RUSSIA: Deep uncertainties cloud Yukos's future

Analysis

Administrative pressure on Russia's leading oil company Yukos has stepped up in recent weeks. After a tumultuous period in late 2003 (see RUSSIA: Yukos affair increases economic uncertainty - November 11, 2003), attacks on the company relented in the early part of this year, amid signs that the Yukos leadership was moving towards a more accommodative position. This appears to have come to an end. The tax authorities' decision in mid-April to present a 3.5 billion dollar tax bill for 2000 prompted the Moscow Arbitration Court to freeze Yukos's assets. This chain of events triggered sharp credit downgrades by rating companies and led to a default warning from a group of foreign creditor banks. Questions about the survival of the company have emerged again.

Tax issues. Substantial tax charges were uncovered in late 2003. The demand covers only alleged tax liabilities, interest and penalties for 2000. The total bill could be much higher when further reaudits for 2001-03 are concluded. At the same time as positions have hardened, some official statements, notably by Finance Minister Aleksei Kudrin, seem to leave the door open to a negotiated position. What is clear is that the extent of the blow to the company will depend not only on the size of the final bill but also on flexibility regarding payment. The claims are being contested, and court hearings will start soon, but the outcome remains uncertain. A negotiated settlement may be possible but must await the consideration of tax claims for other years.

Yukos has paid 3 billion dollars in cash for 20% of Sibneft shares (see RUSSIA: Yukos caught up in elite power struggle - August 5, 2003) and distributed 2.0 billion in dividends. This leaves it with insufficient liquidity to meet the tax demand (if it materialises), despite cash reserves of about 1 billion dollars, strong cash flow generation in a high oil price environment and some flexibility regarding investment plans. Asset disposal could be the only way forward, as the company has recognised that its access to capital markets is limited in the present circumstances. Further tax demands would require more drastic action. Tax claims have the potential to affect the integrity of the company, suggesting that the conflict with the authorities could go well beyond the problems faced by core shareholders.

Rating downgrades. Standard & Poor's slashed its rating of Yukos by five notches last week, pointing to emerging liquidity threats. Moody's has made a less pessimistic assessment, with a three-notch downgrade and the indication that, even in a worst-case scenario that forces the company into insolvency, creditors would probably be paid in full. Downgrades reduce financing options and make asset divestiture the only way to face a hefty tax bill. However, if a political settlement were finally reached and perceived as stable, creditors could support the company as it seeks to get its tax affairs in order.

Default. Concern within the financial community over these developments was clear on April 26 when a group of syndicated lenders served a notice of potential event of default in relation to a 1 billion dollar pre-export facility. For the moment, this may be interpreted just as a technical event, prompted by the tax claim and in line with the provisions of the loan.

Licences. The most damaging threat faced by the company was that it would lose it licences. These concerns have subsided. Licence violations unearthed in the course of audits are likely to result in requests to bring operations into line with the terms of the licences, rather than in automatic withdrawals. A benevolent interpretation of the Yukos conflict with the Russian authorities would suggest that the final aim has been to force a drastic change in the core ownership of the company, without dismembering it or destroying value through licence surrender. Tax threats may serve as an instrument to achieve this end, but they run the risk of going too far and leading to an outcome that compromises the integrity of the company.

Divorce from Sibneft. The terms of the reversal of the merger with Sibneft are another of the uncertainties hanging over Yukos. The issue has been muddied further by a judicial ruling that declared invalid the issue of Yukos shares used for the swap for Sibneft shares. Sibneft is facing problems of its own: it has been confronted with a tax bill for past liabilities. Tax demands on Yukos and the need to raise resources may serve to accelerate the divorce, forcing it to dispose of its stake in Sibneft.

Foreign interest. Recent media reports regarding the acceptance by the Kremlin of a possible acquisition by Total of a 25% stake in Sibneft lend credence to the theory of a forced disposal by Yukos. This would be a neat solution to the current conflict, raising funds to cover tax payments while preserving the integrity of Yukos operations. The result would not be nationalisation by the backdoor, but a market-friendly increase in the foreign presence in the sector. There is genuine foreign interest in Russia. Western companies are aware that the government is open to further foreign participation but would like to cap it, implying some urgency in taking positions.

Sector's future. The oil sector is undergoing important changes. Some tax increases have been introduced and more may be in store (see RUSSIA: State mulls higher taxes on oil sector - February 26, 2004). Licensing changes are also expected. A major oil company is under attack and the intentions of the government are still unclear. As long as this situation continues, foreign investors may express interest but will be in no hurry to conclude actual deals.

Two outcomes can be envisaged:

• Large tax claims may result in Yukos's bankruptcy, renationalisation and the creation of a national oil company. However, this is an extreme case that is unlikely to materialise.
• There is an unequivocal desire for more government influence on developments in the oil sector. However, this need not be achieved through direct ownership. Continued pressure over the company may be oriented to dislodge core shareholders rather than break up the company. They may be keen to reach a negotiated solution that recognises government priorities in the sector, possibly smoothing the way by appointing as Yukos chairman in June the former central bank governor Viktor Gerashchenko, yesterday named as a director, who is believed to be close to the Kremlin.