Russian Oligarchs Part 3: The Party's Over

10 MINS READMay 28, 2009 | 11:03 GMT

Editor's Note: Part 1 of this series examines the oligarchs' rise to power, Part 2 discusses their confrontation with Putin, and Part 3 looks at Putin's successful efforts to co-opt or defeat the oligarchs.

The year 2004 marked a turning point for Russian oligarchs, who started tapping external markets for capital to expand their empires. Then-President Vladimir Putin dampened their political ambitions by toppling some and drawing others into the Kremlin orbit. He did nothing to discourage the inflow of foreign credit, which was unprecedented. Then came the global financial crisis of 2008, which helped create the perfect storm for the oligarchs. The game and the players would never be the same.

By the summer of 2008, events were brewing that would soon drastically reduce the amount of outside money flowing into Russian coffers. The government, for one, was growing increasingly interested in raking back assets from Russia's banking sector. At the same time the Kremlin was preparing to invade Georgia, which it would do in August of that year. By fall, of course, markets were reeling from the onset of a global financial crisis.

It would become the perfect storm for the Russian oligarchs. In January 2009, Russian businesses and banks had roughly $500 billion in outstanding debt, about $130 billion of which had to be paid back in 2009. Russia's oligarchs found their incomes slashed, their companies' crashing and their debts rising — all at a time when credit on a global scale was becoming harder to come by. Such debt overexposure turned into the kiss of death for most of the oligarchs, who had spent much of the past four years borrowing huge amounts of money in order to finance capacity expansions that were now either unfinished or unneeded. The oligarchs' empires — even in their improved form — were unsustainable without more financing.

As a result, oligarchs now wish to portray themselves in a different light. To be called an oligarch today is to be branded "unpatriotic," and many Russian industrial magnates once known as oligarchs now want to be considered, above all, businessmen loyal to the Kremlin. Oligarchs are scaling back their once-extravagant lifestyles and maintaining very low profiles. Every year Forbes publishes its list of global billionaires, and in 2009 many still-eligible Russians asked not to be included in order to avoid Kremlin scrutiny. From 2008 to 2009, the number of Russians on the Forbes billionaire list shrunk by two-thirds, from 87 to 32.

The silovarchs are in a similar situation, but they have two critical advantages. First, they came late to the game of tapping international credit markets. While there are some exceptions, most were not quite as exposed as the oligarchs. Second, since silovarchs are government men they tend to find themselves at the top of the government's "bailout" list. Indeed, silovarchs often participate in the policy planning meetings in which bailout packages are crafted. As long as the silovarchs remain in political favor they will survive the downturn.

With international funds unavailable, the Kremlin has emerged as the sole source of credit for a credit-starved Russian economy. But the bailout money comes with strings attached. Whether the government buys up foreign debt — replacing debts to foreigners with debts to the Kremlin — or grants loans directly to Russian firms, a change in ownership is implied or, in some cases, demanded. Consequently, barring a rapid return to the credit and commodities environment of a year ago, the vast bulk of the oligarchic empires are in the process of reverting to the state. This means that the only oligarchs who will survive the downturn are those the Kremlin chooses to keep — essentially as employees.

Many oligarchs view this as an ironic twist. Those who cobbled together their empires in the 1990s using the "loans-for-shares" program, in which they took on key enterprises in order to keep the ailing country afloat, are now watching the state take on the debt and management of their companies in order to keep ailing industries afloat. But the Kremlin is being very selective in choosing which oligarchs to bail out. It is the government's way of weeding out non-loyalists and consolidating its final control over the country financially, economically, socially and politically. During the first month of the financial crisis in Russia, the government promised bailouts to the tune of $100 billion. After shelling out only $11 billion, the Kremlin froze the plan and began to recalibrate its strategy to deal with the financial crisis to ensure it aligned with its ongoing consolidation efforts.

Another Scramble

When Kremlin power brokers retired to their back rooms to debate the future of Russian industries, the once-mighty class of oligarchs reacted to the news in different ways. One group threw billions of dollars at the state for political protection. Oligarch cash poured in to shore up Russian stock exchanges, keep the currency afloat and stabilize strategic banks and industries linked to the Kremlin. Some oligarchs gave their billions directly to the Kremlin in order to keep the government stable but soon found themselves overextended and asking for help from the government. One example of this was metals magnate Igor Zyuzin — once worth $10 billion and now reportedly worth $1 billion — who knew he was on the Kremlin chopping block after a very public fallout with Prime Minister Vladimir Putin just months before the financial crisis began. Zyuzin poured billions of dollars into the Russian system and in return received a political pardon from the Kremlin and credit with state-controlled bank Vnesheconombank.

Another group of oligarchs have lost billions trying to weather the storm, neither putting cash into their companies nor buying deals from the state. This is because they don't have any cash left. It evaporated into the ether of the stock exchanges, tumbling currency, falling commodity prices or the overall financial system seizure. Many oligarchs within this group considered themselves too big to fall and did not plan accordingly. An example is metals magnate Alexander Abramov, whose company, Evraz Group, has lost 90 percent of its share value since the beginning of 2008. Abramov did not turn to the Kremlin for help and, as a result, was singled out by Putin, who publically accused Abramov of cheating the Russian people over his company's steel prices. So, Abramov sealed his fate with a floundering company and no political protection.

