When Powers Collide: Putin vs. Khodorkovsky

What's at the root of the feud between Russian President Vladimir V. Putin and Mikhail B. Khodorkovsky, the former boss of oil giant Yukos? Government prosecutors have leveled formal charges of fraud and tax evasion against Khodorkovsky. But many in Moscow say the real reason for the Kremlin's attack was the tycoon's campaign last summer to stymie all efforts to raise taxes on the oil industry, which was raking in billions of extra profits as the price of crude rose. Each time a bill came up, the Duma voted down the amendments spelling out the terms of the new taxes. The chairman of the subcommittee on taxation was an ex-Yukos executive and a major Yukos shareholder. Even Communist deputies voted against the amendments.

Later, candidates linked to Yukos started appearing on the electoral lists of various political parties for parliamentary elections later that year. Rumors began circulating of the huge sums Khodorkovsky was willing to spend to bolster his political influence in Parliament.

Putin's government responded by throwing Khodorkovsky in jail. A few days after Khodorkovsky's arrest, the President said of the tycoons: "...having earned billions, they will spend tens, hundreds of millions, to save the billions. We know where this money is being spent: on lawyers, on PR campaigns, on politicians...." Charles Ryan, CEO of United Financial Group, a Moscow investment bank, believes Putin didn't want to appear like a puppet of Big Business. "Putin thinks he would look silly if Russia looks like Latin America in the 1960s, where United Fruit called all the shots," says Ryan.

Khodorkovsky has vigorously denied the charges of fraud and tax evasion, saying they are politically motivated. Yukos also rejects claims that the company illegally lowered its tax bill. What about the rumors of buying votes in the Duma? The company says that Khodorkovsky invested his money, not the company's, and that the contributions were legal. "It's common practice in the U.S., for example, that CEOs fund political parties, sometimes more than one," says Hugo Erikssen, director of the international information department at Yukos Oil Co.

The methods used to quell Khodorkovsky have been controversial. And they're sure to become more so if Moscow ends up dispossessing him of his property. In recent weeks the government has upped the pressure on Yukos. After the authorities opened up new investigations into alleged tax evasion and froze Yukos' assets, Standard & Poor's (MHP ) took the unprecedented step of downgrading Yukos five notches, warning of impending bankruptcy.

A bankruptcy could pave the way toward renationalization, but neither step is inevitable. The tax charges against Yukos are legally shaky because the company took advantage of tax havens in the Russian Far East that were legally recognized at the time. Using them to bankrupt the company wouldn't do much for Putin's or Russia's image, not least because of the numerous international investors and creditors who would suffer as a result.

With the oil baron already behind bars and facing serious charges, a government takeover of his company may not be necessary. Other tycoons, and many Western investors, say Putin is not set on undoing privatizations. Rather, Putin wants the state to enforce regulations and taxes more strictly, as well as retain control over oil export pipelines. "It's probably best for the state to have [Yukos] in private hands and tax it rather than own it directly," says James Fenkner, chief strategist at Troika Dialog, a Moscow brokerage.

It's clear, though, that Putin wants the government to have a final say in big sales of Russian assets to foreigners. Sometimes the state will say yes to such deals. Last year BP PLC spent $7 billion to acquire a 50% stake in Russian oil major TNK, the largest foreign investment ever in Russia. A second acquisition may already be in the works. Total (TOT ) of France has confirmed that it is vying for a large minority stake in Sibneft.

Could Yukos end up in foreign hands? America's Exxon Mobil Corp. (XOM ) was rumored to be eyeing the company before Khodorkovsky's arrest. But perhaps it's too much to expect that the same rules apply to Yukos -- a much larger, and more politically sensitive, company than Sibneft or TNK. "I'm convinced a sale of Yukos to foreigners is absolutely unrealistic," says Mikhail Fridman, the head of Alfa Group, the Russian conglomerate that teamed up with BP. That may well be true -- at least as long as the Khodorkovsky-Putin feud continues.

By Patricia Kranz and Jason Bush in Moscow

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