The New York Times: The Kremlin Flexes, and a Tycoon Reels

EXTRACT: Last fall, it was environmental infractions in pipeline construction that forced Royal Dutch Shell and Japanese partners to sell a controlling stake in their $22 billion Sakhalin II oil and gas development to Gazprom, the state gas monopoly. Then, this June, BP’s local joint venture, TNK-BP, sold its share of a huge gas development after regulators threatened to revoke the license because the field was developed too slowly, which was a technical violation of the terms of TNK-BP’s license. Gazprom, again, was the beneficiary.

THE ARTICLE

By ANDREW E. KRAMER
Published: July 8, 2007
Norilsk, Russia

LAST January, Mikhail D. Prokhorov, a 42-year-old Russian mining tycoon and a multibillionaire, celebrated the holidays in singular style: with dozens of business associates and an entourage of young Russian women at the exclusive ski resort of Courchevel in the French Alps. The vacation, the French police would later say, featured a private concert by Zveri (the Beasts), a popular Moscow rock group, as well as wads of cash left lying around hotel rooms.

Mr. Prokhorov — tall, svelte, intense and often called Russia’s most eligible bachelor — usually unwound at such blowouts and he once told an interviewer that partying embodied his personal philosophy. His antics in Courchevel, where the police detained him for four days on suspicion of making prostitutes available to his guests, even drew the attention of Nicolas Sarkozy, then the interior minister and now the president of France, who quipped to journalists: “There’s a man who aims to please.” (French police released Mr. Prokhorov without charges but identified him as a witness in their investigation.)

Pleasing friends is one thing. Pleasing Vladimir V. Putin, Russia’s president, is quite another. In one of the more bizarre cases of an apparently forced sale of Russian assets, Mr. Prokhorov’s festivities in Courchevel led — as the byzantine channels of power and wealth in Moscow so often do these days — to his agreement to sell his 26 percent stake in Norilsk Nickel, the world’s largest nickel producer. The buyer was Vladimir O. Potanin, his longtime business partner and a favorite of the Kremlin.

Mr. Prokhorov and Mr. Potanin bought a controlling stake in Norilsk, named for the hardscrabble Siberian city where it is located, for a scant $250 million during the hotly contested privatization of state-owned companies in the mid-1990s. Today, Norilsk produces one-fifth of the world’s nickel, a key alloy in stainless steel, and has a market capitalization of $31.9 billion; its profits doubled last year, to $6 billion, buoyed by high demand for steel in China. Awash in cash, Norilsk in late June closed a deal to buy the Canadian mining company LionOre for $6.4 billion and already owns a controlling interest in the Clearwater Mining Company in Montana.

In an interview on state television, Mr. Potanin said he ended his partnership with Mr. Prokhorov, who Forbes magazine estimates has a net worth of $13.5 billion, because of the embarrassing arrest. They have yet to complete the deal, but the partners said they would unwind their businesses before year-end, leaving Mr. Potanin in control of Norilsk. And who, ask some analysts in Moscow, controls Mr. Potanin?

“In Russia today, no serious deal can be made without approval from the Kremlin,” said Irina Y. Yasina, a researcher at the Institute for the Economy in Transition, a research group led by a former prime minister, Yegor T. Gaidar. “A person like Potanin, without the agreement of the Kremlin, can do nothing.”

UNDER Mr. Putin, the Russian government is establishing vast, state-owned holding companies in automobile and aircraft manufacturing, shipbuilding, nuclear power, diamonds, titanium and other industries. His economic model is sometimes compared with the state-owned, “national champion” industries in France under Charles de Gaulle in the 1950s. The policy of forcing owners of strategic assets to sell their holdings has also been compared to recent nationalizations in Venezuela and other Latin American nations.

Rather than expropriating assets outright, Mr. Putin’s government has exploited minor legal infractions at the target companies to force sales. Either government-controlled companies, or companies run by men seen as loyal to Mr. Putin’s Kremlin, are the beneficiaries.

In 2003, for example, prosecutors went after Mikhail B. Khodorkovsky, chairman of Yukos Oil, then Russia’s largest private company, on accusations of tax evasion. Mr. Khodorkovsky was sent to a Siberian prison, and Yukos went bankrupt. The state company Rosneft later acquired most of Yukos’s assets. Last fall, it was environmental infractions in pipeline construction that forced Royal Dutch Shell and Japanese partners to sell a controlling stake in their $22 billion Sakhalin II oil and gas development to Gazprom, the state gas monopoly.

