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. Last Updated: 07/27/2016

The Death of Rosneft

It was supposed to have been a watershed privatization, a chance to set straight years of crooked inside deals. For the Russian government, Rosneft meant redemption.

Not only would the government receive a competitive market price for the company, an integrated oil holding similar to several companies that were hawked to a small clique of businessmen in 1995 and 1996. But the government would also have finally proved to the world it can conduct a privatization in an honest, transparent fashion.

But that didn't happen. For reasons both objective and sinister, Rosneft's financial situationworsened with each month. Oil prices on world markets began sinking rapidly, and confidence in Russia's economic reforms moved in the same direction.

Within the company, a divisive system of management - pitting the president and the chairman of the board against each other - gradually eroded the effectiveness of the company's operations. Debts mounted at an alarming rate, operations at subsidiaries were ignored, and new managers began selling off Rosneft's assets.

The company's death-bell finally tolled in mid-September when a controlling stake in Purneftegaz, an oil production subsidiary and Rosneft's most attractive asset, was secretively sold off to four unknown Moscow-based firms for $10 million in order to cancel some trifling overdue debts. The stake's real value was $500 to $600 million, according to managers and analysts.

Although the exact identities of the figures behind the deal have yet to be established, an investigation by The Moscow Times has traced possible links to industrial giant LUKoil and Kremlin insider Pavel Borodin, while the effective buyer of the stake is directly related to the Moscow Patriarchiate.

The government has since been able to win back three-fourths of its stake in Purneftegaz through arbitration courts, with the hearing on the final fourth set for Dec. 9. But a source close to the four firms has said that a series of appeals is now being prepared, which means months of litigation are ahead before a final verdict.

The continued uncertainty will only exacerbate Rosneft's financial position as the rising cost of debts further erode any value the company may have. Whoever wins, analysts say that the Purneftegaz fiasco has buried any chance the government had to privatize Rosneft, a sale which at one time had caught the attention of such investors as British Petroleum, Shell, Elf Aquitaine and even billionaire financier George Soros.

The story of Rosneft and Purneftegaz contains all the gore of a political-economic system gone wrong: selfish management, bureaucratic incompetence, greedy oligarchs and even Kremlin intrigue. A financial crisis, a fire, obstruction of justice and even bomb threats have played a role in driving the last nails into the coffin of Rosneft. The company may never recover.

The Purneftegaz episode started on June 1, 1998, when a court executor, Sergei Gurov, arrested a 38 percent stake in the company as collateral against three small outstanding loans disbursed to Rosneft in 1996.

The arrest came four days after Rosneft president Yury Bespalov and chairman of the board Alexander Putilov, enemies under the same roof, were fired by then-Prime Minister Sergei Kiriyenko. Shortly before, the government had failed to sell a 75 percent stake in the company.

The size of creditors' claims against Rosneft that Gurov was attempting to fulfill amounted to 36 million rubles ($6 million at the time), which is hundreds of millions of dollars less than both the market and book value of the arrested asset.

Neither the courts, nor Rosneft's creditors, nor Rosneft's shareholder - the Russian government - publicized the share arrest, despite the fact that government officials immediately began preparing a second sale of Rosneft.

One source, who worked at Rosneft for over two years and wished not to be identified, said privatization officials were aware of the arrested shares, but declined to make this information public since it would undoubtedly ruin any chance they had of selling Rosneft.

The government was in the middle of a major budget overhaul and needed the $1.6 billion expected in proceeds from the sale. As is often the case in such high-profile tenders, government officials were hoping that the eventual investor would cancel all of Rosneft's debt.

A chance at rectifying the situation came in August. In order to improve its chances of selling Rosneft, the government invited an outside manager to straighten out the company's operations and sharpen its image. That outsider on Aug. 11 became Alliance Group, a three-month-old management and financial unit set up by Ziya Bazhayev, former president of the oil company Sidanco. Upon learning about the arrested shares in mid-August, Bazhayev immediately took action. "We sat down with the four creditors and reached an agreement with each," he told The Moscow Times. "We even paid one of them right away."

However, Alliance could not formally take over Rosneft's operations until the company's board of directors met and empowered the outside manager to do so.

"We agreed with the creditors that once we received authority to manage Rosneft, then the agreements we signed with them would immediately come into force," said Bazhayev. "If we didn't receive the necessary authority from the board, then the agreements had no legal basis."

