Yukos

August 10, 2004

There's been a lot of talk recently about how Russia's Yukos situation has been driving up the price of oil, and thus weighing on the stock market. I'll try to make some sense of it all here.

Basically, it's a combination of politics and confusion. Yukos is one of Russia's largest oil companies, responsible for about 20% of the country's daily output of crude oil. As Russia is a very large producer of oil worldwide, any problems at a firm like Yukos would clearly have an impact on the worldwide oil markets.

And problems are certainly what Yukos is dealing with right now. Mikhail Khodorovsky, Yukos' largest shareholder, has found himself in the crosshairs of Russian President Vladimir Putin, after Khodorovsky attempted to use his fortune to finance Putin's opponents during the last election. In response, Putin's government has accused Yukos of failing to pay over $3.4 billion, and has frozen the assets of the oil giant.

By freezing Yukos' accounts, the government has rendered the oil producer impotent. Unable to finance its operations or pay its bills, Yukos is rapidly approaching the point of being unable to continue production or shipping. At this point, worldwide oil production will drop by as much as 2%, as Yukos is taken completely off-line, causing a spike in oil prices.

Crude oil prices are already responding to the threat of a Yukos shutdown, hitting record highs just below $45 per barrel. Adding to the fears is the utter confusion regarding the status of Yukos and the courts. Last week, Russian officials siezed control of Yukos' largest subsidiary. The following day, the courts ruled the government's siezure illegal. Today, however, Russian officials again siezed control of Yuganskneftegaz, the subsidiary of Yukos responsible for over 60% of the firm's oil production.

Worrisome to many is the precedent that Putin's actions will set. Few believe that Putin legitimately is concerned about lost tax revenue. There is strong circumstancial evidence that Putin is attempting to punish his opponents and strengthen his allies among Russia's super-rich, especially given his unwillingness to settle the claims against Yukos, or even negotiate with the firm. Many fear the firm will be re-nationalized or dismantled, with the valuable assets resold to other oil firms such as Lukoil at very generous prices.

If there are two things that the stock market hates, they are uncertainty and high oil prices. The Yukos situation involves a lot of both. Until Yukos is either dismantled or pays off the debts the government claims it owes, expect markets worldwide to remain jittery.