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A Conversation with Simon Kukes

Speaker: Simon Kukes, chief executive officer, Yukos Oil
Presider: Stephen Sestanovich, senior fellow, Russian and Eurasian studies, Council on Foreign Relations
February 9, 2004
Council on Foreign Relations

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Council on Foreign Relations
New York, New York

STEPHEN SESTANOVICH: Can I have your attention? We’re going to get started now.

I’m Steve Sestanovich. Let me welcome you to the Council today and welcome our guest, Simon Kukes. Before I introduce him, I should do the necessary for someone in my position in the modern age, which is to urge you all to turn off your cell phones.

The size of this audience suggests to me I don’t have to do an elaborate introduction of Simon Kukes, who is known to all of you. He is—for those of you who know him only in his most recent incarnation as chairman of Yukos Oil, the largest Russian oil company, let me say that he has a decades-long involvement in the oil industry, of a sort that will give him a prominent place when Dan Yergin [chairman, Cambridge Energy Research Associates] writes his updated version of “The Next Prize.” He has worked, starting in the 1970s, for Phillips Petroleum, then Amoco in both Chicago and in Moscow, then TNK—Tyumen Oil Company—where he became CEO [Chief Executive Officer]. I’m sorry; I’ve left out Yukos! Yukos after Amoco and then TNK and then Yukos again. In his current position, he is at the intersection of decision-making and controversies about Russian energy policy, Russian—Russia’s economic development and future, and inevitably some political issues as well, which I suspect we’re going to hear about and get to.

Welcome to the Council.

SIMON KUKES: Thank you.

SESTANOVICH: Mr. Kukes has said that he prepared an hour-long speech which he’s going to cast aside in favor of our [television interviewer] Charlie Rose format here. I’m going to begin with a couple of questions, and we will have a conversation and then open up the discussion as quickly as possible to the many hands that I know are going to spring up with questions for our guest.

Maybe I could begin with this question because it’s much on the minds not only of people in our audience today with a corporate background, but anyone interested in Russian-American relations. [U.S.] President [George W.] Bush and [Russian] President [Vladimir] Putin have spoken as energy as one of the foundations of a strategic relationship between Russia and the United States, and obviously that depends on the large and growing role of Russian in world energy markets. The presidents created a Russian-American energy dialogue to advance this goal. Can you tell us what you think has come out of that and what Russia’s energy future is going to be and what its relationship with the United States can be around this issue in the future?

KUKES: Steve, if I knew you would ask me such a tough question, I would not throw my [speech away]. [Laughter.]

SESTANOVICH: [Laughs.] Well, you can bring it back if you want.

KUKES: Well, let me give you a perspective on Russian oil. Last year, about a year ago, I wrote a forecast for the production allocation of Russian oil. So almost a year passed, I can leave it here. It’s pretty accurate so far.

So I see Russia to become No. 1 producer of crude. If you take gas and oil, it’s No. 1. Now, by 2009, I think by that time they will bypass the Saudis. The growth last year was 11 percent, this year will be maybe nine [percent]. Russia is approaching nine million barrels a day, crude production. So they will be close to 10.5, 11 [million barrels] by 2009. I also see Russian reserves will be increased by 30 percent, conservatively, by that year, because the way reserves were evaluated in the last five, six years, they think they were kind of below, on the low side. Everybody was concerned about too high numbers, so they—so you’ll see it. And the last item, I think—I don’t think crude prices will go soon below 25 [U.S. dollars per barrel]. I’m talking about average for the year. So taking all of this into account, I would say, then, Russian economy and Russia will remain a very strong energy player. And whatever you think about Russia—we need to seek some way to synchronize some strategies, particularly in energy area.

Now, two years ago—I start with the end of your question. You know, the first time in Houston was the organized U.S.-Russian oil dialogue. Unfortunately, there was both the government body involved and private companies, and it’s not easy if you have both. So there was a lot of general talk. There were some specifics—like I remember I suggested a couple of very specific items—suggested, you know, “Let’s ask if [the] U.S. can help to bring Russian [inaudible].” Because right now, Brent [crude oil], just to give you an example, about 400,000 barrels a day of Brent is produced—400,000. And almost nine million barrels in euros, and still Brent is traded in euros. And it would really help for Russian oil companies, for investors, for the government to take some hedging position and do better planning. So I didn’t see much advances here.

