Financial Times (UK) August 5, 2004 Kremlin tightens its control over Russia’s economy By CAROLA HOYOS and ARKADY OSTROVSKY
On July 22, the day that Yukos, the oil company, warned of its imminent bankruptcy and its main production subsidiary was seized by bailiffs, Vladimir Putin, the Russian president, held a meeting with James Mulva, the chief executive of ConocoPhillips, and Vagit Alekperov, the Soviet-era oil boss who now heads Lukoil, Russia's flagship oil company. The president had some good news for Mr Mulva: the government had just signed a decree to sell its 7.6 per cent stake in Lukoil - a private company which represents the Russian state in major international ventures - and signalled that ConocoPhillips was welcome to bid for it. Mr Putin added that he would like to see a more active relationship between Russian and US companies in the energy sector. Investors and traders were confused: should they sell Russian energy stocks because the country's largest oil company was being made bankrupt in violation of shareholders' rights, or should they buy assets because foreign companies were moving in? Of all Russian companies, Yukos has been the most active in seeking foreign investors, while Lukoil has remained cautious about foreign equity partners. But with its seemingly contradictory actions, the government was, in fact, sending a clear message: “we rule”. Having gained almost total political power in the country, Mr Putin and his entourage are proceeding to take control over what Lenin called the “commanding heights” of the economy. This does not mean that Russia is about to start nationalising private business and property or that foreign investment will dry up. It does, however, mean that the Kremlin will decide who can and who cannot invest in Russia. It will increase the state's control over strategic parts of the economy at the expense of the oligarchs who accumulated their wealth through privatisations in the 1990s. Although Yukos was on Wednesday given more breathing space by the justice ministry, which allowed it to pay salaries and to continue operating, there is little doubt that the balance of power is shifting towards more state-oriented companies such as Lukoil. [] Alexander Radygin, an economist at the Institute for the Economy in Transition, --argued in a recent paper that, over the past four years of Mr Putin's presidency, Russia has been moving towards “state capitalism” where power belongs to the bureaucracy rather than to private business. “The dominant trends of the past few years have been the growing expansion of property interests of the Russian state, an attempt to establish control over capital flows in the Russian economy and a desire to make business dependent on state institutions - despite decisions about deregulation, administrative reform and privatisation plans,” Mr Radygin says. This trend is most visible in the oil and gas industry, which accounts for almost 20 per cent of gross domestic product, according to the World Bank. While the state, and people who identify themselves with it, are also strengthening their positions in banking, telecommunications and media, the attack on Yukos is crucial to both domestic and foreign investors because it shows the limitations of the market economy in Russia. Al Breach, chief economist at Brunswick UBS, the Russian arm of the the Swiss bank UBS, says: “The Yukos affair demonstrates that property rights mean very little in Russia compared to politics. The ownership of assets is contingent on a political regime. If the regime changes so does the property structure.” The investigation of Yukos's taxes was initially interpreted by investors as a by-product of a political brawl between Mikhail Khodorkovsky, Yukos's key shareholder and former chief executive, and the Kremlin. Following Mr Khodorkovsky's arrest, they continued to buy Yukos shares believing the company's integrity was not in doubt. Even when Yukos was presented with a back-tax claim of $3.4bn it was seen as an attempt to rid Mr Khodorkovsky of his wealth. Investors were reassured by Mr Putin's promise that his government would do all it could to avoid the company going bankrupt. But the justice ministry's actions over the past few weeks indicate that the campaign was not aimed at merely curbing Mr Khodorkovsky's political ambitions or ridding him of his wealth. Taking financial control of Yukos, one of Russia's most dynamic oil companies, was at least as powerful a goal. Mr Khodorkovsky, who is standing trial for fraud and tax evasion, has volunteered to give up his shares in Yukos to settle the tax debt. The company has offered the government its stake in Sibneft an oil company, which would have paid for most of the tax arrears. Both offers were ignored. Instead, bailiffs, who are part of the justice ministry seized Yuganskneftegas, Yukos's largest production subsidiary, valued at $30bn, and are preparing it for sale to settle the tax bill. Yevgeny Yasin, a former economics minister, says: “This is the most blatant demonstration that the attack on Yukos has little to do with taxes and everything to do with re-distribution of property and control over the oil industry from independent minded private owners to politically loyal hands." Mr Yasin says the Kremlin appears keen to have the same degree of control in the oil industry as it already does in the gas sector. Unlike the oil industry, which was largely privatised in the mid 1990s, the gas sector has remained largely in state hands. The reform of Gazprom, the natural gas monopoly, has long been seen as the litmus test of Russia's commitment to market reforms. But on the eve of his re-election as Russian president in March, Mr Putin ruled out its break-up. The government holds 37 per cent in the company and is planning to increase it to 51 per cent. It will be assisted by Alexei Miller, who was appointed by Mr Putin