promised in a fertilizer company Menatep took over from the government. That may have been a violation of a contractual agreement but it hardly warranted an eight-year jail sentence.³⁵ Outwardly, at least, these arrests did not seem to bother Khodorkovsky. He continued to travel abroad, including a subsequent July 2003 visit to Sun Valley, Idaho, where he mixed with senior American government and business leaders, including Bill Gates, Warren Buffet, and New York Mayor Michael Bloomberg.³⁶ The week earlier he met with Vice President Richard Cheney to discuss Exxon-Mobil’s pending offer to purchase major portions of Yukos stock. Yet despite the arrest of some of his close associates and increasing indications that he, too, might be arrested, Khodorkovsky invariably always returned to Russia. In fact, he did expect to be arrested, but he evidently assumed that he was powerful enough and his friends and lawyers influential enough to win his freedom. Khodorkovsky’s lawyers have reported that he was much more alert to what was happening than he let on. At an October 11, 2003, meeting with his lawyers, just two weeks before his arrest, Khodorkovsky discussed with them the steps to be taken should he be arrested.³⁷

Arrested he was on October 25, 2003. Masked police with submachine guns raided his private jet as it was refueling in Novosibirsk. He and Yukos were charged with tax evasion, grand theft, fraud, forgery, embezzlement, and extortion. He was found guilty and sent to prison in Krasnokamensk in Siberia. The initial sentence was for eight years, but additional accusations made in 2007 could result in another fifteen years.³⁸

In his frenzy to punish Khodorkovsky and destroy Yukos, the prosecutor general not only arrested Yukos’s senior executives but he also went after anyone remotely associated with Yukos, including its lawyers and junior staff. While the list is incomplete, Table 5.3 lists over two dozen people associated with Yukos who have either been jailed or have fled into exile. The case of Svetlana Bakhmina stands out. The mother of two little boys aged two and six at the time of her arrest, she was only a middle-ranking member of Yukos’s legal department. She was taken from her home at 5:00 in the morning, refused bail, and prevented from seeing her children for more than sixteen months. She was found guilty of embezzling $290 million from a Yukos subsidiary and sentenced to seven years in a maximum security prison, a sentence almost as long as Khodorkovsky’s. If her sentence had been one year less, she would have been freed from prison under an amnesty issued for mothers sentenced to six years or less. In her defense, her lawyers argued that as she lived in a two-room apartment, the charges that she had stolen so much money were absurd.³⁹ The real reason for her arrest, claim her lawyers, was that the prosecutor was holding her hostage to force her former boss, the general counsel of Yukos, Dmitry Gololobov, to return to Moscow from his London exile.

This was typical of the way the courts treated the Yukos defendants. Undoubtedly many of the charges, at least against the company’s senior executives, had some merit, but the courts’ assault on mid-level Yukos employees was needlessly harsh. Like Bakhmina, most of those charged were denied bail. By comparison, those charged in the Enron case in Texas were allowed out on bail until they were found guilty. For that matter, Khodorkovsky’s lawyers argued that under the Russian Constitution, “pretrial detention is basically not permitted in a white-collar trial.”⁴⁰ Moreover, Yukos lawyers were also harassed, their homes and offices raided, and evidence withheld.

Khodorkovsky’s lawyers have complained that there was remarkably little effort by either the judges or the prosecutor general to adhere to legal precedents or procedures.⁴¹ Khodorkovsky’s lawyers also pointed out that some of the charges against Lebedev and Khodorkovsky in the fertilizer company case had been heard eighteen months earlier at a civil hearing. After negotiations the dispute was resolved to the satisfaction of the prosecutor general, who subsequently reversed his decision. To bring up the issue again was a form of double jeopardy.

THE PLUNDERING OF YUKOS

As for Yukos itself, it was treated just as harshly. By the end of the trial it was accused of failing to pay $33 billion in back taxes.⁴² Undoubtedly Yukos owed money for back taxes unpaid in its earliest years, but the government seemed unbothered by the fact that in some years the alleged tax bill exceeded total revenue earned.⁴³ As punishment, in December 2004 Yukos’s most valuable asset, Yuganskneftegaz, was sold at yet another rigged auction for $9.35 billion to an obscure and heretofore unknown entity called the Baikal Finance Group, which turned out to be a front for Rosneft. Several outside appraisers insisted that the price was less than half of what such an auction should have yielded.⁴⁴

