Echoing Soviet Era, Putin Uses Oil Giant Rosneft to Tighten Economic Grip

Photographer: Alexi Nokilsky/AFP via Getty Images
Russia's President Vladimir Putin and Igor Sechin visit a Rosneft refinery in the Black Sea port of Tuapse, Russia, on Oct. 11, 2013.

When Igor Sechin was working as President Vladimir Putin’s deputy chief of staff a decade ago, visitors to his Kremlin office noticed an unusual collection on the bookshelves: row after row of bound volumes containing minutes of Communist Party congresses.

The record stretched across the history of the party and its socialist predecessor -- from the first meeting in March 1898 to the last one in July 1990, a year and a half before the Soviet Union collapsed, Bloomberg Markets will report in its March issue.

Sechin regularly perused the documents and took notes, says Dmitry Skarga, who at the time was chief executive officer of Russia’s largest shipping company, OAO Sovcomflot.

“He was drinking from this fountain of sacred knowledge so that Russia could restore its superpower status and take its rightful place in the world,” Skarga says.

Sechin’s back-to-the-future fascination with his country’s communist past is something he shares with Putin, who, soon after coming to power in 1999, restored the music (though not the lyrics) of the Soviet-era national anthem and later described the collapse of the USSR as the greatest geopolitical catastrophe of the 20th century.

Sechin himself is an open admirer of socialist icons such as Cuba’s ailing Fidel Castro, the late anti-U.S. Venezuelan leader Hugo Chavez and the executed Argentine Marxist Che Guevara, says Victor Mashendzhinov, who studied with Sechin at college. As a young man, Sechin served alongside Cuban fighters in the Cold War hot spots of Angola and Mozambique.

This story appears in the March 2014 issue of Bloomberg Markets. Close

This story appears in the March 2014 issue of Bloomberg Markets.

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This story appears in the March 2014 issue of Bloomberg Markets.

State Control

Sechin, 53, has put his careful study of communist-era documents into practice at state-run OAO Rosneft, the world’s largest publicly traded oil company by output and reserves. During a decade at Rosneft, Sechin has turned it into something resembling in size the gargantuan Soviet Union ministry that was once in charge of oil production, mainly by swallowing up rivals.

Beginning in 2004, when Putin appointed him Rosneft’s chairman, Sechin arranged Rosneft’s takeover of the main assets of Mikhail Khodorkovsky’s Yukos Oil Co., according to Khodorkovsky and former Yukos managers Bruce Misamore and Alexander Temerko. Yukos was Russia’s largest crude producer at the time. Last year, having become Rosneft’s CEO in May 2012, he orchestrated the company’s $55 billion purchase of TNK-BP, a BP Plc oil joint venture in Russia.

‘Firm’ Believer

Sechin is the leading exponent of Putin’s stated determination to restore the state’s role in the Russian economy. Putin used Rosneft, through its acquisitions, to return Russian oil to state control. The company, 69.5 percent government owned, controls about 40 percent of Russia’s crude output.

In a similar vein, Putin re-established majority state control of natural gas-exporting behemoth OAO Gazprom. The company had been privatized in the mid-1990s under his predecessor, Boris Yeltsin, cutting the government’s stake to 41 percent.

To develop high-technology industries such as armaments and pharmaceuticals, Putin created Rostec, a state corporation that encompasses 663 companies employing 900,000 people, or 1.2 percent of the entire Russian workforce. He expanded state-run banks OAO Sberbank and VTB Group, whose dominance in retail banking has edged out foreign rivals such as HSBC Holdings Plc and Barclays Plc.

Sechin declined requests to be interviewed or to answer written questions. In a telephone interview on Jan. 20, Putin spokesman Dmitry Peskov said of Sechin: “Sechin is a believer in the role of the state in his economic philosophy while at the same time not excluding a free-market approach. And he is firm in pursuing his viewpoint.”

Slowest Expansion

Of Putin’s relationship with Rosneft, Peskov says, “The president can’t get involved in the affairs of a company.”