We also discussed some opportunity about developing a joint resource with the United States for the third world countries; like there are some empty bases which Russia can supply and other countries can use it, you know, the World Bank can spend—I don’t want to go into details, I know this. It’s one of [several] ideas, and there was a number of others. Well, there was a lot of talk about a production-sharing agreement, but I would say we need to get more specifics on those, because it’s a lot of dialogue, rhetoric—but not much came out in the end of those meetings. So I would say the idea was good. It led people to know each other, share concerns. Now the time maybe comes to [do] something specific.

SESTANOVICH: Well, some Americans have a doubt that the Russian government—and even Russian oil companies—have a serious interest in the large participation of Western oil companies in the Russian energy sector.

Just last week, Exxon Mobil and Chevron Texaco were disappointed with the announcement by the Russian government about the future of their relationship to Sakhalin-3 [oil fields]. And the head of the American Chamber of Commerce said he regarded it as expropriation. And the American ambassador said this was a setback to the energy dialogue. Do you think there’s genuinely an attitude that welcomes partnership on the part of the Russian government and Russian companies, or is this still a very competitive relationship and one that is not welcoming?

KUKES: Let’s separate government and private company.

SESTANOVICH: Okay.

KUKES: All right, let’s start with the easiest one, the private company. Each time you seek a partner or investor, you think what they can bring you. Okay? Technology you can buy now. Low-cost capital, it flows now, and to companies—Russian companies, although it was scarce. Management skill, it’s great, but it’s expensive. So, now if you start to talk about more complex deal, like asset swaps and some kind of complex merger, it’s a different story. But you have to be creative now to get in the Russian oil market, to work with the privately held companies. And what’s the synergy? How can I invest? Can I justify it to investors, some kind of joint venture with an oil merger in Siberia? You know, they will ask me, “What’s the benefit?”

Now, TNK-BP was a different story. I was involved on this. BP [British Petroleum] had some production closed by TNK. It was on all this synergy; you know, they got a similar distribution system, so on. Other oil majors are not active as BP. So, you know, it’s not a simple answer.

As for government, I think government didn’t create any barriers to Western companies to invest. Definitely the tax system is under revision, the licensing system is under revision, and nothing comes because for a while little attention was paid to this. I think we just have to be creative. But I didn’t see anybody running and investing in long-term exploration in Russia or building pipelines. So they’re not throwing money around either.

SESTANOVICH: You mentioned the tax system, which has become a focus of a lot of political controversy recently. The energy ministry and the finance ministry and the economic development ministries are all producing plans to increase taxation of oil companies under the instructions of President Putin, who said he wants several billion dollars more to come out of energy companies starting next year. It’s an understandable interest. And yet the impression that is created among some people is that the Russian government is yet again changing the rules.

You have said recently, I think, that Yukos is prepared to increase its—or change its approach to paying taxes from one of tax minimization to paying a much larger share of profits; but to many Western companies, this looks as though it’s—it reflects the instability of the Russian system. I think the Moscow Times said last week, you know, the changing tax regime in Russia is a sign of instability and discourages long-term projects and investment both by Western and Russian oil companies. How do you see the tax issue now? Is it a sign of the stabilization of the Russian energy sector or a new sign of instability?

KUKES: If you go back four years ago, five years ago, it was really kind of messy. Nobody knew—there were ill-defined procedures, hard-to-interpret laws, [the] taxation system was quite obscure, just in general terms. So four years passed. You know, they have a personal tax of 13 percent in Russia. Profit tax is very reasonable.

Now if you say, okay, what ratio of dividend to taxes [do] Russian companies pay, it’s pretty high toward dividends, very high. I mean, take Exxon, BP, Shell, Amerada-Hess, just name it. They pay an average of two and a half percent dividend yield, and what’s the taxes, it’s—you know. Now in Russia, this number is low. So I would say most of the companies are quite aggressive in interpreting Russian law. There were some offshore zones, some price transfers and so forth. We’re revising. It’s not like we’re going to change. We just see what’s reasonable, what’s not.

But if you look just at numbers, if you compare a Western company to a Russian company, if you look at dividends versus taxes, Russia is relatively low on taxes. And it is quite comparable to other oil-producing countries, even after small—all of them—not small, some increase if they stop doing this offshore optimization. I know for people who are familiar with this, they will introduce a couple of off-shores in Russia. Perfectly legal. So what you do, you optimize all trading over there, and so you pay minimum tax. Well, it’s fine from one hand, but from another, some companies do some revision; it is a fair way to do business. But—

SESTANOVICH: Is that in response to a kind of—to political pressures to change your accounting and your financial policies?