To protect themselves and prevent further plundering of Yukos, in December 2004, some of the American executives working for Yukos sought Chapter 11 bankruptcy protection in a Texas federal bankruptcy court. This action frightened off some prospective purchasers, including Gazprom, which feared that if Gazprom seized Yukos property, their assets might in turn be seized by European or American courts. Hence the sudden appearance of the Baikal Finance Group, which was used to launder the assets so that they could then be sold to Rosneft. If Rosneft itself had entered such a bid at the auction, it might also have been threatened with a lawsuit in a European court. Ever since, both Gazprom and Rosneft have used straws to do the initial bidding on properties being stripped off of Yukos: Neft Aktiv for Rosneft and Unitex for Gazprom.⁴⁵

There was reason for such fears. In 1993, Noga, a Swiss trading company, had used a Western court judgment against Russian authorities to seize a Russian bank operating in Luxembourg. It did this to force payment of the overdue bills claimed by the Swiss firm. (I had served as an adviser to Noga in its effort to collect what it claimed it was owed. Noga was unaware that Russia had such assets in the West. Once alerted, they sought support from a European Court and the East-West United Bank in Luxembourg was seized as a form of collateral to force repayment.) There was every reason to believe if Gazprom or Rosneft themselves tried to buy up Yukos assets, they would suffer a similar fate. That was enough for Gazprom and Rosneft to refrain from making a direct bid. But after due consideration as to whether a U.S. court had jurisdiction in such a case, the Texas judge decided it did not.

The company’s fate therefore was left up to Russian courts. After seeing that Yukos could not pay its debts, the Moscow Arbitration Court on August 2, 2006, declared Yukos bankrupt.⁴⁶ This was despite Putin’s earlier insistence at a RIA Novosti press agency discussion that Russia would not force Yukos into bankruptcy.

In 2007, a second batch of nearly 200 properties, including the 20 percent stake in Gazpromneft (formerly Sibneft) that Yukos still owned as well as its Tomskneft and Samaraneftegaz subsidiaries, were put up for sale to cover the rest of the back tax bill.⁴⁷ Because of the increase in petroleum prices after 2004, the remaining Yukos properties were appraised at a higher level and valued at a minimum of $22 billion, and then again increased to $26 billion.⁴⁸ At that appraisal, what remained of Yukos would have allowed it to sell off some subsidiaries, use the funds to pay back the taxes, and still retain at least some assets for itself. That would mean that it really was not bankrupt. To prevent that from happening, the state authorities recalculated the taxes owed by Yukos and found that they had underestimated what Yukos owed. According to their new calculation, Yukos’s total debt was in fact $26.6 billion, an amount that again conveniently exceeded the company’s newly estimated net worth.⁴⁹ Former Yukos executives argued, however, that the real value of Yukos’s remaining assets was even higher at $37 billion. Whatever the fair value of the property, there was no way the former owners of Yukos would have been able to keep any of the assets. Whenever someone came up with a calculation that showed that the company’s assets were actually more valuable than indicated in earlier estimates, the tax authorities would recalculate the overdue tax debt and somehow come out with an even larger estimate.

The charade continued. In late March 2007, Rosneft, which along with the state was the chief creditor for Yukos properties, organized an auction to sell off the assets it had seized from Yukos. The first auction involved the sale of 9.44 percent of Rosneft’s own stock that Yukos had acquired earlier. Reminiscent of the Loan for Shares auctions of the mid-1990s, Rosneft was not only the auctioneer but—to no one’s surprise—also the winner.

To avoid a repetition of such “done deals,” after the Loans for Shares fiasco, a new requirement was put in place. All future auctions would be valid only if there were at least two bidders. Therefore, in order to lend credence to the March 2007 auction, TNK-BP agreed to enter a bid. However, TNK-BP dropped out after the opening bid raised the $7.5 billion asking price by a mere $97 million.⁵⁰ The $7.5 billion was $900 million less than it would have cost to buy an equivalent amount of Rosneft stock on the London Stock Exchange. If TNK-BP had really been a serious bidder, they would not have let such a bargain pass. It was generally agreed that TNK-BP had entered a bid only to make the exchange look legitimate and so curry favor with Putin and the Kremlin in hope that neither the state nor Gazprom would seize BP’s holdings in Kovykta. There was further evidence that the auction was a charade: the acting head of Yukos in Russia at the time, Eduard K. Rebgun, who earlier had agreed to discount the price of the Yukos assets he was supposed to be protecting, applied to join Rosneft’s board of directors, a blatant conflict of interest.⁵¹ Without apparently being aware of the irony in what he was saying, after the auction Rebgun boasted that the auction “went, thank God, normally.”⁵² For those with memories of Loans for Shares, it certainly did. Once again, however, the sale failed to generate enough to pay off what remained of the original $25 billion tax bill.

