The Yukos Affair and Its Implications

Subject: Case Studies
Pages: 9
Words: 2544
Reading time:
10 min
Study level: PhD

The Russian Federation is the world’s largest country with a land area equal to a ninth of the Earth’s. It covers the whole of the northern region of the Asian continent as well as about 40% of the European continent (Black, 2006). One distinguishing factor about Russia is that it controls the world’s largest mineral reserves and energy resources, which has earned it the name energy superpower. It is leading when it comes to the exportation of natural gas resources, the eighth largest oil reserves, and the second-largest when it comes to coal reserves (Aslund, 2007). Needless to say, it has numerous oil and petroleum companies and corporations that handle the very scarce yet highly demanded commodities. Russia has remained to be the second-largest exporter of oil, with competition from Saudi Arabia when it comes to its production (Barnes, 2006). The essay seeks to discuss Yukos Oil Company which used to be one of the largest companies in Russia, and its affairs. It will focus on its developmental history and related conflicts as well as analyze the implications emanating from the recent collapse.

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Yukos Oil Company used to be Russia’s largest petroleum company since its inception in 1993. It has been under the control of Mikhail Khodorkovsky, a Russian billionaire, together with other renowned business people in Russia (Sakwa, 2009). However, Khodorkovsky was in the past six years arrested, convicted, and imprisoned for eight years for alleged tax evasion and theft claims. The company’s head offices were located in Moscow, the Russian capital city.

The company was legally created on April 15, 1993, subject to Resolution number 354 of the Russian Federal government, and was associated with a number of other enterprises dealing with oil extraction and refinery (Aslund, 2007). During the primary years, Yukos emerged as one of the world’s largest oil companies that are not state-controlled, with the capacity to produce about 20% of the total oil produced by Russia, which represented about 2% of the world’s total production (Sixsmith, 2008). A review of how its assets were acquired reveals that it was under controversial circumstances during the privatization period by the Russian government in the early years of the 1990s. The politically charged privatization process, in general, was marked by bloodshed, and Yukos could certainly not have been an exception. The former Yukos Security Chief, Alexi Pichugin, has faced charges of several murder cases and attempted incidences of murder (Sakwa, 2009). He is also still being investigated together with other partners of Yukos in relation to the killing of the prominent mayor of the Yugansk oil region and who was also in opposition to the creation of Yukos. Khodorkovsky was also linked to the same incidences (Barnes, 2006). However, according to their respective lawyers, the charges brought against Yukos management since its inception have been motivated by political differences and thus the need to find a way of eliminating those perceived to be a threat to the authoritarian politicians (Cohen, 2003).

The largest number of stockholders in Yukos Oil Company owns the company through its offshore holding company known as Menatep. In early 2003, the Yukos management reached a deal for a merger with Sibneft, but soon the merger was undone following the high profile arrest of Khodorkovsky, the Yukos CEO, in October 2003, igniting the now-infamous Yukos Affair. Dramatic encounters with the government unfolded one after the other (Cohen, 2003). Khodorkovsky had earlier on annoyed President Putin by supporting opposition parties in Russia despite being warned to stay out of politics.

In July 2004, the Russian government, through Kremlin, claimed that Yukos Company had abused the tax havens since its inception in 1993, and the company was charged with tax evasion of up to US$7 billion and beyond (Cohen, 2003). A number of oil-producing companies in the outlying regions of Russia had been allowed special tax status by the government in order to enhance their economic progress by reducing the tax burden. However, according to the government, Yukos exploited the opportunity to evade massive tax obligations that cost the company then (Barnes, 2006). The Yukos Oil Company, on the other hand, claimed that they acted within the legal provisions. The government objected to their claims and noted further that the Yukos and its subsidiaries acted fraudulently and deliberately to evade tax payment (Brookes, 2004). The government’s purported efforts to eliminate tax-evading companies were introduced by President Putin. These efforts led to the closure of numerous oil companies, especially the privately-owned ones. Several analysts believe that the descent of tax authorities on Yukos was motivated by their effort to prevent the company from purchasing the extensive oil block in the Duma region since they feared that it would enable the company to block legislative reforms touching on tax payment (Sixsmith, 2008). This clearly depicts the tension that has existed between government forces and the Yukos management, especially with founder Khodorkovsky.

The tax burden labeled on Yukos threatened the company’s stability, and the management had to offer to pay a total of US$8 billion to the government over a period of 3 years (Grace, 2005). This move was aimed at preventing the company from bankruptcy. Meanwhile, Menatep, the Yukos’ parent company, defended the company on the international scene, and it managed to influence Western opinion through the Margery Kraus of APCO. Several resolutions in favor of the Yukos Company were passed in the US House of Representatives as well as at the Council of Europe (Perovic, Orttung & Wenger, 2009).