KUKES: Well, I don’t know. It just time counts, you know, to revise it. There is nothing wrong if you look—you know, go back [to] when I came here in the middle ’70s—you know, remember Love Canal [the environmental damage caused by chemical dumping in the town of Niagara Falls, New York] ? Whatever, it’s environment. Now all major oils talk about, you know, this crystal-clear gasoline, environmental issues, you know, commitment to the blah, blah. It’s not government. Would they do it? Most likely not at this rate.

So in fulfillment of license obligations, they will be more sloppy. So there is always conflict between major companies and some rules which government wants to install all around the world. And it’s fine—balance and check. You’ve got a vital industry in Russia, so the fact that they’re revising—Russia, its significant revenue comes from oil and gas, and they recommend companies to look at their, you know, tax organization. Nobody told you that you should not do this. So I think taxes will go somewhat higher. We’re already planning. Now, how, what, we’re revising? We’re thinking. I didn’t say they need to be completely eliminated.

SESTANOVICH: This would be within the existing tax framework. Of course, the proposals that are being discussed within the ministries are for a substantial increase in overall taxation. Is it your view that taxes are sufficiently low now that there’s a cushion so that increased taxation will not discourage investment or discourage Western partners, or in any way deter the advance of the Russian energy sector?

KUKES: No, I don’t think so. I don’t think Russia will go overboard. Their definite goal—I mean the ministries have an objective, the government has an objective to double the GNP [gross national product] in seven years. It’s very reasonable. They want to attract investors, not just—you know, there is what I would call a different type of investor. Oil investors, they [are] kind of separate, and it’s a natural resource and you normally try to optimize your MPD [managed pressure drilling], you maximize your production right away so you can get oil as fast as you can. It’s not like building cars or roads, some kind of long term.

So there is genuine interest to attract serious investors, long-term investors, and increase. Still, we have got 35 million [people] living below the poverty line. They need to start sometime though, start production and have to raise some taxes. You know, I just give you one example. We’re all bragging how great our production costs are, the lowest in the country. You know, they got less than two barrels—two dollars a barrel. But in the meantime, the [combined] salaries of people who work in Siberia, it’s 400 million [dollars]. Another thing, just by changing this law, they will force some company to reinvest more in some other things which they normally wouldn’t. So there will be more advantages to invest in refining, distribution. You know, you can take a write-off on those.

As you know, the refinery system in Russia is far behind the Western type. The quality of gasoline and diesel [is] still behind the Western standard. So we need to do a catch-up.

So I would say I don’t see anything dramatic that will change. There will be some tune-up. If anything, if anything, for the Western investor, it will provide some study of it. Now if I have to recommend, I would definitely recommend to look in offshore, LNG [liquefied natural gas], some gas-to-oil technology. So some areas in which, for sure, Western expertise is needed. You cannot just buy it easily.

SESTANOVICH: Here there’s a perception that one of the ways in which the government has tried to play politics with its relations with the energy companies is through the imprisonment of Mr. [Mikhail] Khodorkovsky [the former CEO of Yukos Oil, arrested in October 2003 on charges of tax evasion, embezzlement, and fraud].Can you tell us how the Russian business world has reacted to this? What’s the view of the underlying issues? Is this the kind of active intimidation that some people in the West have seen it to be, Russian—the Russian state telling Russian businesses that they’d better start paying greater taxes or cooperating in other ways?

KUKES: You know, Khodorkovsky made a great contribution to the company. Now he’s got some legal problem with the government. The case is in court. It’s not fair for me to comment on this. We had a discussion with him five, six months ago, and he said: “Politics is not your area. You will be heard as oilman.” So, okay, I try to stay away. It will not do any good either to the company, not him, to make any comments. And to tell you the truth, you know as much as I do. I don’t communicate.

You know, some of you might know it. Last week I fired one of the major shareholders who worked for the company. He was the head of [Yukos] Downstream. So right now—we’re practically the only one Russian company who is—run by an independent management, an independent board of directors. Most of [the] others have shareholders running the company—major shareholders. So I just tell you the situation is quite novel, you know, but I’d rather, you know—plus I wouldn’t know what to say anyway.

SESTANOVICH: Okay. We’re going to turn to questions, and I know there are going to be a lot of them. We have our national members on the line through teleconference, but I’m not sure they’re going to be able to ask questions. So perhaps those of you here will try to imagine what they would ask. Let me recognize questioners. We’ll start here and then go over here. Would you identify yourselves when you speak and wait for the microphone?

