Khodorkovsky arrest clouds outlook for Yukos, foreign investment in Russian oil sector

Oct. 28, 2003
Russian financial markets appear to be stabilizing, after the initial shock over the arrest at gunpoint of OAO Yukos CEO Mikhail Khodorkovsky by Russian police over the weekend. But the arrest is prompting concerns over Yukos's planned aggressive expansion plans, and even over the future of foreign investment in Russian energy markets.

Mark Berniker
OGJ Correspondent

NEW YORK, Oct. 28 -- Russian financial markets appear to be stabilizing, after the initial shock over the arrest at gunpoint of OAO Yukos CEO Mikhail Khodorkovsky by Russian police over the weekend.
But the arrest is prompting concerns over Yukos's planned aggressive expansion plans, and even over the future of foreign investment in Russian energy markets.

And there remain questions over the imminent completion of a proposed merger of Yukos and OAO Sibneft to form Russia's largest oil and gas company (OGJ Online, Apr. 22, 2003). At the same time, the arrest casts a pall over the rumored negotiations—confirmed by Russian President Vladimir Putin—with ExxonMobil Corp. for a large stake in the merged company YukosSibneft; ChevronTexaco is also said to be in the running for a big piece of YukosSibneft, although neither supermajor confirmed such interest (OGJ Online, Oct. 13, 2003).

Arrest reactions
Khodorkovsky was charged Saturday (Oct. 25) with having committed $1 billion in fraud and tax evasion, and is being incarcerated in Moscow. Yukos issued a statement calling the charges "absurd," humiliating to the Russian legal state," and "a politically motivated affair."

But that doesn't mean the arrest was unexpected, say analysts.
"Our take is that the arrest of Khodorkovksy wasn't a surprise, given the ongoing tensions between the Kremlin and Yukos," says Alex Brideau, Russia analyst with the New York-based global political risk consultancy Eurasia Group. "We hadn't seen pullback by either side, and we are also in the midst of a very tense political season. Politics seems to be at the heart of this dispute."

"These accusations are immaterial and nonsubstantial' none of them would stand up in a real court, and they amount to sheer legal harassment," says Anders Aslund, director of Russia and Eurasian Program at Carnegie Endowment for International Peace, based in Washington, DC.

Western execs take charge
On Monday, Yukos said Stephen Theede, its chief operating officer and a former vice-president of ConocoPhillips, is being put in charge of all of the company's operations. Bruce Misamore, a second American executive employed by Yukos, will remain as the company's chief financial officer.

"The company has been trying to say the management team is fully capable of running Yukos without him, but there are still questions about major strategic decisions, which he might want to play a central role in," Brideau said.

Three Khodorkovsky loyalists are also part of the senior management team, including Yuri Beilin, Mikhail Brudno, and Peter Zolotarev. If Khodorkovsky were to go to prison, Aslund questions whether the company would stay on its current track.
"These people have stood for increasing production, efficiency, transparency, and energy exports to the US; if you take out the people who have pushed for this, these objectives are likely to suffer," said Aslund.

Putin's balancing act
Analysts say a lengthy prison term for Khodorkovsky would be a negative for Yukos, and possibly a deterrent to future western investment in the Russian energy market. But the Kremlin has gone to great lengths to dispel those fears.

Analysts agree the Kremlin's charges against Khodorkovsky are politically motivated, but the Russian president, nevertheless, is cognizant of the importance of Western investment in his country's energy industries.
"Putin has gone out of their way to reassure investors this is not attack on privatization, or the renationalization of assets, but that doesn't mean the arrest isn't causing some concerns among western energy executives," Brideau said. "Putin's Kremlin doesn't appear to be going after the companies; they seem to be more interested in the individual oligarchs and other leading shareholders."

Khodorkovsky's wealth has been estimated by Forbes magazine to be $8 billion, and his status as the most powerful oligarch in Russia is a lightning rod for Putin and many of his political supporters.
"The objective is political. This is a systematic, deliberate, authoritarian drive by Putin to enhance his powers, and this is good electoral politics, because the oligarchs are very unpopular with the Russian public," Aslund said.
"An insignificant clerk, and a government official, even of the highest level. . .a regular citizen, a midsized businessman and a major businessman. . .irrespective of how many billions of dollars are in his personal and corporate accounts, everyone has to be equal before the law," Putin is quoted as telling Interfax News Agency.

And analysts believe Putin has had a direct hand in the handling of the Khodorkovsky case.
"This kind of action did not happen without some tacit knowledge of the president, which raises the stakes for Khodorkovsky, but the government does not appear to be targeting the company's oil operations," Brideau said.

Future unclear
Yukos's operations are not expected to be severely impacted by the arrest of its chairman, but questions are being raised what his detention will mean for the much-discussed possible merger talks with ExxonMobil, ChevronTexaco, or other potential partners.

While there is still a possibility that there will be a settlement, or a Russian court could dismiss the charges, the fact is the Khodorkovsky case is dominating the current outlook on the Russian energy market, and some think western interests may think twice, before entering Russia.

"US companies are now likely to adopt a wait-and-see stance, and even when they do reenter the negotiation process they will probably be much more careful when evaluating all the risks of such an investment," said Alfa Bank in a research note on Yukos.
"It is a major judgment, that President Putin supports the law enforcers within Russia over the rule of law. The rule of law is secondary, and it shows any law enforcement official has the right over the foreign investor," adds Aslund.

Analysts say that while Khodorkovsky isn't directly involved in the company's day-to-day operations, he is the key negotiator in any merger talks, and would have a major say in bidding on any new licenses in Siberia.
"Without political influence, YukosSibneft will run into difficulties in obtaining new licenses in Eastern Siberia, where it planned further expansion," MDM Group said in
a research note.

Khodorkovsky would undoubtedly insist on weighing in on the company's plans to construct a pipeline to China. Yukos has said it plans to boost production to 2.35 million b/d, and it is counting on the pipeline to China to provide an impetus for expanding its capacity.
Meanwhile, Russian President Putin has come out it support of a competing pipeline, which would lead to Japan (OGJ Online, Oct. 20, 2003).

There are few doubts the Sibneft merger deal will be closed before yearend. However, questions remain regarding how the merger will be executed, how the two Russian oil companies will integrate their operations, and at what pace. When Yukos and Sibneft complete their merger, as expected, the combined company will have a value approaching $50 billion.

On Monday, the rouble was under severe pressure, and both Yukos shares and the Russian stock market fell by more than 10%. But on Tuesday, the Russian stock market stabilized, and Yukos shares actually traded higher.