Yukos and the Russian government.

1. 1
The rise and fall of Yukos can be attributed to many intertwined factors. Yukos came
under the control of Mikhail Khodorkovsky, a businessman and oligarch, after the Russian
government’s “Loans for Shares” program. Yukos was able to excel in a short period of time due
to organizational changes that attracted many investors. However, the company lacked the
flexibility it needed in order to respond to changes in the external environment. On top of this,
Yukos failed due to Mikhail Khodorkovsky’s poor relationships with the Russian government
and Vladimir Putin. From researching this topic, we have identified strengths and weaknesses of
Yukos and the Russian government, as well as drafted recommendations for both firms and
governments.
The end of the twentieth century played a major role in the Russian history. During the
1990’s, after the collapse of the socialist system, a stormy privatization process took place in
many economic sectors of the countries that were mostly under governmental authority. Boris N.
Yelstin served as the first president of the Russian Federation from 1991 to 1999. Yelstin
emerged under Perestroika, Gorbachov’s reformist program, as a clear opponent of the reform
with the main idea of turning Russian socialist economy into a free market. He wanted to
modernize the Soviets traditional economy by reselling company’s shares for profit.
“Loans for Shares” consisted in a privatization program based on issuing state owned
assets among the population. A privatization check was a state security paper that was issued for
the exchange of assets of the state enterprises to private owners during the privatization process
(Seletskii 2002). During 1992 in Russian Federation these kind of checks were called

2. 2
“vouchers”, and were used by the Russian government as an instrument of decentralization of
power.
By doing this, the state not only tried to favor the economy by creating opportunities for
small business to grow and expand their operations, but also to collect money to cover its fiscal
deficit and as alternative source of funds to keep Russian economy afloat.
Moreover, it served as an instrument of decentralization of public controlled enterprises,
so that the state could disperse control and ownership. Because of the mitigating political and
regulatory risks in political affairs, as informal privatization program, Russian Duma had posted
a ban on privatizing stakes on oil companies. However, this just led to a further corruption and
concentration of wealth in hands of the government and oligarchs. That increased the gap
between rich and poor, which is still noticeable when walking by streets of Moscow.
The problem was that Yeltsin was so endeavored with the idea of restructuring the system
that he overlooked several nuances: it is quite impossible to change the country’s economy from
one day to another. In the case of vouchers, the market was heavily saturated with them so that
there was quasi-inexistent demand; people stopped buying them because they lost their value as
they drop significantly in price. We can say that Yeltsin faced the same problem that Gorbachov
did during his “Perestroika” program; Russia was not ready for such a drastic change (Treisman
8).
As the privatization occurred mostly among industrial, financial, and energy sectors of
the Russian economy in 1992, the president posted a decree (N 1403) about the privatization of
oil and gas enterprises. One of them resulted to be the Yuganksneftegaz Company .

3. 3
So, we should trace the privatization of the oil company Yukos to that period of time,
when the privatization of "Yuganskneftegaz” was taking place. Yukos corporation merged with
other large national enterprises: Kubyshevsky, Syzransky and Novokuibyshev refineries,
distribution networks "Bryansknefteprodukt"industry, "Voronezhnefteproduct",
"Samaranefteproduct", "Orelnefteprodukt", "Tambovnefteproduct", "Lipetsknefteprodukt",
"Penzanefteprodukt", "Ulyanovsknefteprodukt" and other kind of construction and service
companies (Steven 2008)
Between 1993 and 1995, Russia was going through an economic recession. By this time
it was typical for oil industries to be denationalized or disrupted. And by the end of 1995, the
debt of Yukos exceeded $1 billion. Therefore, the Russian government decided to sell state-
owned shares of the company (78%) within the already signed by President Boris Yeltsin decree.
Thus the sale was carried out in two stages - on the pledge auction (45%) and in parallel to the
investment competition (33%) (Yukoz Chronicle). The interregional voucher auction started with
the sale of shares of AO "Yugansneftegaz"- the largest enterprise ever exhibited at the public sale
that produces more than 10% of Russian oil distributing it over the international market (Klimov,
Arkady, and Natalia Kalinichenko 1993).
Moreover, OAO acted as a seller itself, and the petition requests were accepted over all
the region of Nefteyugansk and other provincial auction centers. The success for
Yuganskneftegaz in this situation resulted in the OAO’s increase in control and in an increase of
income from the cash auction as well. “The public sale was carried out in several stages: 45% of
the shares, formally enshrined in state ownership, were put up for auction guaranty, 33% of the
shares at the investment competition, and 7.96% for cash auctions. Another 7.04% of the stakes

