Murky Dealings In Russia's Oil Patch

Why is the Kremlin going after giant Yukos just when it may be on the verge of a megadeal with Exxon?

Friday, Oct. 3, wasn't a normal day at the Podmoskovny Lyceum, an orphanage outside Moscow. As bewildered children looked on, machine-gun-toting police surrounded the building while a team of government investigators combed through everything from computer records to children's exercise books in search of evidence of tax evasion by the institution's benefactor, oil giant Yukos. The same day, police raided other premises linked to Yukos.

Thus unfolded the latest chapter in the Yukos Affair, a tale of political and business intrigue that has gripped Corporate Russia for the past few months. The star in the drama: 40-year-old Yukos Chairman Mikhail B. Khodorkovsky. Kremlinologists say Khodorkovsky -- a Communist youth leader turned banker turned oligarch -- is being punished by the Kremlin for using his company to boost his political clout.

Kremlin pummels pesky oligarch: We've read this script before. But the Yukos story gets twisted fast. Consider that just a day earlier, Khodorkovsky and ExxonMobil (XOM ) Chairman Lee R. Raymond were rubbing elbows at a panel in Moscow organized by the World Economic Forum. The Financial times reported that Exxon was offering Yukos $25 billion for a 25% stake -- a deal rumored since August. But neither side will acknowledge that a deal is in the works. ChevronTexaco Corp. (CVX ) is nosing around, too.

And what about Russian President Vladimir V. Putin, who supposedly wants Khodorkovsky taken down a few pegs? He has publicly endorsed the idea of big foreign investment, leaving open for now the possibility of an ExxonMobil-Yukos deal -- a deal that would net Khodorkovsky, already Russia's richest man, several billions. In a recent interview with The New York Times, Putin signalled that he would welcome a major investment in Yukos by Exxon.


It's a riddle wrapped in a mystery inside an enigma, to borrow from Winston Churchill's description of Russia. How the saga is resolved could determine whether ExxonMobil makes one of the biggest oil deals of the year, whether Moscow really wants to open the country up further to foreign investment, and whether Putin and the Kremlin will end their war on Russia's most powerful oligarch.

In this drama, ExxonMobil's motivations are the clearest. The newly completed merger of Yukos and its local rival Sibneft has created the world's fourth-largest nonstate-owned oil company, with a wealth of reserves and output that is rising at a rate of 20% a year. Its exploration and production costs, at $1.47 per barrel, are among the industry's lowest. All of these are attractions in the eyes of the world's largest integrated oil company. Despite its extensive acreage, ExxonMobil has seen production levels fall off in the past year. The U.S. company would also stake a big claim on one of the world's fastest-growing oil patches, and would be keeping pace with BP PLC (BP ), which in February inked a $9.8 billion deal with Russia's TNK. As Paul Collison, a Moscow-based oil analyst at Brunswick UBS puts it: "Russia's risk can be mitigated -- and it has the reserves that these companies need." Just how eager is ExxonMobil to boost its profile in Russia? According to Collison, who recently met with ExxonMobil executives, the American oil major is willing to settle for a minority stake in any Russian venture -- even though it usually demands control.

But whether ExxonMobil gets a deal depends on the Russians. Khodorkovsky stands to profit handsomely from any sale. When the former banker acquired his 36% stake in Yukos at a bargain price during Russia's privatization program in the mid-'90s, most people assumed he would cash out as soon as a rich opportunity presented itself. The surprise was that he actually had a head for the oil business. He seemed to relish the job of turning Yukos into a world-class oil company. And he has succeeded: Yukos is on track to log a $4.3 billion profit on sales of $15 billion this year. A runup in oil prices, and steady improvements in Russia's investment climate, have boosted Yukos' share price by 68% since December, to almost $16. This could be the moment to sell. "If someone comes along and offers you a lot of money for half your company, and if you can make more money working together, then why wouldn't you?" asks Stephen O'Sullivan, co-head of research at Moscow investment bank United Financial Group. Khodorkovsky would not comment for this story.

But money can hardly be Khodorkovsky's only motivation. Like the U.S. oil barons of yore, he is also a philanthropist, sprinkling his wealth across a variety of causes, from Internet training centers to art galleries. He has been bankrolling opposition candidates campaigning for parliamentary elections in December. But the tycoon has stirred controversy. There are currently seven different investigations pending against Yukos and its subsidiaries, with possible charges ranging from tax evasion to complicity in murder, while one of the company's major shareholders has been languishing in a Moscow jail since July on charges of embezzlement. Yukos denies all the charges, saying they are politically motivated.


The relentless bullying may have given Khodorkovsky a further incentive to find a foreign partner. Yukos' boss could be gambling that the government will cease its attacks for fear it might scare off a high-profile investor like ExxonMobil. Yet the reverse could happen: Kremlin hard-liners may go all out to prevent a big chunk of a major Russian company from passing into the hands of a foreign multinational just months before elections.

Of all the wild cards at play here, the wildest is Putin. No major U.S. investor would dream of entering Russia without the Kremlin's consent. Putin has been a long-standing advocate of foreign investment, and only last month met with senior U.S. officials, including Commerce Secretary Donald L. Evans, to discuss cooperation in the energy sector.

So why is Putin saying one thing while Russia's police seem determined to send exactly the opposite signal? The answer may lie in the netherworld of Kremlin politics. With a presidential election approaching next March, rival factions are battling for influence, with Khodorkovsky seemingly caught in the crossfire. Putin may be calculating that the campaign against Yukos is enough to satisfy Khodorkovsky's enemies in the Kremlin without seriously affecting Yukos' development or deterring foreign investors. He'd better be careful: Even tough investors like ExxonMobil can get spooked if the game gets too murky.

By Jason Bush in Moscow

    Before it's here, it's on the Bloomberg Terminal.