11/14/2003: 
Fraud & Conspiracy
Court Refuses Bail to Former Yukos Chief
from Control Risks Group
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The Moscow City Court on 11 November refused to release on bail Mikhail Khodorkovsky, the former CEO of Yukos.
The decision to keep Khodorkovsky in prison was widely expected by observers, but has helped to depress the stock market. It is significant because it demonstrates that Khodorkovsky's 4 November resignation as Yukos CEO did not form part of a deal with the authorities. Instead, it was a defensive moved designed to ensure the smooth running of the company despite the investigations. Control Risks believes that President Vladimir Putin's regime's goal has been from the outset to see the Yukos leadership replaced, rather than to destroy the company.
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COURT REFUSES BAIL TO FORMER YUKOS CHIEFThe Moscow City Court on 11 November refused to release on bail Mikhail Khodorkovsky, the former CEO of Yukos.
The decision to keep Khodorkovsky in prison was widely expected by observers, but has helped to depress the stock market. It is significant because it demonstrates that Khodorkovsky's 4 November resignation as Yukos CEO did not form part of a deal with the authorities. Instead, it was a defensive moved designed to ensure the smooth running of the company despite the investigations. Control Risks believes that President Vladimir Putin's regime's goal has been from the outset to see the Yukos leadership replaced, rather than to destroy the company.
While it is now clear that no deal has been reached between the authorities and Khodorkovsky, it generally believed that his replacement, Semyon Kukes, is politically acceptable. The two US oil companies that are reportedly interested in acquiring a stake in the newly-merged YukosSibneft are likely to have received assurances from the authorities that the investigations into its senior management were not intended to undermine the company.
Khodorkovsky was arrested after his chartered aircraft stopped for refuelling in Novosibirsk. Prosecutors later charged Khodorkovsky with seven criminal offences, including fraud, embezzlement and tax evasion. He is being held in pre-trial detention at Moscow's Matrosskaya Tishina prison. Further arrests of Khodorkovsky's subordinates are possible, but the company as a whole is unlikely to be targeted. Putin on 5 November reprimanded the natural resources ministry for suggesting that Yukos would lose many of its oilfield licences. Khodorkovsky remains determined not to make any concessions to the authorities and not to admit defeat by going into ‘political emigration'. In his resignation statement, Khodorkovsky announced that he intends to focus on the activities of his Open Russia Foundation, a philanthropic organisation that promotes civil society and culture. Khodorkovsky may seek to use the foundation as a springboard for a presidential bid, but the authorities would be unlikely to tolerate this.
Prosecutors on 30 October froze 44% of shares in Yukos in order to prevent Khodorkovsky and the Menatep Group from selling their stakes while the investigation continued. It is not yet clear what will happen to these shares. The prosecutors later announced that they were unfreezing 4.5% of the shares. Khodorkovsky and the Menatep shareholders are unlikely to be allowed to hold on to their stakes: it is conceivable that they might be permitted to sell them (perhaps to a foreign investor) and ‘cash out' of the company. However, it is more likely that the shares will be confiscated by the courts.
Reasons for crackdown
The reason for the enmity between Khodorkovsky and the authorities is not entirely clear. The political threat that Khodorkovsky poses to Putin is not significant: if it is true that Khodorkovsky plans to run for president, his chances are slim given popular hostility towards super-rich businessmen and Khodorkovsky's reportedly Jewish origins. The risk to Putin and the government posed by Khodorkovsky's alleged funding for opposition parties is also insignificant, though Putin may perceive it as a threat. However, the president has made public his annoyance at the attempts by big business to influence policy-making in the Duma (lower house of parliament). Control Risks continues to believe that the main reason for the crackdown lies in the interests of companies such as Rosneft, Transneft and Gazprom, which were threatened by the activities of Yukos under Khodorkovsky's leadership. Yukos is in the process of implementing its merger with Sibneft to form the largest oil company in the country. It wishes to build its own oil pipelines (challenging Transneft's monopoly) and to become a major gas producer (a threat to Gazprom's monopoly). It is also engaged in disputes with Rosneft over the ownership of oilfields. The companies which feel threatened by Yukos have close ties to the 'siloviki' - officials in the government and presidential administration whose backgrounds are in the security services, the police or the armed forces. They may have persuaded the prosecutors to launch the investigations into Yukos, and appear to have convinced Putin that the investigations are for the good of the country. The timing of the crackdown, prior to key elections to the Duma on 7 December and for the presidency in March 2004, may also be significant. Interior Minister Boris Gryzlov is heading the election campaign for the pro-Putin party Unified Russia. Given the unpopularity of the 'oligarchs' among the electorate, Gryzlov may be calculating that the well-publicised investigations into Yukos will boost the party's popularity.
