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Russia's Yukos Trial Does Not Benefit Its Foreign Investment Climate

Angelique van Engelen - 5/21/2005

The trial of the Chief Executive of Russian oil company Yukos, Mikhail Khodorkovsky, has many wondering about the viability of investment projects into Russia. A number of Western companies recently has dropped plans and should Khodorkovsky be jailed for the 10 years people believe he might be sentenced to, the move would be strongly condemned by the US government.

Even though risk analysts likely are adding points left, right and center on the country's risk rating profile, it is not clear if other companies with equally flamboyant directors perhaps are also at risk from similar treatment by Mr. Putin. In the rest of the oil sector, life appears to continue as normal.

The Wall Street Journal reported that Russia has dropped plans to merge Rosneft and Gazprom. "Is Russia trying to save face? [Khodorkovsky] That could lead to foreign investment in Gazprom! Of course you have to ask yourself how brave you feel and what profits there might be after taxes. It appears they have a living tax system in Russia!" one trader at the New York firm Alaron reckons.

He might be right. What were first believed to be new rules tempering investment in direct bids on parts of Russian companies were also recently revealed to be less strict. Yet Russia's tax authorities' arbitrary dealings are putting companies off. The most publicized unexpectedly astortionate tax bill was the April BP tax bill of $1 billion. Several foreign investors are putting plans on hold for Russian ventures, including the Carlyle Group, the large US private-equity firm. According to the Economist's online edition, this group abandoned plans to launch a $300 million investment fund destined for the Russian market. Domestic investors also shy away from the Russian market. The central bank in Moscow reports that net capital flight amounted to at $9.4 billion in 2004. This quadrupled the previous year's amount.

The trial's outcome will also seriously impact US Russian relations. As of May 2002, the US and Russia embarked on an energy dialogue, by which means the two countries promised each other to make sure the oil markets would remain stable. Russia said it would step in whenever Opec output was faltering, the US made similar noises over investment into Russian companies. Soon after, Yukos was the first ever Russian oil company to make a direct oil sale to the US, sending a tanker ship to a US port in Houston, a move that was the first tangible sign of a Russia-US "energy dialogue".

This development also pretty much opened the country's oil industry open up for other investors, people said. US companies and investment funds have long been keen investors in Russian firms. Russia was the first countries in the Eastern parts of Europe where it directed its funds to once investing in emerging markets became fashionable.

The fact that the trial of Mr. Khodorkovsky was suspended early May when foreign dignitaries visited Russia to commemorate the Second World War, is indicative perhaps of the fact that even the Russian government might sense the trial could dent its reputation further. And perhaps that's right. Last February's comments by President Bush and Condolleezza Rice on their visit to Russia reprimanding Moscow for 'backsliding' on its democratic principles did refer to the Yukos case. President Putin's stance on the issue is unavailing however and foreign investors are slightly concerned about other former parastatal companies now doing well. Yet people believe that the Russian President might only be targeting Khodorkovsky for more or less personal reasons and to maintain a firm grip on power. Mr. Khodorkovsky had been considered as a potential Presidential candidate in the next elections in 2008 and last year did not exactly endear himself to Putin by openly accusing him of corruption. He also funded anti-government political parties with his wealth. At 41, Khodorkovsky had already become a billionnaire. That wealth has now been confiscated with old-style, communist methods - a move that some say they had seen coming for a while.

Apparently the rise to prosperity of a few Yukos company insiders had been a thorn in the side of people like Putin, as well as a big part of the poor Russian population which (especially those not living in major cities) every winter struggles to make it through the cold. A former parastatal, the private people running it were enriching themselves grotesquely by not passing the wealth in any distributive way. This happened at a time that everybody in Russia had slight hopes still that free market economic principles would start to throw off likable results. One could say this alone is likely enough reason for the drastic action by the Russian government, but the seven charges brought against Khodorkovsky don't amount to anything of the sort and are also not really based on truth for that matter.

Which is sad. Crooks and faltering economic ideas by politicians are said to have spurred the Russian population into supporting new extremist political parties that are campaigning for a return to old time Soviet ideals.

Even though it is highly unlikely that the Khodorkovsky case will really reveal the misdoings of this good looking, youngish nouveau riche Russian sporting German style glasses and a stylish haircut, he is by no means a good boy. Of course the real insiders will tell you more dirt, but so far, public publications list at least three questionable and even punishable practices for which you should hate Khodorkovsky: squeezing out minority shareholders; moving important meetings at the last moment; hiding shares offshore.

Yet it has to be said that Yukos in recent years has become one of Russia's more transparent companies with western style accounting that allows foreign investors from the US to have exposure. In a sense, the rise of the world oil price has been the death blow perhaps to this ambitious young man, who according to a personal profile in the Financial Times of London had said he'd aspired a career just like the one he's had, ever since age three. Khodorkovsky is not even present at his trial but looks in good spirits from behind the bars which he shares with many others, which is likely a change of atmosphere for him off late. Yukos, which was pumping 2% of global output and a fifth of the domestic market's production.