4. 4
were taken among the Yukos workforce and 7% transferred to the balance of the company for
subsequent sale on the secondary market” (Pravosudov, 2009).
The winner of the sale-off was recognized as the firm “Laguna,” which belonged to the
bank “Menatep” and in 1996, they became the owner of the company. After taking over the
company, Yukos switched their practices in order to become more Westernized. Yukos was the
first Russian mega-firm to change their accounting standards to an international focus. Then, in
accordance with the U.S. Generally Accepted Accounting Principles (GAAP), they became the
first Russian oil company to report its quarterly financial statements. After westernizing their
disclosure policy, Yukos became known as the most transparent industrial corporation in Russia
(Aron). This was achieved by reaching better management of investor relations, including more
Westerners on its board and aiming to gain better access to international financial markets
(Dixon, Marc 283).
These changes in Yukos’ management and business model allowed it to thrive in a
market economy. However, Yukos’ reaction and flexibility to their local environment proved to
be their downfall. Khodorkovsky’s management and tight control of Yukos, while successful in
the market, inhibited the company’s ability to react to changes in the external environment. In
addition to his control, Khodorkovsky’s focus on a Western-style business model distanced
Yukos from local relations. Good relationships with the government in Russia was crucial for a
company in the oil industry to be successful (Dixon, Marc 285).
In reality, a main reason for Yukos’ collapse was Khodorkovsky’s poor relationship with
President Vladimir Putin and the Kremlin. Putin saw Khodorkovsky as a threat to him

5. 5
politically. With his sights set on putting Khodorkovsky in jail, Putin charged him with fraud and
tax crimes and, ultimately, he was arrested. After his arrest, although most managers remained
loyal to the company, Yukos was struggling because most of its accounts and assets had been
frozen (Dixon, Marc 287).
On October 25, 2003, Yukos chairman and CEO Mikhail Khodorkovsky was arrested at
gunpoint by government security agents at an airport in Siberia during a refueling stop for his
private corporate plane (Mydans and Arvedlun, 2003). At the time of his arrest, Khodorkovsky’s
estimated worth was around $8 billion (Myers and Arvedlun, 2003), and he was Russia’s richest
man. Khodorkovsky’s arrest came less than a month after Yukos’ merger with its smaller rival
Sibneft; the newly formed YukosSibneft was Russia’s largest oil and gas company and the
world’s fourth-largest oil producer, worth around $36 billion (“Yukos Completes Merger,”
2003).
Khodorkovsky’s arrest occurred on a Saturday, and when markets opened up on the
following Monday, the Moscow RTS (Russian Trading System) plunged by more than 20
percent (Cohen 2003). Khodorkovsky was charged with seven counts of fraud, tax evasion, and
forgery (Myers and Arvedlun, 2003), but many analysts believe that his arrest was more of a
political maneuver. As Ariel Cohen of the Heritage Foundation (2003) states: “Yukos introduced
Western accounting standards and management, pioneered shipping Russian oil to the U.S.
market, and launched a private consortium to build a pipeline from western Siberia to the arctic
port of Murmansk. It has also bought hundreds of millions of dollars worth of U.S. oil
equipment.

6. 6
Over the years, Yukos paid billions of dollars in taxes and gave hundreds of millions to
charity. It was also the company most independent from the government, and the attack on
Yukos suggests that other companies may soon be on the chopping block.” In addition, “the
Kremlin [has] accused Khodorkovsky of preparing for a constitutional coup by inundating the
Duma with his loyalists, financially supporting opposition political parties, and harboring
presidential aspirations for 2008” (Cohen 2003). In the eyes of Vladimir Putin, Khodorkovsky’s
continuing financial success, economic transparency, and possible political ambitions were all
indications that he was becoming too powerful.
Khodorkovsky was initially charged with ten years in prison on charges of fraud,
embezzlement, and tax evasion. The Russian government determined that they were owed $7
billion in unpaid back taxes; when the first payment of $3.4 billion went unpaid on July 7, 2004,
government agents raided a share registry office in search of documents that might contain
information about the Yukos’ asset ownership (Baker and Glasser 2004). This raid was the
beginning of the end for Yukos, as Russia’s Tax Ministry put a 77% share of the
Yuganskneftegaz subsidiary of Yukos, responsible for pumping 60% of Yukos’ oil, up for
auction on December 19, 2004 (Dougherty 2004). Yukos’ former owners had a court injunction
passed in Houston, Texas, on December 16 in order to delay the auction and likely purchase of
the Yugansk shares by Gazprom, Russia’s state-sponsored gas company (Kozuharov 2004). The
auction took place as planned on December 19, and Gazprom conceded its first bid to mystery
company Baikal Finance Group. Baikal then placed its bid of $9.3 billion, slightly above the
initial starting price of $8.65 billion, but far below the estimated value by German investment
bank Dresdner Kleinwort Wasserstein by about $5 billion (Kozuharov 2004).

