Politics, Putin, and Oil Producers, Oh My!

Moscow’s Meshchansky District Court adjourned early today for the second day in a row during the reading of the verdict in the trial of OAO Yukos Oil Co. founder Mikhail Khodorkovsky.

The man who was once Russia’s richest (worth about $15 billion) is being tried on 11 counts of fraud and tax evasion. The trial and the events leading up to it have been highly politically charged, with some speculating that the charges were nothing more than a strategy on President Vladimir Putin’s part to quash Khodorkovsky’s rumored political aspirations, as well as those of the opposing politicians whom the oil tycoon privately funded.

Of course, we here at PROFIT CONFIDENTIAL are more concerned with profits than politics. While I’ll happily leave the political speculation to other writers in other commentaries, in the next few paragraphs I’d like to give you a clearer picture on what the aftermath of the Yukos headlines could mean to the global eye.

First, a little background: Mikhail Khodorkovsky gained control of Yukos during controversial privatization auctions during the mid-1990s when insiders had the opportunity to buy Russia’s natural resources for a song. Soon after, Khodorkovsky consolidated control of the company and set to work to strengthen it and its assets.

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The company, under Khodorkovsky’s direction, became the first major Russian company to adopt international accounting standards. The company merged with Sibneft (a smaller oil company) and became the world’s fourth largest oil producer. Yukos was soon seen as a glowing example of corporate transparency and labeled an investment darling.

In circumstances that have been questioned the world over and that we won’t get into here, Khodorkovsky and his partner Platon Lebedev were arrested and charged with fraud in 2003. They have been in prison ever since, and the company has come under heavy fire by the Kremlin.

After having its legal and tax practices examined under a Kremlin microscope, Yukos has been slammed with a $28- billion bill for back-taxes. In December 2004, the government seized the Yukos-owned Yuganskneftegaz (the company’s biggest oil production unit) as equity towards the owed funds. Rosneft, Russia’s state-owned oil company, picked up the unit for a little less than $10 billion. Today, Yukos struggles, facing what seems like an insurmountable debt load and a near-certain inevitability to claim bankruptcy.

And this is what it comes down to for investors, commodity experts, and economists. Today, we’re not questioning whether or not the guilty verdicts in the Yukos case will be read — for they eventually will… we’re questioning what will happen when Yukos claims bankruptcy.

Many people see a push for Yukos’ bankruptcy as the true strategy behind the Kremlin’s investigation of the company and its leaders. What would be the result, you ask, after the jail doors slam behind Khodorkovsky? The collapse of Yukos would likely enable the Kremlin to take control of the company’s remaining assets.

You see, since 1999, Russian oil production has increased by 48%, up to a phenomenal nine million barrels a day. The country is without question the world’s largest oil producer. However, at the same time, Russia is the only major oil exporter on the planet where the state is not the major operator.

Yukos controls about two percent of the world’s oil reserves — a powerful position, to be sure. If the Kremlin could get its hands on these reserves, it would be a step in the right direction for Russia to realign its oil politics with those of the rest of the international stage.

In this respect, it seems a little more logical that Putin would orchestrate the trial of Khodorkovsky not for his own political gain, but to secure Russian oil fields in the international oil market.

As terrorism threatens oil delivery from Saudi Arabia, and the war on terrorism has limited Iraq’s contribution, energy hungry regions like China, India, and North America will reassess where they get their supply of the black gold.

If and when Russia regains control over its oil reserves, it will certainly be positioned as the world leader in crude oil. At that time, the country would likely join OPEC. More secure Russian oil tomorrow could ultimately balance today’s ups and downs in the industry. Such a move could keep oil supply up, prices down, and SUV drivers like George happy the world over.