Der Spiegel: KREMLIN INC.

Reshaping the World Order with Russian Gas and Oil

gazprom-facility.jpgOpposition politicians in Moscow have a name for the Russian oil and natural gas market: “Kremlin Incorporated.” It’s not the market that decides who the state-owned energy company Gazprom sells to — it’s Russian President Vladimir Putin. The gigantic concern is run by cronies from Putin’s days as deputy mayor of St. Petersburg.

A seemingly endless desert of ice covers the Yamal Peninsula, which lies north of the Arctic Circle. Even the March sun fails to warm the air temperature above -20 degrees Celcius (-4 degrees Fahrenheit).

Yamal’s indigenous population, members of the Nenets tribe, travel through the bare tundra — dotted only with fir trees and shrubs — on handmade wooden sleds pulled by reindeer. A dozen workers stand at the center of the peninsula, along the Obskaya-Bovanenkovo train route. Brigadier Alexander Balasovitch uses a crane to lay 25-meter (82 feet) train tracks on the ground.

A brawny colleague from Georgia uses a heavy wrench to fasten the new train tracks. His breath leaves a thin layer of hoarfrost on his chin. They are hardened workers from all over the former Soviet Union, and they’ve grown accustomed to the raw climate, with temperatures that can drop to as low as -61 degrees Celsius.

Yet as inhospitable a nook as Yamal may be, it is considered a “region of strategic interest” by Gazprom, the Russian energy giant. Below the peninsula’s thick layers of snow and ice lie enormous reserves of natural gas. Measuring more than 10 billion cubic meters, they are Russia’s largest reserves. One day, natural gas condensate and other resources will be transported southwest on this train route on its way to Europe.

Heat from the cold and barren land is already warming German living rooms. Last year, 40 billion cubic meters of natural gas from the region were consumed in Germany — about two-fifths of the European country’s total natural gas consumption.

Gazprom, the giant corporation controlled by the Kremlin, which also now has former German Chancellor Gerhard Schröder on its payroll, wants to dramatically expand natural gas extraction on the Yamal Peninsula in the coming years. Eighty kilometers southeast of Yamal, in Yamburg in western Siberia and in nearby Novyy Urengoy, two Gazprom subsidiaries are already channeling 74 percent of their natural gas into the pipeline to Europe.

 From CEO to prison inmate

The steel drilling derricks of a facility run by the Yuganskneftegas oil company, which employs 6,000 workers, are located about 500 kilometers south of Novyy Urengoy. The crown jewel of Russian oil production, the facility was part of the business empire of oil baron Mikhail Khodorkovsky until 2004.

The former CEO of what used to be the largest private oil company in Russia is now an inmate at the Krasnokamensk penitentiary in eastern Siberia following his conviction on charges of business-related crimes including tax fraud. The Nefteyugansk facilities, once the prime asset of his company, were purchased by the state-owned Rosneft corporation for $9.35 billion dollars at a 2004 auction organized by the Kremlin. Putin’s deputy chief of staff, Igor Sechin, is also Rosneft’s chairman.

Rosneft made its initial public offering on the London and Moscow Stock Exchanges in time for the G-8 summit in St. Petersburg in mid-July. The purpose was clear: to mobilize capital for new investments in Siberia and in the far eastern regions of Russia. The IPO was coordinated with the Kremlin. And the move was meant to signal that Rosneft was open to doing business with the rest of the world and was designed to help the corporation achieve its goal of becoming one of the most important global players in the oil business.

But the Kremlin has no intention of surrendering its influence over the oil and gas business. Under Putin, the Russian government has expanded its stake in Gazprom to over 50 percent. In September 2005, the corporation — whose chairman of the board Dimitry Medvedev is the Russian deputy prime minister — purchased a controlling interest in the oil corporation Sibneft for $13 billion. With its acquisition of Yuganskneftegas, Rosneft, which controls Russia’s largest oil reserves, catapulted itself to become the third-largest Russian oil company.

