On the last wednesday of September, Russia's second largest oil company, Lukoil, hoisted the Stars and Stripes up a flagpole outside its Moscow headquarters to celebrate a landmark deal: with a $2 billion bid, the U.S. firm ConocoPhillips had just won an auction for the Russian government's 7.6% stake in the firm. The two companies promptly announced a strategic alliance to develop oil reserves in the Russian Arctic and potentially work together in Iraq. For Jim Mulva, Conoco's president and chief executive, the deal amounted to a coup, giving Conoco access to 8 billion bbl. of proven oil reserves at a relatively modest cost. Lukoil was delighted, too, because it is counting on the Americans to help it extract and market the oil more efficiently. But as Mulva and Lukoil president Vagit Alekperov toasted their accord with champagne, they were careful not to mention the one issue that overshadows the future of the Russian oil industry: the fate of Lukoil rival Yukos, the largest and most successful Russian oil company, which is being hounded out of business by the Kremlin.
A year ago, Mikhail Khodorkovsky, a billionaire who built Yukos into an energy powerhouse, was arrested and put on trial for alleged fraud and tax evasion, charges he says were trumped up. Since then, Yukos has been hit with a $24 billion bill for back taxes, and the government announced in November that it will auction off the company's most valuable subsidiary, Yugansk Oil & Gas, on Dec. 19 to pay the tax bill a move Yukos ceo Steven Theede lambasted as "government-organized theft to settle a political score." The Kremlin set the starting price for the auction at $8.65 billion, roughly half the $14.7 to $17.3 billion valuation put on the firm by bankers Dresdner Kleinwort Wasserstein.
Many in Moscow expect the Yugansk auction to be just the beginning of a final carve-up of the company. Yukos is trying to stop the forced sale, which violates Russian statutes stipulating that non-core assets be sold first in the event of tax claims. The firm has launched legal proceedings against the Kremlin under an international energy charter and says it will sue the winner of the Dec. 19 bidding. "This has nothing to do with taxes and everything to do with expropriation," argues Robert Amsterdam, a Toronto-based lawyer for Khodorkovsky.
Yukos is unable to pay its tax bills because its accounts have been frozen, making it hard to pay suppliers and staff as well. In early November, authorities issued an arrest warrant for the company's chief lawyer, Dmitry Gololobov. Last week, the firm's chief financial officer, Bruce Misamore, fled the country along with other top management, citing fear for their personal security. And the Yugansk auction is scheduled the day before a shareholder vote called to decide whether to file for bankruptcy protection; a principal reason Yukos hasn't already done so is that a majority of the board believes it would be impossible to find a Russian court willing to approve the petition. Indeed, the day before Conoco signed the Lukoil deal, the Moscow court where Khodorkovsky is on trial refused to allow former German Justice Minister Sabine Leutheusser-Schnarrenberger, who's serving as an official European human-rights representative, to speak with him. The Yukos case "has set the Russian judicial system back a decade," says Sarah Carey, a Washington lawyer who serves on the Yukos board.
It's an odd time for an oil rush. The West's leading oil companies are making a run for Russia just as President Vladimir Putin consolidates his power and reasserts control over the energy business (among other things). State interference in the economy increased restrictions on foreign ownership, the assault on Yukos and big shifts in taxation has raised concerns about Putin's commitment to the rule of law. Many Russians are voting with their wallets. This year capital flight will easily exceed $10 billion, up from $2 billion last year. Even some top officials have misgivings. Andrei Illarionov, Putin's chief economic adviser, said recently that the Yukos affair is "a Pandora's box, and it was a serious mistake to open it." Why, in such a seemingly hostile and risky environment, does Big Oil think Russia is a good investment?