Even as Putin, 61, stages the world’s most expensive Olympics, the $48 billion Winter Games in Sochi, to showcase the glories of present-day Russia, he has spent his time in office reshaping the economy to resemble the country’s Soviet past.

Oil from Rosneft’s Achinsk refinery flows through a state-controlled pipeline system. Photographer: Ilya Naymushin/Reuters/Landov

Oil from Rosneft’s Achinsk refinery flows through a state-controlled pipeline system. Photographer: Ilya Naymushin/Reuters/Landov

After Rosneft’s March 2013 acquisition of TNK-BP, state-owned enterprises accounted for more than 50 percent of Russia’s gross domestic product, up from 30 percent in 1999, according to data published by BNP Paribas SA’s Moscow unit and the European Bank for Reconstruction and Development, or EBRD.

Russia’s economy grew 1.4 percent last year, Economy Minister Alexei Ulyukayev said yesterday. That’s the slowest expansion since the 2009 recession. The ministry projects growth will average 2.5 percent a year through 2030, compared with an annual 7 percent from 2000 to 2008.

Competitive Realities

“Under Putin’s rule in Russia, the state is monopolizing key branches of the economy,” says Anders Aslund, a senior fellow at the Washington-based Peterson Institute for International Economics. Aslund was an economic adviser to Yeltsin in the 1990s, when the government carried out a wave of selloffs of state assets that put 70 percent of the economy in private hands.

“Incredibly, Putin seems oblivious both to the collapse of the Soviet Union’s economic system and why it happened,” Aslund says. “Half of the economy is controlled by state companies, and that is why the Russian economy isn’t growing.”

Such criticism ignores competitive realities, Peskov says.

“For example, in shipbuilding it’s absolutely pointless to carry out privatization,” he says. “You can privatize enterprises, but they won’t be competitive; they will be doomed to failure. So consolidating the assets under the state’s wing is the only way to preserve key sectors of the economy.”

Widespread Malaise

The slowdown in Russia coincides with widespread malaise in some of the larger emerging markets -- including Brazil and India, which along with Russia and China make up the BRIC countries, as they are known.

Russia is No. 14 in Bloomberg Markets’ annual ranking of emerging-markets countries. Its growth has decelerated or remained unchanged every quarter since Putin won a new term as president in March 2012.

Putin has said Russia stacks up favorably with many European countries on some key economic indicators. For example, Russia’s unemployment rate for November was 5.4 percent compared with 11.1 percent in the euro zone.

“The economy is in much better shape than in a number of European countries,” Peskov says. “That is why we don’t take this criticism seriously.”

State Capitalism

In furthering Putin’s mission, Sechin is more than just a loyal underling to the president, says Khodorkovsky, who accuses Sechin of orchestrating the destruction of Yukos. In December, Putin showed he’s confident enough in the economic change he’s wrought to free Khodorkovsky, once Russia’s richest man and Putin’s most powerful rival.

Khodorkovsky, who was imprisoned in 2003 on tax evasion and fraud charges and spent 10 years in prison camps, says Sechin tried to block his release.

“I don’t have any such information,” Peskov says. “I doubt it.”

Khodorkovsky also says Sechin has helped to shape as well as execute Putin’s economic policies.

“Sechin is a real oligarch, in the classic meaning of this word,” Khodorkovsky told Bloomberg News in an interview in Berlin on his fourth day of freedom. “He convinced Putin that state capitalism is right and is realizing this idea in practice.”

Strategic Industries

Putin, a one-time KGB colonel, maintains his tight grip on the economy by drawing on Sechin and other members of his inner circle to ensure that loyal allies direct the country’s industrial strongholds and revenue flows. Sechin, like Putin, is a St. Petersburg native and worked for Putin in the 1990s when the Russian leader was deputy mayor there.

Like Sechin, Putin’s favored few are men who were associated with him before he became president. They include the CEOs of Gazprom, Sberbank, Rostec and monopoly rail operator OAO Russian Railways. Gazprom, Rosneft and Sberbank are now the country’s three largest companies by market capitalization.

