Kremlin Reasserts Hold on Russia's Oil and Gas

By ERIN E. ARVEDLUND and SIMON ROMERO

New York Times

December 17, 2004

MOSCOW, Dec. 16 - On Sunday, Russia plans to auction the jewel of what used to be its most profitable, high-profile and well-run private company - the oil giant Yukos. And if the auction takes place, the winner most likely will be a financially opaque, government-run natural gas behemoth, Gazprom.

Practically overnight, Russia and its president, Vladimir V. Putin, would create an energy company that not only controls about 20 percent of the nation's oil exports but also has some of the world's largest energy reserves. A Kremlin campaign that unfolded over the last year will have succeeded in dismembering the country's foremost private oil company, and it will send a signal to Russia's business elite that the state is back in business - literally.

But late Thursday, the drama playing out in Russia over the auction was upstaged by that in a Houston court. The Russian government's plans for the auction hit a potential complication when a federal bankruptcy judge, Letitia Z. Clark, issued a temporary injunction intended to block Sunday's auction.

In doing so, Judge Clark granted a request sought by the management of Yukos, which took the unusual step of filing for bankruptcy protection on Wednesday in Houston. The judge based her decision on testimony by Bruce Misamore, Yukos's chief financial officer and an American citizen, who said that investors in the United States stood to suffer from the auction. It was unclear whether the decision would influence Russian officials guiding the auction, since most the company's legal challenges are being appealed in Russia. But the injunction raised a question about how several large European and American banks with plans to finance Gazprom's bid would respond. The banks have extensive operations in the United States and might be concerned about ignoring the restraining order, which could set the state for a protracted legal battle.

Lawyers for Deutsche Bank, one bank that was planning to finance the bid, had argued Thursday that Yukos had no justification for seeking bankruptcy protection in the United States because its oil exploration activities were entirely in Russia and Yukos has no employees in the America aside from Mr. Misamore.

Mr. Misamore, however, said he had no alternative but to seek justice in a Houston court after returning to the city this month. He testified that he returned to the United States after being told that he faced unspecified risks if he returned to Russia. Yukos was created under questionable circumstances from the remains of state oil assets in the early and mid-1990's. On its face, the Russian government is trying to sell off Yukos's largest production subsidiary, Yuganskneftegas, to pay back a tax claim of more than $27 billion. But the startlingly low opening bid of $8.65 billion, which the government set, is expected to tip the scales toward a state-friendly bidder like Gazprom. Two other largely unknown companies have submitted bids but their presence is seen as purely an effort to make the auction seem valid. Foreign investors, including oil companies from China, India and other overseas energy investors, have been discouraged from participating.

Of course, the Kremlin has all along controlled monopolies like Gazprom. But Mr. Putin is making no secret of the fact that he views Russia's oil and gas, diamonds and precious metals as strategic natural resources - weapons in his nation's fight to regain its global economic status. Whether the Kremlin initially intended to destroy Yukos, or merely to make an example of it to private business, is unclear - but the result, said Fiona Hill, senior fellow at the Brookings Institution in Washington, is "not outright nationalization, but creeping nationalization."

For Mr. Putin, oil may also be more than just a strategic asset. It is a symbol of power and a resource that helped support the Soviet government, especially during troubled economic times. Thanks to oil exports, the Soviet Union managed to maintain the illusion of economic health even during years of stagnation in the 1970's and 1980's.

It is also Mr. Putin's best hope of restoring Russian ambitions and presenting a facade of security.

Only months ago, Yukos was the darling of Western investors and it was poised to become an international oil giant with influence far beyond Russia's borders.

If the auction takes place Sunday, Yukos will essentially die that day - a casualty of efforts by Russian prosecutors that came with the tacit blessing of Mr. Putin. The founder of Yukos is now being held in jail, it's the company's American executives are in self-imposed exile and its shareholders are out billions of dollars. Russia's actions have set foreign and domestic investors on edge, prompted capital flight and raised questions about the rule of law and how businesses will fare.

Gazprom is the largest natural gas company in the world, with a quarter of all gas reserves. By adding Yukos's oil assets, it will become one of the largest energy company in the world by reserves.

"The Kremlin wants to set the strategic economic agenda, and that means not leaving the long-term strategies and decisions about how revenues should be spent to private companies," Ms. Hill said. "The state wants control of the commanding heights. This is how Russia positions itself as a superpower."

With a bulked-up Gazprom, Mr. Putin will take a leaf out of the book from China, Japan and South Korea, where governments worked hand-in-hand to champion certain industries and build successful corporate leaders. Mr. Putin was probably paying close attention when China's high-tech giant Lenovo Group bought the personal computer business of I.B.M. this month.

The Kremlin hopes to create huge, world-class corporations in important sectors-a phenomenon Vladimir Konovalov, a member of the Petroleum Advisory Forum, a lobbying group, called "ship of state" companies.

Sergei Bogdanchikov, who would lead Gazprom's oil and gas business, said Gazprom wanted to compete with giants like Exxon Mobil, Royal Dutch/Shell and BP. Ms. Hill said it was even possible that Gazprom might someday buys oil assets outside of Russia.