QUESTIONER: My name is Astrid Tuminez, and I’m affiliated with the U.S. Institute of Peace. Mr. Kukes, is it central to the growth strategy of the Russian oil industry for Russia to become the key oil supplier to China? And, Steve, would you comment on the geopolitical implications, if any, of Mr. Kukes’s answer?

KUKES: Oh, you want to me to quarrel with Japan? If you take it from a short point of view, it’s no question the pipeline going south from eastern Siberia to China is the most advantageous, the most [inaudible] project. Very good for Yukos.

Now, if you talk about global strategy for Russia—like what’s Russia in 10 years. Let’s assume this is eastern Siberia, and there is the Baikal River, the cleanest river in the world. And there is Daqing [a major Chinese oilfield], and idea was to build a pipeline from here to Daqing. Okay. And like I said, it’s a great idea. But eastern Siberia is not studied practically at all, and there is a strong suspicion there’s elephant oil fields here [in Eastern Siberia], here on the skirt we already see. To develop this, you really need to have a major pipeline going through this area to attract investors. Your exploration gets much cheaper, your production cheaper because you get a major pipeline going through this north.

Now, a northern route is rather disadvantageous to Japan. So right now, Russia is discussing. [The] decision is not made. Can they still go north and have—there’s enough oil to have a pipeline going north, then east to Nakhodka—and then have a kind of—some pipeline going again to that same place. So a decision is not made. I know the meetings, some on the pipeline, will be in Moscow this week. I cannot attend it. They discussed Murmansk [a city in northern Russia] and an eastern pipeline. I think everybody is leaning toward building Murmansk for sure. Now, on the east, a decision is not made. And again, it depends how you approach it. From a certain point—of course China. And Yukos just signed a big contract to deliver 200,000 barrels a day, starting next year, by rail cars to China. We just signed it. So, to us, it’s—say again, what had you every government. My philosophy—and it’s very hard to develop a strategy for a company, take it separately from the strategy for the whole Russia, it’s why—because we bought on land, by pipeline, transportation, consumption. And, you know, there are no swaps in Russia. Like, you produce a product in one area, you cannot swap to another refiner. That system is not developed. That’s another thing that U.S.-Russian relations can do, help to develop some swap market. Anyway, I didn’t answer your question because it’s not easy to answer. [Laughter.]

SESTANOVICH: But geopolitically, I would say, Astrid, that Russia does not mind being courted by both Japan and China. [Laughter.] Yes?

QUESTIONER: I’m Lucy Komisar. I’m a journalist. I have a sheaf of documents here. They include bank statements from the Geneva Bank LEU—L-E-U [spells letters]—LEU in German, and corporation papers which the Russian prosecutor has, and it shows how secret offshore shell companies operated for the Menetap [the corporation that owns Yukos] deputy chairman and Yukos finance director Alexei Golubovich and did insider trading of millions of dollars in Yukos and other Russian stocks. If it wasn’t to cheat investors and the Russian tax authorities—no taxes on capital gains—what was the function of this network of companies in the secrecy jurisdictions of Switzerland, Luxembourg, British Virgin Islands, the Seychelles, Panama, and the Bahamas? [Laughter.]

KUKES: [Chuckles.] I mean, I joined Yukos two months ago. [Laughter.] And I—the only thing I can promise you, if you send me some kind of letter, we’ll try to answer you. But I have no, no clue. I don’t know what to say. Sorry.

KOMISAR: This doesn’t show that Khodorkovsky really is a crook?

SESTANOVICH: Yeah, in the back here?

QUESTIONER: To the rescue, right? Roswell Perkins, Debevoise and Plimpton. You referred to the licensing system as being under revision. That I assume refers to new licenses. My question as to existing licenses, do you foresee the government embarking on a requirement of re-bidding on all of the existing licenses in the energy field?

KUKES: What the government is doing now, they are checking how well we followed the rule of law of developing oil fields also, because sometimes we get flooded. You know, sometimes we, like normally in Russia, it’s a very strict procedure after you start a new oil field. Like, you drill, you have to comply [with] where you would drill. You have to demonstrate what kind of production you would have and so forth.