But neither Gazprom, with its 175 subsidiaries, nor Rosneft are particularly transparent by international standards. The manner of Gazprom CEO Aleksei Miller — who was a confidant of Putin during the latter’s time as deputy mayor of St. Petersburg and who obtained his position thanks to the Kremlin — is more reminiscent of a Kremlin official than the head of one of the world’s largest energy corporations.

Who Miller closes business deals with, whom he sells gas to and at what price is decided less by the market than by the Russian president, who Miller regularly briefs. The team surrounding Miller is recruited mainly from the personal networks of St. Petersburg-based Putin associates, as well as from old comrades from the Committee for State Security, a.k.a. the KGB.

KGB connections

Gazprom Deputy Chairman Sergei Ushakov is one former KGB man. Like his predecessor Sergei Lukash, who came to Gazprom from the Federal Guards Service, Ushakov is responsible for security matters at the corporation. Gazprom’s chief accountant, Elena Vasilyeva, worked in the Central Accounting Office of the Port of St. Petersburg Open Joint Stock Company during the 1990s — where Miller was director for development and investment at the same time.

interactive-map.jpgMany St. Petersburg professionals who have entered the oil business and made a career there have grown breath-takingly rich during the last few years, insiders say. “A lot of them have dollar bills in their eyes,” jokes a former KGB leader. Gary Kasparov, a chess world champion active in Russia’s political opposition, remarks cynically that Russia has “the richest bureaucracy in the world.”]The shady business networks prosper in part thanks to the absence of public criticism. Putin’s associates in the gas business have used Gazprom’s holding company Gazprom Media — which has purchased the country’s largest private TV network, NTV — to cure the country’s journalists of whatever inclination for investigative journalism they may once have had. The two main state-owned TV channels tend to be soft on Gazprom anyway.

True, Gazprom board member and Russian Economics Minister German Gref wanted to split up Gazprom when he took office in 2000. But Miller had a word with Putin, and the president was quick to put his foot down. The official line since then has been that plans to split up Gazprom are “not on the agenda.”

Putin considers it a personal achievement that Gazprom is now worth about $260 billion and ranks as the third-largest corporation worldwide in terms of market capitalization, after ExxonMobil and General Electric. The position Gazprom now holds in the international energy trade is “the result of concerted state activity,” Putin said in his state of the nation address in May.

During the past few years, Putin has in fact been telling his associates in the gas business to make sure Gazprom’s weaker subsidiaries shape up. One consequence of the corporation’s newly centralized structure has been a loss of power at the subsidiaries: The company headquarters decide their budgets for them, on the basis of internal negotiations.

A political instrument

One result of this is that the corporation that controls the largest gas reserves in the world lacks funds for long-overdue investments. For example, Gazprom has failed to meet the aims formulated in a program for the “reconstruction and technical adaptation” of gas pipelines — the program came complete with a timeline that ends in 2006. A report from the central auditing authority also laments that the state-owned corporation has not invested sufficiently in the exploration of new gas extraction sites.

villager.jpgIf Gazprom continues to develop its facilities for extracting the natural gas under the Yamal Peninsula as slowly as it has been doing until now, “we could end up waiting another 300 years before extraction begins,” Resource Minister Yury Trutnev said sarcastically at a conference of Russia’s leading state officials in Moscow.

What is more, the state is using Gazprom as a political instrument. For example, the energy corporation has to provide millions of Russians in small villages with gas for heating. The costs associated with the related pipelines run to $1 billion.

Gazprom’s headquarters are still subsidizing a number of subsidiaries that have little to do with the gas business. The beneficiaries include a boiler factory in the town of Armavir, in the North Caucasus, a producer of gas stoves based in Vladikavkas and a tire plant in Omsk, Siberia.

The burden of the corporation’s social commitments is even weightier: The Russian price for natural gas has been fixed so low by the state that Gazprom makes a loss with its domestic sales. That’s not likely to change soon, since the Kremlin is resolved to prevent impoverished Russian citizens taking to the streets to protest gas price hikes — especially one year before the Duma elections scheduled for late 2007.

