Russian IPO Is A Hazy Mix of Oil and Politics

In addition, Western governments are undoubtedly weighing the potential costs of criticizing the Rosneft offering. The Kremlin has hinted that it is close to deciding which companies will get exploration rights to a major gas field and firms from Norway, France and the United States are all in the running. Companies from Britain, Italy and Germany are also seeking investment opportunities in Russia.

Just what foreign investors think about these issues will affect the price of the Rosneft shares. Whereas companies such as Exxon Mobil Corp. or BP PLC have stock prices that reflect a price equal to about $17 a barrel for their proven oil and gas reserves, publicly traded Russian oil and gas companies carry prices that imply a value of less than $4 a barrel, according to William F. Browder, chief executive of Hermitage Capital Management, one of the largest foreign investors in Russia.

The huge discount shows the price of mixing oil and politics; Western investors will risk less money. Moscow's treatment of Browder has added to the uncertain climate; it has denied the London-based financier a visa to return to Russia, despite his decade-long status as one of its most enthusiastic foreign investors. Undaunted and still heavily invested in Russian oil stocks, Browder hopes that the gap between market valuations of Russian and international reserves will narrow. "Russia is still cheap, Russia is still flawed and I can still make money," he said.

But politics could encourage investors whose hopes are focused on other areas. State-owned companies from China, which is eager to build close energy ties to Russia, are expected to bid for big blocks of Rosneft shares. Oil and Natural Gas Corp., India's biggest oil explorer, said it is "examining" the possibility of buying a stake in Rosneft, Bloomberg News reported.

As political risks go, Rosneft might be a good one. Sechin, the Rosneft chairman, has been a confidant of Putin's since the early 1990s. In his authorized biography, Putin says that Sechin worked as a military translator in Mozambique and Angola in the 1970s. Later Sechin became a member of the St. Petersburg city council, where he dealt with foreigners including Michael McFaul, now a Stanford University political science professor who in the early 1990s was encouraging democratic reforms in Russian city governments.

"He was friendly, very organized and easy to get along with," McFaul said. "And he was the first person who ever told me straight out that he had worked for the KGB." Putin also was a member of the KGB.

In Moscow, Sechin is believed to be the leader of a Kremlin faction, including many former KGB members, who share Putin's vision of a strong central government and powerful security apparatus.

"Apart from Rosneft, he is clearly an important person in Russia, with tremendous authority and a say in many issues. But I don't think anyone has a clue what he thinks, including on energy policy," said one U.S. lawyer who does business in Russia and who did not want to be identified for that reason.

Many Russia experts also believe that Sechin played a key role in the campaign against Yukos.

"Rosneft instigated the Yukos affair. Bogdanchikov and Sechin attacked Khodorkovsky because they wanted his assets. Putin had political interests, but this was an asset grab from the beginning," said Anders Aslund, a senior fellow at the Institute of International Economics. He says that Rosneft is expected to buy what's left of Yukos from the bankruptcy court, adding another 400,000 barrels a day or more to its production. "Now, in order to be able to buy more property, they want to make an IPO so they can recycle the money and take over more private companies," Aslund said.

Not everyone has a lot of sympathy for Yukos in this saga. It was one of a dozen companies created in the early 1990s when Russia divided up the state energy industry for privatization and Khodorkovsky's financial group, Menatep, bought it at an auction that Menatep itself ran through a front company, said Leon Aron, director of Russian studies at the American Enterprise Institute.

"It's not like Khodorkovsky had acquired his rights in some legal way," McFaul said.

But by the late 1990s, Khodorkovsky began to change his image, investing in Yukos oil fields and seeking to run the firm according to international standards. Led by Yukos, production at private Russian oil companies rose 8 percent to 9 percent a year between 1999 and 2004, Aron said, while Rosneft's production grew at an "anemic" 1 percent to 2 percent a year.

That's why many economists believe that Rosneft's rise is bad for the Russian oil industry. "This is a subversion of the IPO's traditional purpose," said Aron. "You raise money to invest in business and expand. The track record of Rosneft is such that the prevailing opinion is that the money will be pocketed by the company, by the management, perhaps by top people in government along with some canceling of debts."

McFaul added that it is ironic that Sechin and Rosneft's other executives are using the same tactics as Khodorkovsky. "These guys are using his strategy, complete with hiring PR people in Washington, who are spinning people like me and telling me why the offering is not such a bad thing. It seems like they're following a similar trajectory: They used political power to steal assets and now they are trying to legitimate those assets in the West, which was exactly what Khodorkovsky was trying to do. My investor friends see that and yet the potential payoffs of being involved in Rosneft are so outrageously high that they say you're a fool not to have some part of it."

At the London Stock Exchange, officials would not comment on Rosneft. But Jon Edwards, the LSE's senior manager for Russia and Eastern Europe, said "a lot of quality Russian issuers are getting short shrift." He added that "the psychology of Russian managers has changed over the past five years. Many of these manager-owners are interested in seeing their companies grow and not just in cashing out."