Now, what happened was the last few years brought us all this Western technology and we started to optimize wells, and normally you have to clear it with the government. But all oil companies have done it, and sometimes, you know, you kind of don’t pay much attention to the paperwork. So I think the government will go well by well and maybe bring some, you know, some noises, maybe there will be some small penalties. But I don’t see any—I mean, just don’t believe it. And I don’t think it will happen that they will take any even minor oil fields away, a producing oil field, from one company. And you know, at best—I mean, at the worst they might have some penalty.

But there’s nothing wrong, nothing wrong in it because sometimes you put your best people to optimize your net back rather than follow, you know, procedures. And we have somebody on our board who is a very well-known exploration person, and he insisted we have a board meeting on the 26th, and management will talk specifically on these old, so to speak, oil fields, how well they comply with licensing, like what changes we’ve done recently, and did we get them approved.

I—you know, about three days ago, we issued a joint communique with the minister for natural resources. And we said, “Well, they’re doing the correct thing. It’s okay if they keep a little pressure on us.” I don’t see any—people take it further. They treat it like it’s [an] attack of the company. I don’t view it.

SESTANOVICH: Doesn’t this open up a lot of opportunities for harassment and corruption that Putin has said he’s really trying to get away from?

KUKES: No, just opposite—you follow the rules. I mean, if there is no rules, then, actually not. If they check and find out, and we didn’t—or other companies didn’t do filings [and] certain procedures, there will be penalties, taxes—and it’s all official. You know, if anything, it’s a step in the right direction.

SESTANOVICH: Yeah?

QUESTIONER: Andrew Gundlach, Artemis Advisors. Sir, you said you would surpass Saudi Arabia by 2009. I’m curious if there’s anything the Saudis can do to stop you, in your opinion. And, more importantly for the world oil markets, if—let’s assume that the market share faction of the Saudi royal family is in power. How do you see the Russian-Saudi relations and Russian-OPEC [Organization of Petroleum Exporting Countries] relations? Thank you.

KUKES: You know, I personally see there is a swing in attitude of OPEC countries to Russia. I remember two years ago, they were visiting, making presentations and in some respect, like “Here we are, we know everything and you guys—” It was kind of old brother to young brother. But I think now they realize there will be a shortage of oil. Really, the low prices [are] gone. You might see them for a month or two. I mean, we’re not slowing down our demand, but it’s hard to get oil. Environmental issues, right? Nobody wants to pay for it. I mean, we don’t want to monkey around with some super-old oil field. Taxes will go up everywhere. So one day—take this scenario—we’ll start fighting each other and we’ll slow down our oil fields. So some day they will start to jump at Saudi Arabia, like you slow down your production. So I would say it would do much more good for us to kind of be positive towards each other, because I think the world is heading towards a shortage of crude.

QUESTIONER: Christian Caryl, Newsweek magazine. Mr. Kukes, you mentioned consultations about the Murmansk pipeline. I would be curious to know whether Yukos is still interested in financing construction of a pipeline like that, or would Yukos be perfectly happy to see that done by, say, Transneft [Russia’s state-owned pipeline company] or some other government institution? Thank you.

KUKES: Well, I think from the beginning, all this idea about private company-owned pipeline, it was a dream. I mean, there [is] no way. It’s just nonsense. I’ll tell you why, because first of all, we are not in business to run pipeline. And the second one—it’s really we’re trying to spin off our assets—it’s what our shareholders want. And we are not [an] operator of pipelines. We’ve got Transneft, who has one of the lowest tariffs in the world—[they] operate very nicely [and] keep increasing, actually, export capacity through drag-reducing agent [and] putting [in] new pumps.

So I would say we can participate in some kind of finance, but I think the ownership should be—and operator—should be Transneft. It will throw in a monkey wrench if you get four companies having their own pipeline in Russia, because right now we have equal accessibility, regardless of whether you’re major or minor. About 35 percent of your crude goes through the pipeline for export. Now, if it’s your own pipeline, then it can impact a lot of small companies. So, anyway, I don’t know why this idea for building private pipeline becomes so popular.

Yes, to have this pipeline built, the sooner the better. But the mechanism of finance for this, it’s obscure, like when you talk about if—[inaudible]—then that’s easy, both Japan and China [are] willing to provide and loan. Murmansk—no, I would say this is one of the obstacles we have to overcome. This is something for joint U.S.-Russian energy.

SESTANOVICH: Well, you’re absolutely right that the United States liked the idea not only of having the pipeline built but [also] of private ownership, because it seemed to promise a break-up, or a least an eroding of the Transneft pipeline monopoly. And it wasn’t just the U.S. government. The private oil companies that launched the consortium seemed to be in favor of that, too. Are you saying they were all wrong?