Putin, Sechin and other senior figures want to ensure that big companies central to the economy are in state hands, says Chris Weafer, a senior partner at Moscow-based consulting firm Macro Advisory.

“They hanker after what they recall as the stability of the Soviet system, and part of that is keeping control of so-called strategic industries,” he says.

‘Necessary Role’

Despite his relatively low profile internationally, Sechin looms large at home.

“Sechin is easily the most influential person in the country after Putin,” says Sergei Markov, a political analyst and vice rector of the Plekhanov Russian University of Economics in Moscow. “Putin trusts him more than anyone else.”

Having Sechin in control at Rosneft reflects Putin’s commitment to large government-run corporations.

“The experience of successful economic modernization of countries such as South Korea and China shows that the state has a necessary role to play,” Putin said in a 2012 campaign manifesto. “Large private capital willingly doesn’t want to go into new areas because it doesn’t want to carry major risks.”

Lately, that private capital has been flowing away from Russia. Concerns about Putin’s treatment of Khodorkovsky and what it said about doing business in Russia encouraged investors to pull $420.6 billion out of the country since 2008 to the end of last year, according to the central bank -- a trend the government has said it wants to reverse.

Sochi Olympics

Khodorkovsky’s release from prison won’t be enough to allay the concerns of foreign investors, said Alexander Kliment and Yael Levine of Eurasia Group, a political-risk research firm, in an e-mailed commentary on Dec. 19. His release, they say, was a public relations stunt ahead of the Sochi Olympics and doesn’t mean the business climate will improve.

The key drag on the economy is corruption, much of it concentrated in the state sector, says Elena Panfilova, head of Berlin-based Transparency International’s Russia branch. Russia was ranked the most corrupt nation among the Group of 20 advanced economies in the organization’s 2013 Corruption Perceptions Index.

Another hindrance is the fact that state-run companies face no incentive to cut costs and eliminate waste because nonstate shareholders are in a minority, says Mattias Westman, CEO of London-based Prosperity Capital Management, the largest Russia-focused equity investor, which manages about $4 billion in Russia and other former Soviet countries.

Stifling Enterprise

Jim O’Neill, the former Goldman Sachs Asset Management chairman who coined the term BRIC in 2001, says Putin’s stifling of private enterprise has led to Russia’s growth slowdown.

“Unless they do undertake reform, that’s the future,” O’Neill says.

Kingsmill Bond, chief strategist at Sberbank CIB, an investment arm of Russia’s biggest lender, says some investors and commentators hold Russia and China to different standards on transparency and human rights issues. With Russia trailing behind China’s 7.7 percent growth in 2013, Bond says, “it would be fair to say that Russian capitalism is judged more assiduously than that in China.”

Largely thanks to Rosneft and Gazprom, Russia (population: 143 million) is the world’s largest energy exporter by barrels of oil equivalent a day and the biggest crude producer after Saudi Arabia. The government receives about half of its budget revenue from oil and gas exports.

Perilously Dependent

The EBRD said in December 2012 that Russia was becoming perilously dependent on commodities and failing to prepare for falling oil output in 20 years. Lev Snykov, a partner at Greenwich Capital in Moscow, says the price needs to be at $120 a barrel or higher for the government to be able to balance the budget. The price of Brent crude was $107.23 on Jan. 29.

When Sechin became CEO of Rosneft, he had already been deeply involved in the company. As chairman beginning in 2004, he had a decisive say in strategic decisions because of his unrivaled access to the president, according to Vladimir Milov, who was deputy energy minister in 2002.

As a boss, Sechin displayed a ruthless streak, Milov says. In 2010, he initiated the sacking of CEO Sergei Bogdanchikov, a lifelong oilman who had kept Rosneft afloat through the volatile economic times of the late 1990s, Milov says.

He says Bogdanchikov had his own relationship with Putin, though not as close as Sechin’s. The pair wrestled over operational control, and Sechin eventually forced Bogdanchikov’s exit, Milov says.