7. 7
By conceding its bid, Gazprom avoided possible litigation in the Texas court injunction.
Baikal Finance Group had only been founded a month or so before the December 19 auction, and
its origin and motives remained unknown only for a short time; within days of Baikal’s victory in
the auction, it was discovered that Baikal Finance Group was registered under an address that
also housed such buildings as a pub and cellular phone and jeans stores (Kozuharov 2004).
More importantly, four days after the auction, 100% of Baikal Finance Group’s shares
were bought by Rosneft, Russia’s state-owned oil company (Finn 2004). By the end of 2004, the
Russian government claimed that Yukos owed $28 billion in back taxes, and that the Yugansk oil
fields, which pumped 1 billion barrels of oil per day and accounted for 60% of Yukos’ oil output
and 11% of Russia’s oil outputs, were sold to recoup some of Russia’s losses (Finn 2004).
The shadowy movements and business transactions of Vladimir Putin and the main
players in the oil and gas industries in Russia began to pay big dividends once the sale of the
Yuganskneftegaz fields were finalized. Rosneft acquired the Yugansk fields at the end of 2004,
and their net profit that year was $620 million. During the first nine months of 2005, their net
profits skyrocketed to $3.7 billion. In other words, because Rosneft’s oil reserves more than
doubled by the acquisition of the Yugansk oil fields, sale of oil and gas by Rosneft jumped from
$1.9 billion to $11.5 billion between the end of 2004 and the end of the third quarter of 2005
(“Yukos Oil Boosts Rosneft Profits,” 2006).
Auctions of Yukos’ assets continued throughout the mid-2000s, with Gazprom and
Rosneft bidding virtually unopposed, and Rosneft acquiring “three of the former core production
units of Yukos and five refineries, which made Rosneft Russia's largest oil producer and
refinery” (“Russian State Oil Company,” 2007). One 2007 auction resulted in Rosneft acquiring

8. 8
Yukos’ former transportation assets, including its assets used to export oil to China, for $729
million (“Russian State Oil Company,” 2007).
While the Russian government was profiting handsomely from the newly privatized oil
industry, Mikhail Khodorkovsky was being tried and jailed. His trial began in June 2004, and did
not finish until May 2005. He was found guilty on six of the seven charges he faced, and he was
sentenced to nine years (later shortened to eight) in a medium-security Siberian prison camp, on
top of paying back $600 million in taxes and penalties (“Yukos Ex-Chief Jailed,” 2005). Many
believed that Khodorkovsky’s sentence was only long enough to ensure that he remained in jail
throughout the duration of the 2008 presidential election (“Yukos Ex-Chief Jailed,” 2005). With
Khodorkovsky in jail and Rosneft buying up all of Yukos’ former assets, Yukos was completely
bankrupt by the beginning of November 2007, and as such, Yukos was deleted from the Russian
Register of Enterprises at the end of November 2007 (YukosLibrary, 2013).
New charges were brought against Khodorkovsky earlier in 2007 for damages against
Yukos totaling $30 billion, and for laundering $16 billion of those funds. He was not charged in
2007, but the case was brought up again in a Moscow court in 2010, and Khodorkovsky was
sentenced to an additional thirteen and a half years, with the seven and a half years of his first
sentence to be subtracted from the total (Bessonov 2011). Khodorkovsky would have remained
in jail until 2017 according to the original court ruling, but two appeals dropped his sentence
from 2016 to 2014 (Baczynska 2013).
In August 2013, Moscow’s top court shaved two months off of his sentence, allowing
Khodorkovsky to walk free in August 2014 (Baczynska 2013). However, after Khodorkovsky’s
petition for clemency and an early release to be with his ailing mother, Vladimir Putin allowed