KUKES: Yeah. [Laughter.] I was not for it. We just joined the choir. But—[laughter]

SESTANOVICH: Are you satisfied that it is going to go forward built by Transneft?

KUKES: Just imagine—we don’t have any joint venture in Russia. Look at our merger with Sibneft. We merged, we divorced, we merged, look[s] like [we are] heading for divorce again. Can you imagine? It’s like four companies get together with no experience in pipelines, in finance, and start to build pipeline with no resources. It’s like—I don’t know, it’s like four Jewish people discuss where you have dinner—you never have—you all get hungry. [Laughter.] It’s not realistic. It’s one of the dreams, great dreams. And, plus, what’s wrong? Transneft’s very consistent. It’s government—okay, I can go on and on.

SESTANOVICH: Yeah, over here.

QUESTIONER: Yuri Kirilchenko, Russian News Agency. Mr. Kukes, now that Vasily Shakhnovsky [former president of Yukos-Moscow and a major shareholder] is freed [from custody after his October 2003 arrest on charges on tax evasion and fraud], will he find his place back in Yukos management, Yukos Moscow probably?

KUKES: No. We just closed his office. No. We don’t want major shareholders. It was my kind of ultimatum, because we talk about corporate governance, and you have major shareholders running the company, you have advantage, access to information. It’s not—we have judicial responsibility to those shareholders. So Mr.[Mikhail] Brudno [former member of the Yukos management and a major shareholder] is gone, Shakhnovsky is gone. He’s not coming back.

SESTANOVICH: Yes? Why don’t you wait for the microphone, Padma.

QUESTIONER: I’m the Harriman professor at Columbia University, Padma Desai. I have a somewhat broad question, and I hope a manageable one, emerging from the Khodorkovsky situation. Are the lessons being learned by Russian oil industry and Russian big [inaudible] together in general? Is that they are being told, keep away from political activism, pay your taxes, and the rest is up to you—production, investment, technology, management—you are free to do all that? Are these the signals being conveyed by the president of Russia?

KUKES: Nice way to drag me into it. [Laughter.] You know, really I shouldn’t answer this question, because it will not do any good to anybody now. But, to be honest, there’s a certain lesson to learn. That’s why I’m trying to focus on oil, and I am not answering your question. [Laughter.]

SESTANOVICH: Yes?

QUESTIONER: Jun Okumora, I’m president of JETRO [Japan External Trade Organization] New York—we’re a Japanese institution. Going back to the eastern pipeline, can Yukos live with what you have characterized as the long-term solution as opposed to the short-term solution you suggested, which may or may not benefit your new contract with—vis-a-vis China?

KUKES: Well, it’s a government decision which pipeline to build. Both routes still have nice returns. So I would say it’s not a privately held pipeline. It will be government-run. It all depends what view you take. So I can—and, again, it’s not like what Yukos decides. You can produce or we can—like exports of crude have the biggest net back, regardless how we export it, where it’s exported, you know. It still gives you six, seven dollars a barrel better net back than the best rail car. So I don’t know. It will be a government decision. We provide our forecast for production, and then they have to work overall strategy—country development, GNP. This pipeline will cost twice as much on the one hand. But it will create some job opportunity. But, again, to China it’s a much better, faster return. And if I have to speculate—not speculate—I would say somewhere within four or five months a decision will be made on Murmansk. And then another six, eight months before they make a decision on which way to go. But I’m concerned about ability to build two pipelines at the same time.

SESTANOVICH: Can I follow up on Padma Desai’s question about the relationship between business and politics? It’s sometimes said—and I believe Putin has complained about this himself—that he objected to the activities of business figures in trying to influence votes in the Duma [Russian parliament]. You are now facing a situation where there is going to be consideration by the Duma of substantial increase in taxation of oil companies—and with ministries that seem to be rather divided on the issue. It’s said that the Finance Ministry was proposing an increase at the low end, the Energy Ministry at the high end. When this issue comes to the Duma, how do you envision it [that] business interests get represented and reflected? Or do you just wait to be told what the taxation rate will be? Do you have a way of participating in a national debate about such a policy, as you envision the arrangement that political leaders are telling you they want?