But the financial crash of Aug. 17 changed everything. A board meeting planned for that week had to be canceled since nearly all Rosneft board members - bureaucrats from various ministries - went to the Russian White House to stick closely to the action. Rosneft's problems were the last things on their minds. In the meantime, a fire broke out in the headquarters of the Fuel and Energy Ministry, further complicating the work of several board members.

Two more planned board meetings - one on Aug. 23, the day after Kiriyenko was sacked, and another on Aug. 27 - were also canceled, and finally Bazhayev decided to call it quits. He held a news conference that day announcing that Alliance was leaving Rosneft.

Thus, the one chance to prevent the enormous scandal that followed was lost. "Bazhayev was the only person who tried to regulate this debt," said Yury Movashev, vice president of MAPO-Bank, one of the Rosneft creditors that attempted to retrieve its money.

Ironically, once Bazhayev dropped out, the next day, on Aug. 28, the board of directors finally convened and nominated deputy fuel and energy minister Sergey Chizhov .

Chizhov claims he knew nothing about the arrest of the Purneftegaz shares. "I found out about the arrested shares about three days after I became acting president," Chizhov told The Moscow Times in an interview.

This is strange since Chizhov attended an Aug. 24 press conference held by Bazhayev at which the latter announced that Rosneft's stake in Purneftegaz had been frozen. Alliance officials say there is no way Chizhov could have not known about the arrest before becoming acting president.

Chizhov says he immediately ordered an investigation that revealed that the shares were indeed under arrest and in the custody of Dialog-Optim. The Moscow-based bank with, no connection to Dialog Bank, is contracted to arrange sales for the Moscow city courts in such cases.

But Chizhov said he was led to believe that the shares were going nowhere. "My people went [to the bank], where they were told, 'There's nothing to worry about, there are no buyers [for the stake]'," Chizhov said. Together with the court executors' department, Dialog-Optim told Chizhov's assistants that they would be informed as soon as something took place, Chizhov said.

However, the shares were sold by Dialog-Optim on Sept. 11 to four small firms. Control over a company that annually produces 8 million tons of crude and last year had revenues of over $800 million was sold for $10 million. The 42,319,075 shares were bought in equal portions by Feniks, European-Siberian Oil Co., PAKK-Invest and MAK-Tsentr.

In a letter sent to Prime Minister Yevgeny Primakov, the department of court executors, a division of the Justice Ministry, claimed that the department contacted several Western banks, in particular ABN-Amro and Salomon Smith Barney, to participate in the purchase. In addition, LUKoil and Sidanco were also approached.

Strangely, Rosneft's lawyer, Alexander Dobrovinsky, who contacted dozens of Western banks, learned that one of the two Western banks was actually telephoned by Dialog-Optim about two weeks before the actual saletook place, at approximately the end of August. This was the same time that Chizhov said Dialog-Optim assured him that there was "nothing to worry about" and that "there were no buyers."

As a Western banker explained to Dobrovinsky, Dialog-Optim proposed that the Western bank purchase the stake and in turn sell it back to a Russian entity. Dialog-Optim, in the words of the Western banker Dobrovinsky spoke to, wanted to bring a Western financial institution into the deal since Russian law enforcement agencies "wouldn't crack down on a Western bank as they would on a Russian bank if a scandal breaks out."

The four companies paid $10 million for the shares on Sept. 16, and on Sept. 17, the Central Moscow Depository received a court order to transfer Rosneft's 38 percent stake to the four companies, which it carried out. Dobrovinsky said the four companies biggest mistake was being too greedy.

"If that stake had been sold for $90 or $100 million, which is still three, four, even five times beneath the market value of the company, then there wouldn't have been such a scandal," Dobrovinsky said.

"Even after all [Purneftegaz's] debts, [38 percent of] the company is worth more than $10 million," said Bazhayev.

Chizhov said that, upon learning about the sale on Sept. 17, he immediately appealed to Prosecutor General Yury Skuratov to block the share sale lest "they disappear in Switzerland," in the words of the deputy minister. The prosecutor's office agreed and froze the accounts of the four buyers.

The money for the shares, which was paid for, not by the four firms, but a fifth unknown party, is also currently frozen in the Bank of Moscow on the account of the department of court executors.