But this was not the end of the struggle. In May 2007, the state put the Yukos headquarters up for sale. An obscure company called Prana bid an amazing $4 billion. By doing so, the total collected by the state exceeded the amount the state was owed. No matter, Yukos was still treated as a bankrupt company.

In an effort to salvage something more from the bankruptcy, some former Yukos stockholders have threatened lawsuits against what they claim has been the illegal expropriation of Yukos. The lawsuit was intended to deter Western companies from bidding and Western banks from lending money to Rosneft so they would not have the funds they needed to bid for Yukos properties. It is also why Rosneft itself did not bid in the auction. Instead, yet another straw called RN-Razvitiye, patterned on the Baikal Finance Group model, did the bidding and won. This was to protect Rosneft from a Western lawsuit. Like Baikal Finance Group, RN-Razvitiye came out of nowhere in January 2007, three months before the auction.⁵³ It clearly was created just for the purpose of bidding on Yukos. It turns out that at the time that RNRazvitiye was capitalized at only $385. Nonetheless, it easily and quickly managed to borrow the $9 billion it needed to bid in the auction, something I wish my banker would let me do.

Taking no chances, Russian authorities also sought to discredit Yukos’s financial reports. It sued PricewaterhouseCoopers (PWC), Yukos’s accounting firm, claiming that PWC misrepresented Yukos’s earnings. Initially a lower Russian court found PWC guilty and ordered that it pay $15 million in back taxes. Under pressure PWC did the state’s bidding and disassociated itself from ten years of its own audits of Yukos (not something to be proud of). This move undermined Yukos’s argument that it had fully paid its taxes.⁵⁴

While the Yukos case has to be an embarrassment for those who insist that Russia is “a normal country” that is coming to embrace the concept of “rule of law,” it did accomplish what Putin wanted—the removal of Khodorkovsky from the economic and political stage, the dismemberment of Yukos, and its effective renationalization and redistribution to state-controlled entities like Rosneft. More than that, by transferring ownership of most of Yukos to Rosneft, Putin prevented Yukos and its petroleum reserves from falling in the hands of Exxon-Mobil or any other foreign entity. At the same time, Putin enhanced the role and capabilities of another one of his designated national champions by putting another 11 percent of the country’s petroleum output back in the state’s hands.⁵⁵

SIBNEFT’S TURN

Having reined in Yukos, Putin’s next target was Sibneft. Its takeover was done so quietly hardly anyone noticed. As we saw, when threatened with jail, then chief owner Boris Berezovsky hastily fled to London. On his way out, he sold off his share of various properties to his one-time protégé, junior partner, and erstwhile sportsman Roman Abramovich, who in turn was happy to relay most of his new possessions on to the state. Among other properties, Berezovsky transferred control to Abramovich of the aluminum company Rusal, the TV network ORT, and, most important, the petroleum company Sibneft. This undid an earlier merger between Yukos and Sibneft agreed to in April 2003. At that time, Khodorkovsky had paid $3 billion for a 26 percent share of Sibneft stock. After Khodorkovsky’s arrest, Abramovich put the merger on hold but neglected to refund the $3 billion.

For a time, Abramovich also flirted with the subversive idea of selling half of his share of Sibneft to a foreign company. He considered offers from Chevron-Texaco, Shell, and Total.⁵⁶ But after the inevitable visits from the Russian tax authorities and significant claims of some $1.4 billion in tax arrears, in September 2005 Abramovich agreed instead to sell his 72 percent stake in Sibneft to Gazprom for $13 billion.⁵⁷ Renamed Gazpromneft (Gas Industry Petroleum), this gave state-dominated Gazprom a major stake in the petroleum sector for the first time. With the transfer of Sibneft to state ownership, the state once again gained control of 30 percent of Russia’s total oil output.⁵⁸

Don’t shed any tears for Abramovich. By working with the state and Putin, he was able to sell Sibneft at a price that made him Russia’s richest man with a net worth estimated by Forbes Magazine at over $18 billion. This leapfrogged him over the now jailed Khodorkovsky, whose earlier $15 billion had been mostly in Yukos stock. After the company’s bankruptcy, it was worth only a fraction of what it had been.

