Russia's latest energy power play.

Russia's latest energy power play.

Russia's latest energy power play.

Events beyond our borders.
Oct. 4 2005 1:36 PM

All Oligarchs Are Not Created Equal

Russia's latest energy power play.

Abramovich gets a thumbs-up from the Kremlin, too. Click on image to enlarge.
Abramovich gets a thumbs-up from the Kremlin, too

The purchase last week by Gazprom, Russia's state gas monopoly, of a 73 percent stake in Sibneft, the country's fifth-largest oil company, marked the latest stage in the Russian government's ambitions to reclaim a spot in the club of global superpowers—this time on the back of its energy assets rather than its nuclear arsenal. The acquisition, corporate Russia's largest ever, also vividly demonstrated that if you're a big Russian oligarch, it pays—in this case, to the tune of a cool $13.1 billion—to stay friends with the folks in power.

The biggest beneficiary of the Kremlin's latest effort to recapture some of its lost glory by tightening its control over Russia's energy assets is Sibneft's majority owner Roman Abramovich. More widely recognized in some circles as the owner of England's Chelsea Football Club (and, in other, colder, circles as the governor of the remote northeastern Russian region of Chukotka), Abramovich and his well-connected buddies paid $100 million for Sibneft—which now produces the equivalent of around 3 percent of total U.S. daily oil consumption—in 1996, during Russia's privatization fire sales. The sale of Sibneft to Gazprom puts the finishing touches on the obituary of Russia's privatization process: State sells off asset on the cheap; businessman restructures asset and lets the market establish a price; state buys it back—yielding a 19,900 percent profit (including dividends) to businessman and cronies.

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If Abramovich needs any reminder of what might have been, he need only look to his erstwhile oligarch cohort, former Yukos Oil Co. head Mikhail Khodorkovsky, who is sitting in a Moscow jail cell awaiting a transfer to a prison colony in the depths of Russia. (For the background on Khodorkovsky, click here.)

Khodorkovsky was hardly the only big businessman in the fast-and-loose Russia of the 1990s to apply a very liberal interpretation to the letter of the law—particularly among the oligarchs who made billions of dollars by grabbing Mother Russia's crown jewels for kopeks on the ruble. But he was alone in two significant respects, which were central to his downfall: He began to exhibit an unhealthy interest in politics, which the Kremlin may have perceived as a potential and highly unwelcome threat; and he indicated that he might sell Yukos to a foreign oil producer, if the price was right.

Even before energy became the touchstone of global geopolitics, auctioning off a large chunk of Mother Russia's natural-resource wealth (even though it was privately owned) to a foreign entity was viscerally abhorrent to the economic nationalists who populate Putin's inner circle. (Worsening matters for Yukos was that it was in talks to acquire none other than Sibneft; Abramovich scuppered the deal in November 2003, even though the transaction was legally complete and cash had changed hands.) By going after Yukos, in one masterstroke the Kremlin eliminated a potential rival and ensured that more of Russia's assets didn't fall into the hands of evil foreign entities like ExxonMobil, Chevron, or Total, a big French oil producer. (ConocoPhillips and BP have significant stakes in Russian oil companies, but neither is a majority partner and both ventures have been carefully stage-managed from the Russian side.)

The cost to the Kremlin of bankrupting Yukos was a public-relations disaster of Siberian proportions, though, as the Putin government came under intense global criticism for its heavy-handed treatment of Khodorkovsky and Yukos. The Kremlin weathered the political uproar, however, and investors—never noted for their long memories—have similarly forgiven and forgotten, pushing up Russian stocks by 60 percent since the end of the Yukos affair in May, when Khodorkovsky was convicted. Now the Russian government faces the challenge of explaining to the Russian electorate why the Kremlin is making ridiculously wealthy oligarchs even richer at the expense of the state—instead of, say, spending more on health care, infrastructure, or education.

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Abramovich avoided Khodorkovsky's fate in part by sticking to his knitting (his governorship may be little more than a politically savvy charity effort, a socially acceptable way for him to sprinkle some of his vast wealth in one of the most desperately poor parts of Russia) and knowing which side of his bread was buttered. Critically, he is accepting a lower price for Sibneft than the company likely would have fetched if foreign oil companies had been allowed to bid. But a guaranteed paycheck of $13.1 billion (and being able to spend it while not wearing striped institutional clothing) should help assuage the pain of money left on the table. (Gazprom attempted but failed to gain control over the assets of Yukos; the victor was Rosneft, a Russian government oil company.)

With the acquisition of Sibneft, the Kremlin is serving notice—for anyone who's been under a rock for the last few years—that it intends to leverage its control over a good chunk of the world's energy reserves to shimmy back up the league tables of geopolitical power. Russia's nuclear arsenal is rusting away, the country needs a booster chair plus a few phone books to sit at the economic table with the rest of the G8, and its regional sphere of influence has contracted to the point of invisibility. So, by marshaling Russia's energy assets, the Kremlin wants to rebuild a bit of the global respect it used to enjoy.

Indeed, with 9.27 million barrels of oil production per day in 2004 (compared with total U.S. oil production of 8.69 million barrels and top dog Saudi Arabia's 10.37 million barrels), Russia is the world's second-largest oil producer and exporter. As the largest oil producer that is not part of oil cartel OPEC, Russia is potentially a swing oil producer, which means that the incremental oil it pumps (which can make the difference between global demand being met and not being met, depending on market conditions) can play an outsized role in determining the global price of the commodity. With the acquisition of Sibneft, the Russian government boosted its total ownership stake in the Russian oil output to around 30 percent (close to 60 percent of the energy sector overall). Through gas giant Gazprom—the proud new papa of Sibneft—the Russian government controls around one-third of the world's natural-gas reserves (twice the level of No. 2 Iran). Energy from Russia accounts for more than one-third of Germany's total consumption, and recent and ongoing pipeline projects will only increase Western Europe's reliance on Russian energy.

The Russian government isn't alone in its pursuit of oil assets. China and India, to name two of the more aggressive suitors, have intensified the global race to secure energy assets by bidding for far-flung oil producers. Both countries are significant importers of oil, and both are anxious to secure energy supplies to fuel continued economic growth. But, unlike most other participants in the energy scramble, Russia is sitting pretty as the second-largest net oil exporter after Saudi Arabia. The Russian government merely aims to tighten its grip on its domestic oil industry—and is trying to consolidate its position domestically—rather than scramble to find reserves internationally. Russia may aim to follow in the footsteps of Saudi Arabia, Iran, or Mexico, where state-owned companies pump the black gold from the ground. But the Kremlin will have to pay up for the privilege, as illustrated by its recent purchase.

Meanwhile, Russia's remaining private oil companies—apparently wanting to remain so—go to great pains to display their loyalty to the Kremlin. The backbreaking tariffs that rob them of much of the potential profit windfall of high oil prices prompt hardly any protest. The country's oil companies recently announced a voluntary domestic price freeze on gasoline prices through the end of the year, which will help soften public discord over the rising cost of fuel.

Efforts by the Russian government to increase its control over energy assets are likely only the first step. The endgame of the Kremlin's acquisitiveness for energy assets, and what it will mean for the geopolitical balance of power, is anyone's guess.