The true owner of the four obscure companies that bought the shares is unknown.

All four of the companies are linked to International Economic Cooperation, a company established by the business affairs directorate of the Moscow Patriarchate in 1990. With the patronage of top Kremlin and government officials, the IEC became a leading exporter of crude oil. In 1994 alone, IEC exported 7.7 million tons of oil, or approximately 10 percent of Russia's total exports that year. Proceeds were supposedly used to restore churches and fund pet projects of the Kremlin.

Vitaly Kirillov, president of IEC, is a well-known figure in the industry, and last year led an abortive attempt by a consortium of investors to buy a 20 percent stake in Banca di Roma for $1 billion. He is also president of Feniks, a limited liability partnership and one of the four buyers of Purneftegaz. Feniks also owns 60 percent in IEC, as the Moscow Patriarchate has sold off its controlling stake to 20 percent over the past two years, IEC said.

A source said that Vladimir Kolesnikov, who is also vice president of IEC, heads another buyer, European-Siberian Oil Co.

A third buyer - PAKK-Invest - appears to have links to Putilov, Rosneft's former president and board chairman. A spokesman for PAKK-Invest's president, Dmitry Bugayenko, said that his boss has close ties with Putilov stretching back years.

Little is known about the fourth buyer, MAK-Tsentr. The Russian press has linked it to IEC, although Tavrovsky could not confirm this.

IEC said that all four companies have asked IEC to manage the Purneftegaz stake on their behalf. However, another source said that IEC handed management rights to ousted former Rosneft president Putilov. Tavrovsky refused to comment.

IEC said that, with the help of unnamed foreign investors, it has prepared a $350 million investment program for Purneftegaz that will ease the company's $300-plus million debt burden and maximize operations.

It condemned the government's bid to take back the Purneftegaz shares as an example of communist renationalization of industry and interference by the government in the court system.After some initial setbacks, the Russian state now looks like it is winning back control of the 38 percent.It lost an appeal of the decision to sell the shares on Sept. 25 , but the public outcry at the loss of the shares forced the government to persevere.

President Boris Yeltsin ordered Primakov on Oct. 14 to ensure that the Purneftegaz stake be returned within two weeks. Given the president's state of health, it is believed that the actual order was prepared by someone else.

Purneftegaz became a litmus test for the new government's political will. Insiders claim that pressure from the executive branch mounted on the judiciary, and on Oct. 28, representatives from the Justice Ministry, the State Property Committee and the department of court executors met in the office of Deputy Prime Minister Vladimir Bulgak to discuss the case.

However, Dobrovinsky denies that any political pressure was brought to bear to win a favorable outcome in the case. In fact, he said he was called in to one law-enforcement ministry and told that he would receive no assistance in winning a favorable verdict. "I was told I would be acting entirely alone, that no one would talk to a judge on my behalf, and no one [in the government] would go to pains to help me," Dobrovinsky said.

Moreover, it was recommended to Dobrovinsky that he try to have the case moved to a more neutral territory, such as the Tyumen region. Dobrovinsky refused, confident that he could win the case on the basis of the law.

The tension surrounding the case heightened after a bomb threat forced the cancellation of a court hearing on Oct. 28 to decide the legality of the court executor's arrest.

Eventually, however, a series of hearings were held, and the court returned three-fourths of Rosneft's stake in Purneftegaz. The crucial arguments, according to Rosneft's lawyer Dobrovinsky, were first, Gurov's improper appraisal of the seized asset, which failed to take into consideration that a 38 percent stake is a controlling stake, and therefore the value should be significantly higher than a simple mathematical calculation of the market price times the number of shares; and second, irregularities in the mechanics of Gurov's decision to sell the stake. Gurov had failed to conduct an open offering and inform Rosneft about the sale.

Virtually no hope remains that the company can be sold in the foreseeable future.

The company is drowning in debt: A financial director at Rosneft informed Chizhov in a letter that the company had over $1 billion in aggregate debt as of July 1. "The company has been ruined," said one oil analyst.

To somehow salvage the wreckage, bureaucrats at the Fuel and Energy Ministry have pulled from the shelves an old idea of merging Rosneft with Slavneft and Onaco, two other state-owned integrated oil producers. Chizhov said there is no clear consensus on the idea.