Abramovich was not only Russia’s richest man. Since he had effectively moved to London, he also became Great Britain’s richest man. One of his new homes was a 440-acre estate in Sussex, the other a mansion in London’s exclusive Belgravia district. His other purchases included two of the world’s largest yachts and the Chelsea soccer team for which he paid $250 million—not bad for a poor boy with a murky background who started out in 1996 as a junior oil trader and office manager at Sibneft.⁵⁹

FRIENDLY PERSUASION

No company can assume it is immune from harassment by the state, particularly if that company fits in nicely with Putin’s notion of national champion. Mikhail Gutseriev, for example, who formed Russneft in 2002 by building on assets acquired from Slavneft, until then a state company, claimed that because of pressure from the police and federal tax authorites, he was being forced to sell his company to Oleg Deripaska. It was clear Deripaska was acting on behalf of Putin. At the time in 2007, Russneft had become Russia’s seventh largest oil company, producing 16 million tons of crude oil a year. Gutseriev later denied that he had come under pressure but there were rumors that he had angered Putin when Gutseriev attempted to buy up Yukos assets, thereby making it hard for state-owned Rosneft to do so.⁶⁰ Other companies that have in effect been similarly renationalized include VSMPO-AVISMA, a titanium producer that was purchased by state-owned Rosoboronexport, a military arms exporter, and Nortgaz, all of whom have been forced to become national champions.⁶¹

With state ownership restored over what used to be Yukos and Sibneft, among the larger companies, the state lacked a majority share of the stock only in Surgutneftegaz, LUKoil, and TNK/BP. As for Surgutneftegaz, this was not a problem. For all intents and purposes, Surgutneftegaz behaved almost as if it were under state control, and as such, a national champion. Rarely if ever did the company deviate from state policy or face complaints or even allegations about law violations, environmental abuse, or tax delinquency. The CEO, Vladimir Bogdanov, was an “ole boy” uninterested in the high life who preferred living in Siberia rather than in that fleshpot Moscow. He also saw nothing wrong in keeping his corporate operations as secretive and opaque as possible. Bogdanov and his staff controlled more than 50 percent of the company’s stock, which they held very closely.⁶²

This close control does not mean that Surgutneftegaz has managed to avoid all controversy. After being praised in 1998 and 2004 for the way its workers were treated (this was in sharp contrast to those working for Yukos, who complained about being underpaid and harassed), those same workers at Surgutneftegaz nonetheless went to the streets in a May Day protest in 2006 to demand higher wages and an end of the arbitrary awarding of bonuses to management favorites.⁶³ Similarly, at the other end of the ownership pyramid, outside minority stockholders have complained about insider self-dealing and the lack of transparency. The Harvard Management Company, which manages Harvard University’s $34.9 billion endowment (as of June 2007), filed a claim against Surgutneftegaz with the American Arbitration Association in New York. It charged that Surgutneftegaz’s management withheld $400 million in dividends that were hidden by senior management but should have been paid to minority shareholders, including $3.7 million which it said was owed to Harvard.⁶⁴ That publicity and subsequent legislation by the Russian government induced Surgutneftegaz to pay out an acceptable dividend return to its stockholders, although as of early 2007 it had not agreed to make up for the missed dividends of the past.⁶⁵

LUKoil’s willingness to adapt to state policy was not quite as swift as Surgutneftegaz’s, but only rarely has it or its CEO, Vagit Alekperov, overtly challenged the state or Putin’s policies. How LUKoil and the state have generally worked in tandem was highlighted in September 2003 when President Putin joined with Alekperov to inaugurate a LUKoil filling station in Manhattan. Why not? Establishing Russian beachheads in the center of New York City and New Jersey is just what “national champions” are supposed to do, whether they be state or privately owned. Like any good multinational corporation, LUKoil, as we mentioned earlier, bought into the U.S. market by acquiring Getty Petroleum Marketing Limited in 2000. This brought it 2,000 stations stretching from Maine to Virginia, and it bought another 1,000 from Mobil. It expects all these stations to be converted into LUKoil outlets by 2008. This will give LUKoil 7 percent of the market in its territory but as much as 24 percent in New Jersey and Pennsylvania (where it is concentrated).⁶⁶ Initially, these stations were supplied with crude oil from the Middle East, which was then refined in the United States. LUKoil plans, however, to replace that Middle East oil with its own crude from Russia in 2008. Reducing our reliance on Middle East oil would be very much in the U.S. national interest, but given how Russia uses its petroleum exports for political purposes, there is no guarantee that future imports from Russia will not at some time be used in a similar way.

In addition to its retail presence in the United States, LUKoil, as a national champion, also purchased from ConocoPhillips 376 Jetts gas stations that were located in Belgium, the Czech Republic, Slovakia, Poland, Hungary, and Finland. This is in addition to the refineries it operates—or plans to operate—in Turkey, Kazakhstan, the Netherlands, Bulgaria, Romania, and Ukraine. Before the U.S. invasion, LUKoil also operated in Iraq.