Then, this June, BP’s local joint venture, TNK-BP, sold its share of a huge gas development after regulators threatened to revoke the license because the field was developed too slowly, which was a technical violation of the terms of TNK-BP’s license. Gazprom, again, was the beneficiary.

Coincidentally, Mr. Prokhorov and Mr. Potanin own a minority stake in that same BP gas field. Their 26 percent stake was not touched, perhaps because of Mr. Potanin’s close ties to Mr. Putin. But in the case of Norilsk, Mr. Prokhorov’s arrest, analysts say, seems to have been a fortuitous accident that gave the Kremlin cover for exerting more control over this strategic metals company.

Mr. Prokhorov and Mr. Potanin both declined to be interviewed. But the end of their partnership is yet another milestone in how the Kremlin and a class of ambitious, enormously wealthy Russian businessmen known as oligarchs do business together.

“Property rights are very conditional in Russia, to this day,” said Olga V. Kryshtanovskaya, a sociologist at the Institute of Sociology of the Russian Academy of Sciences who studies Russia’s business and political elite. The government lets big industrialists “exist only under conditions it considers acceptable,” she said, adding: “When the Kremlin considers a capitalist such as Prokhorov no longer acceptable, he is deprived of his property, by one means or another. Private business exists only by the grace of the state.”

In Norilsk itself, a dirty, desolate city 1,900 miles northeast of Moscow, Mr. Prokhorov’s extravagant lifestyle raised hackles. The city began as a slave labor camp for political prisoners and common criminals in the 1930s, expanding quickly in the 1940s with an influx of prisoners of war. The town’s name, like perhaps no other place in Siberia, is evocative of hardship and the gulag.

Mr. Prokhorov’s otherworldly wealth could not be in sharper contrast to the city that created it. It is not hard to find a metal worker in Norilsk willing to curse the billionaire, who has a reputation in Russia of traveling the world — not just France — in a private jet packed with young women, a practice that has even been satirized in a juice commercial on state-controlled television.

The ad, which did not name Mr. Prokhorov, was shown in March. Set to the tune of “Puttin’ on the Ritz,” it portrayed an imagined newscast of police officers escorting a line of young women dressed in lingerie and fur hats, followed by a tycoon in a bathrobe. The ad cut to a woman in a Russian apartment watching the news. The tag line was: “Some enjoy fantasies of the good life. Others drink juice.”

In Norilsk, they imbibe toxic fumes. Yuri A. Liman, a supervisor on a smelting line, works in a cloud of carcinogenic metal dust caused by the grinding of ore. His factory is surrounded by mud because sulfur dioxide emissions have killed the vegetation for miles around. The winter lows dip to 45 degrees below zero. “There was some injustice,” Mr. Liman said, taking a break to step away from the heat and flying sparks of a giant nickel furnace. But, he added: “If I had billions of dollars I would also relax with the women in France.”

Others aren’t so sanguine. Some Norilsk residents say the city’s grim history is enough reason to renationalize the factory.

In the 1990s, activists erected memorials at a hill in an outlying district of town, a place sometimes called the Golgotha of Norilsk because it was an execution ground for gulag prisoners. In the 1970s, owing to shifts in the underlying permafrost, human bones began surfacing in the spring thaw, and washing to the foot of the hill. “It was a constant problem,” said Natalya S. Boyarkina, the curator of the Norilsk city museum. “The children would find them and play with them.” In 1975, a Norilsk factory bulldozer reburied the bones without ceremony.

Valery A. Knyazkin, 81, a former prisoner, interviewed in a retirement home here, said: “The Norilsk factory was built by prisoners. How can you privatize something like this?” He said he was sentenced to work in Norilsk for committing a murder in 1942, instead of receiving a death sentence. His eyes widened as he recalled being marched to work each day past the hill used for executions.

“I curse our government for selling a state factory to a speculator,” Mr. Knyazkin said. “Who is Prokhorov? Where did he come from?”