The holiday homes and sanatoriums financed by the corporation in Sochi on the Black Sea coast and elsewhere also cost more than they make for Gazprom. But the special rates the corporation’s employees receive when they want to spend their vacation in the shade of the palm trees on Sochi’s shingle beach help make Gazprom a strike-free business, just like the option of free visits to health resorts owned by the corporation.

With its 350,000 employees, Gazprom presents itself as a paternalistically administered island of social partnership in the rough seas of Russia’s post-Soviet capitalism — as a model of the “socially responsible business” that Putin has called for.

Mixing business with politics 

The financial losses associated with the state-owned corporation’s business engagements in two regions south of the Russian border show that the gas giant follows the logic of political power more than the laws of the market. For years Gazprom has been providing natural gas to Transnistria, a rebel republic located in Moldavia that has never been recognized as a state by the international community.

hodori.jpgBy July of last year, the would-be state had run up a natural gas debt of $495.6 million. But even though Transnistria’s “president,” Igor Smirnov, has made it perfectly clear that his republic can’t pay, and even though Gazprom managers have occasionally threatened to cut off the gas supply to the rebels by the Dniester River, the threat has never been implemented. The reason? President Putin has decided that the pro-Russian rebels need to receive massive support in their struggle with the Moldavian state.

The investments effected by Gazprom in South Ossetia, another republic not recognized as a state by the international community, seem to be another such case of subsidies disguised as business. The heavily armed de facto rulers of the impoverished self-proclaimed republic in Georgia can now look forward to receiving natural gas from neighboring North Ossetia, which is part of Russia’s territory.

Gazprom’s leadership went as far as receiving South Ossetian “President” Eduard Kokoity for negotiations last October. The subject of the negotiations was an ambitious pipeline construction project. The pipeline would lead across the Caucasian Crest and into South Ossetia’s capital city of Tskhinvali. Both the smirking rebel leader and the Gazprom managers knew only too well that the project, developed by the Kremlin, wasn’t motivated by expectation of financial gain, but by the desire for political power.

A new Russian empire

And so Moscow-based ideologues of Russian power like Alexander Prochanov, the editor in chief of the patriotic Savtra newspaper, are already giving their imagination free rein. “With its steel pincers,” Prochanov writes, “Gazprom could build a new kind of Russian geopolitical empire.”

The oppositional Moscow weekly Novoye Vremya has found a name for the state-crafted power network of the Russian oil and gas industries: “Kremlin Incorporated.” Vadim Kleiner criticizes the company management’s tendency to cooperate with dubious intermediary firms. Kleiner’s candidacy for Gazprom’s supervisory board, where he wants to defend the interests of minority shareholders, has been unsuccessful for years.

The activities involving intermediate firms first came to light during the conflict over natural gas carried out between Russia and Ukraine in January 2006. Gazprom used the intermediary trade firm RosUkrEnergo as an exporter to Ukraine. RosUkrEnergo is an obscure company based in Switzerland. One half of its shares is owned by Gazprom’s bank, the other is owned by dubious Ukrainian businessmen.

The state-orchestrated oil deals are hardly more transparent. Insiders know the obscure business transactions often follow a three-part scheme. First an oil trading company purchases petroleum from an oil production company, paying only between a tenth and one-fifth of the market price. Then the trading company sells the petroleum to subsidiaries in tax havens such as the Cayman Islands or the Bermuda Islands, below the world market price. Finally these subsidiary companies offer the petroleum to Western customers at the standard international price.

In 2005, Gazprom was Russia’s most important tax payer: It paid €14 billion ($18 billion) in taxes. But estimates by Moscow’s central auditing authority suggest that the Russian state loses out on three to four billion US dollars in tax payments every year, due to the devious business transactions involving sunny tax havens.

It’s not just stinginess towards the tax authorities that is all the rage among Russia’s oil and natural gas executives. They shy away from investing in outdated refineries too. The principle underlying this choice is the same that ruled the economics of real socialism: Live off what you have for as long as you can.

