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Corruption Watch: May 2, 2003

2 May 2003, Volume 3, Number 15
By Roman Kupchinsky

If any one sector of economic activity were to be singled out as a major source of crime and corruption in the former Soviet Union, it would unquestionably be the energy business. The profits to be made in the sector are so immense -- and the state regulations that govern it so flexible and often violated -- that it is little wonder so much crime and corruption in Russia, Ukraine, Kazakhstan, and Turkmenistan is to be found in the energy sphere. It is the energy business, above all others, that brings crime and government together into one nexus.

Furthermore, by its international nature, it has drawn Western companies into this nexus. The recent arrest in New York of an American investment banker, James Giffin, for alleged activities in connection with ExxonMobil deals in Kazakhstan represents an example of what critics suggest is a vast web of seemingly illicit dealings that former Soviet energy has bred. In this case, the Kazakh president, his son (the head of the major state oil company), ExxonMobil, and Giffin have been implicated to varying degrees in alleged bribery and the solicitation of bribes, while President Nursultan Nazarbaev appears to have sheltered upward of $1 billion in a private, offshore account.

As Maria Danilova points out in the "End Note" below, the Slavneft privatization is another demonstration of the power the Russian state has in ensuring that insiders win the most lucrative tenders in the gas and oil industry -- and pay an unfeasibly low price.

Corruption in the post-Soviet energy sector was put to the test in a U.S. court that refused to rule on a suit brought against Naftohaz Ukraine, the Ukrainian state gas-trading company. According to a ruling by the U.S. Second Circuit Court of Appeals on 15 November 2002, the issues in the suit were as follows: Gazprom filed a claim for $88 million in connection with losses stemming from gas it alleges was stolen by Naftohaz with its insurer, Sogaz (a fully owned subsidiary of Gazprom); Sogaz paid Gazprom and was in turn reimbursed by reinsurer Monegasque De Reassurances S.A.M. (Monde Re) of Monaco, a subsidiary of Reinsurance Australia Corporation Ltd., in accordance with a reinsurance agreement. Amazingly enough, Sogaz paid Gazprom $88 million within five days.

Monde Re in turn took Naftohaz to the Russian Arbitration Court and won, with the court ordering Naftohaz to pay Monde Re $88 million on 31 May 2000. Naftohaz appealed that decision with the Russian Supreme Court, which upheld the Arbitration Court ruling on 24 April 2001. But Naftohaz still refused to obey the court decision and pay Monde Re.

Monde Re then sued Naftohaz and the Ukrainian government (since Naftohaz is a state-owned company) in the United States, where on 1 September 2001 the District Court for the Southern District of New York rejected the case, claiming that it is not the appropriate jurisdiction. That decision was upheld on 15 November 2002 by an appellate court.

Gazprom is a state-owned company (the Russian state recently increased its stake in the company), and the refusal of the state to reform this monopoly is indicative of the attitude of Russian leaders from the top down with respect to this company.

When President Vladimir Putin removed the previous leadership of Gazprom, the Russian and international press heralded the step as a move to reform the company. More than three years later, the new Gazprom management has turned out to be less than transparent in its dealing,s and many Russian observers see it virtually as Putin's personal enterprise.

In Ukraine, a country that produces negligible amounts of gas or oil, corruption finds its way into both the control the state wields over the pipeline system that transports Russian gas to Ukraine and on to Europe, and into the distribution of Russian oil and gas to domestic consumers. This is the system once ruled over by Pavlo Lazarenko, the former prime minister now awaiting trial in San Francisco on charges of money laundering; it is this system that produced Naftohaz Ukraine, the single largest state-owned energy corporation in the country, appears immune to state audits; a former director, Ihor Bakaj, is believed to have been a major contributor to President Leonid Kuchma's election campaign and has come under heavy scrutiny from the parliamentary commission on combating corruption. Formal requests for the Prosecutor-General's Office to investigate Bakaj have come to naught, according to the head of that parliamentary commission, Hryhoriy Omelchenko.

The danger that this creeping criminalization of the energy business holds for Europe and the United States can be found in the state of world energy markets. With Europe increasingly dependent on Gazprom (the company currently supplies one-quarter of Europe's needs, and this percentage is rising), the danger of a sort of energy blackmail is on the increase. At the same time, Russia, with huge gas reserves, is strapped for cash but is not developing proven reserves. Instead, Russia appears to be relying on purchases from Turkmenistan to supplement both its domestic and export goals. The political situation in Turkmenistan is meanwhile unstable, and Turkmen President Saparmurat Niyazov might someday face a real political opposition and be removed. Turkmen gas can only reach world markets through pipelines currently controlled by Gazprom, so all three sides (Western Europe, Russia, and Ukraine) are arguably dependent on keeping a strongman in power to ensure access to his country's gas. This arrangement is all the more tenuous in light of the threat from organized crime to both policymaking and the gas-transit business.

The Czech daily "Mlada fronta Dnes" reported on 23 April that corruption in the republic has not abated. According to a GfK survey cited by the paper, the segment of people who admitted to bribery has risen for the fifth year in a row, with 37 percent saying they have bribed people. The paper reported that bribes in the Czech Republic amount to an estimated 40 billion Czech crowns annually ($1.3 billion). RK

The public-relations director of a major Siberian oil-pipeline company was shot dead while driving in Moscow on 6 April, reported. As Dmitrii Ogulchanskii, 35, waited for a light to change at around 8 p.m., a man emerged from another car and shot him three times. Ogulchanskii died at a nearby hospital. The victim was in charge of public relations for Sibnefteprovod and formerly served as a lawmaker in the legislature of Siberia's Khanty-Mansii Autonomous Okrug. Detectives speculated that the slaying was linked to Ogulchanskii's activities in one of those jobs. Steve Shabad


By Maria Danilova

Russian privatization is probably one of the most-debated topics of Russian postcommunist transition because it is believed to have generated widespread corruption and lawlessness. While scholars are still debating its first stage -- voucher privatization -- nothing has received as much criticism and condemnation as the second phase of privatization, in which Russia's biggest industrial and natural-resources companies were transferred to private owners.

