In the past 6 years the economy of Russia has been steadily improving. Russian government is in the process of de-privatizing its major natural and industrial resources. Among those national gems is an oil and gas company YUKOS. This paper is about the history of YUKOS and its role in the rise of Russian economy.
Perestroika
Russia was part of Soviet Union from 1917 to 1991. During this period Russian economy has had its ups and downs, but it has always trailed behind United States and Europe. After the October Revolution in 1917 “Bolsheviks Party (Russian Communist Party) established state control by nationalizing land, industry, banking, and foreign trade” [1]. The economy became centralized rather than market based. This centralization introduced many problems in management of Soviet natural resources, and industrial and agricultural sectors. Russia and other republics belonging to the Soviet Union suffered from inefficient allocation of labor and inadequate pricing of products. For instance, the price of bread was actually lower than the price of wheat that was used to make that bread. Farmers had to feed the livestock with bread rather than wheat, because bread would cost less. The bureaucracy associated with central planning was also keeping the factories from being re-equipped and renovated, which led to lower productivity and lower product quality. Some Soviet leaders like Nikita Khrushev, who was in office from 1953 to 1964, were trying to improve the efficiency of the central planning by changing some of the elements of the system. He attempted to “decentralize the state control by eliminating some of the ministries and organizing regional economic councils” [1]. However, these changes yielded even more problems. The system needed to be completely reorganized in order to improve the economy.
Gorbachev and Reagan (right) and the image of Glastonst (left)
In 1985 Mikhail Gorbachev assumed power. He was the originator of the ideas of Glasnost (from Russian public voicing) and Perestroika (from Russian restructuring). The goal of the Perestroika Program was to fundamentally change the regime of Stalinist system. This program allowed private ownership and foreign trade of private enterprises. Gorbachev also proposed a “Soviet Joint Venture Law, which allowed foreigners to invest in the Soviet Union” [1]. The foreign partners were allowed majority ownership and control of Russian enterprises. These reforms decentralized the state’s control over the economy. The companies that used to rely on government’s support in case of bankruptcy no longer had that safety net. A lot of businesses were struggling and eventually went bankrupt since they didn’t have efficient management, which wasn’t a priority during the Soviet era. Many private business owners just didn’t have the entrepreneurial expertise in order to keep themselves in business. Gorbachev’s attempt to improve the economy yielded the opposite effect. In the early 1990s Russian economy underwent a major disintegration due to the fall of Soviet Union regime causing the Soviet GDP to decline by 17 percent. “In 1992 the retail prices in Russia increased by 2520 percent.”[1]
Privatization
In 1991 Boris Yeltsin became the president of Russia. He was a democrat and a strong supporter of economical and political reforms.
Boris Yelstin
One of such reforms was the privatization of small enterprises that started in 1992. A lot of companies that belonged to state were sold at public auctions at a fraction of their market value. The assets of oil and gas companies like Yuganskneftegas and Kuybyshevnefteorgsintez (which were united to form YUKOS in 1993) were also privatized. This period of time was called the “oligarchic privatization”. The oligarch criminal groups (oligarchs means “the few who rule” from Greek) that controlled political parties rigged the auctions in their favor. During this time the rivalry between the competitors for resources led to bloodshed. About three quarters of state firms were privatized by the end of 1993.
Russian people were given privatization vouchers, which in theory could be used to buy stocks on the market.
Russian privatization voucher
“In reality the most privatization vouchers ended up in murky privatization funds, which tended to disappear as rapidly as Russia’s privatization itself. “[4] Some of the managers of the privatization funds ended up making a lot of money, while the average voucher holders were left with nothing.
How Russian oligarchs got rich
The history of YUKOS is closely related to the history of its founder and CEO Mikhail Khodorkovsky. Khodorkovsky was a very ambitious young man. He attended Mendeleev Institute of Chemical technology and was getting excellent marks. At school he became a communist activist and a member of Komsomol (the Communist Youth League).
Mikhail Khodorkovsky
His affiliation with communist ranks allowed him to start his own private café business in 1986. In 1987 Khodorkovsky and his friend Alexey Golubovich opened a center of “science and technology” called Menatep. This organization was trading computers and other goods like alcohol. By 1988 his business was bringing about 80 million dollars per year ($10 million USD). Khodorkovsky used the money that he made from trading to obtain a banking license. In 1988 he found Bank Menatep. The bank was really successful and it grew rapidly, because it was licensed to trade in hard currency (money of a politically stable country, USD is an example). After Perestroika a lot of businesses needed hard currency to trade with foreign companies, and Menatep was charging high interest rates on that currency.
Khodorkovsky saw the connection between the reforms and an opportunity for free market. He supported the reformist democrats during the coup of the Parliament building in 1991.
The coup of the Parliament Building in 1991
This action made him many political friends. Among these friends was Boris Yeltsin, who just became the president of Russia at the time. In 1994 Khodorkovsky bought the state owned fertilizer company Apatit, which made him even more money. However, his greatest move was to buy the state owned oil company named YUKOS. Bank Menatep purchased YUKOS for about $300 million on a public auction in 1995. Thanks to his political connections Khodorkovsky was sifted out from many potential buyers. The price that the company was purchased for was ridiculously low for what it was worth. The claim that YUKOS owed $2 billion was added to make the price more realistic and less suspicious to the public. By the end of 1997 the company was worth $9 billion.