‘Simply Amazing’

While serving as Rosneft chairman, Sechin was also appointed deputy prime minister with responsibility for the energy sector in 2008. He held the Rosneft position until 2011, when government officials with a potential conflict of interest were required to quit board seats at state-run companies.

He was the most effective bureaucrat in the government, says former Central Bank First Deputy Chairman Sergei Aleksashenko.

“From the point of view of bureaucratic management, he was simply amazing,” says Aleksashenko, director of macroeconomic research at the Higher School of Economics in Moscow. “He worked like a machine.”

Under Sechin, Rosneft has grown into a leviathan. From 2010 through 2013, its annual revenue increased 128 percent to an estimated $143.6 billion, according to a forecast by 13 analysts surveyed by Bloomberg.

Big Oil

Its oil and gas output of 4.88 million barrels a day as of the end of the third quarter of 2013 was greater than Exxon Mobil Corp.’s 4.02 million and PetroChina Co.’s 3.8 million; its proven oil and gas reserves, including TNK-BP, rose to 29.6 billion barrels at the end of 2012, above Exxon’s (25 billion) and PetroChina’s (23 billion).

The company posted an eightfold rise in third-quarter profit in 2013, after recording a 167 billion ruble ($4.98 billion) gain on the value of TNK-BP. Sechin clinched his latest deal on Dec. 20 -- the day of Khodorkovsky’s release -- with the acquisition of Morgan Stanley’s global oil-trading and transport business for an undisclosed sum.

Sechin has also presided over a $270 billion supply deal signed in June that will make China Russia’s largest crude customer during the coming decade.

Compared with non-state-owned energy giants such as Exxon, Rosneft is inefficient. Even though Rosneft’s lifting costs -- the cost of getting oil out of the ground -- are less than a third of Exxon’s, the Russian company’s workforce is less productive.

Huge Reserves

Net profit per employee at Rosneft was $70,815 in 2012, versus $620,026 for Exxon. Rosneft’s price earnings ratio was 5.4, compared with Exxon’s 13.2 as of Jan. 13. Rosneft shares fell 6.87 percent in 2013, while Exxon shares rose 16.93 percent during the year.

“The main reason to hold Rosneft is the reserves,” Greenwich Capital’s Snykov says.

Sechin had no hands-on oil experience before joining Rosneft as a manager. Initially, operational control was left to Bogdanchikov. Still, Sechin’s resume as a state bureaucrat served him well, with his rise neatly trailing his boss’s.

Born in what was then called Leningrad, he attended a school specializing in French. His parents, who both worked at a metallurgical plant, were divorced when Igor and his sister Irina were young.

After finishing secondary school in 1977, Sechin studied Portuguese at Leningrad State University. Unlike children of well-connected parents, Sechin was admitted on his own merits, says fellow student Mashendzhinov, who is now CEO of First Media Co., a St. Petersburg-based advertising firm.

Rock Concerts

Sechin pored over Marxist-Leninist texts and could cite from memory biographical details of Communist leaders through the decades, recalls Larisa Volodimerova, another fellow student. He wasn’t one to frequent underground rock concerts frowned upon by the authorities, says Volodimerova, now a human rights activist who lives in Amsterdam.

After graduating in 1984 with a Ph.D. in economics and being fluent in Portuguese and French, Sechin joined the Soviet Army and served as a translator in Portuguese-speaking Mozambique and Angola, where Soviet- and U.S.-backed factions competed for dominance during the final decades of the Cold War.

“A trip to a hot spot was seen as a good career move then,” Mashendzhinov says.

In Angola, where Soviet officers served as advisers to Angolan insurgents and Cubans fighting at their side, Sechin’s friendships led to an affinity with Castro’s island bastion of communism.

Downed Cuban

One day, Sechin witnessed at close hand the death of a Cuban pilot whose plane was shot down by Angolan rebels, according to Anatoly Kolomnin, the deputy head of the Moscow-based Union of Veterans of Angola.