The accounts of the second stage of Russian privatization given by scholars and journalists vary from "insider privatization" to "backdoor give-away" to "the greatest single property grab." Russians themselves sometimes refer to Russian privatization as "prikhvatizatsya," Russian for "grab-ization." Indeed, the privatization tenders that took place in the mid-1990s have been notorious for giving away Russia's crown jewels to a select few oligarchs for mere kopecks compared to what the government might have collected, had the auctions been fair and open. Such schemes gave rise to corrupt oligarchic capitalism in Russia and, according to critics, caused the state to become hostage by the same "Big Business" that it had helped to create. However, as the recent sale of Russia's eighth-biggest oil company, Slavneft, has demonstrated, the government appears to have failed to learn its lessons. Or it has learned the wrong ones.

The notorious privatization sales held in late 1995 have become a stain on Russia's transformation process. In his book "The Oligarchs: Wealth and Power in the New Russia," David Hoffman gives a detailed account of how Russia's strategic enterprises were sold for a song to a handful of wealthy businessmen. According to the loans-for-shares scheme, a controlling stake in the state's most lucrative companies was first given to the tycoons for safekeeping and managing in exchange for a loan to the government. But lo and behold, the impoverished state failed to repay the loans and the tycoons could then resell the bonds. No wonder, the oligarchs then sold the shares to themselves -- and cheaply.

What brought these tenders their ill reputations was the fact that by no means did they meet the standards of a free and open market economy that the Russian government had set out to build. As Hoffman's account demonstrates, the auctions were rigged and the winners were handpicked by the Kremlin well before the sales began. Thanks to the fierce lobbying of oligarchs, foreigners were excluded from directly participating in the purchase of Russia's biggest enterprises. The oligarchs had this way ensured that they would not have to compete with Western bids, which likely would far exceed what they could offer. This, however, also signified that the state, which was starved for cash, was sure to be ripped off.

Indeed, the tycoons managed to purchase Russia's industrial crown jewels for a song. In her book "Sale of the Century," Chrystia Freeland writes that Vladimir Potanin gained control of 51 percent of the Siberian oil company Sidanco for "only pennies more than the state's floor price of $130 million," while two years later British Petroleum paid more than four times that price for a 10 percent stake in the oil company.

Worse still, in order to aid the oligarchs' acquisitions, the government went so far as allowing them to organize auctions in which they themselves would take part. Hoffman describes how Mikhail Khodorkovskii was organizing the tender for oil company Yukos through his bank, Menatep, while simultaneously participating through one of his front companies, Laguna. Khodorkovskii won the tender for the 33 percent block of Yukos shares by bidding just $125,000 more than the starting price of $150 million.

Such personalized privatization has had grave effects on the Russian economy. The capitalism that it created is widely perceived as corrupt, distorted, and inefficient. Moreover, the state was taken hostage by the tycoons it had enriched. When Putin came to power, he vowed to brake the grip of capital on the state. Yet more than five years later, the "prikhvatizatsya" appears to be continuing. The sale of 75 percent of Slavneft, the biggest oil company still in state hands, bears much resemblance to the notorious privatization schemes that the Kremlin had mastered so well. In "The Washington Post" of 25 January, Yevgeniya Albats reports that, in December, Slavneft, Russia's eight-biggest oil company, was sold for less than half of what the government could have gotten for it.

As was the case in late 1995, foreigners were barred from participating in the Slavneft tender. The Chinese firm CNPC, according to sources, was willing to offer over $4 billion; but after a talk with Russian economic authorities, the company withdrew from the auction, Albats writes. Similarly, Rosneft, a firm that also intended to take part in the tender and claimed to be willing to offer $3.1 billion, was prevented from bidding. The winner of the auction, paying $1.86 billion, was a firm called Investoil -- representing oil companies TNK and Sibneft, the latter owned by Kremlin insider Roman Abramovich.

The loans-for-shares sales that were held in late 1995 can be, if not justified, then at least explained by the government's drive to prevent at any cost a communist comeback in the 1996 presidential election: By transferring its most valuable assets into the hands of wealthy and powerful businessmen, the state might be ensuring they do not allow for the return of a communist regime. However, such an explanation is in no way plausible in 2003, when Putin enjoys widespread public support and Russia is unlikely to elect a communist president. But the government appears to be repeating the same old scheme it has practiced many times before.

According to Albats, the Kremlin has in fact followed up on its pledge and distanced itself from some oligarchs; but on the other hand, it is eagerly rewarding others who are loyal to it. Instead of the "invisible hand" of the market, the invisible hand of the Kremlin ensured that Abramovich, whose bid reportedly was far from the highest, won the tender for Slavneft. In exchange, the fact that Abramovich's Sibneft controls Russia's biggest and most far-reaching television channel could be of great assistance to Putin's re-election bid.

But in a country where teachers, doctors, and pensioners go chronically unpaid or receive stingy salaries, and where, among other ills, there are over 1 million homeless children, an extra $1 billion-2 billion would have come in handy.

(Maria Danilova is a graduate student at Central European University in Budapest.)