In 1998 Russian economy collapsed taking down many of the banks with it. Russian government allowed the ruble to fall. The government defaulted and “stopped a $40 billion dollar payment in ruble bonds” [7]. The Bank Menatep also went bankrupt. Many bankers have lost everything. However, Khodorkovsky had other assets besides Bank Menatep. He had YUKOS and he had minerals that he purchased for a very low price during the government public auctions back in 1995.
Khodorkovsky turned out to be a better manager of YUKOS than everybody anticipated. “He was one of the first oligarchs to realize that foreign investment was needed in order to build a global business.”[6] Khodorkovsky wanted to attract foreign investors by making YUKOS transparent to the public. Very few investors wanted to do business with Russia after it defaulted in 1998. The first thing he did to make the company transparent was admitting that he had shares both from YUKOS and Bank Menatep, because he previously denied this fact. “YUKOS revealed the identity of its shareholders for the first time and started paying large dividends.”[6] Khodorkovsky was particularly interested in keeping good relationships with Unites States. He worked hard to gain American investors’ trust. In 2001 YUKOS held a delegation of US Congress, where Khodorkovsky had been made an “honorary member of Congress” by the head of delegation Congressman Curt Weldon. In his speech, Curt Weldon congratulated Khodorkovsky with this achievement:
“There is no denying that your remarkable success and achievements have thoroughly impressed us. I am convinced that YUKOS can serve an excellent example of how Russian companies and Russia’s entire economy can develop and succeed in building a prosperous future”. [10]
Khodorkovsky hired many executives from large Western oil companies, placing them in senior roles [6]. Among them was Texan Steven Theede, who became a CEO and COO of YUKOS-Moscow after Khodorkovsky’s resignation, and Bruce Misamore, who became a CFO.
YUKOS-Moskow CEO Steven Theede (left), and CFO Bruce Misamore (right)
This was another smart move on the part of YUKOS’s owner. He wanted to be perceived by American investors as a “crusader for stockholder and investor rights” [9]. That’s why he hired a public relations firm from Washington DC. Khodorkovsky contributed $1 million to the U.S. Library of Congress. He also set up the “Open Russian Foundation, which donated to US hospitals, museums and universities” [9]. The company regained its trust from foreign investors. YUKOS stocks increased dramatically. Many foreign investors started pouring money into the company. In 2001 and 2002 Khodorkovsky’s “net worth increased by four times” [9] and he became 16<sup>th wealthiest man in the world with the net worth of $15 billion. In 2003 YUKOS was worth $27 billion.
Khodorkovsky’s sentence
Khodorkovsky was not only a brilliant manager, but also a political activist. He was “meeting with students, staff, and residents in different cities, lecturing them on democracy, good governance, economics liberalism, and property rights” [11]. YUKOS was supporting Yabloko and Union of Right Forces parties, which were the opponent parties for Putin’s United Russia Party. Khodorkovsky bought a significant number of State Duma deputies. Many believe that President Putin viewed Khodorkovsky as a political rival. That’s why the president decided to go after YUKOS and destroy Khodorkovsky by taking away his most precious possession. In 2003 the YUKOS owner and his old business partner Platon Lebedev, who was the second largest shareholder in the company, were arrested on charges of personal and corporate tax evasion and illegal purchase of state-owned fertilizer company Apatit. Khodorkovsky had to resign as a CEO of YUKOS and the steering wheel was passed on to Simon Kukes, who was a US citizen of Russian descent.
YUKOS CEO Simon Kukes.
Steven Theede became the CEO and COO of YUKOS-Moscow. In December 2003 YUKOS was presented with a $3.5 billion tax bill, which the government claimed was owned by the oil company for year 2000. In July 2004 the $3.5 billion dollar bill was followed by another $3.4 billion dollar bill for year 2001. “In a move to prevent bankruptcy, the oil company management made a friendly offer to the government to pay $8 billion dollars in the period of three years.”[3] However, the authorities claimed that that wasn’t enough and they presented YUKOS with another $10 billion dollar tax bill for year 2002. In May 2005 after series of trials Mikhail Khodorkovsky and Platon Lebedev were found guilty on charges of tax evasion and were sentenced to nine years in prison.
Mikhail Khodorkovsky (left) and Platon Lebedev (right) in jail
Re-nationalization of YUKOS
YUKOS was formed in 1993 during privatization of state owned enterprises by a merger of two major entities Yuganskneftegas (Yugansk + petroleum + gas) and Kuybyshevnefteorgsintez (Kuybyshev + petroleum + Organic Synthesis).
YUKOS office building in Moskow.