In all these endeavors, LUKoil consulted with President Putin. It was also careful to ask for Putin’s blessing when LUKoil wanted permission for ConocoPhillips to buy up a substantial percentage of LUKoil stock. Putin agreed but insisted that ConocoPhillips limit itself to no more than 20 percent ownership. He seemed comfortable with an investment of that size. Unlike the TNK-BP arrangement, holding ConocoPhillips to only a 20 percent share was more likely to ensure that LUKoil would retain operating control.

IS TNK-BP NEXT?

Putin seemed especially appreciative that LUKoil had the courtesy to ask him for his approval before negotiations were completed, not after, as was apparently the case when BP bought 50 percent of Tyumen Oil (TNK). While Putin attended the TNK-BP merger ceremonies along with British Prime Minister Tony Blair in London, it later became clear that Putin was not happy with this arrangement. TNK made the mistake of not only involving Putin after most of the terms had been agreed to but additionally of allowing BP to take over the company’s management and thus gaining effective control of a valued Russian resource. Officially this was a 50/50 partnership, but under the agreement, BP personnel took over operating control of the partnership.

Nevertheless, despite some rough patches when the BP personnel assigned to the partnership found their work culture at odds with TNK’s, BP was able to bring a more efficient and productive management to the operation. Using its own technology, BP has been able to tap deposits heretofore beyond TNK’s ability to exploit; as a result, it discovered that TNK-BP has considerably more workable reserves than TNK realized it had.⁶⁷

By mid-2007 there were recurring rumors that Putin and the Russian government were not happy with the extent of BP’s involvement and that the government was seeking some way to ease the private Russian owners of TNK out of the partnership, put state-controlled Gazprom in their place, and then reduce BP to a minority stockholder. Putin and Co. may again be maneuvering to create another national champion and in effect, renationalize the company.⁶⁸

In hopes of preventing pressure on BP, the CEO of BP, Lord John Browne, and his successor, Tony Hayward, sought to ingratiate themselves and BP with Putin. That is why they arranged a meeting with President Putin in March 2007 and proposed that BP bid in the auction to buy 9.44 percent of the Rosneft shares that Yukos owned before it went into bankruptcy. As we saw, to be legal, there had to be at least two bidders in the auction and at the time it looked as though there would be only one bidder, Rosneft. By entering its bid and thereby ensuring that there were two bidders, but not bidding enough to win, BP acted to help out Rosneft and Putin. For much the same reason BP bought up $1 billion of Rosneft stock in an initial public offering of its stock in London earlier in 2006.⁶⁹ By doing so, BP pushed up the price of Rosneft stock, and yet its stock purchase was not large enough to give BP any operational control. BP hoped that these two gestures combined would ward off future attempts by Gazprom or even Rosneft to muscle out either their Russian oligarchs or BP itself from their TNK-BP partnership.

All of this chess board maneuvering has led to a good deal of second guessing as to whether there would have been less harassment of TNKBP if BP had settled in the beginning for just 49 percent ownership. This became clear after Putin declared that exploration in new Russian fields off and onshore would be limited to companies in which the Russian partner had at least 51 percent control. Given the historic reluctance in Russia to let foreigners have too much control over Russian resources (foreign money is welcome; it is the control that is not), Putin might well have set the Russian share even higher if BP had agreed to only 49 percent or even 45 percent. Compared to ConocoPhillips’s 20 percent limit, anything even close to 50 percent was considered dangerous.

IT’S TIME TO CHANGE PARTNERS AGAIN

With petroleum prices hovering around $100 a barrel, all of Russia’s petroleum producers have prospered. Nevertheless the companies that are not state-dominated national champions, even those firms controlled by Russian executives, are occasionally reminded that they are there to do the state’s bidding. Like a well-bred and carefully trained horse that still needs the periodic sting of the whip to remind the horse that it is a horse and the man in control is the jockey, the Kremlin will almost as a matter of routine periodically send in tax collectors and inspectors, not only to collect taxes and carry out inspections but also to harass. Beginning in 2006, environment authorities joined in this minuet. Almost every private energy company operating in Russia (foreign and Russian alike) has been subjected to such visits and harassment in one form or another. LUKoil, for example, has had to deal with charges that it was behind schedule in exploration, drilling, and starting production at eleven oil fields in the Komi Republic.⁷⁰

As often as not, given the sorry track record of Soviet and the successor Russian oil companies in polluting their oil fields, there is probably something to the pollution charges. But recently there has often been another reason for these accusations. The unpublicized agenda for such warnings is meant to mask the effort by state-dominated Rosneft or Gazprom to muscle their way to an equity position in these private ventures at a reduced price. That seemed to be the real motive in a whole series of cases: LUKoil in the Komi Republic; Royal Dutch Shell, Mitsui, and Mitsubishi on their Sakhalin II project; Exxon and its partners on the Sakhalin I project; as well as threats against the TNK-BP partnership at the Kovykta natural gas project near Irkutsk, a threat the BP March 2007 bid for Rosneft stock seemed designed to ward off.⁷¹ Once Gazprom becomes a partner, especially if it becomes the dominant partner, the charges of pollution miraculously seem to disappear.