9. 9
his release in December 2013, just short of the Sochi Winter Olympics (Anischuk and Heritage
2013).
Much to Vladimir Putin’s probable relief, Mikhail Khodorkovsky now resides in
Switzerland with his family (“Khodorkovsky To Get Permit,” 2014). Since Khodorkovsky’s
release, however, Russia’s financial problems have begun to pile up. On July 28, 2014, the
Permanent Court of Arbitration in the Hague ruled that the 2003 prosecution of Khodorkovsky
and the subsequent liquidation of Yukos was in violation of international law, and as a result, the
Russian government owes former Yukos stockholders $50 billion, the largest compensation
package in history (“An Expensive Lesson,” 2014). Russia has until January 2015 to pay or face
interest on what it owes, and although Russia has $175 billion in state reserves, $50 billion
equates to about 13% of the state revenue for 2014 (“An Expensive Lesson,” 2014).
What’s more is that future lawsuits against Rosneft and Gazprom are likely; a ruling is
expected soon in a case between Yukos and Rosneft, in which Yukos is demanding
compensation of losses estimated at $333 million, as well as interest accrued since February 7,
2011 (“Dutch Court,” 2014). BP, which owns a 20% stake in Rosneft, has already issued a
“‘material adverse impact’ to its business, and the prospect of sustained, worldwide litigation
against Rosneft in the wake of the Hague ruling only adds further cause for uncertainty and
concern”(“An Expensive Lesson,” 2014).
Ukraine-related sanctions will shave off around 1% of Russian GDP this year, but the
$50 billion owed to the Hague, about 2.4% of GDP, is to be paid in cash. If the amount is not
paid to the Hague by January 1, 2015, “Russian property abroad could be seized to satisfy the
claimants” (Bershidsky 2014). There has been little word from Putin or the Russian government

10. 10
as a whole thus far as to when this money might be paid, especially since the economic sanctions
imposed by the United States and others have rendered Rosneft unable to raise the funds needed
for their business operations.
Rosneft is the largest oil industry of Russia. 70% of the shares are from the Russian
government. According the BBC, Rosneft`s president, Igor Sechin, who is a close friend of
president Putin, has said sanctions imposed by the US will not affect the company´s trade. US
government sanction is specifically to him, because he is in the list of individuals of Vladimir
Putin´s inner circle. However, there have not been any sanctions to Rosneft, and the company
BP, which owns the 20% of Rosneft, said they will not stop investing in the Russian firm. Sechin
assured Rosneft shareholders and partners would not be affected by the US announcement.
However, according with other article of BBC, last August Rosneft asked from National
Wealth Fund of the Russian government, which finances state pensions, $42Bn loan because
they have seen affected by the sanctions on Russia. Rosneft`s president, Igor, communicated that
the company needs the money because the United States bans the credits and loans with a
maturity of longer than 90 days,and the European banks are also agreed to. Rosneft has a debt of
$44.5 billion because of the acquisition of TNK-BP in 2013.
According the economist, Rosneft wants to be in the rank of oil superpowers. In 2012
was dealing to buy TNK-BO, its absorption of various domestic oil firms and Britain´s BP they
got to increase the output to 4.9 million barrels a day, even more than Exxon Mobil who was the
biggest oil producers in the world, but in terms of capital, Rosneft was still behind Exxon Mobil.
However, the output is in a maximum point because in order to keep the barrels rolling they need

11. 11
oil from reservoirs that are far more difficult to tap, causing that in a couple of years the output
will decrease.
The latest sanctions are intended to stop the maximum production of Rosneft.
Russia’s laws and regulations played an important role in the rise and downfall of Yukos. Yukos
was one of the key players in the Russian economy; in 2000 it was the number one company in
the oil and gas industries. The owners of Yukos controlled all the financial flows in the country
and practically all the economic resources. The causes of the company’s poor economic
performance were the rise of costs of extractions of oil, and because of the non-payment of
customers (YukosLibrary, 2013). The industry costs were rising with the increase of the
industry’s production, and with the rising inflation this growth was even more significant. And in
the case of debtors; it is difficult to select solid customers as they are determined by the state on
the face of Energy Ministry (YukosLibrary, 2013).
In Russia, exports are also strictly regulated. Taxes and duties on oil exports had a
significant impact on the company’s funds, which makes business in the oil industry less
attractive for investors, as well as less profitable for oil firms itself. Likewise, Yukos faced a
taxation issue. According to the consulting firm CenterInvest “CMK,” about 65% of revenue
goes to the payroll of taxes (Klimov, Arkady, and Natalia Kalinichenko, 1993).
To all of this we can add that “Yuganskneftegaz” had a massive number of constructions
in progress, which also made the company’s financial condition more unstable. Due to the fact
that the mining process constitutes a vital part of the firm’s manufacturing process, there was a
high probability that there could be interruptions in business performance if there are some