four years ago as chief executive to reassert control. Mr Miller has bought back many of the assets sold or transferred to other companies by the previous managers. Now he wants to go further and build Gazprom into a state-controlled, broad energy holding. The company already owns about 10 per cent of UES, the electricity monopoly, and is in the process of creating an oil business. Reform of UES - headed by Anatoly Chubais, the author of Russia's controversial privatisations of the 1990s - has also been put on ice. According to Mr Chubais's plan, UES should have been divided into power generation companies and sold to private investors while the grid stayed in state hands. But Mikhail Fradkov, the prime minister, has delayed the sell-offs because of unease over who the buyers might be. It seems unlikely in the present political climate that the government would allow the uncontrolled sale of energy assets which could increase the size of the oligarchic groups. While energy remains the backbone of the Russian economy, the state is also strengthening its position in other areas, including banking. The banking sector is still dominated by Sberbank, which has 20,000 branches across the country and holds 62 per cent of all deposits. The central bank is pushing ahead with banking reform but it has no plans for breaking Sberbank's monopoly. “We shall not even think about what to do with Sberbank until 2007,” Andrei Kozlov, a deputy chairman of the central bank, has said. The recent liquidity crisis in the banking system shook public confidence in private banks and bolstered the position of Sberbank and Vneshtorgbank, both state-owned institutions. Problems at Guta Bank, which suspended operations last month, triggered a wave of withdrawals from private banks. Alfa Bank saw an outflow of $240m from retail accounts in just one week. Sberbank reported a net inflow of Rbs10.2bn and Vneshtorgbank, the second largest state bank, not only saw its deposits grow by 9 per cent in July, but took over Guta Bank for Rbs1m and assumed its obligations with $700m of assistance from the central bank. Control of the banking sector gives the government the possibility of allocating capital to any industry of its choice. “Sberbank and Vneshtorgbank give credits to Russia's largest companies and have exclusive access to the biggest and cheapest financial resources - the savings of the populations and deposits of the central bank," Mr Radygin of the Institute for the Economy in Transition says. The state appears equally reluctant to give up control over the population's pension savings, despite a provision for future pensioners to transfer some of their savings to a private scheme. “One gets an impression that the real aim of the government was not to reform the pension system but to maximise financial resources under the state control,” Mr Radygin says. Meanwhile, both state-owned and some private companies are urging Mr Putin to exercise tougher control over the market economy. Last week the heads of energy companies Lukoil, Rosneft, Transneft and TNK-BP said in a letter to Mr Putin that “the management and regulation of economic processes in the market economy is a natural and necessary obligation of the state”. The principles of “managed democracy” which has already led to an almost total control of political process by the Kremlin, is now being extended to business. The question is who will manage the commanding heights of the economy? One group that seems well placed to benefit from growing state control is the siloviki - people with a background in security services and the military, many of whom lost out in the 1990s. Since Mr Putin's election as president, however, they have managed to penetrate almost every level of the political pyramid. Last week Igor Sechin, the deputy head of Mr Putin's administration who is closely associated with the siloviki, was appointed chairman of Rosneft, the state-owned oil company. Mr Sechin, who acts as a gate-keeper for Mr Putin, is widely believed to be one of the initiators of the attack on Yukos. (Mr Sechin's daughter recently married the son of Vladimir Ustinov, the prosecutor general, who made the case against Yukos shareholders.) Mr Sechin's appointment led many analysts to believe that Rosneft could become the recipient of at least some of Yukos's assets. Another candidate for Yukos's assets is Surgutneftegas, a company tightly controlled by Vladimir Bogdanov, a Soviet-era oil man loyal to the Kremlin and Mr Putin. “Russia is following the path of former Soviet republics such as Azerbaijan or Uzbekistan, where economic wealth is concentrated in the hands of a ruling political clan. Putin may not realise that he is creating a new oligarchy which, once it has enriched itself, will pose a considerable threat to his own authority,” says Olga Kryshtanovskaya, a sociologist who has conducted a study of Mr Putin's political elite. Mr Breach says: “We are moving from a system which was deeply imperfect but tried to live up to the rule of law and market principles, to a system that is more political.” So what are the lessons and implications for foreign investors? The key lesson is the lack of respect for property rights. “What matters is control over the cash-flow, rather than ownership,” says Mr Breach. This poses a serious risk for minority investors in any Russian company. It also means that market capitalisation of Russian companies is likely to remain low compared with their foreign counterparts. Although the oligarchs who enriched themselves during the 1990s privatisations were far from being at the forefront of corporate governance - many of them diluted minority shareholders's stakes and siphoned profits into private bank accounts - over the past decade they transformed outdated Soviet assets into thriving and increasingly transparent businesses. This was well reflected in the growing