KUKES: No, first of all, Steve, you asked me earlier, and I don’t foresee the tax increase first. The second one, if you look historically for 300 years in Russian history, they don’t do anything like in a hurry. If anything, it’s a kind of slow process. You know, there’s practically no—[speaks Russian phrase]—in Russia. Can you imagine this wealth was transferred from government to private hands? And really if you look in the last 10 years it was quite peaceful. So my point—I don’t expect any big move, earth-shaking moves. I think people are reasonable, government’s reasonable. Now then so I don’t see a big tax increase anyway, because when they look at our model they are very well aware. Like they increase taxes, but most companies will be cutting CAPEX [capital expenditures] this year. Like we have our budget introduced to the board of directors on February 26th. I want the surprise to see our budget—CAPEX cut. And they understand this. You increase taxes, people will invest less—quite knowledgeable people—and Duma gets educated. And I have found out there’s some people who represent—understand business came from business. So I don’t see any revolutionary or anti-oil mood.

SESTANOVICH: Others questions? Yeah? And then over here.

QUESTIONER: David Slade, Allen & Overy. Back to the question of increasing Russian oil production. There’s another theory out there that the Russian administration is pretty happy with oil production levels now and would more or less like to keep them there and concentrate on manufacturing, and when it comes to petroleum exports, concentrate on gas where it still controls production. And that may help explain why there’s such little progress on building the pipelines. Would you care to comment on that? And if you’re really inspired by the question, comment on whether or not Mr. Khodorkovsky’s pushing for private pipelines might have as much to do with his difficulties now as politics?

KUKES: Well, the last one, that’s easy—not. Okay? Now, as of the pipeline, I mean gas and oil, it’s two separate things. And then it’s with private industry—and government does not dictate how much oil we should produce.

Now, in saying this, this year alone, we will have 320,000 barrels of extra capacity. Transneft is building near St. Petersburg additional capacity. They are also improving—putting extra pumps to increase further the capacity of Druzhba Pipeline going southwest. So basically we’ll get 400,000 more. And then plans for 2005 are also in place.

So why it takes so long to make a decision? Well, it’s a big responsibility, you know, to build. It will be the major project in Russia. And they talk about five billion [dollars]. Multiply five and two [pipelines]—[and you get] 10 billion [dollars]. You’re talking about three years. It’s one percent additional to GNP for three years. It’s quite big.

SESTANOVICH: Over here.

QUESTIONER: Thank you. Vijay Vaitheeswaran from The Economist magazine. I wonder if you could comment about the opportunities and the obstacles perhaps that you might see for your firm, and for the Russian oil sector generally, in Iraq in particular and, specifically, how you see things unfolding on that opportunity. Thank you.

KUKES: You know, we are not in Iraq yet, and unfortunately. And right now we’re kind of busy settling all kinds of litigation and trying to rebuild a little bit the company. So it’s not our prime objective to look at any international projects as of now. So sometime in five, six months, we can look back at it.

But, you know, I take this approach: If you go somewhere, what do you bring to potential partners? Low-cost capital. Can [Yukos] offer a better deal [in] technology, marketing? No. So are we such a desirable company for Iraqis? Even I’m not so sure. How would they sell our involvement? They’d rather deal with a company who has experience in working this region. So answering the question, now we’re not in Iraq—we’ll look at it, but it might be in six, seven months.

SESTANOVICH: You’ve been quoted, since you’ve mentioned the litigation and other problems that you are trying to dig out from under—you have been quoted as saying that the investigations into Yukos are, quote, not as bad as people outside think. Can you tell us a little bit about how you see the timeframe for resolving some of these problems that you have now with federal authorities?

KUKES: Well, I didn’t see any kind of new charges coming for the company. And then they request—it’s in line with what they originally were doing. So I didn’t see any kind of lack of desire to talk with us, you know, to even we’re talking about discussing tax, comparing notes, or they think we underpaid—we don’t see so. So we set up some kind of team to look at it. So we have a dialogue. So they drew the line, and we’re trying to draw the line between shareholders—you know, current shareholders and the company.

My objective: to preserve the company and to be sure it stays where it is. Production on target. Because, don’t forget for a number of years, Yukos was a premier company, and government will be very upset if suddenly our production started dropping and people get de-motivated. So you have to be careful here. But my task—

SESTANOVICH: That’s your warning to the government?

KUKES: Warning to the government? No—who I am to warn the government? I’m little—

SESTANOVICH: Yeah, you’re the CEO of Yukos. You are saying that it would be a bad thing if production were to be—

KUKES: I’m not warning the government.

SESTANOVICH: —declining.