SAKHALIN

The Shell dispute in Sakhalin is complicated. Sakhalin is a large island off the Russian mainland in the Sea of Okhotsk north of Japan. There was evidence as early as the late nineteenth century that Sakhalin had deposits of oil. But because the environment there involves such extremes in weather and offshore working conditions, Soviet and then Russian companies were unable to work the deposits on their own. Thus in 1975, Soviet authorities agreed to allow Japanese companies in to explore the region for gas and oil. This was one of the rare instances after World War II when the Soviet Union allowed a foreign company to engage in commercial activity inside the Communist state.

Working conditions on and around Sakhalin are some of the most challenging in the world. Russian authorities understood that and knew that most of the work would have to be done offshore. It is so cold that the sea freezes over most of the winter, putting a halt to existing work; and the ice floes are a continuing risk to the drilling rigs. That was why Russian authorities concluded they could not do the work themselves and agreed to sign favorable Production Sharing Agreements (PSA) with foreign companies who have had more experience working in such a difficult environment. Exxon-Mobil, for example, solved the ice floe problem by locating its drilling rig on dry land and then after drilling vertically, it redirected its drilling efforts horizontally under the sea to the oil-bearing deposits. That is a technology that Russian companies have so far not been able to master.

Yet it is easy to understand why the Russian authorities went after Shell to revise the original Production Sharing Agreement (PSA). Shell had initially indicated that developing their project would cost $10 billion. That allowed for how risky the work would be. Under the terms of the PSA, only after Shell and its partners (none of whom were Russian companies) had recouped their costs would Russia begin to share in the profits of the operation. In July 2005, however, Shell announced that it had underestimated the costs and challenge. In fact, because of higher steel prices and more complicated work, the cost would be $20–22 billion.⁷² About the same time Exxon reported that its costs would also be higher than anticipated, not the originally estimated $12.8 billion, but $17 billion. This was high but not double the original price like Shell’s.⁷³ But if the Russian government were to wait while Shell recouped $20–22 billion, they might never see any profit. Whether the higher estimate was accurate or not, Shell must have known the higher cost would upset the Russians. The Russians could understand that there might be some increase, but not as high as twofold.

Not surprisingly, therefore, the Russians began to pressure for a rewriting of the original PSA. They would have done that as a matter of course even if Shell’s costs had not risen so much. As we have seen, concessions such as PSAs offered at a time of need tend to be disavowed once Russia regains its strength and self-confidence.

As in the past, the Russian government sought to protect its interests by forcing Shell to include Gazprom in the venture as a partner. Remember that Sakhalin II was the only PSA project until that time that had no Russian partner. Recognizing its shaky status, Shell agreed to yield to Gazprom and sold it a 50 percent equity plus one share at the bargain price of $7.45 billion. Considering Shell’s earlier estimate that the project would entail an expenditure of $22 billion, Gazprom evidently was able to bully its way in for $3.55 billion less than it should have paid for a half interest share. As the Godfather would have said, Gazprom made Shell an offer that it couldn’t refuse. What was embarrassing to outside observers, however, was the alacrity, even enthusiasm, with which Shell, Mitsui, and Mitsubishi agreed to Gazprom’s offer, as if they normally write off $3.55 billion every day. Insisting that Shell harbored no hard feelings, the CEO of Shell, Jeroen van der Veer, fairly bubbled over with gratitude to Gazprom for its willingness to step in as a partner for such a trifle while he also “enthusiastically thanked Mr. Putin for his support.”⁷⁴

Shell is not the only company that has been forced or found it necessary to kowtow to the Russians. Total, the French petroleum company, has been equally submissive and humble. Like all energy companies, it has discovered that as-yet-untapped investment opportunities are more and more difficult to find, so it must take what is offered. A good example is how Total responded after Gazprom changed its mind and decided to bring in Western companies to help it develop the vast but difficult to work Shtokman natural gas deposits. Earlier Gazprom had solicited proposals from several Western energy companies as to how they would develop the Shtokman gas fields, but in October 2006, Gazprom rejected them all and decided it would do the work itself. However, after reflecting on the location of the deposits—500 to 600 kilometers (300–360 miles) offshore in the Barents Sea with its icebergs and storms—Gazprom decided to seek Western help after all. It selected Total from a half dozen companies that offered to do the work even though Total has relatively little experience in such harsh Arctic work conditions. Total does, however, have extensive experience with liquified natural gas (LNG) operations, and much of the Shtokman gas will eventually be shipped in liquified form.

