Analysis: After Yukos' funeral

Yukos, Russia's largest privately owned oil company, will be broken up on Sunday. After stumbling under debilitating back-tax claims of over $28 billion, the company's most important production unit, Yuganskneftegaz, will be sold at auction with Kremlin-controlled Gazprom the likely winner.

Vladimir Putin's plan to create international energy heavy weight is about to become a reality. However, the aftermath of the Yukos is poised to create a number of international political and financial headaches.

It took the Kremlin over a year to crush Yukos and harass the company's core shareholders. Exorbitant back tax claims, the arrest and trial of top company officials such as Mikhail Khodorkovsky and Platon Lebedev, and the freezing of Yukos' assets and bank accounts have brought Yukos to its knees. Yukos' publicly trade shares have taken the wind out of Russia's once booming stock markets.

Filing bankruptcy in a U.S. court this week has given Yukos a small victory, but will not save Yuganskneftegaz from the auction block. The Houston bankruptcy court has ordered a 10-day stay blocking the auction and barring international financial institutions from assisting Gazprom, the favored winner of the auction, to finance Yuganskneftegaz's purchase. Russian justice officials have dismissed out of hand the U.S. ruling and claim the auction will be carried out as planned.

The bidding price for Yuganskneftegaz will start at slightly over $8 billion -- significantly lower than its valuation. The two other bidders are unknown financial institutions, suggesting that Gazprom's bid will win at a sum no higher than the starting price. Overnight, Gazprom -- the world's largest natural gas producer -- will become an energy giant with a small number of international peers.

This has been the Kremlin's plan from the start. Deemed a national security issue, the Kremlin geared up the entire state bureaucracy to employ any means necessary to capture Yukos to serve state interests. As a privately owned company, Yukos was in a position to significantly impact Russia's domestic and international energy polices. After Sunday, the Kremlin again will be in charge of Russia's energy sector.

However, the Kremlin's destruction of Yukos and seizure of Yuganskneftegaz may have unintended international political and financial consequences. Yukos' level of success in dealing with Russia's legal system has been nil. In foreign courts, Yukos' chances of legal victories have already been proven successful.

Will be getting Yuganskneftegaz easier than keeping it? Group Menatep, Yukos' core shareholders, has already started to test this proposition. Having failed in Russian courts, Group Menatep is on the offensive internationally. It has already filed a notice against Russia under the Energy Charter. This international agreement, which Russia is part of, bars state authorities from expropriating investors.

Menatep has also threatened to sue any investment bank loaning money to Gazprom to purchase Yuganskneftegaz. It is also widely expected that Menatep will take its case to the European Convention of Human Rights. Being a signatory to the convention, the Kremlin may be forced to explain why Yukos' legal rights were trampled on.

Menatep is also likely to contest Yuganskneftegaz's right of ownership in Western courts. Given the strong protection of private property Western courts adhere to, Menatep most certainly will attempt to damage Gazprom in much the same way the Kremlin damaged Yukos. Court orders could conceivably see Gazprom's foreign assets and bank accounts arrested. Natural gas and oil exports could technically also be seized. If this were to happen, Yukos' international legal fight could turn into a nasty international energy problem.

Gazprom may face other problems. If Yuganskneftegaz's right of ownership remains in limbo, Gazprom's plans to created large joint ventures around the world could also be in doubt. Other international energy giants for the foreseeable future will take a wait-and-see approach when thinking about partnering with Gazprom.

What has happened to Yukos has caused an international outcry against Russia. But will this outcry go as far as to block Russian oil and gas exports? If Menatep is successful in its legal bids seeking compensation, governments, particularly in Europe, will be pressured to respond. In 2003, Gazprom supplied Europe with more that 25 percent of natural gas needs; 28 percent of that total was sent to Germany.

What was primarily a Russian domestic affair could quickly turn into an international headache. Western courts will take Menatep's legal claims seriously. European governments, as well as China, will be forced to react if gas and oil imports from Gazprom are put in danger. Property rights and energy security are set to collide.

A number of legal experts have claimed that the Kremlin has not taken into account the international legal ramifications the Yukos affair. However correct the legal experts are, they may have overlooked the most important point Putin is gambling on. Russia has valuable energy resources to export and it is up to energy hungry importers to decide just how much they need oil and gas -- even if it is from Gazprom.

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(Peter Lavelle is an independent Moscow-based analyst and the author of the electronic newsletter on Russia, Untimely Thoughts, at untimely-thoughts.com.)

(The Washington Times, 12.17.2004)