THE answer to Mr. Knyazkin’s second question is telling: the Soviet elite. Both Mr. Prokhorov and his Norilsk co-owner, Mr. Potanin, grew up in well-connected Moscow families. The Prokhorovs were academics — his father directed a laboratory, his mother was dean of a university chemistry faculty — and as a young man he followed their footsteps into one of the Soviet Union’s most prestigious colleges, the Moscow Financial Institute. He graduated in 1989 with a degree in finance.

Characteristically for the Russian oligarchs, Mr. Prokhorov became wealthy in his 20s, after passing through a phase of selling jeans in Moscow in the late 1980s. In 1993, he parlayed jobs at state banks into the chairmanship of the board, at 28, of a new private bank, Unexim Bank — which went on to buy Norilsk Nickel three years later during the government of Boris N. Yeltsin. It was at Unexim Bank that Mr. Prokhorov met Mr. Potanin, who was one of the bank’s directors.

Mr. Potanin, a onetime deputy prime minister and the son of a Soviet foreign trade official, has a reputation as an upstanding family man and a sponsor of the Russian Olympic team. He handled the pair’s relations with the Kremlin — and was often vilified by critics who say he used his political connections to buy Norilsk for a fraction of the value.

However fortuitous their rise as industrial titans, the two men did convert an inefficient Soviet behemoth into a modern corporation. After gaining control of Norilsk Nickel, they spun off noncore assets and streamlined one of the mining industry’s most complex logistics operations, which relies on nuclear-powered icebreaker convoys to export metal slabs over the frozen Kara and Barents Seas.

Mr. Prokhorov, with support from advisers at McKinsey & Company, the American consulting firm, decided to try out an experimental class of Finnish freighters that could make the trip without an icebreaker escort.

Analysts credit Mr. Prokhorov with spinning off the company’s gold assets to form Polyus Gold, now Russia’s largest gold producer. It trades on the London Stock Exchange and has a market capitalization of about $8.5 billion.

“Norilsk management has actually done quite a good job,” says Michael Kavanagh, a senior metals analyst at UralSib in Moscow and a former Merrill Lynch mining analyst in South Africa. Norilsk stock routinely outperforms the world’s largest mining companies: BHP Billiton, Rio Tinto and Anglo American. “They created enormous shareholder value.”

Mr. Prokhorov took a hands-on role in Norilsk. At the copper factory, one of three smelters in town, the work force was reduced to about 2,250 by moving about 1,950 employees into contract jobs, a move that angered many people in the city. Mr. Prokhorov also invested $100 million in pollution controls at the copper factory.

Yet the entire Norilsk complex is still a major polluter. At least twice, the factory missed its own emission reduction targets. The smelters still emit 1.9 million tons of sulfur dioxide a year, more than the entire country of France; tests show elevated levels of heavy metals, which are carcinogenic, in children’s blood and urine in Norilsk.

Back in Moscow, Mr. Potanin proved his loyalty to Mr. Putin. In 2004, at a crucial juncture in modern Russian political history, Mr. Potanin aided the Kremlin’s campaign to restrict freedom of speech by firing the editor of Izvestia, a newspaper that he controlled, after it published accurate accounts of the Beslan school hostage crisis. Mr. Potanin subsequently sold Izvestia to Gazprom, the state gas company.

Last summer, government officials approached Mr. Prokhorov and Mr. Potanin to discuss a possible sale of Norilsk to the government, said a metals industry adviser who has close ties to the government and requested anonymity because he had not been authorized to discuss the partners’ business with the media.

Mr. Prokhorov, a free-market enthusiast who once said that the Norilsk factory had no obligation to the city around it other than to pay taxes, objected to a sale, according to this adviser. Mr. Potanin favored opening talks. “Naturally, if they gave up, he would be the first to do so,” the industry adviser, who knows both men, said. “He is closer to the authorities.”

In Moscow, much speculation has swirled over whether the Courchevel police raid that precipitated Mr. Prokhorov’s sale to his partner was a setup, somehow orchestrated to push Mr. Prokhorov out of Norilsk. French police said the detentions were linked to a wider, continuing investigation into Russian prostitution at ski resorts in the Alps that had begun the previous year.

Mr. Prokhorov’s lavish parties, in any case, were hardly a secret. Tvoi Den, a Russian tabloid, said of Mr. Prokhorov that “his generosity is enough for everyone — he isn’t stingy in spending on close friends, on countless acquaintances, and on the fair sex.” Mr. Prokhorov’s entourage called him “the Holiday Man,” according to Tvoi Den, and the Russian Orthodox Christmas party he traditionally held in Courchevel on Jan. 7 was a highlight in the social calendar of the Russian rich.