There was little doubt that Total was eager to win the contract. That explains why it agreed to participate even though it will have no equity in the project. Total insists this will not prevent it from carrying some of the Shtokman reserves on its financial statements, something all energy companies are under pressure to do because the more reserves that are listed on their books, the higher the price of the company’s stock is likely to be. The reason it may not be able to include some of the Shtokman reserves on its books is that Total has agreed to operate primarily as a service company; in addition, the project involves enormous risk. But since it wanted to be involved, Total did not have much choice in the matter. This was another instance where the Russians realized that they could drive a hard bargain—and they did.

Total is not alone. Exxon and its partners in their PSA in Sakhalin I came under similar pressure. Strictly speaking, the Russian authorities did not question the earlier tax concession and cost estimates they had originally agreed to in December 1993.⁷⁵ That would have been an outright contract violation. Instead, they latched on to cases when both Shell and Exxon had violated pollution standards (in some instances, serious violations) as a way of calling for the cancellation of the original PSA.

Gazprom used the same tactics on TNK-BP in Kovytka, also in northern Siberia. For fear of being pushed out of Kovytka entirely, BP offered Gazprom a controlling share in the project, which according to some estimates is worth as much as $20 billion. For BP’s 62.42 percent stake in Rusia Petroleum (worth about $12.5 billion), which holds the license to develop Kovykto, Gazprom has agreed to pay between $700 and $900 million—quite a bargain, at least from Gazprom’s point of view.⁷⁶ It did not seem to matter that the reason for TNK-BP’s failure to produce the 9 billion cubic meters of gas per year it had promised is that Gazprom refused TNK-BP access to its monopoly pipeline network. The only alternative was for BP to sell its gas to a nearby community. But because there was so little industrial development there, there was only need, at most, for 2.5 billion cubic meters of gas in the region.⁷⁷ If it were to produce 9 billion cubic meters of gas as it had promised, the only thing it could do with it would be to burn it (flare it). That would not only be a waste of a valuable resource but would violate a Russian law and also add to the carbon dioxide in the atmosphere, a form of pollution that would also warrant criticism. To Putin, BP’s failure to act was inexcusable. In a June 1, 2007, press conference, Putin pointedly insisted that BP had been fully aware of these requirements beforehand and should never have entered an agreement if it could not meet them. The Russian owners of TNK were reported to believe that this was all a pressure tactic to force them to sell their share of the partnership at a cheaper price to Gazprom.⁷⁸

There was also speculation reported in Forbes Magazine online that in an effort to hold on to its stake at Kovykta in the north, BP had offered to create a joint venture with Gazprom that would provide Gazprom with an equity interest in BP’s LNG operation in Trinidad and Tobago.⁷⁹ Such an offer would require that Gazprom allow BP to stay in Kovykta at least as a partner with Gazprom. What makes this attractive to Gazprom is that the Trinidad-Tobago facility that BP operates there is the supplier of 65.5 percent (16.56 billion cubic meters) of the LNG the United States consumes. If such a joint venture is created, it will provide Gazprom with its first major entry into the U.S. natural gas market, something they can broach at this point only with LNG capability.

Gazprom’s refusal to allow petroleum producers to ship their byproduct gas through the Gazprom pipeline network was a legacy of the Soviet era when the Ministry of Gas was assigned a target in cubic meters of natural gas and the Ministry of Petroleum was assigned a target in tons of petroleum. Neither ministry was credited if it produced the other’s product. For the Ministry of Petroleum, the easiest way for its producing units to dispose of the by-product gas released as they extracted crude oil was to flare it. When these oil wells were privatized, the private firms saw the value in the by-product gas, and it made as much sense for them to burn money as to burn gas. By contrast, Gazprom, even though it has private shareholders, is still essentially a state-dominated company that has not fully rid itself of the Soviet bureaucratic culture, and so profit is not the only or even uppermost consideration. And since these “Gazoviki,” as John Grace says they are called,⁸⁰ control the major cross-country pipelines, energy producers have to play by their rules, which strictly limit the amount of natural gas produced by non-Gazprom-controlled units into the Gazprom pipeline distribution system. That is why, according to a report in the Moscow Times and estimates by the World Bank and the International Energy Agency, Russia accounts for almost 11 percent of the more than 110 billion cubic meters of gas flared worldwide each year into the atmosphere.⁸¹

