YukosSibneft Share Seizure: First Shots in a War
Oct 31, 2003
stratfor.biz
Summary
Russian authorities froze the bulk of shares in Russian oil major YukosSibneft on Oct. 30. The development signals the start of a war between the Kremlin and the country's powerful oligarchs.
Analysis
Russian media exploded Oct. 30 with reports that Russian authorities had seized a majority stake in oil major YukosSibneft, whose chairman, Mikhail Khodorkovsky, was arrested Oct. 25 on charges of tax evasion and fraud. Within hours, Alexander Voloshin, the head of the presidential administration, submitted his resignation in protest.
What is happening is nothing less than the opening shots of a Kremlin war on Russia's oligarchs. President Vladimir Putin feels that the oligarchs who plundered the country in the 1990s -- of whom Khodorkovsky is the one with the most obvious political ambitions -- need to be finally purged or made permanently subservient to state interests. Putin's plan is to ensure the oligarchs can never again ride roughshod over Russia's national interests -- and in the case of the leadership of Yukos, that means driving six powerful men either into prison or out of the country.
Putin hopes that by excising the oligarchs' influence he can turn large swathes of the Russian economy over to Western firms, allowing them to remake the economy in their own image. This liberalization-by-confiscation technique has got most investors understandably cross-eyed, and it is far too early to predict whether Westerners will continue to pour cash into Russia over the long haul. Even those with a long-term view currently are sitting tight, waiting to see how far and deep the current investigations will go.
The Logic of Seizure
Yukos spokesman Alexander Shadrin, eager to defend his boss and cast the government in as negative a light as possible, quickly confirmed the Oct. 30 seizure, stating that "a controlling stake of 61 percent shares has been seized." He added, "This is a brutal violation of constitutional and legal rights as shares belong to a foreign company, which itself is controlled by a number of shareholders, most of whom have nothing to do with the so-called case of Khodorkovsky."
Later in the day, the General Prosecutor's office issued a statement adding more context to the development, noting that the government had frozen all shares of YukosSibneft held by Menatep, a Gibraltar-based holding company that Khodorkovsky long has used to manage his Russian assets. Menatep holds 44.1 percent of the total shares in YukosSibneft; of those shares, Khodorkovsky holds 59.5 percent.
The difference in figures can be explained by the fact that Yukos is in the final stages of purchasing Sibneft, another Russian oil firm. Approximately 61 percent of "Yukos" shares is the same as 44 percent of "YukosSibneft" shares.
Prosecution spokesman Natalya Veshnyakova said, "The arrest of the Yukos shares was done within the framework of the criminal case against Khodorkovsky to prevent any material losses. The shares have only been frozen, no one has seized them. There is no question of confiscating or nationalizing them." The holders of these shares are the core six men who created and have operated Yukos since its founding; the frozen shares can no longer be sold, although their holders can still collect dividends and exercise voting rights.
Of the six core shareholders, Khodorkovsky and Platon Lebedev, Menatep's president, already are in jail awaiting trial. Another, Vasily Shakhnovsky, was appointed to the Federation Council (where he has immunity from prosecution) by a regional government friendly to Yukos on Oct. 27, immediately after being charged with tax evasion. The General Prosecutor's office is trying to reverse Shakhnovsky's election so he too can be arrested. A fourth principal, Leonid Nevzlin, has fled to Israel, where he has applied for citizenship. The final two core shareholders, Vladimir Dubov and Mikhail Brudno, are being monitored by the authorities. A number of London-based Menatep managers have applied for political asylum.
This isn't the end of the matter. Even if the Yukos crisis ended today, Stratfor's sources within the Kremlin have indicated that Putin has decided to bring the oligarchs either to heel or to account. The resignation of Voloshin, long a representative of the Yeltsin Family faction of oligarchs within the Kremlin as well as a behind-the-scenes kingmaker, indicates that the ascendance to power of Putin's allies in the country's security apparatus has been mirrored by a decline in the political leverage of the oligarchs.
The Purges Continue
Considering that Khodorkovsky's arrest is only the first attack in a wider conflict, the question becomes: Who is next?
There is a short list of likely suspects:
At the top is most likely Putin's own prime minister, Mikhail Kasyanov. Like Voloshin, Kasyanov is a member of the Yeltsin Family, and like Voloshin, Kasyanov has found himself increasingly at odds with Putin's efforts against the oligarchs. The day after the share seizure, Kasyanov said, "I will refrain from any assessment, but my concern is great." He also said this is a "new phenomenon, whose consequences are difficult to define."