12. 12
delays or cancellations on oil drilling and manufacturing. That resulted with a negative return on
investment (Klimov, Arkady, and Natalia Kalinichenko, 1993).
Political risk and corruption were also two factors that impacted Yukos. The privatization
process of Yukos included several illegal practices by both the federal authorities and private
enterprises. This had an important impact on the strategic movements of the country. In addition,
relationships with the government are an important aspect of doing business and Russia. Due to
the fact that Yukos was increasing their communications with not only Western board members,
but also Western companies, negatively affected its relations with the government. The
centralized and and totalitarian Russian government led to Yuko’s downfall when Vladimir
Putin, who had a negative relationship with Khodorkovsky, campaigned against Yukos and
eventually arrested Khodorkovsky.
The oil industry in Russia began in the 19th century, when the first fields were discovered
up in the Baku region, in the Caucasus. And at the end of the century they discovered another
fields in discovered in Krasnodar Krai. In 1898 there was a civil war until 1920 which totally
destroy the oil industry. More than 150 oil and gas fields were discovered in the USSR. Just after
the Great Patriotic War (1941-1945). The first fields that was discovered, in the Baku region, got
nationalised by the soviet authorities, so the government was the only owner and has the
monopoly of the oil industry in Russia.
In the most basic sense, Mikhail Khodorkovsky and the role he played as Yukos’
chairman and CEO was Yukos’ main strength. Not only was he already a successful
businessman, but he was the driving force of change and westernization. He invited Westerners

13. 13
to be members of the board, adopted Western-style accounting practices and allowed for
transparency. This helped Yukos expand their reach and market. These operational changes
within the company is a strength that helped Yukos excel in a short period of time. At the time,
Yukos’ market capitalization was number one among all of the Russian companies (Dixon, Marc
284).
However, at the same time, Khodorkovsky was a weakness to Yukos as well. While he
did Westernize the company, he had too much control and management in the company.
Khodorkovsky insisted that his employees bypass other managers and come straight to him
(Dixon, Marc 280). There are many other factors that contributed to the collapse of Yukos.
Khodorkovsky’s business model inhibited Yukos from having the flexibility to respond to
changes in the external environment. More specifically, Yukos westernization and transparency
hindered its relationship with the Russian government, which was detrimental to the company.
In addition to the business model, there were weaknesses within the privatization process
itself. Yukos had weak legal protection of property rights during the privatization process, which
resulted with a concentration of wealth in the hands of a small group of people whose main
purpose didn’t consist in rising business competitiveness of the Russian economy but for the rise
of personal profitability (Caravan 2014). In addition to this, the privatization was carried out
without the consideration of making an effective economic analysis, missing information about
the industry and operating region, state influence and interference on the control of assets and
analysis of the corporation (Caravan 2014).
There are recommendations for both governments and companies that we think will allow
for better communication and success. First, the Russian government should develop a better

14. 14
strategy for privatization and transition into a market economy. In doing so, the development of
an effective judicial system is crucial in order to ensure legal practices and to guarantee
economic transparency and protection of property rights. In addition to this, governments should
provide national and socio-economic security, as well as environmental protection, in order to
preserve the health and well-being of the population.
As far as legislation, the government should enhance the measures for taxes for
companies in the energy sector, especially those that are based on raw material exploitation.
“The introduction of direct taxes on natural resources companies; tax on the use of natural
resources should be high as they belong to all the people” (Caravan 2014). Finally, and maybe
most importantly, governments should encourage the growth of economic clusters and develop
competition for further innovation and economic improvement. In doing so, they can attract
strategic foreign investors. Therefore, the state should ensure the investors’ rights. All of these
measures can encourage the growth of venture capital companies.
In the case of corporations, firms should develop strong relationships with local
institutions, such as student innovation centers and businesses. When it comes to Russia
specifically, we would not recommend for firms or individuals to invest or get involved with
Russia. If so, it would be wise to do a thorough investigation of the company and who is
involved within it.
Ultimately, the Russian government holds a lot of power over many aspects of the
business environment. Due to this, it would be extremely difficult for a foreign company,
especially, to operate legally and successfully without government interference. With this

15. 15
thought, we can confidently say that it is important for a firm, whether domestic or foreign, to
strengthen local relationships. The geopolitical environment in Russia is affected by many
multifaceted factors, and we can consider that the country´s current situation is the result of some
rebounding effect in the past, some possible errors that could have been made; miscalculations in
the formulation of the economic strategy as a whole system. The Russian government’s takeover
of Yukos and subsequent liquidation of its assets has proven to be more problematic than
advantageous.

16. 16
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