- The Washington Times - Tuesday, June 7, 2005

A harsh, nine-year sentence meted out by a Russian court on May 31 against the former owner of YUKOS oil company Mikhail Khodorkovsky and his partner Platon Lebedev, disrupts U.S.-Russian relations and sends a chilling signal to Western and Russian investors.

President George W. Bush, in unusually blunt language, said, “It looked like he [Khodorkovsky] had been adjudged guilty prior to having a fair trial.” Earlier this year, Sens. John McCain, Arizona Republican, and Joe Lieberman, Connecticut Democrat, supported by California Reps. Chris Cox, Republican, and Tom Lantos, Democrat, tabled legislation in Congress in February calling for suspension of Russia’s membership in the Group of Eight leading industrial countries citing an “assault on democracy and political freedom.”

It did not have to be this way. The Khodorkovsky trial and preceding destruction of his oil company, YUKOS, went much further than the very real issue of the powerful business tycoons, called oligarchs, who in the 1990s often evaded taxes and played politics. The crackdown, as often before in Russian history, threw the baby out with the bath water.

The lessons of the Khodorkovsky trial are just beginning to sink in. American and international policymakers and business leaders understand the rule of law in Russia is deeply flawed. Justice was clearly selective, and the legal proceedings deeply flawed, with retroactive application of the tax code, arrests of Khodorkovsky’s lawyers, and violations of criminal procedure.

Many an oligarch may well have committed the crimes of which Khodorkovsky and another oligarch, Lebedev, were accused. However, prosecutions have been rare.

Dmitry Medvedev, President Vladimir Putin’s chief of staff, said Khodorkovsky’s prosecution was carried out to “set an example” for Russian business — presumably, to transmit the message businesses had better be sure to pay their taxes and stay away from politics. And in the midst of the Khodorkovsky trial, Mr. Putin initiated retroactive amnesty for privatization violations of the kind for which Khodorkovsky was subsequently convicted and sentenced. In his State of the Federation annual address, Mr. Putin also criticized “terrorization” of businesses by the tax authorities — the same bureaucrats who brought down YUKOS by generating a $30 billion tax liability.

Unsurprisingly, as a result of all this, Russian and Western investors have been voting with their feet. Capital flight from Russia quadrupled during 2004. According to the Russian Finance Ministry, it has reached $9 billion to $12 billion. According to Mr. Putin’s own economic adviser Andrey Illarionov, who harshly criticized the YUKOS affair, it may be as high as $24 billion.

Few in Russia deny Khodorkovsky may have nurtured some political aspirations and that his company supported Duma members from the two liberal opposition parties — Yabloko and the Union of Right Forces—and even some communists.

However, the Kremlin’s abuse of Russia’s tax authorities and criminal justice system by using them to launch massive retaliation against a political foe raises questions about Russian separation of powers.

The crackdown on YUKOS and subsequent steps by the government have destroyed any hopes Russia was developing a privately owned and financed oil sector. Such a model, if allowed to flourish, would have helped Russia integrate into the global economy and brought Western investment and know-how into its energy industries on a scale inconceivable with the government a dominant player in oil and gas. Today, foreign investment in the Russian energy sector is falling, sector efficiency is declining, and production, which until 2003 was growing by leaps and bounds, is flattening.

YUKOS was among the champions of an oil export pipeline to Murmansk, and another one to the Chinese North-Eastern city of Daikin. Now the Murmansk pipeline seems dead in the water, and Daikin has morphed into a branch of the main pipeline projected across Siberia to the Pacific port of Nakhodka — but by a government-owned pipeline monopolist, Transneft.

The Russian government is consolidating power in the extractive sector. Yugansk, the main production asset of YUKOS, was auctioned off in an opaque procedure in December 2004 to a fly-by-night corporate shell, and then quickly transferred to Rosneft, a government-controlled oil company.

This spring the tax authorities initiated a $1 billion tax claim against TNK, the Russian partner in the $6 billion joint venture with British Petroleum called TNK-BP, the largest Western investment in Russia. Exxon has announced it will freeze investments in the Sakhalin Island oil projects after the Russian Energy Ministry asked it to pay $1 billion more.

Russian Natural Resources Minister Yurii Trutnev in February said a number of attractive mineral projects will be closed to Western investors, only to be seconded by Mr. Putin, who called for a “strategic sectors” law to bar foreign investment in selected industries. Finally, Russia’s government plans to acquire more than 10 percent of the gas monopoly GAZPROM, which will give it formal control in that arena.

Thus, the YUKOS affair and the Khodorkovsky verdict are only a part of a troubling trend — the Russian state is reconsolidating control over the “commanding heights” of the economy.

The demise of Khodorkovsky and YUKOS also resulted in a crackdown on his charity, Open Russia, which supported a slew of nongovernment organizations that promoted democracy, human rights, civil society and Internet-based education and sent hundreds of students to study abroad.

The Russian secret services’ indulge in harsh rhetoric against Western and foreign-funded NGOs. The NGOs were accused of ties to Western intelligence services; some were harassed.

The United States and the West must recognize Russia has changed. The U.S. and Russia still have important joint interests, including preventing Iran from becoming a nuclear armed power, joint efforts to secure Russian nuclear and other weapons of mass destruction arsenals and materials, the war on terrorism and economic cooperation.

However, the lack of transparency, deficiencies in the rule of law and the threats to property rights and political diversity make U.S.-Russian relations more fraught with suspicion — and economic cooperation more difficult.

Ariel Cohen is senior research fellow in Russian and Eurasian studies and international energy security at the Heritage Foundation.

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