There is, however, little reason to suddenly purge Kasyanov. In addition to the obvious uproar that such a major government reshuffle would cause, presidential elections are less than five months away. Putin can simply make Kasyanov a lame duck and rule around him. Kasyanov's "departure" does not need to be loud to be complete.
A more visible target is Anatoly Chubais, CEO of electricity monopoly Unified Energy Systems, who commented Oct. 30 on the change in government tactics: "It is bad and it is serious." On the same day, the FSB spent 15 hours methodically raiding the offices of Novosibirskenergo, a key UES subsidiary. The Yukos investigations began in a similar manner.
Chubais would be a sweet target. He was the man who designed the rigged privatization schemes in the mid-1990s that Putin -- and the general population -- so despised because they created the oligarchs in the first place. He also is running for Duma office, ranked as the third-highest candidate on the Union of Right Forces' party list. In addition, he is the leader of the St. Petersburg clan of oligarchs and -- following Khodorkovsky's arrest and Abramovich's departure -- now the most influential businessman in the country. Nabbing Chubais would both allow more foreign control over the Russian power grid, something Putin feels is necessary to make it fully functional, and ensure that the most anti-Kremlin faction of the St. Petersburgers would be stunned into silence.
Chubais also might be getting ready to fight. According to the Russian press, Chubais has requested that Voloshin remain at his post as chairman. Chubais and Voloshin, being from different oligarchic factions, have never seen eye-to-eye. It appears Chubais is trying to close ranks with the Family in an effort to ward off additional anti-oligarch Kremlin attacks. Setting aside that the Russian population would cheer like teenagers at a rock concert if Putin were to vanquish Chubais, it is the red-haired oligarch's effort to grow a flower of opposition that Putin must nip in the bud.
Of course Putin will need to get the government to close ranks as well, and there are indications that some of his own ministers are a bit squeamish about the road down which Putin is driving them.
Finance Minister Alexei Kudrin said on Oct. 23 -- two days before Khodorkovsky's arrest -- that "the actions by law enforcements agencies must be lawful. Events are beginning to affect the economy. I hope the judges will be well-balanced and objective in taking decisions." Kudrin has proven discreet in the days since the arrest and probably will stay on.
But the same cannot be said for Deputy Economy Minister Arkady Dvorkovich, who is the next man likely to leave the Kremlin. Despite explicit orders from Putin to his government not to comment on the share seizure, Dvorkovich warned investors on Oct. 30 to think twice about what level of political risk they were comfortable with when they invested in Russia, saying, "This precedent shows that the risk of someone looking into old sins exists."
When it comes down to it, Russia now is operating on Putin's agenda. Many a Russian businessman has skeletons in his closet: It was simply the nature of doing business in Russia in the 1990s, and to a lesser degree, even in 2003. The prioritizing of this anti-oligarch campaign can best be summed up by a comment from Abramovich. When asked whether he thought he might be the next oligarch, he said, "I am not the one to be asked that question. In this case nothing depends on me."
Preventing Panic
Considering the damage that the government's tactics could inflict on Putin's longer-term strategy of revitalizing the Russian economy with foreign investment, it is no surprise that the president is in damage-control mode. Within hours of the shares seizure, Putin held a 900-minute Q&A session with investors, in which he appeared apologetic about the market volatility his efforts were causing, determined to see the situation through to the end and suitably conflicted about how current events were endangering his long-term goals for Russia. In a speech that made it clear he was aware of exactly where Russia's weaknesses were, he said, "It is very clear for us that the Russian economy's development depends in large part on investment activity."
Though many investors voted with their money and pushed the RTS index down 8 percent on that day alone, this is about the wisest thing -- in diction and tone both -- that the president could say. And he followed it up with a teaser, claming that international investors would be able to purchase shares in state-run Gazprom -- the Holy Grail of the Russian energy industry -- directly within a few months.
He followed up the Gazprom announcement with another soothing move. Voloshin's replacement will not be a former KGB hack, but rather Dmitry Medvedev, chairman of Gazprom's board of directors. Medvedev also is a member of the more liberal faction of the St. Petersburg clan of oligarchs, a group that favors large-scale economic reforms and foreign investment into Russia that has broadly aligned itself with Putin since his ascendance to the presidency in 2000.
In fact, since the share seizure Putin has slipped only once, when he compared the Yukos investigations to investigations by U.S. authorities into Enron and WorldCom. Since both of those firms disappeared after the investigations, it was not exactly a comparison that investors found endearing.