One of the resolutions passed in the Council of Europe directly condemned the Russian government for its deliberate attacks on Yukos. The council termed the actions as intimidation by the different law-enforcers against Yukos Company and its business partners as well as a number of other institutions associated with Mr. Khodorkovsky. Furthermore, they noted that the auctions by the government were carefully crafted in terms of public relations to justify their deliberate attack of the Yukos Oil Company. The Council of Europe warned the Russian government that its actions were contrary to the law as stipulated in Article 7 of the ECHR.

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With reference to Article 1 of Additional Protocol to the ECHR, which relates to the protection of property, the council questioned the circumstances under which Yukos’ asset, Yuganskneftegaz, was sold by auction to Baikal Finance Group (Aslund, 2007). Of much concern was the rate at which the takeover of the buyer was made by the state-owned Rosneft. At the center of the controversy are the minimum price that the auction was made and the pressurization of Yukos to sell off its key asset on the basis of renewed and exaggerated tax claims by the government. This revelation leaves little doubt of some element of political motives in the war launched against Yukos by the government agencies.

In mid-2006, Yukos management filed for bankruptcy protection in the United States based on a bank deposit of $4 million. The company estimated its asset value at $12.3 billion against $30.8 billion in debts, together with the ‘alleged’ tax owed to the government of Russia. In a statement contained in the application, Yukos blamed the Russian government and its agencies of unwarranted, illegal, discriminative, and exaggerated claims on tax which with time have led to raids and seizures and the ultimate intimidation, arrests, and imprisonment of Yukos officials (Perovic et al., 2009). However, weeks of deliberations could not convince the Houston court, which concluded that Yukos could never be allowed to assert domicile in a foreign land, like the United States of America. After about five weeks, creditors of Yukos saw it worthy of filing for bankruptcy when the manager in charge of bankruptcy indicated that Yukos needed liquidation (Cohen, 2003).

Further analysis of the events leading to the sale of Yukos’ assets brings deeper revelations. When Khodorkovsky was arrested, the media at the time, both in the West and in Russian opposition-controlled media, claimed that the arrest of the company’s CEO was due to his political activism (Sakwa, 2009). Shortly after the arrest of Khodorkovsky, the Russian government decided to freeze the ownership of 44% of the company’s total shares (Sixsmith, 2008). In defending the move, the government claimed that it was acting with the aim of preventing some of the shareholders, including Khodorkovsky, from trading off a large portion of the company to one of the US oil firms known as Exxon.

Soon, a Yukos’ meeting for the shareholders was called and it was scheduled to take place on December 20, 2004, with the aim of discussing a “crisis plan.” This kind of meeting is a legal requirement in Russia for any company that may intend to apply for bankruptcy. However, a day before the meeting, the Russian government opted to sell one of Yukos’ principal assets, Yuganskneftgas, through a well-coordinated auction, as mentioned earlier, in order to recover about $28 billion, which it claimed the company owed the government (Sixsmith, 2008). This was due to the company’s loss of an appeal by the company to pay the debts over a period of three years. After the efforts by Menatep managed to influence foreign opinion, most American and European oil firms opted not to bid in the auction. Eventually, the Baikal Finance Group bought the asset at a low price of $9.4 billion bid. The bid was too low compared to the asset’s value which was estimated at about $15 billion over the past few months before the sale (Sakwa, 2009). A deeper investigation revealed that the proposed financiers to Baikal Finance Group include the state-owned Gazprom, China’s National Petroleum Corporation, Russia’s central bank, and India’s ONGC. This arrangement was strategically made to win foreign credibility in the auction. A focus on the way the auction was conducted reveals that the participants had reached a deal of who was to win the auction since there were only two bidders and one of them never placed any bid, except the Baikal Finance Group (Perovic et al., 2009). The role of political forces in Russia in the violation, or at least manipulation, of the laws, was evident since Gazprom had been barred by America’s Houston court ruling from participating in the auction (Grace, 2005).

Following the treatment that the Yukos Company was receiving from government agencies, it resulted in the shake-up of the entire management. Reliable sources indicate that by December 2004, most of Yukos’ board members and other senior officials had opted to run out of the country due to the then building up fear of arrest (Brookes, 2004). Government prosecutors were out pursuing and summoning most members of the management for interrogation concerning their role in the alleged tax evasion by Yukos (Grace, 2005). Former members of top management of Yukos who are also exiled, Mikhail Brudno and Vladimir Dubov, have been placed on an international warrant of arrest. The Russian government seemed to have found an ‘official’ way of haunting the entire company.