KUKES: I’m not warning the government. I’m just doing my job. I think it’s not a premier company of once, though [Yukos is] still a premier that meets the target. It’s not good for anybody.

SESTANOVICH: I hope we’ve got time for a couple more questions. Over here.

QUESTIONER: Peter Osnos, Public Affairs Books. What is your appraisal—with the presidential election about six weeks away—what is your appraisal of the state of Russian democracy and the rule of law? After all, we’re interested, most of us, in the development of Russia, and that’s the kind of question that we’re all asked every day as people who follow the country.

KUKES: And I’m an American citizen. I’d rather talk about Bush’s re-election. [Laughter.]

SESTANOVICH: You’ve got a captive audience here. [Laughter.]

KUKES: If you teach me whom I should vote for. I don’t have any comments. I don’t have a Russian passport. I don’t know. I know one thing: Putin is highly respected. I spent—I told Steve during lunch—2001, I spent the whole year in Siberia. We fired our production person, so I had to spend a year in Siberia. And I actually lived there. And I tell you, they respect Putin. He has stability. The population wants stability. They want decreased poverty. And there are some steps in this direction. He’s very, very popular. So some of it may be politics, but some of it is genuine support for a president. You know, after Russia fell apart it was kind of devastating for us all. I mean, they want to be big and influential. And so now it’s some inspiration for stability, respect.

SESTANOVICH: Over here.

QUESTIONER: Roy Goodman from the United Nations Development Corporation. Sir, speaking of President Bush, would you care to comment on his policy as it relates to Alaskan oil development, particularly his efforts to try to seek greater oil independence for the United States from the supplies of the Middle East? Do you think this is a commendable approach, or would you criticize it as being not appropriately objective?

KUKES: Well, let me answer you as a Russian executive. I remember two years ago, we got some request from Congress—[for a] 10-year supply. [It was] two years ago in a cold winter, and [there was] a shortage in the Midwest of some heating oil. And they asked me, “Why won’t you supply it?” It will be—when I was—heating oil to Midwest, two years ago. And my answer was, “Look, because of environmental issues, you are shutting some refineries. You’d rather bring product from Venezuela or Russia. You know, you invest money and you start to produce your own fuel, bring oil.” So to me it was—you know, I think if Alaska should be developed—because then if you’re talking about Russia’s offshore, there’s also areas of where you’ve got a lot of national parks—and still there is pressure to us to open new oil fields. Like when we talk about China, one of the obstacles—we have a beautiful national park, and if you go to that thing, you practically have to shut down this. So I’m not deeply understanding what’s behind this, but I think if we will in Russia increase production, the U.S. has to tap [into] some [of its own] resources too.

SESTANOVICH: Yeah, over here. We’ll have to make this the last question

QUESTIONER: Chris Osborne at Medley Global Advisors. Recently, in fact today, I think it was approved by the Turkish government—Tatneft [a Russian oil company] acquired or is in the process of acquiring the largest refinery business in Turkey. From your point of view, beyond saying, you know, they think it’s a good business and that’s why, why do you think Tatneft did this deal?

KUKES: I don’t know. I mean, Tatneft is low on crude, and so I don’t know. I don’t know what’s the strategy. But we also look at Turkey as an interesting opportunity there, but we just decided—declined. But over all, sooner or later, us majors will move to Central Europe more aggressively. It’s inevitable—Germany, Poland—they have to put their act together first.

SESTANOVICH: You said you wanted to add a word of reflections on sort of how the West should be treating Russia. Maybe I could give you the last word on that topic.

KUKES: Well, yes. You know, the way you view things, it’s very important for Russia to be a big player [and] continue to do most work westernizing the country. And somehow when I say there are other obstacles for Russia, like the WTO [World Trade Organization] or to be accepted by certain organizations, and Russia has to do these only then, and people don’t understand. There are very few people who really want to move to this Western direction. If anything, I will do my best to try to incorporate Russia to as many important Western organizations without imposing a lot of conditions, because it can go both ways. Russia can go both ways. And the more you put strict rules—and Russia financially it’s doing well; you know, the country is behind the president—so you might start to encourage isolation. So I think it is my wishful thinking that if you want to see Russia as part of the Western community, maybe you should overcome this look-down attitude.

SESTANOVICH: Well, you’ve ended our meeting in exactly the way that we like to end these, with opening up a lot of topics that will be the stuff of discussions in the future. Thank you very, very much for this discussion. Thanks to all of you for coming. [Applause.]

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