Foreign Reactions and Putin's Next Steps
As a consequence of the arrest and seizure -- not to mention the authorities and oligarchs gearing up for a long slog -- Russia has returned to net capital flight as the feel-good investments of the past year deduce that the Russian winters are cold. At this point, most of the cash is fleeing from bonds, currency trading and stocks -- the RTS index ended 17 percent lower on Oct. 30 from its Oct. 24 close. This so-called "hot" money is proving true to its name and at the current rate, capital flight for 2003 could exceed even the massive levels of the late 1990s. Russia's stock market bubble certainly is being deflated, and it might yet be popped.
Luckily for Putin, so far no major direct investors have announced they are canceling their investments, but neither is anyone plowing ahead. Threats during the week of Oct. 20 of investigation by the Natural Resources Ministry even managed to put ExxonMobil and Royal Dutch/Shell's multibillion-dollar Sakhalin operations on hold, and this week's events have done nothing to whet foreigners' appetite for holding long positions.
What investors do depends largely upon Kremlin actions at this point, and the best gauge for that will be what happens with the frozen shares. On the up side, the government released a 4.5 percent stake the day after the initial seizure, stating that it had discovered that this portion had nothing to do with the people under investigation. That distinction will help (slightly) to soothe some (very) frazzled nerves and did indeed help stocks -- including Yukos' -- rebound slightly.
Beyond simply releasing Khodorkovsky from jail and reuniting him with his assets -- which is a non-possibility -- Russia is in a legal no-man's-land right now. There is no precedent anywhere in the world for the share seizure. Either of the two most likely developments -- an outright nationalization of the shares or their outright sale to a foreign energy major -- would require legal gymnastics, and the markets would react accordingly. Stratfor sources within the Kremlin indicate that Putin heavily favors the latter, but even this "best-case scenario" indicates a general disregard for privacy rights.
One of the side effects of this ordeal will be a broad rationalization of share values in Russia. Many have charged that Russia's stock market long has discounted the political risk that the country is steeped in, the Yukos crisis likely will remind investors of exactly what they have gotten into. Driving the point home, on Oct. 30 the World Economic Forum released its new competitive index: Russia ranked 70th, just below Tanzania.
But Russia is still the world's largest supplier of primary energy, and its natural gas and oil output -- which for now does not depend upon foreign investment -- will continue to climb in the months ahead. Fear-induced capital flight is certainly on the agenda, but there is no reason (for now) to expect any industry meltdowns, industry collapses or debt defaults. Even Yukos' operations continue to run smoothly, and the company's COO, Steven Theede, formerly of ConocoPhillips, seems to have moved seamlessly into the driver's seat. Moody's has even taken pains to emphasize that it stands by its recent decision to upgrade Russia to investment-grade status. Moody's ratings historically tend to minimize the impact of political risk -- it's a debt-and-dollars rating that focuses on fiscal conditions -- but that does speak well for Russia's economic fundamentals, even if it isn't an endorsement of current political wrangling.
That does not mean the process will be pleasant. What is clear is that the Kremlin is willing to use legally questionable steps in its fight against the oligarchs, including the selective seizing of property rights and the selective enforcement of criminal statutes. Should a targeted oligarch not back down, Putin is willing to put entire business empires into legal limbo. Few argue that Russia would be a worse place to invest with the oligarchs gone, but the road from here to there will require Putin to take steps -- such as the Oct. 30 asset-freezing -- that will make even the most stalwart investors' blood run cold.
Make no mistake, it is the Kremlin -- not Khodorkovsky or a potential foreign suitor -- that will determine broad strokes of YukosSibneft's future development for the time being, and that is an authority Putin plans to assert over Russia's other strategic industries. Other oligarchs will take this lesson to heart and either begin sharpening their knives for the potential fight ahead (Chubais), make preparations to leave the country (Abramovich), or begin negotiating terms with the Kremlin (Deripaska). In the meantime, it is even likely that a handful of slow investors might find themselves caught in the crossfire.
This fight between the state and oligarchs has been coming for years, and Russia will have to work this out for itself. For now at least, that makes the country a not-so-nice place where some people are doing not-so-nice things to each other. So long as special forces are kicking in doors and arresting CEOs (often the Russian version of an audit), most foreign investors will be cooling their heels. Once the dust clears and the oligarchs are gone or neutralized, Russia -- and investors who like Russia -- might pick up where they left off.
But that day isn't going to be soon.
Russia will come back, and it probably will come back improved. But even if an optimistic assessment from a Stratfor source with the Russian Security Council proves true, the Putin team expects this state of affairs to persist through the first half of 2004.
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