Moreover, in late 2005, Vasily Aleksanyan was appointed the Yukos’ Executive Vice President with the hope that he was going to restore the company’s reputation and protect its legitimate stakeholders. However, barely six months later, he was arrested by government agencies to the furry of the entire Yukos Oil company membership (Brookes, 2004). As if the arrest was not enough, a “New Management” was installed with top officials being well-known loyal members of Rosneft who were out to bring down Yukos Company. In July the same year, the ‘management’ scheduled that creditors would vote whether the company should file for bankruptcy or not. On realizing that the outcome of the vote was predetermined, the then CEO, Steve Theede, decided to resign a week earlier so as not to participate in the sham meeting (Smith, 2004). The exit of the legitimate top officials must have been the first success story of the “New Management.” The continued multibillion-dollar back-tracking of tax by the government led to the ultimate bankruptcy of the company and subsequent sale of assets at lowly priced state-imposed and coordinated auctions.

As Khodorkovsky approaches the end of his eight-year term in prison, the government has filed new charges against him as well as revisiting the old charges. This has raised a lot of concern from an international dimension, especially from the West. In fact, the US president, Barack Obama, describes it as being too odd since no one can serve twice the prison term for similar charges (Sakwa, 2009). This is seen by Yukos’ lawyers as a scheme to totally crash it and prevent any possible re-emergence once Khodorkovsky is released from jail.

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The above discussion clearly points out the multidimensional implications of the Yukos affair both in Russia and foreign states. Russia’s political leadership has asserted itself as a force to reckon with when it comes to the control of major oil exploring and refining corporations, including Yukos (Sakwa, 2009). The Yukos affair provides a field for analyzing the Russian government and what it is capable of doing. The use of the various agencies and institutions to bring down Yukos Oil Company indicates its commitment to ensuring the total control of major resources, thus avoiding any political competition. The vigor with which top government officials became engaged in the Yukos affair creates doubt about its motive. Owners of large oil companies like Khodorkovsky are considered by the present government to be potential political opponents and thus must be destroyed (Perovic et al., 2009). This will serve to reinforce the already existing authoritarian leadership.

The Yukos affair also has an economic implication. By reclaiming privately-owned oil and gas companies, the government will control the prices of the most needed commodities in order to achieve its economic stability and the maintenance of the status quo (Smith, 2004). This implies that the economy will be in full control of the state if this trend of affairs is anything to go by. Therefore, as a result of the affair, the Russian government has and will easily be able to control energy supplies to the consumers in the larger Eurasian region and use it to negotiate favorable foreign policies (Brookes, 2004). Just as advanced arms positioned Russia above its enemies during the cold war, the proceeds from oil and natural gas have enabled Russia to remain stable, especially after the government’s takeover of major oil and natural gas firms, Yukos included. Shareholders and investors in the Yukos Company have tried to sue following the company’s failure to pay their dues (Perovic et al., 2009). One can conclude that the implications of the Yukos and related affairs are far-reaching, and the same trend seems to have taken root in the Russian government, which is not ready to entertain any threats, especially from oligarchs.

The essay had elaborated on the Yukos affair from its preliminary foundation to its full-blown status in October 2003 when the company’s CEO, Khodorkovsky, was arrested and jailed for an eight-year term which has since been reviewed by renewed charges. It has discussed the forced sale of assets belonging to Yukos by the government, which from analysis reveal that it was the government’s strategy to take over the formerly world’s largest producer of oil. The essay has gone ahead and highlighted some of the implications of the Yukos affair, which seem to be greatly felt within Russia and beyond.

References

Aslund, A. (2007). Russia’s capitalist revolution: why market reform succeeded and democracy failed. Peterson Institute

Barnes, A. S. (2006). Owning Russia: the struggle over factories, farms, and power. Cornell University Press

Black, J. L. (2006). Understanding the Russian federation. Academic International Press

Brookes, P. (2004). The Yukos Affair and its implications. The Heritage Foundation: National Security Affairs, NY; New York

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Cohen, A. (2003). The Yukos Affair: Protecting Democracy, Private Property, and the Rule of Law. The Heritage Foundation: Kathryn and Shelby Cullom Davis Institute for International Studies

Grace, J. D. (2005). Russian oil supply: performance and prospects. Oxford University Press

Perovic, J., Orttung, R. W. & Wenger, A. (2009). Russian energy power and foreign relations: implications for conflict and cooperation. Taylor & Francis

Sakwa, R. (2009). The quality of freedom: Khodorkovsky, Putin, and the Yukos Affair. Oxford University Press

Sixsmith, M. (2008). Putin’s Oil: the Yukos Affair and the struggle for Russia. Continuum Plc.

Smith, K. C. (2004). Russian energy politics in the Baltics, Poland, and Ukraine: a new stealth imperialism. CSIS Report