Making the rich richer

True, the Russians sell roughly $500 million worth of oil every day, and this has caused the value of the ruble to rise. But the rest of the Russian export economy — which is not particularly competitive anyhow — suffers from this state of affairs.

Instead of benefiting the Russian economy, the oil boom has made Moscow’s billionaires even richer. Their villa neighborhoods surround the city like a ring of lard. Ten of the 33 billionaires featured on the 2006 Forbes list got rich thanks to the oil business.

The economic boom doesn’t benefit the majority of the Russian population. According to official figures, about 70 percent of Russians had a monthly income of less than €200 ($257) in 2004. Twenty-seven percent brought home less than €100 ($129) a month.

Worse yet, many citizens, especially in rural areas, still don’t have access to natural gas — and this in the country that has the largest natural gas reserves in the world. Countless villagers heat their homes with wood-burning stoves, just as in the 19th century.

Despite rising oil prices, Russia’s economic growth rate is declining, as the World Bank laments. During the first quarter of 2006, the growth rate of Russia’s industrial production was three percent — even less than the same period the previous year.

The “national projects” staged by the Kremlin were accompanied by grand propaganda campaigns. With some €3.2 billion in funding, the projects see the government improving education and health systems, the construction of apartments and improvments in the agricultural sector — as if there were no end of funds available to distribute. But in reality the projects function as a surrogate for real structural reform. Nothing is improved by the projects except the meager salaries of employees. What is more, the projects also fuel inflation in a country where the inflation rate already stood at 5.4 percent between January and April of this year.

If the country doesn’t begin investing its revenue from the resource trade into the modernization of its economy, “then Russia will become the Nigeria of natural gas,” warns Yuri Solosobov of the Institute for National Strategy in Moscow. The Nigerian state is widely seen as a prime example of how not to handle oil profits.

The struggle over the revenue set free by the resource trade tends not to lead to reforms, but rather to strong-arming and violence. With increasing frequency, the struggle over oil and natural gas leads to bloodshed. On March 23 of this year, Igor Khorshunov, the deputy chairman of a company run by the Gazprom subsidiary Sibur was gunned down in the town of Togliatti.

Khorshunov, a veteran of the war in Afghanistan and a retired commander of the domestic intelligence service, had been charged with curbing the influence exercised on the company by organized crime. The manager of another Sibur company had been injured by shots from a machine gun in neighboring Samara two months earlier.

In the fall of 2004, bandits kidnapped and murdered a leading executive of the Gazprom subsidiary Yugtransgas in the town of Saratov near the Volga River. A short time earlier, his colleagues at the Zentrgas company in Tula, south of Moscow, buried their former vice chairman, Boris Shishikin. He was beaten to death by an unknown killer on his way home.

When such cases occur, Russian prosecutors usually conclude that the homicides are “related to the professional activities of the victim.” But they seldom find out who the perpetrator is or who hired him. Police investigations are most likely to be successful when the perpetrator suddenly falls from grace politically, as was the case with Alexei Pichugin.

The former chief of Yukos’s security service first had to appear in front of a Moscow court in March of this year. He faces the charge of having ordered the assassination of Vladimir Petuchov, the mayor of the oil town Nefteyugansk, in June of 1998. The local politician is said to have complained about the corporation’s reluctance to pay its taxes.

Investigators in Moscow would like to know more about the special jobs Pichugin was charged with by Leonid Nevslin. Trained as a computer engineer and known for his interest in the bloody history of the Bolshevik purges, Nevslin was vice chairman of Yukos and responsible for the company’s security service, making him Pichugin’s boss.

But before a bill of arrest could be issued for Nevslin, charging him with tax fraud and accomplice to murder, the former chairman of the Russian-Jewish Congress obtained Israeli citizenship and moved from chilly Moscow to the milder climes of Tel Aviv. Israel categorically refuses to extradite its citizens to other states.

Der Spiegel
September 4, 2006
By Uwe Klussmann

http://www.spiegel.de/international/spiegel/0,1518,432414,00.html.

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