Yet another group of oligarchs are those who have poured their money into their companies to keep them afloat regardless of whether it decimates their personal wealth. There are really only two examples of this oligarch type: LUKoil chief Vagit Alekperov and Severstal chief Alexei Mordashov. Both have poured between 50 percent and 80 percent of their wealth into their companies to avoid having to turn to the Kremlin for support. These two oligarchs have long strived to stay independent from the government without alienating themselves politically. They adhere to the Kremlin's wishes without giving themselves over as servants to Putin or giving the government an excuse to come after their companies. They are most likely the only oligarchs who will come out of this ordeal having any resemblance at all to the old breed.

Most oligarchs have tried to mix the three approaches described above in order to survive, but finding a balance between the financial crisis, the credit crunch and an increasingly aggressive Kremlin is nearly impossible. One oligarch who appears to have had some success is Oleg Deripaska, chief of United Company RUSAL and investment firm Basic Element and formerly the wealthiest man in Russia. Deripaska has long had political aspirations, which he put in check after the Khodorkovsky-Yukos affair. Deripaska poured part of his reportedly $36 billion into his company while giving the rest in various ways to the Kremlin, leaving him with an estimated $3 billion to $4 billion. As a company, RUSAL is still stable, and Deripaska has maintained a close relationship with the Kremlin, particularly Putin.

In the long run, however, Deripaska knows that his power independent of the Kremlin is gone and he will have to adhere to the government's whims from here on out. Putin is currently discussing the creation of a state metals giant, similar to energy champions Gazprom and Rosneft, and he wants RUSAL — the world's largest aluminum company — to be a major part of that (more about the metals giant below). According to STRATFOR sources, Deripaska has been told he would remain chief of the metals industry, which would give him enormous power in Russia, but he would still be under the Kremlin's thumb.

Kremlin Offensive

Deripaska's submission to the Kremlin does not mean that oligarchs across the board are accepting their fate. These are tough and competitive entrepreneurs who survived the 1990s and numerous industrial wars and are disinclined to kowtow to the state.

But the Russian government has implemented a series of deft moves that have further undermined the oligarchs. First, the Kremlin wanted to know just how much money the oligarchs and their companies had. Since the start of the financial crisis, members of the Russian security apparatus, principally the Federal Security Service, have been assigned as "observers" inside most major Russian companies, institutions and banks. This has allowed the state to inventory the revenues, assets and foreign currency holdings of strategic institutions to see if they match what the companies are officially reporting. It has also allowed the government to figure out how much the oligarchs should be contributing toward mitigating the financial crisis and to weed out those that don't really need government bailouts.

Then the Russian government embarked on a sweep of the world's tax havens to take stock of Russian oligarchs' cash and assets offshore. The Kremlin struck a deal with the government of Cyprus — the largest haven for Russian funds outside the country — to obtain a list of Russian "clients" who are using the country to shelter their money. Russian oligarchs and other businessmen also register their companies in Cyprus (as well as other countries), and the Cypriot government has agreed to turn over to the Kremlin the name of any Russian company registered in Cyprus that has Russian shareholders.

In return, the Russian government removed Cyprus from its economic blacklist and started developing an economic investment plan for Russian companies (approved by the Kremlin) to invest heavily in Cyprus. The Russian government is negotiating similar deals with Ireland, Luxembourg and the Bahamas. Russia is not the only country going after tax havens. The German government has signed an agreement with Liechtenstein to gain access to that country's offshore client list and has allowed other European countries, the United States and Russia to have access as well.

What's Left?

This concerted government offensive has enabled the Kremlin to decide which companies to let fail, which to bail out and which to smash or absorb as it tackles Russia's financial problems. The Kremlin already has plans to merge many of the empires together, in addition to the metals sector, in order to create national champions like Gazprom and Rosneft. STRATFOR sources say the government has actually been wary of moving on the metals industry because so many dangerous and powerful oligarchs control it. Rumor has it that Putin is considering combining four of the top seven metals companies — RUSAL (aluminum); Norilsk (nickel); and Metalloinvest, Mechel and Evraz (steel) — along with the chemical company Uralkali to create a metals giant. As it happens, such a move would also bring together five of the most powerful oligarchs — most of whom do not get along — and Putin would have to carefully sort out and choose which oligarchs to keep under the proposed metals umbrella.

The Kremlin is considering doing the same sort of consolidation with many of the banks that the oligarchs control. It would keep a few of the banks around — those that are Kremlin-friendly — to ensure that corporate lending would still originate from several sources. Overall, however, the government and not individuals would hold controlling stakes in nearly all the banks. (Most banks in Russia are chartered to lend to certain sectors, which will reinforce the Kremlin's control over who gets the cash.)

Because of the financial crisis and government consolidation, the once-powerful oligarchs no longer have a say in their future and are merely along for the ride. Indeed, they no longer constitute a powerful and distinct business "class." Some oligarchs will survive the shakeout, but not with their independence. To some degree, they all will become part of the Kremlin machine so carefully engineered by Putin. As copper oligarch Iskander Makhmudov said in a rare interview: "The oligarchs now have mixed fortunes, but we will all end up being soldiers of Putin one day."

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