Mark Berniker
OGJ correspondent
NEW YORK CITY, Nov. 7 -- As controversy continues to swirl around the OAO Yukos scandal, experts see the Kremlin looking to limit the potential damage on foreign energy investment in Russia.
While traveling in Europe, Russian President Vladimir Putin moved to allay mounting concerns about foreign energy investment conditions in Russia, given the crisis surrounding the recent jailing and resignation of OAO Yukos Chairman and CEO Mikhail Khodorkovsky. On Thursday, Putin openly criticized a recent threat made by the Russian Natural Resources minister over the possible revocation of two oil licenses previously granted to Yukos, one for the Talakanskoye field in eastern Siberia.
Damage control
Putin said that his government isn't in the business of revoking licenses and that Yukos is free to continue its operations, despite the detention of Khodorkovsky. Putin's words came on the heels of comments by Natural Resources Minister Vitaly Artyukhov, quoted in the Russian daily Rossiskaya Gazeta as saying it is "practically inevitable" that Yukos will have production licenses for several of its oil fields revoked.
"The legal incorrectness of the statement by the natural resources minister, who has shown his absolute ignorance of basic legal concepts, causes deep regret," Yukos spokesman Alexander Shadrin told Interfax news agency.
Analysts sees Putin's response as an effort to stem the damage to investor confidence and anxiety about the rule of law in Russia.
"Putin himself has never spoken with such specificity on a particular matter before the Ministry of Natural Resources, [so] we're reading this as a very strong indication he is very sensitive to the impact of the Yukos law enforcement action. . .is having on investor sentiment," said Ian Hague, partner and cofounder of Firebird Management LLC, based in New York. "Russian politicians are falling all over themselves to say critical things, and they threaten damaging actions against foreign investors."
Hague has vested interests in how the Khodorkovksy controversy turns out, adding that Firebird owns close to $12 million worth of Yukos shares, a small share of the $31 billion company. Hague said Firebird also has sizeable investments elsewhere in the Russian oil and gas sector.
"There's been a movement by some members of the Russian Duma to call for revoking previously grandfathered [production-sharing agreements]," said Hague, specifically referring to the Sakhalin-I and Sakhalin II oil and gas megaprojects off Sakhalin Island, led by ExxonMobil Corp. and Royal Dutch/Shell Group, respectively, and Total SA's Kharyaga oil field development in the Timan-Pechora region.
"Certain members of parliament are seeking to curry favor with the FSB [Federal Security Service, successor to the KGB] and Russian Prosecutor's office by moving to revoke the grandfather clauses attached to these projects, but they are misreading the political tea leaves. They think that billionaire oil company owners who try to run for president will get in trouble, especially if they haven't always complied with the Russian tax code, which no one does," said Hague.
"Putin underestimated the reaction in the West. I think the Kremlin is in retract mode," said Michael McFaul, senior associate at the Carnegie Endowment for International Peace on a conference call hosted by United Financial Group, adding he thought Putin's recent reversal of his Natural Resources minister's comments were "politically orchestrated."
Putin awareness of fallout growing
While Putin has said that international oil companies interested in investing in Russia will be there for the long haul, nevertheless, he also may have made some misjudgments in the handling of the Yukos scandal.
"Putin is having to navigate between two extremes: one extreme is an uncompromising attitude on Khodorkovsky as a political opponent, and the other extreme is the concern that his actions raise in the investment community, in Russia and abroad," Hague said.
"Mr. Putin doesn't see his political strategy as incompatible with foreign investment and economic reform. He sees this being about one guy going too far outside of the rules of the game," said McFaul, adding this scandal may hurt his reputation internationally, but is not hurting him politically, at home in Russia.
Late on Friday, another disturbing development occurred: The offices of George Soros's Soros Foundation were raided in Moscow, just days after the billionaire investor and philanthropist publicly said the "persecution of Khodorkovsky sends an unmistakable message, that nobody can be independent of the state."
The foundation, which oversees several charitable organizations in Russia, has been at the center of a 2 year commercial dispute over control of the building in which it is housed.
Credit risk concerns raised
While some are minimizing the significance of the Yukos scandal, two major credit ratings agencies are voicing concern about the risks of operating in the Russian market.