market capitalisation of the companies. They have also proved their ability to survive the tough and often lawless conditions of Russian business. The siloviki and state bureaucrats have no such record. They have shown little respect for the right of minority shareholders so far - as the Yukos affair demonstrates - and they may be reluctant to open up their business interests to shareholder scrutiny. For strategic investors, the trend towards greater state control of the economy does not mean the end of foreign investment and privatisations, but implies that any merger or acquisition - particularly one involving a foreign company - is impossible without the Kremlin's approval. The sale of assets is likely to take into account the political loyalty of the buyer. Russia will remain an attractive investment for oil companies looking to replace their reserves (see below). But instead of negotiating with the company - as ExxonMobil did when it pursued a stake in Yukos - energy companies are having to talk directly to the Kremlin - as ConocoPhillips did when it formed a partnership with Lukoil. Large foreign companies have plenty of experience of operating in authoritarian environments, such as the Soviet Union in the 1970s and China today. In the short term, state control of the economy could provide stability for foreign companies and reduce their risk of facing aggressive Russian business practices. In the long term, as Mr Breach argues, any system based on the political allocation of resources is prone to crisis, as the collapse of the Soviet Union demonstrated only too vividly. Despite machinations, oil companies pursue deals The moves against Yukos by Vladimir Putin, the president, have brought a new level of uncertainty to Russia's oil sector. But for the world's largest international oil companies, the country is too big a prize to let go. Continued turmoil in Iraq, surging demand in China and dwindling production and reserve growth have combined to make oil companies and consumers desperate for oil. And Russia is seen as the country outside Saudi Arabia with the most potential to help meet strong global demand. Oil executives - most of whom are cautious about speaking of Russia's political moves for fear of the Kremlin or giving away their strategy - are uneasy with Moscow's strengthened grip over its oil assets. Nevertheless, they continue to search for opportunities, driven by fierce competition over reserves and concerns that the Kremlin will be likely to allow a limited number of foreign deals. Outside Russia the pickings are slim, with many oil executives believing that the world's large fields have already been discovered. Many of the remaining reserves lie in the Middle East, where regimes such as those in Saudi Arabia and Kuwait, have kept the doors largely closed to international investment. BP, the world's second largest energy group, is the only big oil company with a corporate deal in Russia - an $8bn joint venture with TNK. Last week, BP revealed that its production would have fallen 7 per cent in the first quarter of this year from last year had it not been for its partnership; instead it reported overall production growth of 18 per cent in the second quarter. Lord John Browne, BP's chief executive, last week said the Yukos affair had had no impact on TNK-BP and that “everything was going in the right direction”. Analysts say that ExxonMobil, the world's largest energy group, which has a relatively small presence in Russia, needs to make the biggest new investment because of its size. It had been looking to link up with Yukos, but analysts now expect Yukos's biggest subsidiary to go to a Russian buyer. Meanwhile, ChevronTexaco has had its eye on Sibneft. In April, France's Total retained bankers to advise them on how to get its hands on a share of the company after Roman Abramovich, its largest shareholder, made clear his eagerness to sell. ConocoPhilips, of the US, is looking to expand its relationship with Lukoil, Russia's second largest oil company. The company says that one of its options is to buy the stake the government intends to sell later this year and augment it with shares bought from Lukoil's top management. Royal Dutch/Shell, the world's third largest energy group, already has its biggest single direct investment in Russia's Sakhalin region. “We are keeping an eye on what happens and are thinking through whether those opportunities are available to us.” says Malcolm Brinded, head of the company's exploration and production. The large number of suitors -and a record high oil price have given Mr Putin the opportunity to play coy. He did, however, welcome potential US investors when he met James Mulva, head of ConocoPhilips, last month. “I would like to see relations between Russian and US businesses develop more actively,” he said. While Mr Putin has not made it easy for foreign investors, industry observers say Russia needs the oil companies to develop its resource base. “Without advanced technology it would not be possible for Russia to reach its full production potential,” says Stewart Johnston of Charles River Associates, industry consultants. The US has made clear that it wants to form a strategic partnership with Russia to reduce America's dependence on the Middle East. But Spencer Abraham, US secretary of energy, has told Mr Putin that some of his recent decisions, including the threat to revoke ExxonMobil's exploration license in eastern Siberia, could dampen US investor interest. Mr Putin has yet to go as far as the leaders of many of the world's biggest oil-rich states when they nationalised their oil industries between 1960 and 1980. But his slow progress in authorising foreign investment for oil has delayed supplies the world needs. __________________________________ Do you Yahoo!? Yahoo! Mail - 50x more storage than other providers! http://promotions.yahoo.com/new_mail