DURING the four days of Mr. Prokhorov’s incarceration in France, stock in Norilsk Nickel and Polyus Gold dropped sharply amid the uncertainty over his fate; Norilsk’s market capitalization dropped by $2.3 billion, and Polyus Gold’s by $800 million.

In that stock slide, Mr. Prokhorov personally lost about $820 million on paper, based on his publicly disclosed holdings in the companies, though the share prices have since rebounded. A Norilsk spokesman called the arrest a “regrettable misunderstanding.” Vedemosti, a Russian business newspaper, reported that Mr. Potanin might pay Mr. Prokhorov, in part, in shares in Polyus Gold.

Mr. Prokhorov said recently at a Moscow news conference that he now plans to start an investment fund focused on electricity and alternative energy, particularly hydrogen fuel cells. He works out of a Moscow office; aides declined to say whether he might emigrate, as other out-of-favor oligarchs have done. Mr. Potanin, in an interview on state television in February, said the partners had discussed the sale before the Courchevel event, but that “the scandalous situation accelerated the announcement.”

Neither commented publicly about the reputed disagreement over a sale to the government. Mr. Prokhorov, however, said in an interview with the newspaper Kommersant that there was only one buyer for a majority stake in Norilsk Nickel — the government — and that this hobbled the company’s ability to expand internationally. As majority owners, he said, he and Mr. Potanin were unable to use their shares as currency in the mergers and acquisitions sweeping the global metals business because the government would be unlikely to approve any transfer of a large stake to foreigners.

In the turbulence of the leadership change, Norilsk Nickel now trades at a discount to international peers, based on the volume of nickel produced, though its stock has risen steadily on the back of high world nickel prices.

That discount, which Citibank estimated in a note to investors in June as being roughly 30 percent, is often attributed to political risk — nationalization — or to so-called oligarch risk, a peculiar calculation in Russian equities that tries to measure the chances that a particular oligarch will strip assets from a company, to the detriment of minority shareholders.

Citibank said political risks at Norilsk were “significant given historical events in Russia.” Mr. Potanin’s press office did not respond to requests for comment. Despite the risk, Citibank had a buy recommendation on the stock because of the discount.

Ralph T. Morgan, an American and former mining and metals consultant specializing in the former Soviet Union at McKinsey & Company, was hired three years ago as deputy general director of Norilsk Nickel. He is also a member of the board. Mr. Morgan played down the risk of nationalization at Norilsk Nickel. “I think it’s overrated and overstressed by foreign investors,” he said in a telephone interview. “Shareholders change all the time. It’s not under management’s control,” he said, referring to Mr. Prokhorov’s announced sale to Mr. Potanin.

“The discounts you see in Russia, and other emerging markets, are related to a host of factors,” he added. “Political risk certainly figures into the discount, but I don’t think it’s the only factor.”

He also noted that the discount is shrinking; Norilsk stock has risen twentyfold since 2000, he said, “despite all the recurring rumors about what might happen to this company.”

RUSSIAN commentators have said that among government companies potentially in line to buy Norilsk from Mr. Potanin are Alrosa, the state diamond monopoly, or Rosoboronexport, the state weapons trader, companies allied with competing factions in the Kremlin. Rosoboronexport will soon be folded into a state holding company called Russian Technology.

Alrosa, where the finance minister Aleksei L. Kudrin is chairman, is associated with a liberal political group, while Rosoboronexport is linked with a hard-line Kremlin faction known as the siloviki — men with previous backgrounds in the secret police or military.

“There have been rumors about some state corporation taking control of Norilsk Nickel, just like Roman Abramovich’s Sibneft was taken over by the state,” Izvestia, the newspaper that also passed into state hands with Mr. Potanin’s help, wrote in an article published in early February.

“But this is unlikely to happen in the near future,” the paper concluded. “Potanin has repeatedly demonstrated his loyalty to the authorities, showing that the strategic Norilsk Nickel company is in reliable hands. The authorities are unlikely to object to the idea of this profitable asset being controlled entirely by one morally upright stakeholder.”