Interest from US oil majors
The Wall Street Journal (US) on 15 September reported that US oil majors ExxonMobil and ChevronTexaco were interested in purchasing at least a blocking stake (25% plus 1 share) in YukosSibneft. Although no bids have been made public, there has been considerable speculation that ExxonMobil is most likely to be the successful bidder and is in talks to purchase a stake of up to 40% for an estimated $25bn. Khodorkovsky and ExxonMobil CEO Lee Raymond were sharing a podium at the World Economic Forum (WEF) meeting in Moscow on 21 October when Khodorkovsky received news of raids on Yukos. Raymond reportedly met Putin for 30 minutes during the latter's September visit to New York. Before proceeding with any purchase, a US oil major would require some assurance from Putin that YukosSibneft's business would not be seriously endangered by the prosecutor's investigations. Opinions are divided as to whether the authorities would approve of a purchase of a stake in YukosSibneft by a US major. Some observers saw the latest crackdowns on Yukos and Sibneft as an attempt to prevent such a deal, with Yukos and Sibneft management hoping that having a US partner on board would provide much-needed protection from the authorities. In contrast, Control Risks believes that Putin would be interested in a deal between YukosSibneft and a US major, provided that Khodorkovsky either sold his stake in the company as part of the deal or at least yielded control of the company. Now that Khodorkovsky has resigned from the company, YukosSibneft could become the cornerstone of serious energy co-operation with the US.
31 Oct 2003
> RESIGNATION OF PRESIDENTIAL ADMINISTRATION CHIEF IS ONLY A PARTIAL VICTORY FOR HARD-LINERS
President Vladimir Putin on 30 October issued a decree appointing Dmitry Medvedev as head of the presidential administration. Medvedev replaces Alexander Voloshin, who submitted his resignation on 25 October.
Voloshin's resignation is a clear defeat for the 'Family' or 'oligarch' faction – the close circle of politicians, businessmen and relatives of the president that participated in running the country under former president Boris Yeltsin. It also deprives the embattled Yukos company of its most powerful political protection. However, Voloshin's replacement does not have a security service background, and this fact offers hope that the hard-liners in the presidential administration have not scored a total victory. While the 'siloviki' (hard-liners with backgrounds in the army, security services or police) , have increased their power, their instinctive desire for more authoritarian rule and greater state regulation of the economy will be counterbalanced by the so-called 'St Petersburg liberals', who favour market reforms.
Medvedev and Kozak
Rumours that Voloshin had submitted his resignation emerged on 26 October and were finally confirmed late on 30 October with the news of Putin's decree appointing Medvedev as the new head of the presidential administration. Like Dmitry Kozak, who has been promoted to the position of first deputy head of the presidential administration, Medvedev worked alongside Putin for the St Petersburg city administration under former mayor Anatoly Sobchak. Sobchak was a democrat and a liberal reformer, though his leadership of the city became mired in allegations of corruption and incompetence. Medvedev was an expert on the mayor's office committee for external ties from 1990-95, while Putin worked as Sobchak's first deputy. Putin clearly places a high degree of trust in both figures. Since 2000, Medvedev has been chairman of the board of directors at state monopoly Gazprom. Soon after becoming president Putin attempted to appoint Kozak as prosecutor-general, but reportedly bowed to pressure from the Yeltsin entourage to keep Vladimir Ustinov in the position. Kozak has since been responsible for devising a full-scale reform of local government and its relations with the regional and federal authorities.
With the appointment of Medvedev, Putin appears to want to continue the balancing act between rival factions in the administration. The 'Family' faction, whose sole remaining advocate is Voloshin's ally and deputy head of the presidential administration Vladislav Surkov, may be removed completely. The balance now will be between the 'siloviki' and the St. Petersburg liberals. The latter faction is likely to be responsible for the economy. The same reconfiguration of factions is likely to be echoed in the government. Control Risks believes that Prime Minister Mikhail Kasyanov, another representative of the 'Family', will also be replaced, probably very soon after the Duma (lower house) elections in December. Finance Minister Aleksei Kudrin, a St Petersburg liberal, is likely to retain his post.
Implications for business
Removing the 'oligarch' faction from the institutions responsible for running the country is likely to deprive the Putin regime of a great deal of expertise in economic management. Management of the macroeconomy, which has been so skilled in recent years, may suffer as a result. The investigations into Yukos may well be followed by examinations of other domestic companies, causing instability on the local stock market and some renewed capital flight. Overall macroeconomic stability should endure these shocks with few problems.
Despite the crackdown on Yukos, the leadership has not dramatically changed its attitude to foreign investment, which will continue to be welcomed provided that it is not seen as threatening the national interest. Broadly speaking, Putin sees foreign investment as a vital factor in restoring the country's strength through economic growth. The Yukos crackdown clearly emphasises the fact that non-payment of taxes will no longer be tolerated. Semi-legal schemes, such as the use of offshore subsidiaries to minimise tax payments, will also make foreign and domestic businesses vulnerable to prosecution.
Foreign investors should think twice about choosing as a local business partner an 'oligarch' company, i.e. one that:
* has a high profile;
* made vast fortunes during the murky privatisations of the 1990s;
* is led by someone who likes to get involved in politics; and
* does not enjoy close ties to the non-'Family' factions in the government.