In Cuba about three years ago, Sechin sought out the pilot’s widow and son, says Kolomnin. He brought the son to Russia for his university studies, Kolomnin says.

What turned out to be Sechin’s best career move of all came in 1988, when he went to work at St. Petersburg’s city hall, where he became acquainted with Putin.

In 1994, when filmmaker Igor Shadkhan came to interview Putin, then a newly appointed deputy mayor, he was surprised to see Sechin in the reception area of Putin’s office. Shadkhan says Sechin was the only male secretary in sight, recording the names and details of all visitors in a thick, black notebook.

“Putin chose Sechin because he wasn’t talkative and can be trusted with any information,” Shadkhan says.

Confounding Rivals

When Putin went to Moscow in 1996 to work as a senior Kremlin official under Yeltsin, Sechin followed as a lower-ranking bureaucrat in the presidential administration. When Putin became president in 2000, Sechin spent eight years as his deputy chief of staff.

Constitutionally barred from serving more than two consecutive terms as president, Putin bided his time for four years as prime minister and installed Sechin as deputy prime minister while Dmitry Medvedev sat in as head of state. When Putin reclaimed the presidency in 2012, he appointed Sechin as CEO of Rosneft.

Ex-Sovcomflot boss Skarga says that even after 2000, no one took Sechin seriously, seeing him merely as Putin’s loyal sidekick. Yet within a few years, according to Khodorkovsky, Sechin confounded his rivals by masterminding the 2003-2004 attack on Yukos.

Corporate Jet

After Khodorkovsky was arrested by armed police at gunpoint in a corporate jet in Siberia in October 2003, Yukos was eventually driven to bankruptcy, owing the government $26.6 billion, according to Claire Davidson, a spokeswoman for the former management.

With Khodorkovsky sidelined, Sechin personally launched takeover talks with Yukos Vice President Alexander Temerko in the summer of 2004, says Bruce Misamore, Yukos’s Ohio-born chief financial officer at the time.

The Kremlin wanted to imprison Yukos executives so that they couldn’t prevent the takeover, says Temerko, who now runs a London-based business that manufactures North Sea oil and gas platforms.

“Sechin was the main ideologue and driver behind the Yukos case,” Temerko says. “He was intimately involved in the process from start to finish.”

Peskov says there’s no truth to these allegations.

The government subsequently dismantled Yukos. Most of the company’s assets eventually ended up in Rosneft’s possession. That was always Putin’s endgame, says Misamore, who as a former director of Yukos helps run two Dutch foundations that hold Yukos’s overseas assets.

“His philosophy was, private ownership of the commanding heights of the economy is not acceptable,” Misamore says. “He wanted to take it back to the Soviet Union.”

Western Technology

In acquiring first Yukos and then TNK-BP from BP and its billionaire partners in March 2013, Rosneft gained control of companies that had pioneered the use of Western technology and management in Russia.

Yukos hired foreign executives such as Misamore, who made it the first Russian company to switch to quarterly financial reporting under U.S. accounting standards. Yukos also introduced new drilling techniques to bolster crude output, which had been in decline during most of the 1990s.

BP set up TNK-BP in 2003 with Putin’s blessing. While the new company paid $19 billion in dividends to BP from its inception, according to BP’s 2012 annual report, infighting between the Russian and U.K. partners eventually led to last year’s takeover.

Increased Production

Under that deal, BP has a 19.75 percent stake in Rosneft and BP CEO Bob Dudley occupies one of two seats BP will eventually be entitled to on Rosneft’s nine-person board of directors. Former Exxon Senior Vice President Donald Humphreys and former Morgan Stanley CEO John Mack are among the four independent board members.

TNK-BP increased production by more than 40 percent during the nine years before Rosneft bought it.

“The concern is, will Rosneft be able to achieve that same level of operating efficiency as TNK-BP did before it was acquired?” says Rob West, an oil analyst at Sanford C. Bernstein & Co. in London. “That really is the big question.”