As if to show they play no favorites, not only did the Russian government harass TNK-BP and Shell, which are British and Dutch, and LUKoil and its minority stockholder, ConocoPhillips, which is American; they also went after the French company Total in 2006. It, too, had been granted a Production Sharing Agreement in December 1995 to develop the challenging Khargyaga oil project in the Nenets Autonomous District in the far north. Just as with similar projects in the Russian Far North, the weather is extreme: bitter cold and dark in the winter and swampy and infested with mosquitoes in the summer. The mid-1990s was also a time when the Russian economy had serious problems and needed all the outside help it could get. Total had a 50 percent share in the project. Forty percent of the remainder was held by Norsk Hydro of Norway, and 10 percent by the Nenets Oil Company, which is owned by the Nenets Autonomous Region. Total was charged with failing to drill as many wells as it had promised. Moreover, Total also failed to pump the associated gas released with the crude oil from the well back into the well. Instead, it flared that gas. As a penalty, Total was told its license for the PSA would be withdrawn.⁸²

Such threats should not have come as a complete surprise to Total. This was not the first time the rug had been pulled out from under an agreement or pending agreement originally made at a time when Russia was relatively weak. In September 2004, Total had all but concluded a deal to invest $1 billion in Novatek, a semi-private gas producer in Russia.⁸³ According to Total, the deal was canceled after Russian regulators imposed numerous obstacles. Total attributed the cancellation of the deal to pressure from Gazprom, which wanted to exclude foreign equity investors from the gas sector.

IT’S NOT WHAT YOU DO, BUT HOW YOU DO IT

What emerges from these cases is that once they were able to revitalize their energy sector, the Russians ceased to be a supplicant. They no longer felt the need to offer the generous terms that come with a PSA—a colonial treaty, as Putin now calls it. That change in status also led Putin and those around him to find ways to regain control over the mineral assets, energy, and metals that had slipped from state control in the Yeltsin era.

In some cases, this was done by effectively renationalizing the properties; in other cases, it was done indirectly with threats of legal action as well as not-so-friendly visits from the tax authorities. Rather than a threat, sometimes all that was needed was a friendly chat. Whichever method Putin chose to follow, by 2008 and the end of his term, President Putin had effectively reversed the process of privatization, at least among what Lenin had called the “commanding heights” of Russian industry (see Table 5.4).

Putin noted in our September 2005 Valdai Hills Discussion Group meeting (organized by the RIA Novosti press agency for foreign specialists) that while we in the West have criticized the Russian government when it sought to reassert control over its energy assets, this, after all, is the pattern of ownership in all but a few countries, such as the United States and the UK.

The Western response to Putin’s effort to restore the government’s control over the commanding heights of Russian industry, should not be anger that the state wants to take control but with the way the state does it. In the case of Yukos, the state and/or Putin reasserted control of Yukos by putting Khodorkovsky in prison and harassing over two dozen of his associates by either jailing them or threatening them with jail. In the meantime, the state picked up the pieces of Yukos at laughable fire sale prices. The state also employed crude tactics against Shell at Sakhalin II, BP in Kovykta, and Total in Kharyaga. Of course, almost every foreign operator in Russia is subjected to close, sometimes too close, supervision. Exxon-Mobil, for example, as of August 2007 had been subjected to ninety inspections at its Sakhalin work site. This is not to claim that the Western companies were completely innocent of the charges made against them or to deny that other countries often harass energy companies operating within their borders. But without an independent court of appeal to adjudicate these complaints and insist on due process, Gazprom or other state surrogates seem to feel no hesitation in launching campaigns of harassment that force the foreign companies involved to yield a controlling share to Gazprom for either nothing or a vastly underpriced sum.

Faced with a state determined to regain what it considers to be its priceless and historic legacy, the foreign partners were given no choice but to surrender. As Daniel Yergin of Cambridge Energy Research Associates has noted, this is not the first time energy resources around the world have been nationalized or for that matter in Russia itself.⁸⁴ This is Russia’s ball game, not to mention their ball, and bat, and playing field, so they can do what they please. What is disappointing is that they are not doing it in what the Russians would call “a civilized way.” Perhaps there is no “civilized way” acceptable to those who feel their property is being stolen, but if Russia wants to be—as indeed it feels it deserves to be—a member of the G-8 group of developed and democratic market economies, it will have to discipline itself from returning to the ways of its past. Instead, it should adopt less peremptory and more lawful methods of regaining control over its natural resources.