Kremlin Playing Oil Game For Keeps

by Catherine Belton

Staff Writer, 

The Moscow Times

29 December 2003

News of the July arrest of Yukos co-founder Platon Lebedev was greeted with disbelief and excitement in Saudi Arabia, a kingdom increasingly nervous about losing its market-maker status in the global oil industry to long-time rival Russia.

According to a source close to OPEC in Riyadh at the time, the Saudi royal family moved within days of the arrest to capitalize on the apparent sea change in Kremlin policy, approving the first official visit to Moscow by a crown prince in 71 years.

"The arrest was seen as confirmation that the Russian government was building a policy independent from the United States," the source said. "Before then, they feared Moscow was boosting oil output at Washington's bidding. They saw a window of opportunity to engage Russia in longer-term co-operation. They saw a sign that Russian government was moving to slow down production growth," he said.

"That level of dialogue would not occur if the Arabs did not see Russia as being independent from America."

Indeed, through the legal onslaught against Yukos, in particular the jailing of Mikhail Khodorkovsky, Russia's richest man and its most influential pro-American voice, President Vladimir Putin has clearly defined the new rules of the game. In doing so, Putin is not only increasing the power of the state domestically, he is also repositioning the state geopolitically.

As the rest of the nation's oligarchs quake and rush to toe the Kremlin line, the wheels have been set in motion for a shift toward greater state control of business, particularly over the commanding heights of the economy, the peak of which is the oil sector.

Putin, it seems clear, is intent on restoring Russia's clout on the world stage, and a key plank in this new plan appears to be nourishing the defense sector with energy revenues, setting the stage for a tectonic shift in the political and economic landscape.

It's All About 'Values'

The most common explanation for why the Kremlin chose to go after Khodorkovsky and not the other tycoons is politics, that he was funding opposition parties and trying to buy a stable of loyal lawmakers.

But no less irritating to those in power is Khodorkovsky's pursuit of what is essentially an independent foreign policy, including pushing for privately owned pipelines to ramp up exports and quench U.S. thirst for a non-Saudi supplier. He has also cultivated and endeared himself to some of the most influential policymakers, politicians and businessmen in the West.

Although the official Washington line is that America is worried about what Khodorkovsky's arrest means for democracy in Russia, the question of what it means for oil prices and supplies is not far behind.

U.S. President George W. Bush called Putin twice this month to raise concerns about where Russia is headed, according to a senior State Department official. On Dec. 1, Bush called to express concerns about whether the rule of law was being used selectively. Then, after pro-Western, pro-market parties collapsed in the Dec. 7 State Duma elections and were replaced with nationalist factions that ran on an anti-oligarch platform, he called again.

"We want to develop a strong and positive relationship with Russia. That's going to be easier for us to do if Russia is moving down a democratic path," the U.S. official said.

"There is concern about this after the [Organization for Security and Cooperation in Europe's] findings on the election. There is a concern that it did not meet the standards it could have."

The OSCE issued a scathing report criticizing the parliamentary vote because of what it said was the unfair use of administrative resources and the media monopoly given to pro-Kremlin and nationalist parties.

"If we have a divergence on values issues that could impose some limitations on [the U.S. Russia partnership]," the official said. "We are trying to engage and have a dialogue on values issues so that the gap does not increase."

The Khodorkovsky case is also a major concern, the official added.

"We're still trying to understand what the Khodorkovsky case means: whether it is just about Khodorkovsky or the first step in a broader effort to gain a greater hold on economic players ... such as the energy sector," the official said. "It's not clear enough yet to make a judgement."

"The hope is that this plays out in a way that is not a threat to developing a market economy. This is the kind of environment that would be most attractive to foreign investors. [Foreign investment] is going to increase Russia's ability to export [oil]."

The concern is that a group of Kremlin hawks called the siloviki, former KGB men who are not known for their love of America or the free market, could seek to use the Khodorkovsky case to increase their leverage over the economy and over policy.

"There is a group within the Kremlin that is looking towards perhaps greater influence for the federal government [over the economy]. How far that goes and how far that influences their view towards the U.S. remains to be seen," the official said.

Playing Chicken

As the investigations into Khodorkovsky and Yukos grind on, so do the chances that the fallout could unravel the fragile market economy and threaten Russia's ties with the West.

The fear is that longer Khodorkovsky sits in jail, the greater the chances the situation might spin out of Putin's control, giving the siloviki greater power to confiscate assets.

"A game of chicken is going on between Putin and Khodorkovsky," said Chris Weafer, chief strategist at Alfa Bank. "The longer this goes on, the bigger the risk that Putin will lose control of the situation. The longer it goes on the more chance something will happen -- asset seizures -- that will ruin the investment case."

In recent weeks, the pressure has mounted.