This leaves as desirable partners the following types of local company:
* small and medium-sized businesses;
* companies that emerged after the mid-1990s;
* large companies whose leaders are willing to stay out of politics, such as Norilsk Nickel; and
* large companies with close ties to the right factions in government, such as Gazprom and LUKoil.
22 Oct 2003
> NEW GOVERNMENT DEPARTMENT TO MONITOR MAJOR OIL COMPANY ACTIVITIES
The natural resources ministry on 20 October announced the establishment of a new department that will monitor the fulfilment of licence agreements by foreign and domestic major oil companies.
The department's activities will affect major Western oil companies, such as ExxonMobil (US) and Royal Dutch/Shell (UK/Netherlands), that are operating under production-sharing agreements (PSAs). It will provide the government with another potential means to apply pressure on such companies if it wishes to do so. The department may also be used to apply additional pressure on oil major YukosSibneft, which is currently the subject of a major investigation by the authorities. It is too early to tell whether the new department will make it more difficult for such companies to operate, but its creation adds to the impression that the authorities are seeking to assert greater control over the oil industry.
Deputy natural resources minister Aleksandr Povolotsky stated that Royal Dutch/Shell, ExxonMobil and YukosSibneft would be the first companies inspected by the new department, which will include members of law enforcement bodies. He also said that all of YukosSibneft's operations in the country would be examined. The companies concerned have all stated that they are prepared for new inspections by the ministry.
The natural resources ministry has in recent months been engaged in disputes with all of the three companies mentioned. The ministry has alleged that Royal Dutch/Shell has failed to produce the amount of crude oil stipulated in its licence at the Salym oil field. It has also accused ExxonMobil of delaying its explorations at Sakhalin-1 and refusing to allow the ministry's inspectors access to certain sites and has similar complaints regarding the Sakhalin-3 project, for which ExxonMobil hopes to obtain a formal licence. The ministry has raised the possibility of reopening this licence to tender under normal tax regulations because it blames ExxonMobil for delaying the project by at least two years. The ministry has also raised serious environmental objections to YukosSibneft's plans to build an export pipeline to China.
17 Oct 2003
> KREMLIN IDENTIFIES PRIORITIES FOR 2004-08
The Vedomosti newspaper on 17 October reported that President Vladimir Putin has approved five priorities for government policy during his second presidential term in 2004-08.
Putin has until now been noticeably vague regarding objectives for his second term in office, which all observers agree that he will win easily, though he has called for an ambitious doubling of GDP by 2010. The five priorities identified for the second term are education, health, the creation of a market for affordable housing, modernising the army and ending the isolation of the Kaliningrad exclave. This suggests a policy shift towards directly addressing the needs of society, from the first term's goals of tackling the major barriers to foreign investment and reviving the macro-economy. However, it is unclear whether this new information regarding Putin's second term is intended at least partly as election propaganda. The government will continue to face challenges that have not yet been fully addressed, such as reform of the bureaucracy, the banking system and the natural monopolies. All of these will face opposition from vested interests.
According to Vedomosti, Putin on 11 July gathered in the Kremlin a group including 27 parliament deputies from all the main political parties and headed by former government apparatus chief Igor Shuvalov. The group settled on the five priorities mentioned above because they provoked the least disagreement. Putin on 20 September approved the plan and asked the Shuvalov group and the government to develop a detailed programme for achieving these goals. Finance Minister Aleksei Kudrin, Economy Minister German Gref and presidential administration chief Aleksandr Voloshin are all reportedly involved in the project. The aim is to have five draft laws ready for consideration by the Duma (lower house) in April-May 2004, after the presidential elections in March. The measures will mostly be welcomed by the population, which so far has seen little benefit from economic growth of more than 20% in recent years. However, the education and health reforms will involve the public paying for these services, which will be less popular.
Putin's strategy for his second term appears mundane compared with the measures that he has implemented since 1999 to reassert central control. However, this partly reflects the country's newfound stability. Shuvalov argues that by addressing these social problems the government can at the same time boost economic growth, partly by increasing labour productivity and life expectancy. Years of chronic underfunding and corruption have seriously undermined the health and education services. Doctors accept small bribes in the form of 'gifts' almost as a precondition of treatment, and the introduction of private medical insurance in the mid-1990s has failed to solve the funding crisis. Higher education institutions are often accused of selling degrees and other qualifications to students, which has caused a serious decline in the prestige of those institutions. In both cases a large injection of money is necessary before any noticeable improvements can be made. The market for affordable housing is currently under the control of mid-level bureaucrats and riddled with corruption. Putin lost face over Kaliningrad in 2003 when he was forced to accept a visa regime for Russian citizens travelling by land through Lithuania to and from the exclave. The stated desire to 'bring Kaliningrad out of the ghetto' is likely to mean an injection of federal funds to revive the regional economy and an attempt to improve sea-based transport links that circumvent the visa regulations. Efforts to reform the military, including moving from conscription-based to professional armies and reducing overall troop numbers, have been under way for several years but face considerable opposition from vested interests within the army.
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