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Kremlin Inc. Widening Control Over Industry
Critics Say Russian Government Is Using Takeovers to Do Its Political Business

By Peter Finn
Washington Post Foreign Service
Sunday, November 19, 2006

VERKHNYAYA SALDA, Russia -- The orange glow of molten titanium ingots illuminates the cavernous factory, one of several Soviet-era facilities that sprawl across 5,000 acres in this small city east of the Ural Mountains. The hot metal will soon be fashioned into dozens of parts destined for Boeing's new aircraft, the 787 Dreamliner.

This throbbing, isolated complex was moved here as the Soviets evacuated their industrial complex to the east in the face of the German advance in 1941. Now it is the headquarters of VSMPO-Avisma, the world's largest manufacturer of titanium, the strong, lightweight metal that is a basic element in the aviation industry. Near collapse in the early 1990s, the company was resurrected into a world-beating enterprise, a key supplier for Boeing Co., Airbus and Rolls-Royce that now controls 27 percent of the global titanium market.

What happened next has become a common occurrence for companies that are too successful in Vladimir Putin's Russia: VSMPO-Avisma was taken over by the state.

In industries such as energy, aviation, engineering, mining and car manufacturing, private companies that emerged after the collapse of the Soviet Union are being brought back under state control or consolidated in the hands of businessmen loyal to the authorities. Government ministers and Kremlin insiders now sit on the boards of the country's largest companies.

And Kremlin Inc.'s appetite for control shows no sign of abating. According to Tatyana Stanovaya, a senior analyst at the Center for Political Technologies in Moscow, the Kremlin is also eyeing new stakes in energy as well as diamond extraction, metallurgy and machine building.

The Kremlin defends the swelling economic role of the state as an essential element in the creation of powerful companies that can compete in the global economy. The takeovers are also officially called a necessary reversal of dubious privatizations in the 1990s that deprived the state of income and strategic assets crucial to Russia's security.

But the emergence of the government as a preeminent business player has also led to charges that the Kremlin is using its vast powers to force itself on unwilling partners, and is wielding its new economic clout as a foreign policy weapon while enriching political insiders.

This effective renationalization of key industries is also a retreat from the goals of privatization, a pillar of Russia's efforts to become a market economy after the collapse of the Soviet Union. The drive to put property in private hands stemmed from a belief that such companies would be more efficient, and more attractive to investors, than the industrial dinosaurs of Soviet times.

"The state has decided it's time to gather all the stones that were cast away; it's all according to the Bible," said Vladislav Tetyukhin, 73, an entrepreneur who, along with his partner, Vyacheslav Bresht, was behind the titanium company's ascent. He bowed, reluctantly, to the takeover. "They told me that for the state it will make sense to have everything in one fist."

Rosoboronexport, the state-owned Russian arms-trading company, this month took the majority of seats on the board of VSMPO-Avisma after acquiring 66 percent of the company's shares, including the stakes of Bresht and of Tetyukhin, who will stay on as general director. The new chairman of the board is Sergei Chemezov, the head of Rosoboronexport and a former KGB officer who served in Dresden, East Germany, with Putin. Chemezov declined to be interviewed.

"Within the global economy, the principal requirement is to be strong and competitive; otherwise, you'll be devoured," Sergei Markov, a political analyst and Kremlin consultant, wrote in a recent article. "Vladimir Putin's policy is becoming increasingly clear -- to promote the creation of a pool of major Russian companies that could become global players. That would enable Russia to preserve the independence of its economy and, amid free competition, to save the choicest morsels of the Russian economy from being acquired by foreign multinational corporations."

Others are deeply skeptical. "We should differentiate between state capitalism and bureaucratic capitalism; here we have bureaucratic capitalism, groups of state bureaucrats taking control of companies," said Nikita Belykh, leader of the small Union of Right Forces party. "The attempts of the state to get control of various companies can be explained by the desire of officials to redistribute property. And the lack of transparency in these deals is scary and dangerous."

The growing state role in the economy began with oil, when the state-owned energy company Rosneft took control in late 2004 of the prime assets of Yukos, the company founded by Mikhail Khodorkovsky. The oligarch was imprisoned for tax evasion and fraud, and his company was dismantled. The state-controlled energy giant Gazprom, in which the government took a majority stake in 2005, purchased Sibneft, the oil company owned by tycoon Roman Abramovich. Soliciting rival bids was never considered, according to Putin's former economic adviser, Andrei Illarionov.