A team of some 300 investigators has arrived in Moscow from the regions where Yukos is active to help with the investigations. And, in what appears to be an attempt to push Khodorkovsky into making a deal, Tax Ministry reports have been leaked claiming the company owes $5 billion in back taxes. Also hanging over his head, many observers say, is the possibility that prosecutors will pursue a conspiracy to murder charge in addition to the tax evasion and fraud charges. A mayor in Nefteyugansk, where Yukos has one of its main production units, was shot dead in 1998 just days after he complained to the Kremlin that Yukos was not paying its taxes. Khodorkovsky denies any involvement.

With each passing day, analysts say, the danger rises that the state will try to take back the assets Khodorkovsky won in controversial privatization auctions nearly a decade ago, raising the specter of a rollback of market reforms.

Some $9 billion worth of Yukos shares already have been sequestered by prosecutors as "collateral" for Khodorkovsky's alleged crimes.

"It seems like Khodorkovsky is trying to goad Putin into taking even stronger action," Alfa's Weafer said. "It seems like he's sitting in jail, saying go ahead destroy my company, but you'll take everything else down with you."

Putin's recent behavior adds credence to this view. On Tuesday, the same day as a Moscow court extended Khodorkovsky's stay in jail another three months, a visibly tense Putin indicated for the first time that the Yukos affair might not be an isolated case and threatened action against other oligarchs that gained their wealth in fraudulent privatizations if they did not toe the line.

Prior to those remarks, Putin had repeatedly stressed -- in public and in private meetings with Western bankers -- that the attack on Yukos and its parent company Group Menatep was is an isolated attempt to impose law and order and does not pose a threat to market reform.

Indeed, analysts say, there appears to be a personal animosity between Putin and Khodorkovsky that started long ago and has grown more intense in the last year.

Pipelines and War

Early this year, as the government began to block Khodorkovsky's efforts to build Russia's first privately-owned pipeline, the oil tycoon began to publicly lash out at the Kremlin for what he claimed were its intention to impose bureaucratic "Saudi-Arabian-style" rule.

Then, on March 20, a day after America went to war against Iraq, he publicly sided with the Americans, saying the campaign would be beneficial to Russia's economy. More galling to the Kremlin, he also criticized the government's opposition to the war, saying that aligning with France and Germany was "not in our interests."

Backing the war was one thing, but attempting to build private pipelines was a far more serious matter and appears to be one of the main causes of Khodorkovsky's troubles. It was certainly a policy that was essential for a U.S. drive to mold Russia as an alternative supplier of crude, one free from the restrictions other major suppliers in the increasingly unstable Arab world imposed to control prices. It was a policy, however, that was a direct threat to one of the state's few remaining levers of control over the nation's oil billionaires, and was seen as a direct threat to state sovereignty.

"Building privately owned pipelines was clearly an important issue for the U.S.," said Julia Nanay, senior energy analyst at the Washington-based Petroleum Finance Corporation. "It is important for the U.S. to have certainty with respect to pipeline access, and for them to gain upstream access. Without private pipelines the Russian government is free to decide how much oil gets to the market," she said.

"State ownership of the network gives the government OPEC-style control over exports."

Looking Pretty

When Putin came to power in 2000, Khodorkovsky was just beginning to make himself look good. Despite running roughshod over the interests of minority shareholders, attempting to lock them out of shareholder meetings and allegedly whisking company profits to offshore zones, a top-dollar makeover of both himself and his company quickly made him the poster boy for how U.S. capitalists wanted to see Russian capitalism develop.

His image adorned the front pages of most of the West's business glossies. A special edition of Business Week even pictured him alongside U.S. National Security Advisor Condoleeza Rice in an article about global leaders of the future.

"Khodorkovsky in particular was seen as having turned a corner," said Michael McFaul, an expert on Russian politics and its relations with the United States at Stanford University. "He was seen as a pioneer in pushing for transparency and for pro-Western values."

Sending a pioneering tanker of Russian crude to Texas ahead of the first U.S.-Russian Energy Summit may have caused some consternation in the Kremlin, but it won him plaudits and meters of column space in the Western press. His tale of personal redemption was so convincing that United Financial Group CEO Charles Ryan and other investment bankers were calling for the "Yukosization" of the nation. Khodorkovsky became so popular, and seemingly invincible, that he began to contemplate political power and pushed for the creation of a parliamentary republic.

There seemed to be no slowing the man down. Yukos surpassed LUKoil as Russia's top producer at the beginning of the year, and a few months later announced that it was buying smaller rival Sibneft. That takeover, derailed last month at the last minute, would have created Russia's first oil supermajor and turned Khodorkovsky into a truly major global player.

On top of it all, Khodorkovsky was preparing to sell a large stake of Yukos -- with or without Sibneft -- to a U.S. oil giant, reportedly either ExxonMobil or ChevronTexaco.

Washington was in love.

A Seat at the Table

In no time, Khodorkovsky had gone from robber baron to just plain baron, gaining access to the most powerful and influential people in Washington, including Bush's wife, father and vice president.

