Russia's Investment Climate

One last post, for now, on the investment climate in Russia. 

Anders Aslund of the Peterson Institute reminds us how the Russian government trashed the privately held Yukos oil company so that the state owned firm Rosneft could pick its assets up cheaply: US-Russia Economic Relationship: Implications of the Yukos Affair:

In 2003, Yukos Oil Company was Russia’s most valuable company. A majority of shares were held by a group of owners led by Mikhail Khodorkovsky, who was also CEO. Yukos had been privatized cheaply, as were most Russian companies, in 1995. It led the revival of the country’s old oil fields, drawing on international technology and expertise that boosted Russia’s oil production by 50 percent from 6 million to 9 million barrels a day between 2000 and 2004.

Yukos’ shares were traded freely on the two main Moscow stock exchanges (RTS and MICEX), and about 15 percent of the companies stocks were traded over-the-counter (OTC) in New York as American Depository Receipts (ADRs). Most of them were held by American institutional investors and some by individuals. Yukos was one of the greatest success stories in the Russian economy, and its stock price skyrocketed in the early 2000s. Its market capitalization peaked at $45 billion in October 2003, which means that the US ownership might have been some $6.7 billion. This figure is the best approximation of the total losses of American investors, because the value of these shares is now minimal.

In early July 2003, the Yukos executive Platon Lebedev was arrested and, on October 25, 2003, so was Mikhail Khodorkovsky, the CEO and main owner. The actual accusations were long nebulous, but eventually Khodorkovsky was charged with tax fraud. Yukos was the largest private taxpayer in Russia, although it minimized its profit taxes by legally registering its subsidiary companies in low-tax regions in Russia. The authorities reopened audited tax returns and denied the legality of various tax shelters. Initially, they slapped Yukos with $3.4 billion in back taxes, penalties, and interest for 2000. Then the biased tax authorities did the same for later years as well, ending up with the startling number of $32 billion, and the amount continues to rise, most of which represents penalties.

Although there are many possible reasons for the demise of Yukos, two stand out. First, by jailing the wealthiest and most outspoken businessman, President Putin consolidated his authoritarian rule. Second, the state-owned company Rosneft absorbed almost all Yukos assets, which would be worth some $100 billion today, at a minimal cost, while Rosneft currently has a market capitalization of $91 billion.

While denying that he had instigated Khodorkovsky’s arrest, Putin explained to Western visitors that it was necessary because Khodorkovsky was buying up Russian politics. Putin’s central motive was to enhance his political control by jailing the most politically active oligarch. At the same time some of his aides wanted to seize Yukos assets.

In the ensuing process against Khodorkovsky and Yukos, Russia’s legal authorities violated every rule in the book. No credible legal tax case existed to begin with. The Russian authorities dismissed the first two judges because of their impartiality. The offices of several defense counsels were raided, and they were harassed and punished. All rules regarding arrest, confiscation, and communication were violated. Khodorkovsky was denied bail, which is otherwise customary in nonviolent cases.

In the end, Khodorkovsky was sentenced to eight years in jail and sent off to East Siberia. Many other Yukos employees were condemned to lengthy prison sentences on the flimsiest of grounds. Yukos’ main asset, Yuganskneftegaz, was sold off in a fire sale in December 2004, to an unknown shell company, Baikal Financial Group, for an uncontested bid for $9.35 billion. This sale was premature; noncore assets did not go first as they should in an executive auction; no real competing bids were allowed; the bidder was a temporary shell company representing Rosneft; the sale price should have been about twice as high; and state banks financed Baikal’s bid. The obvious purpose was to confiscate Yukos’ finest oil field, which produced two-thirds of Yukos’ oil, and give it to Rosneft. After the auction, Putin was the first to clarify that he knew who the owners of the shell company Baikal were. His economic advisor Andrei Illarionov called this sale “the scam of the year,” which caused his demotion.

Treatment of American Shareholders

The treatment of American shareholders in Yukos is the focus here, but naturally the confiscation of several billions of dollars of US property has broader implications for US investors, the United States, and the US-Russia relationship.

Trade in Yukos’ stocks has continued uninhibited, and the shares are actually still traded however minimal their price, leaving the enterprise value at a speculative $0.7 billion.

In a series of public statements throughout this process, Putin continuously denied any involvement. On October 27, 2003, two days after Khodorkovsky’s arrest, he responded to protests: “But there will be no meetings and no bargaining over the law enforcement bodies and their activities, so long, of course, as these agencies are acting within the limits of Russian legislation…. Neither the executive authorities nor even the Prosecutor’s Office can deprive someone of their freedom, even for the period of pretrial detention. Only the court has this power...and before the court, as before the law, all should be equal.” Yet Putin ignored the many declarations of the Moscow Collegium of Lawyers that the prosecutors violated the procedural norms in the investigation against the Yukos managers.

Before a visit to Rome in early November, Putin declared that the state did not want to destroy Yukos: “I am categorically against reexamining the results of privatization.… This is why there will not be a deprivatization or a reexamination of the results of the privatization, but everyone will have to learn to live according to laws.” In Rome, he stated with implicit reference to Khodorkovsky: “Having made their billions, they spend tens, hundreds of millions of dollars to save their billions. We know how this money is being spent —on what lawyers, PR campaigns and politicians it is going, and on getting questions like these asked.” The last words referred to the French journalist who posed the question.

On June 17, 2004, Putin told reporters: “The Russian administration, government and economic authorities are not interested in bankrupting a company like Yukos…the government will try to ensure that this company does not go bankrupt.” On September 6, 2004, he said: “I don’t want to bankrupt Yukos…. Give me the names of the government officials who want to bankrupt Yukos and I’ll fire them.” On September 24, 2004, he reasserted: “We shall do this in strict accordance with the law. I want to stress it— in strict accordance with the law…. The state did not set before itself the task to nationalize this company or lay hands on it. And there is no such aim now…”

In spite of his many unequivocal declarations to the contrary, Putin disregarded the law, successfully bankrupting and confiscating Yukos. He hardly uttered a true word about the Yukos affair. He insisted that the state must not interfere in the judicial process, but all the details indicated that prosecutors and judges received daily instructions from the Kremlin to be ruthless and lawless.

Foreign investors’ belief in Putin’s declarations was so great that the Yukos stock price held up well for half a year after Khodorkovsky’s arrest until April 2004, and thereafter the ensuing decline was gradual. The stock price vacillated sharply with prosecutors’ public statements, suggesting that insiders speculated on the basis of these allegations. Foreign investors, who were naïve enough to believe in Putin’s words, lost billions of dollars, but the biggest losers kept quiet so as not to reveal their folly to their shareholders. Russia’s stock market took a break in 2004, but then it surged again.

At least three well-known major American fund management companies made big bets on Yukos stocks and held on to them, reassured by Russian declarations that Yukos would not be bankrupted. Nobody doubted the value of the real assets. According to well-informed American investment bankers, one of these US fund made a major loss of a few billion dollars on Yukos, while two other US funds lost about half a billion dollars each. Thus, the total losses to US institutional and individual shareholders amounted to several billion dollars, and a reasonable guess is $6–7 billion. None of the really big losers from Yukos have publicized its losses, because they do not want to scare off their investors. The many shareholders who have complained tend to be individual investors with much smaller holdings.

Comments

[woonlasten verzekering]

Investment climate in Russia,reported in this well constructed article appears to be interesting. Thanks

[windows7 configuration]

What was score on the A+ Cert 220-702. I scored 770 on my test.