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Jamestown Foundation
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Russia and Eurasia Review
Volume 2, Issue 15
July 22, 2003
THE YUKOS AFFAIR: POLITICS TRUMPS ECONOMICS
By Elena Chinyaeva and Peter Rutland

Elena Chinyaeva holds a doctorate in modern history from Oxford University and is a writer for Kommersant-Vlast, a leading Russian political weekly. Peter Rutland is a professor at Wesleyan University and editor of the Russia and Eurasia Review .

Moscow is gripped by what may be the biggest political ruckus since President Vladimir Putin took office. Against a backdrop of mounting terrorist attacks by Chechen separatists, the security forces have chosen to launch a wave of arrests of allegedly corrupt state officials and businessmen. The main target now seems to be Mikhail Khodorkovsky, the head of the Yukos oil company, whose company website describes him as "the richest man in Russia."

Americans can surely understand the political payoff from corruption investigations: Witness the parade of corporate executives on "perp walks" in the wake of the Enron scandal. But Russia's market economy is at a much more precarious stage of development. There is a real danger that several years of painstaking work on difficult structural reforms has been ruined in a week of feverish activity by law enforcement agencies.

MEN IN MASKS

On June 23, in a dramatic operation that was televised live, 300 officers from the Federal Security Service (FSB), the procurator general's office, and the Interior Ministry arrested General Valentin Ganeev, the head of the security service at the Ministry of Emergency Situations, and five senior police officials. On June 26, the procurator general's office accused Liberal Party leader Mikhail Kodanev of organizing the killing of fellow party leader Sergei Yushenkov in April. On July 2, prosecutors arrested Platon Lebedev, a co-owner of the Yukos oil company and one of Russia's newly-minted billionaires. He was taken from a hospital where he had checked in a few days before, and remains in custody three weeks later. He has been charged with malfeasance in the long-forgotten privatization of a fertilizer company. The prosecutors followed up with raids by the now familiar masked police in search of evidence of tax evasion in the offices of Yukos and its partner, Sibneft.

This storm seemed to break out of a clear sky. Russia was experiencing unprecedented political stability, and its fifth year of economic growth. GDP increased at 7.2 percent in the first half of this year, and personal incomes rose even faster. The budget is balanced, debts are being paid, and currency reserves have hit US$60 billion. In February, British Petroleum announced its intention to buy Tyumen Oil Company for US$6 billion--the biggest foreign investment deal in a century. For the first time in a decade, in the first quarter of 2003 investment inflows exceeded capital outflows. The government finally tackled the thorny problem of reform of the heavily subsidized electricity and housing sectors, getting a controversial package of laws through the parliament. And commentators such as Anders Aslund were assuring Washington that the oligarchs had finally matured into responsible and effective business leaders.

The arrests shattered this rosy picture, alarming Russian and Western investors. Yukos shares fell 7 percent on the day following Lebedev's arrest, and a week later the general RTS-index had fallen 47 points, or 9.2 percent. Then on July 16 the market crashed a further 5 percent, the largest one day decline since 1998. The ruble also started to slide; the Central Bank intervened with US$500 million on July 15 to stabilize the rate.

Why, then, such a July surprise? There are two logics driving the current campaign: One political, and one economic.

A POPULIST PLOY

The political logic is driven by the election timetable. The Kremlin has put a lot of effort into building up a loyal "party of power," United Russia, which it hopes will form a majority, with its allies, in the State Duma to be elected in December. The first arrests in the current crackdown--of senior police officers--happened on the eve of a United Russia congress, which gathered under the slogan "Together with the president!" Boris Gryzlov, the leader of the party, also happens to be the minister of the interior, and thus could claim an important victory in the battle against crime and corruption. [1]

United Russia has a problem: Its lackluster image and dull leaders are not attracting the popular support it needs to take over the Duma. The latest VCIOM opinion poll put its support in June at 26 percent--behind the Communists at 27 percent. Although President Putin is still very popular, there is widespread distrust of the government, and Putin's personal ratings do not seem to be helping United Russia. So something had to be done to boost its image.

For several months observers had been warning that United Russia needed to run against something. The usual suspects--the Communists and the Chechens--were old hat, having served as the target of the presidential election campaigns in 1996 and 2000. So a new enemy was needed. The options were limited: The United States, "corrupt officials," or the oligarchs. In the end, it was decided to find a "guilty oligarch."

Many commentators have suggested that an important reason for the attack on Yukos was the fact that its leader, Mikhail Khodorkovsky, was openly boasting about funding "opposition" parties such as Yabloko and the Union of Right Forces (SPS). This is only partly correct. First, it is no secret that these parties were financed by oligarchs since their inception--with Khodorkovsky backing Yabloko since 1999. Second, SPS is not an "opposition" party in any meaningful sense of the term: Its members and sympathizers occupy most of the key economic posts in the current government. Neither SPS nor Yabloko, with their pro-Western philosophies, pose a serious threat to President Putin--and they will be lucky in any event to clear the 5 percent threshold in the December election.

The singling out of Yukos as the principal focus of this campaign has more to do with the politics of oil than the politics of elections.