Several Western oil majors are currently being investigated for licensing and environmental violations, which some analysts describe as a thinly disguised effort to rewrite deals cut in the 1990s and increase the state's stake in energy projects. A $22 billion project led by Shell on Sakhalin Island, north of Japan, is now threatened with the loss of its license. Other billion-dollar projects, involving British Petroleum, are facing a similar fate. State control of oil production rose from 10 percent to 30 percent from 2004 to 2006, and could reach 50 percent next year, according to a recent report by the British company Control Risks Group.

"We welcome foreign investment, but the state has to have a controlling stake in the pillars of the economy," said Vladimir Tarachev, a member of parliament for the ruling United Russia party. "This is not nationalization."

The government is considering a law that would prevent foreign investors from obtaining control of companies working in some industrial sectors, such as energy and mineral resources, defense, aviation, space and nuclear power. And according to Tarachev, there is a strong lobby within the government to subject all foreign investors seeking minority stakes in certain industries to an approval process controlled by the FSB, the domestic successor of the KGB.

Presidential staffers and state officials, including ministers, now sit on the boards of state-controlled businesses such as Gazprom and Rosneft as well as mining, shipping, railway and airline companies. Deputy Prime Minister Dmitry Medvedev, a potential presidential candidate in 2008, is the chairman of Gazprom. Defense Minister and Deputy Prime Minister Sergei Ivanov, another possible presidential candidate, has just been proposed as the head of a new unified aviation corporation that will bring all the country's airline manufacturers under the umbrella of a state-controlled company.

The marriage of politics and business has led to charges that companies such as Gazprom have wielded their power to punish countries such as Ukraine and Georgia, which had drifted from Russia's orbit. Gazprom recently announced it wants to more than double the price of natural gas for Georgia. "State companies are used to solve political tasks both inside the country and internationally," said Vladimir Ryzhkov, a member of parliament and leader of the small opposition Republican Party. "So economic logic becomes a victim of political interests."

Mikhail Pak, an analyst at the investment group Capital in Moscow, said in an interview that titanium could become a tool to realize, for example, Russia's desire to form a strategic partnership with EADS, the parent company of Airbus. Executives at the Netherlands-based company shot down suggestions that Russia might take a management role in the company.

"The state wants reliable people to head these corporations, loyal, patriotic people who will be very different from owners of the 1990s and act for the national interest as the Kremlin defines it," said Stanovaya, the analyst. "And that coincides with the concrete interests of individuals around Putin who strengthen their own economic position as property is redistributed."

Last year, Tetyukhin was invited to tea at the Moscow headquarters of Rosoboronexport, and the conversation, he said, quickly took an unpleasant but not unexpected turn. Executives from Rosoboronexport told him that they wanted to buy a controlling stake in the titanium concern. The tea, he said, suddenly did not taste so sweet.

At first, Tetyukhin and Bresht publicly protested any sale of their shares, but their company quickly found itself under investigation by the tax police, and the prosecutor's office launched an inquiry into VSMPO-Avisma's share structure. Before it was acquired by VSMPO, Avisma, a raw materials supplier, was owned by Khodorkovsky, a potentially dangerous connection.

Rosoboronexport said it planned to move into the metals industry to "prevent the enterprises of the metallurgy sector from being usurped by various organizations, including those acting in the interests of foreign capital and using illegal methods."

Resistance at VSMPO quickly wilted. Tetyukhin, who kept a 3.8 percent stake in the company, said he reconciled himself to the sale based on assurances that Rosoboronexport will maintain the titanium concern as a reliable supplier for its international partners, which now account for 75 percent of the company's $1 billion in annual sales.

In August, Boeing and VSMPO signed a contract for supplies of titanium and semi-finished products worth $18 billion over 30 years. Michael Tull, a spokesman for Boeing, said: "We meet with VSMPO on a regular basis, as we do with all our strategic suppliers. We don't discuss publicly the subjects of those meetings, but without a doubt we have a very close relationship with VSMPO that enables ongoing, regular communication regarding all issues."

The United States imposed sanctions on Rosoboronexport in August for selling equipment to Iran that allegedly could assist in the development of weapons of mass destruction, a charge the company has strenuously denied. The Boeing deal, however, is not affected by U.S. sanctions, which apply only to purchases by the U.S. government, not private companies.

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