Before Khodorkovsky purchased the company from the public auction YUKOS owed about $3.5 billion dollars to the government and almost went bankrupt. Khodorkovsky bought the company and turned it around. YUKOS became Russia’s biggest and most profitable oil company. It was responsible for approximately 19% of Russian oil production and 2% of the world production. It was refining about 16% of oil in Russia. The daily output was about 1.6 million barrels. The company’s oil reserves were 14.7 billion barrels and gas reserves were approximated to 8 trillion cubic feet. Russian government could not take a chance to let such a huge national asset to be controlled by foreigners, since YUKOS was a publicly traded company both in Russia and abroad. Russian government decided to regain control over its largest oil producer, and teach Russian businessmen a lesson to stay out of politics, by ruining Khodorkovsky’s life and driving the company to bankruptcy. “President Putin’s chief of staff, Dmitry Medvedev, has admitted that the prosecution was intended to ‘make an example’ for Russian business, which will now be chastened to pay its taxes dutifully and stay away from politics” [12]. As a result of Russian government’s pursuit to ruin YUKOS one of the company’s major oil producing entities Yuganskneftegas was auctioned off in Moscow and sold for $9.35 billion dollars to Bailkalfinansgroup. In December 2004 the state owned firm Rosneft merged another state owned gas firm Gazprom, and bought Baikalfinansgroup, thus acquiring Yuganskneftegas. Therefore, Yuganskneftegaz got renationalized. YUKOS essentially got decapitated. It lost the first letters of its name “YU”, which stands for Yuganskneftegaz. The remainder of the company is still active today, however experts believe that it won’t last much longer.
Russian economy is on the rise
Russia is the world’s second largest oil producer and exporter after Saudi Arabia. Some experts say that Russia has actually overtaken the Saudi Arabia in this regard [14]. The increased oil and gas exporting in the past 10 years became the main reason for the growth of Russian economy. Russian companies, like Lukoil, have shown even more interest in Western gas station chains in the past 6 years. Lukoil bought the US company Getty Petroleum Marketing “and its 1291 service stations in 13 Atlantic coast states, for about $60 billion as early as 2001.”[14] In 2002 “Lukoil purchased 795 service stations in New Jersey and Pennsylvania from ConocoPhilips for $265.75 million.”[14] Lukoil also became the largest oil supplier in Iraq, replacing Halliburton oil and gas company. Russian oil is also exported to many other countries like China, and Japan. The two countries were battling for the share of Russian oil for a while. Japan even proposed to finance the Eastern Siberia-Pacific Ocean pipeline project by paying the Russian state owned oil company Transneft (this company carries out 75% of the country’s total oil exports) $16 billion USD. However, China gets its oil from Russia via Trans-Siberian railway (1 million tones of oils per month as of 2006) and recently the $700 million China-Khazahstan pipeline was finished. This pipeline is capable of transmitting 20 million tones of oil annually.
Russian economy and its currency (Russian roubles) are strongly dependent on the prices of crude oil. The energy sector brings about 30-40% of Russian governments total revenues. “Given that Russia exports 150 million tons of crude oil per year, it is easy to compute that a dollar change in the world market price of oil per barrel would result in a USD 1.1 billion change in Russia’s annual export revenues” [13]. The GDP of the country is also strongly dependent on the market price of crude oil. In the graphs shown below the relationship between the prices of oil (bottom right corner graph in Figure 1), GDP (upper left graph in Figure 1), government’s total revenues (upper right graph in Figure 1), and the rouble’s real exchange rate (bottom left corner graph in Figure 1) is obvious. The big dip in all four graphs corresponds to the crisis of August 1998, when Russia’s economy collapsed. During this time the rouble collapsed significantly (bottom left graph in Figure 1). However, in the past 8 years the prices of oil soared. This effect made Russia rich. The government’s revenues have increased dramatically.
Russia’s economy improvements are also due to improved labor productivity. Between 1999 and 2004 the labor productivity was increasing by 10% per year. Another factor of economy improvement was a more efficient tax collection. YUKOS served as a good example as how serious Russians became when it came to taxes.
The effect on Russian economy of YUKOS going bankrupt
President Putin’s agenda to ruin YUKOS backfired on Russian economy. Russia’s wealth depended on the success of foreign investment in the country. After Khodorkovsky’s arrest many Western investors were afraid of the country’s political instability and they started to back away: “The RTS index - Russia's equivalent to the Dow Jones industrial average - shows little sign of recovery after immediately dropping 14 percent upon Khodorkovsky's arrest, and foreign capital is again fleeing the nation.”[11]. “The negative attitude of investors towards political and economic tendencies in Russia has formed. The statement of Russia’s most influential businessman Mikhail Khodorkovsky about large scale capital flight from Russia immediately prompted the withdrawal of billions of dollars from the country “[15]. Russian stocks and bonds were being sold very rapidly. The country lost billions of dollars. On July 14, 2003, the Russian stock market lost $6 billion dollars, and another $4 billion were lost on July 17.
Russia’s uncertain future
Russian economy continues to grow. However, many experts believe that a strong dependence of the country’s economy on crude oil cannot be good in a long run. In order to mitigate the effect of oil price jumps and their consequences Russia needs to diversify its exports. The Russian economy is also very dependent on foreign investments, but the political instability in the country tends to push foreign companies away. The rate of investment depends “on investor confidence in respect for property rights on the part of the government.”[16] The YUKOS affair does not look well from this point of view.