The credit rating agency Moody's has put Yukos and OAO Sibneft, with which Yukos soon is set to merge, on "negative watch." Moody's said it "believes that this action is unprecedented and that the potential impact on the financial creditors of Yukos and bondholders of Sibneft is unpredictable."
Standard & Poor's has said it may revise its rating for Russia, if there is considerable capital flight or a downturn in the economy stemming from the crisis. A downgrade in Russia's credit rating could cost both the government and private Russian oil companies dearly in future borrowing costs, but S&P isn't saying that is going to happen.
"The arrest and resignation of Mr. Khodorkovsky, the freezing of the company's shares, and the subsequent Russian stock market decline does not affect our rating on Russia, but these events corroborate what we mean by repeatedly indicating that weak political institutions, a weak legal system, and clear political infighting between various political actors constrain the existing ratings," S&P said.
"My expectation is that when Yukos reports its next financial results, I think S&P will have cause to revisit their most recent outlook," said Hague.
Fate of Khodorkovksy's Yukos stake
While analysts weren't terribly surprised that Khodorkovsky was arrested, they say the clumsy handling of the scandal by the Kremlin makes it a very difficult situation to predict. One key question is what will happen to Khodorkovsky's Yukos shares, which have been frozen.
"If a Russian court finds Khodorkovsky guilty, then some portion of his Yukos shares have the potential to be forfeited, and my guess is that block of equity will be sold to ExxonMobil [Corp.] or Chevron[Texaco Corp.] through the negotiations with the Kremlin," said Hague. Both supermajors have been reported as being interested in buying a large stake in the merged YukosSibneft.
McFaul he said he didn't think Putin wants to prevent ExxonMobil or ChevronTexaco from being a partner with Yukos. He added Putin's strategy is to marginalize Khodorkovsky and "eliminate him as a political actor, but not to eliminate Yukos."
McFaul said he thinks Putin believes the major western oil companies are going to do business in Russia, because its future oil potential is too potentially lucrative to ignore.
ExxonMobil has plans to explore fields off Sakhalin Island in the Far East with estimated reserves of 2.3 billion bbl of oil. Putin has confirmed that Yukos held talks about selling a stake in the company to ExxonMobil. On Thursday, Andrew Swiger, chairman of ExxonMobil's international division, told a conference in London that Russia is "a long-term proposition" for his company, and it may even expand its presence in Russia in the future, according to Bloomberg News.
Market fallout
Beyond whether Russia's oil industry will be damaged by the scandal, there is the current issue of Russian production vs. efforts by the Organization of Petroleum Exporting Countries to limit production in a bid to strengthen world oil prices.
Russian Energy Minister Igor Yusufov has called on OPEC to raise production, saying prices were too high. Then on Wednesday, OPEC Sec. Gen. Alvaro Silva-Calderon was in Moscow expressed the group's interest in developing "cooperation with Russia as closely as possible." Silva-Calderon said he thought prices are "not too high" and that oil prices at OPEC's target band of $22-28/bbl for a basket of OPEC crudes are "fair."
Russia is the world's second largest oil exporter after Saudi Arabia, and the largest non-OPEC producer. There are reports Saudi and Russian officials met last week, but details of those discussions are not available.
"The [Persian] Gulf Arab oil producers think this is a golden opportunity for increased cooperation with the Russian government, because of a perceived increase in the state's control over the oil sector," said James Richard, a cofounding partner of Firebird Management.
However, Richard says Russia is vastly different from OPEC members, and its energy assets are being used to transition the country's economy away from dependence on energy. He said Russia is getting pressure from Saudi Arabia to "jump on board to OPEC's pricing plans."
Russia has said it will increase production, and there is no indication that if OPEC were to ask Russia to cut its oil exports, that it would comply.
"We do not think the whole Yukos controversy will impact world oil prices. The Russians are in the middle of a multiyear ramp-up in production, and the upper limit hasn't been reached. Russia's export potential is limited by the state of the pipeline infrastructure, not anything internal to the Russian oil companies themselves," Hague said.
Russian oil output for the first 9 months of 2003 was up 11%, compared with the same period a year ago. While OPEC decided to cut production to 900,000 b/d beginning Nov. 1, it is possible that Russia and other independent producers will continue to keep pressure on OPEC's planned productions curbs.