A PIPELINE TOO FAR

Yukos made the mistake of being too successful. It was the first oil company to adopt Western accounting standards, and even started to pay dividends to shareholders. It improved management and increased investment, boosting output by 23 percent over the past year--and surpassing Lukoil as the number one oil producer in Russia. On July 7 Yukos reported net profits of US$1.3 billion on second quarter sales of US$3.9 billion.

Its plans for the future are even more ambitious. A month ago Yukos announced its intention to merge with Sibneft, Russia's fifth largest oil producer. If it goes ahead, this merger would turn Yukos into the fourth largest oil major in the world.

Khodorkovsky aims to develop a network of privately owned export pipelines that will break the monopoly of the state owned Transneft corporation. Khodorkovsky overcame government objections and just weeks ago won approval for a new US$4 billion pipeline to carry West Siberian crude to Murmansk for export by sea. The new pipeline is expected to have a peak capacity of up to 150 million ton a year. By comparison, in 2002 Russia exported about 200 million tons. And in late May Yukos signed a declaration of intent with the Chinese National Petroleum Company to build a 2,400-kilometer pipeline from Angarsk in Siberia to Daqing, with capacity of 20 million tons per year. Although Transneft signed on as co-sponsor of the project, it would almost certainly preclude the building of a parallel pipeline from Angarsk to Nakhodka, which is favored by the Japanese--and possibly by the Russian government, for strategic reasons.

In addition, Khodorkovsky has campaigned to scrap the production sharing law, which places strict conditions on Western investments in Russian energy and mineral projects, and which is favored by the government and by Lukoil. [2] Khodorkovsky instead wants Western companies to take equity stakes in Russian companies.

Khodorkovsky has also been courting Western companies and governments in an aggressive public relations campaign that is presumably paving the way for future economic deals and political support. In 2001 he created the Open Russia Foundation, "Russia's first-ever international corporate philanthropic organization," with luminaries such as Jacob Rothschild and Henry Kissinger on the board. Last year, he symbolically shipped a tanker of Russian crude to Houston. On July 2 he met U.S. Ambassador Alexander Vershbow a few hours before Lebedev's arrest and informed him of what was about to happen.

It was probably Khodorkovsky's aggressive business strategies--and not the funding of rump parties like Yabloko--that set off the alarm bells in government circles. The Russian government relies heavily on loyal energy companies like Lukoil, Gazprom and Transneft: To fill its budgetary coffers; to subsidize domestic manufacturers; to gain influence over neighboring states in the "near abroad;" to win friends in Europe; and to provide cheap energy to Russia's hard-pressed denizens.

Khodorkovsky's plans--and achievements--threatened to break up these cozy relations, which have been the backbone of Russia's political economy over the past decade.

THE ICARUS EFFECT

In a Russia where the Federal Security Service is clearly ascendant, and where innocuous agencies such as the U.S. Peace Corps or AFL/CIO have been denounced as tools of Western hegemony, Khodorkovsky's ambition to develop his own foreign investment policy starts to resemble that of the mythical Icarus. Did he really expect Putin to stand by and watch the rising star of Yukos eclipse the state bureaucracy as the major player on world energy markets? Did he not notice that in every other country that is a major oil exporter, the production of oil is a state owned monopoly?

The "hunt on Yukos" is hardly unprecedented. On the contrary, it is consistent with the policies Putin has pursued since the day he took office. Oligarchs like Vladimir Gusinsky and Boris Berezovsky, who played politics and flouted their independence from the Kremlin, were crushed. The rules of the game were clear, and Khodorkovsky was breaking them. Putin is proud of Russia's traditions, and it is an established tradition to hammer down the nail whose head sticks out. As recently as June 20 Putin said in his annual press conference: "I am absolutely convinced that the much talked about equal distance between various business representatives and the authorities has been achieved in our country in the past few years. Today, those who disagree with this position, as they used to say, are no longer with us." The first shot of the current "war on the oligarchs" was fired at the end of May, with the release of a think tank report warning of a "crawling coup" with Khodorkovsky in the lead. [3]

President Putin himself has not tried to make political capital out of the Yukos affair. Television coverage has been modest, and his first public statements on the matter, on July 11, were characteristically equivocal. Prime Minister Mikhail Kasyanov, on July 8, even described Lebedev's arrest as an "overreaction."

The true story behind the crackdown, if and when it becomes known, may prove to be still more Byzantine, the product of factional struggles within the presidential administration. The media are speculating that a clique of Kremlin hardliners is behind the action--two deputy heads of the presidential administration, Igor Sechin and Viktor Ivanov, and FSB chief Nikolai Patrushev.

It looks increasingly likely that the Yukos and other arrests mark the beginning of the parliamentary campaign, in which Russia's long term economic interests might well be sacrificed to the short term political goal of bolstering the electoral chances of the United Russia party and its backers in the Kremlin.

1. On July 2, the Justice Ministry allowed Gryzlov to combine the posts of interior minister and party leader, on the curious pretext that the United Russia supreme council, which he chairs, is not the party's executive organ and thus Gryzlov is not formally a member of the party.

2. See Sergei Kolchin, "Prospects for investment in oil production in Russia," Russia and Eurasia Review, vol. 2, no. 10, May 13, 2003.

3. Vladimir Prybylovsky, "Oligarchs true and false," Russia and Eurasia Review, vol. 2, no. 12, June 10, 2003.