For American consumers and investors, the obituary of Yukos would be a symbol of what Russia can do to companies that have come into such riches that even the Kremlin is envious.

Mikhail B. Khodorkovsky, a little-known banker, took oil assets won at a controversial state auction in 1993 and developed Yukos into the country's most prominent and profitable commercial enterprise, worth nearly $40 billion a few months ago; it is now worth only $2 billion.

Early on, Mr. Khodorkovsky fought bitterly with some foreign shareholders. But in 2000, he decided to embrace Western-style corporate governance practices. Yukos's value soared, and Mr. Khodorkovsky even sought a merger with a smaller rival, Sibneft, and then to sell his combined company to Exxon Mobil or ChevronTexaco.

The company did not become as visible as the Russian oil giant Lukoil, whose red-and-white gas stations are popping up in Manhattan and in other East Coast cities. But Yukos traced the arc of Russia's post-communist economic recovery, with all the good and bad that post-Soviet capitalism offered. And Yukos put Russia on the map as an alternative to Middle Eastern oil - even as the campaign against Yukos helped push oil prices to over $50 a barrel.

Yukos and Gazprom are vastly different. Mr. Khodorkovsky, 41, had no experience in the oil business. But he salted the ranks of Yukos with expatriate engineers, like the Americans Joe Mach and Ray Leonard in exploration and production. Yukos sponsored Formula One race cars, and its headquarters in downtown Moscow boasted open architecture and posters of Mr. Khodorkovsky.

By the time it was a decade old, Yukos was Russia's top oil producer, with a global brand name. It was pumping 1.7 million barrels a day, or 2 percent of the world's supply. Mr. Khodorkovsky met with Condoleezza Rice, the national security adviser in the Bush administration, in Washington, he visited Houston on energy summits, and he pushed for Russia to start shipping oil to the United States. The production costs at Yukos were lower than Russian competitors; it was the first private Russian oil company to export crude to China; and it proposed building a privately financed pipelines to Asia. Other companies have been less embracing of free-market practices. Gazprom, for example, still provides some employee housing, kindergartens and special stores for workers. It boasts in television ads that it contributes a billion rubles a day - about $35 million - to the federal budget, and Aleksei Miller, its current head, is a Putin loyalist.

Mr. Putin, according to reports in the Russian media, was furious that a private energy giant was making decisions - and headlines - that were usually reserved for those in power behind Kremlin walls. Mr. Khodorkovsky financed politicians and parties who pushed his agenda in Parliament, like lower taxes for oil companies. But then, not long after he revealed negotiations to sell part of Yukos to a major Western oil company, Mr. Khodorkovsky was arrested and jailed in October 2003. These days, he goes to criminal court four days a week in Moscow.

His lawyers posted a statement from Mr. Khodorkovsky on his Web Site on Thursday, lamenting Yukos' downfall. "Such a turn of events is upsetting," he said.

So does the state-sponsored auction of Yukos mean foreign investors are still welcome in Russia? Conventional wisdom is divided.

Foreign investors are still welcome in the energy sector, but only in specific projects, and only on the government's timetable.

British Petroleum spent about $6.5 billion buying half of TNK, Russia's No. 3 oil producer behind Yukos and Lukoil. But even TNK's Russian shareholders conceded that such a deal probably would not have happened in this new environment. ConocoPhillips this year took an equity stake in Lukoil, but it was capped at 20 percent - not a controlling stake. Companies like Exxon Mobil, ChevronTexaco, Shell and others will be allowed to invest in specific projects - perhaps Gazprom's giant undeveloped Shtokman gas field-but not to buy companies outright.

"Putin is definitely re-Sovietizing" the oil and gas industry, said Michael J. Economides, a professor at the University of Houston and the co-author of "The Color of Oil."

The death of Yukos has rattled even the world's biggest oil companies. Lee R. Raymond, chief executive at Exxon Mobil, earlier this month said he was re-evaluating whether it was the right time to invest in Russia. Mr. Raymond said in a television interview Dec. 7 that the government's actions against Yukos raised questions "about how they are going to manage their natural resources."

"Until some clarity comes to that, I think it's going to be pretty difficult for people to think about putting large sums of money in as an investment," Mr. Raymond said.

All along, the Russia government has argued that Yukos was merely a tax cheat, and that auctioning off Yuganksneftegas, which pumps a million barrels a day of oil, was meant simply to cover the tax bill.

But the sheer mountain of taxes the government claims seems to undermine that argument: Yukos now owes over $27 billion for the years 2000 through 2003-more than all its revenues in some years, and during a period of record high oil prices.

Meanwhile, Mr. Khodorkovsky's imprisonment has prompted other Russian businessmen to wonder if they might face government actions.

Igor Shuvalov, an aide to Putin, acknowledged earlier this year that "whatever the outcome, the Yukos affair will be negative for the country because it harms its image."

But the end of Yukos has revealed unpleasant truths about Russia's lack of rule of law, and has corrupted every institution that was dragged into the process.

Erin E. Arvedlund reported from Moscow for this article and Simon Romero from Houston.