Cracks In The Kremlin

A messy battle over the control of oil assets is the latest sign that Putin's administration is in disarray

The seemingly never-ending saga of the Yukos affair -- the long-running feud between President Vladimir V. Putin and the Yukos oil giant of imprisoned oligarch Mikhail B. Khodorkovsky -- looked as if it had reached a denouement in December, when the Kremlin confiscated Yuganskneftegaz, Yukos' main production subsidiary, and folded it into state oil company Rosneft. But as one battle fades from the headlines, a new one has taken its place, this time inside the walls of the Kremlin itself: the battle for the spoils.

That's how Kremlinologists are interpreting a bizarre series of events in early March, when Russia's two state energy companies, Gazprom and Rosneft, duked it out in public over the details of a long-delayed merger. In reality, Kremlin-watchers say, the two companies' managements are proxies for rival groups inside Putin's secretive Kremlin entourage. One group is led by the President's chief of staff, Dmitry Medvedev. The other is captained by his deputy chief of staff, Igor Sechin. Each man looks to be angling for the job of chairman of a new state-controlled oil and gas behemoth to be created by the merger of Gazprom and Rosneft. "There's obviously a great big bun fight going on inside the corridors of power," says Chris Weafer, head of research at Russia's Alfa Bank.


The dispute over the Gazprom-Rosneft merger is just the latest sign that Putin's administration is in disarray. Last year key reforms to restructure the gas and electricity sectors ground to a virtual standstill amid constant ministerial infighting. More recently, Cabinet squabbling has shifted to fiscal policy. Prime Minister Mikhail Fradkov wants to slash taxes and boost spending. Economy Minister German Gref and Finance Minister Alexei Kudrin favor fiscal restraint.

But the tussle to control the new energy giant could be the biggest clash yet inside Putin's Kremlin. Last December, Rosneft acquired Yugansk in a controversial auction orchestrated by the government. The deal catapulted the small state company into a major player, controlling some 20% of Russia's oil. But it also complicated plans by Gazprom to merge with Rosneft. After the auction, Yukos shareholders threatened to sue Rosneft and anyone who helped it pay for Yugansk. That was a problem for Gazprom, which was eager to extend its business abroad and did not want any exposure to ugly litigation. Suddenly, Rosneft looked less attractive as a merger partner.

On Mar. 3 it seemed the problem had finally been solved when Gazprom chief Alexei Miller announced that terms for the merger with Rosneft had been settled. Yugansk would be left as a stand-alone company, to be managed by Rosneft's president, Sergei Bogdanchikov. At first glance, that looks like a good deal for Bogdanchikov. But he and his Kremlin allies didn't like the trade-off, which was turning over the rest of Rosneft's oil assets to Gazprom and abandoning any hope of a bigger role in managing the new energy major. At any rate, on Mar. 4, Rosneft published a statement on its Web site contradicting Miller's assertion that Yugansk would not be included. Gazprom struck back, insisting Miller was right all along. Finally, Rosneft withdrew the statement from its Web site on Mar. 5, calling it the result of a "technical error."

Not likely, say the Kremlinologists. "The contradictory information about the merger is connected with the conflict of two groups in the entourage of the President," says Dmitry Orlov, general director of the Agency for Political & Economic Communications, a consulting group. The Gazprom lobby is composed of Miller and Medvedev, who in addition to his Kremlin job is chairman of Gazprom. On the other side are Bogdanchikov and Sechin, who became chairman of Rosneft's board last summer.

What's clear is that this round, at least, has gone to the Gazprom crowd. That's probably good news for investors in Russia. The final go-ahead for the merger means restrictions on foreign investment in Gazprom shares may soon be lifted. The Russian government has long made clear that once it controls 51% of Gazprom's shares, which it will after merging Gazprom with Rosneft, the "ring fence" around Gazprom will go. The government figures that once it has a controlling stake, it can afford to let foreigners buy as many shares as they like.

But Rosneft's climb-down is also important because it is a defeat for Sechin, who is a leader of the siloviki (men of power), the Kremlin faction of former KGB officers that waged the campaign to dismantle Yukos and bring down its chief, Khodorkovsky. In contrast to Sechin, Gazprom's Medvedev, a former law professor, is seen by many experts as a leading Kremlin "liberal." "This is the first time we've seen the siloviki badly beaten on a key issue," says Anders Aslund, head of the Russian & Eurasian Program at the Carnegie Endowment for International Peace in Washington.


Local Kremlinologists tend to be more cynical, seeing little difference in principle between the two Kremlin groups. "This has nothing at all to do with ideology. It's a battle of groups inside the ruling elite, that's all," says Orlov. He believes the battle is not yet over.

Of course, bureaucratic infighting in Russia is a long-established tradition. What's more unusual, but increasingly common these days, is outright defiance of Putin. Gref, for instance, has openly slammed the renationalization of Yukos. Presidential Economic Adviser Andrei Illarionov has gone even further, calling it "the swindle of the year" and denouncing "the climate of fear" facing business. In late February former Prime Minister Mikhail Kasyanov, who headed Putin's government between 2000 and 2004, caused a storm with a stinging attack on Putin's policies and a call for liberals to rally in defense of democracy. Communist and nationalist opponents are also becoming bolder, after Putin's poorly managed reforms to the social benefit system sparked mass public protests. Even normally docile pro-Putin parliamentarians have called on the government to resign.

The increasingly open splits in the government show that Putin's leadership is growing weaker. His authority has been damaged by recent fiascos, such as his failed policy in Ukraine and the bungling of benefits reform. Although it's unnerving for investors who crave political stability, Putin's ebbing prestige may ultimately be a healthy development, if it means one-man rule is giving way to greater pluralism.

The confusion at the top is likely to get even more complicated as the battle to succeed Putin, who under the constitution is supposed to step down in 2008, heats up. But if Putin can't stop his closest advisers from squabbling over energy, he's likely to have an even tougher time controlling the succession.

By Jason Bush in Moscow

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