Rosneft managed to increase crude production by an annual average of more than 3.5 percent from 2009 to 2012. While that looks faster than TNK-BP’s annual 1.5 percent rise over the period, West says that’s largely because strong government ties have given it access to new resources such as the Vankor field in Siberia -- the biggest oil find in Russia in 25 years -- which started pumping oil in 2009 and now accounts for almost 10 percent of Rosneft’s production.

Huge Debts

Rosneft is also shouldering huge debts, says Tatiana Mitrova, head of the oil and gas department at the Energy Research Institute of the Russian Academy of Sciences. Following the TNK-BP deal, the company’s indebtedness more than doubled, to $72 billion.

To ease financial pressures, Rosneft has drawn down the first tranche of up to $70 billion in advance payments from China National Petroleum Corp. in exchange for supplies, according to a Jan. 15 Rosneft statement.

In October, Rosneft separately signed a provisional $85 billion agreement to supply China Petrochemical Corp. with 100 million metric tons of crude over 10 years. While any advance payments from that deal could provide a cash lifeline, the agreement may also restrict Rosneft’s ability to supply other customers at potentially higher prices, West says.

Soft Spot

Rosneft, together with other Russian oil producers, is investing $13 billion in Venezuela in partnership with state-owned monopoly Petroleos de Venezuela SA. Rosneft was not put off by PDVSA’s questionable performance. Even as proven reserves almost quadrupled from 1999, when Chavez became president, to 2012, the country’s crude output declined about 13 percent to 2.7 million barrels a day, according to the BP Statistical Review of World Energy 2013.

Sechin has demonstrated a soft spot for Venezuela and for Chavez, who died last March. Sechin, who sported a Chavez-emblazoned T-shirt during a trip to Venezuela in 2012 and headed the Russian delegation to the leader’s funeral, said last year that the country is “our No. 1 priority.”

At a ceremony to mark the naming of a Moscow street in Chavez’s memory, Sechin read from the patriotic poetry of Vladimir Mayakovsky, a Soviet revolutionary poet.

‘Go-To Man’

“Chavez always told us that if you need to sort out an issue with Russia, you go to Sechin,” Diosdado Cabello, president of the National Assembly, told reporters before meeting Sechin in Moscow last October. “He’s the go-to man.”

Sechin is the go-to man at home as well, says Sovcomflot’s ex-head Skarga.

“The richer Rosneft becomes, the more his influence grows,” Skarga says.

Unlike those Russians who accumulated vast wealth during the privatization of state industries, Sechin isn’t preoccupied with money, says Skarga.

“He doesn’t have any billions,” he says.

What Sechin does have, Skarga says, is power. He will have it as long as Putin does, says Masha Lipman, an analyst at the Carnegie Moscow Center.

Putin has been in power for 14 years. Under a 2008 amendment to the constitution that allows presidents to serve two consecutive six-year terms, Putin could remain as president until 2024, when he would be 72 years old.

‘Psychological Milestone’

Though politically stricken by economic stagnation, Putin is likely to stand for re-election in 2018, says Andrew Monaghan, a senior research fellow at Chatham House, a London-based research center.

“Putin’s leadership currently looks steady and sturdy enough to last until the next election,” he says.

Sechin looks well set, too. He now has his eyes on a post-communist breakthrough: In a Jan. 9 research note, Sberbank said Russian oil output will probably approach the Soviet-era peak of 11.4 million barrels a day by 2016 or 2017.

“It would be a very big psychological milestone for Russia to get back to the Soviet-era peak production,” says Julian Lee, a senior analyst at the London-based Centre for Global Energy Studies.

It would be a boost, too, for the former city hall secretary whose study of the Soviet communist past has positioned him to play a leading role in shaping Russia’s economic future.

To contact the reporters on this story: Irina Reznik in Moscow at ireznik@bloomberg.net; Stephen Bierman in Moscow at sbierman1@bloomberg.net; Henry Meyer in Moscow at hmeyer4@bloomberg.net

To contact the editor responsible for this story: Stryker McGuire at smcguire12@bloomberg.net

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