In June, just days before Lebedev's arrest, he rubbed shoulders with Vice President Dick Cheney while attending the American Enterprise Institute's World Forum, a conference for the world's business and political elite run by former U.S. President Gerald Ford. At the Beaver Creek, Colorado, powwow, he attended an exclusive dinner for 15 people, one of which was Cheney, according to a source close to Khodorkovsky. He was the only Russian invited.

Earlier in the year, Khodorkovsky attended a lavish reception organized by Laura Bush at the Library of Congress and ate dinner at the same table as Condoleeza Rice. Again, he was the only Russian invited.

Although Khodorkovsky had no private meeting with these people, according to the source, it was widely reported that he did meet one-on-one with Energy Secretary Spencer Abraham less than two weeks after Lebedev's arrest.

Greasing the Wheels

The oil baron actively sought to join the exclusive club of global shakers and movers. In 2000, as he began his corporate clean-up drive, he turned to Lord Jacob Rothschild, a key member of the influential banking dynasty that for centuries has been seen as the maker or breaker of governments around the world.

According to several sources close to the matter, Rothschild agreed to introduce him as a "debutante" to the world's ruling elite of financiers and politicians. By December 2001, Rothschild and Khodorkovsky had launched the Open Russia Foundation, a philanthropic organization aimed at promoting ties between Russia and the West. Other heavy hitters moved on board too -- U.S. foreign policy guru Henry Kissinger and former U.S. Ambassador to the Soviet Union Arthur Hartman joined the foundation's board of trustees.

It's not clear how deep Khodorkovsky's ties with Rothschild go. Russian media widely speculated that Rothschild was in line to take over the reins of Group Menatep, the holding company for the assets of core Yukos shareholders, as the last link in an emergency chain of command -- reports that Menatep, after months of refusing to comment, eventually denied. A spokesman for Rothschild said the lord had no business relationship with Khodorkovsky.

However, there are signs of financial links between the two.

According to its own web site, Menatep made commitments to invest in excess of $150 million with a number of global investment funds, including Global Asset Management, an influential investment fund founded by Rothschild in the early 1970s. The report did not specify how much exactly went to Global Asset Management.

Bush and the Pentagon

Menatep courted other powerful funds with its oil billions too, investing over $300 million in the Pentagon-linked Carlyle Group, according to a source close to Carlyle.

That's no small change for a fund that manages some $17 billion in assets, and it's more than Chukotka Governor and Sibneft oil tycoon Roman Abramovich paid for the Chelsea soccer club, a move that was also seen as a PR bid to shore up ties with the Western establishment.

Certainly, investing that sort of money with the Carlyle Group, a defense industry insider that boasts former U.S. Secretary of State James Baker, ex-British Prime Minister John Major and, until recently, former U.S. President George Bush among its advisers, opens doors, the source said.

"[Gaining access to the Carlyle Group] means you're with people who are sitting at the nexus of policymaking and money-making, people with their feet firmly planted in both worlds in Washington," said the source close to Carlyle. "It means you can talk to a very small group of people and make sure your issues are heard. You can build up very meaningful relations on a personal level that go beyond business."

Just over a month before Khodorkovsky was arrested, George Bush senior paid a visit to Russia in his capacity as a Carlyle advisor, stopping first in St. Petersburg before jetting off to Sochi to meet with Putin, who was vacationing with his family. On his way back home, he and Khodorkovsky attended a very select dinner in Moscow organized by Carlyle. The Moscow financial world was abuzz with unconfirmed reports that Bush had come to help negotiate the sale of a stake in Yukos to Exxon or Chevron.

It's not clear what the older Bush talked about with Putin. Many investors dismiss the rumors of his possible bidding for Exxon or Chevron as overblown and unlikely for a man of Bush's stature. Soon after Khodorkovsky was arrested, however, Carlyle called off plans to launch, together with oil-to-telcoms giant Alfa Group, its first private equity fund in Russia. Bush quit the group shortly thereafter. Carlyle spokeswoman Katherine Elmore-Jones said the 79-year-old former president had decided to retire.

Elmore-Jones could not confirm or deny the reported $300 million Menatep investment in Carlyle. She said she could not reveal how much investors had placed with the group, and pointed instead to a press release posted on the Menatep web site that said it had invested up to $50 million in various Carlyle funds in 2002.

It's not clear, either, who was courting whom in this game. Khodorkovsky needed Western movers and shakers to help him launder his image and sell off his company for one of the handsomest profits in world history. But the West, too, stood to gain from the relationship by promoting an increasingly powerful oil baron who was promising to help give them access to Russian reserves and was lobbying for key projects while becoming a powerful statesman in his own right.

Either way, he had become a key figure for the West.

"Khodorkovsky was the face of Russian oil for the United States," said Nanay of the Petroleum Finance Corporation. "In terms of the message he relayed when he came to Washington and his strategies for private pipelines and for a sale to a U.S. oil major, what he was doing was clearly in U.S. interests," she said. "But now, after his arrest, this seems to be unraveling."