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Executive Summary Part 1. Origins of the conflict of interests between the authorities and Yukos owners 1.1. Strategy of Vladimir Putin 1.2. Policies of Mikhail Khodorkovsky 1.3. Results of Yukos lobbying 1.4. Development of conflict between the Kremlin and Yukos 1.5. Reasons of Khodorkovsky’s arrest 1.6. Intentions of the government in the Yukos Case Part 2. Impact of the Yukos Case on the oil and gas industry 2.1. Changes in taxation 2.2. Redistribution of ownership in the industry 2.3. Possibility of selling stakes in oil and gas companies to foreign investors Part 3. Impact of the Yukos Case on relations of business with authorities 3.1. Main financial-industrial groups in Russia 3.2. Influence of financial-industrial groups on the government 3.3. Possible persecution of other financial-industrial groups including Alfa Group Part 4. Changing investment climate 4.1. Growing state control of business 4.2. Deterioration of Russian companies’ market performance 4.3. Limitations for foreign companies’ activities in Russia Part 5. Conclusions Appendix 1. Yukos’ place and role in the Russian oil and gas industry List of Tables: Table 1. Results of Yukos’ lobbying; Table 2. Time line of the Yukos Case; Table 3. Consequence of Yukos asset sales that would suit company shareholders; Table 4. Changes of the oil export tax rates; Table 5. Changes of the mineral extraction tax rates; Table 6. Main financial-industrial groups of Russia; Table 7. Affiliation of financial-industrial groups with political parties and government officials; Table 8. Share of taxes in export prices of oil as $35 per bbl; Table 9. Share of taxes in export prices of oil as $30 per bbl; Table 10. Russian oil companies’ production and exports in the first half of 2004 Table A-1. Russian oil companies oil and NGL production in 2003 Table A-2. Russian oil companies’ primary refining in 2003 List of Charts: Chart A-1. Russian companies’ oil production in the first half of 2003, mln b/d Chart A-2. Russian companies’ oil export in the first half of 2004, mln b/d Chart A-3. Distribution of oil reserves among Russian companies

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Part 2. Impact of the Yukos Case on the oil and gas industry 2.1. Changes in taxation Having placed Mikhail Khodorkovsky in custody, the Russian authorities began demolition of mechanisms that had helped the former chairman of Yukos achieve spectacular results in business. The government started with eliminating the legal amendments that had been lobbied by Yukos, and closing the legal loopholes for minimization of taxes. The arrest of the former Yukos chairman has made the necessary impact on those lawmakers that used to support the oil lobby. In November 2003, soon after Khodorkovsky was detained, the State Duma cast a unanimous 371 votes to annul the so-called “Yukos amendment” to the Law on the Customs Tariff, which limited the rate of the export tax on refined products to 90% of the export tax on crude oil. The new amendment was adopted in three readings at once. The government also made the lawmakers annul privileges enjoyed by quasi-free tax zones in Chukotka, Mordovia and Kalmykia from January 1, 2004. These zones were convenient tax havens for subsidiaries of Yukos, Sibneft, TNK-BP and other Russian companies. These zones, as well as the practice of employing a disproportionate number of disabled persons, resulted in significant lowering of taxes. Such companies paid the effective profit tax at the rate of only 7-13% instead of the officially required 24%. In May 2004 President Putin signed into effect a number of amendments to the fiscal legislation. The rate of the export tax on oil became steeper for oil prices over $25 per bbl. From August 1, 2004, the Russian oil companies have to pay the export tax according to these new rules, and the new rate ($69.90 per ton) was much higher than the rate that was valid for two months before that date. The same amendments introduced a new formula for the mineral extraction (severance) tax, to come into effect from January 1, 2005. It will mean a larger tax burden on all produced oil. Part 3. Impact of the Yukos Case on relations of business with authorities 3.1. Main financial-industrial groups in Russia Before Vladimir Putin’s ascension to power, Russian political elite was predominantly influenced by a number of Financial and Industrial Groups (FIG), the largest of which were: Alfa (with such assets in oil industry as TNK [Tyumen Oil Company]), Menatep (owner of YUKOS), Interros (Sidanco), a group headed by Boris Berezovsky and Roman Abramovich (and holding Sibneft), another faction led by Vagit Alekperov (Lukoil) and a number of other smaller structures. Once Vladimir Putin became President of Russia, some FIGs maintained their influence and became even further embedded in politics. They were Alfa, Abramovich’s Millhouse, and, during the first years of Putin’s term in the office, Menatep. Others distanced themselves— or were distanced—way from power (this was the fate of Interros, and also of Berezovsky’s and Alekperov’s FIGs). A newly formed coterie of so-called “men from St. Pete” became a critical new factor of political life. This sobriquet refers to natives of St. Petersburg who assumed power because of their personal acquaintance with President Vladimir Putin. After Putin reshuffled all the top echelons of power and positioned his own faithful man at the top of Gazprom, “men from St. Pete” can also be viewed as a prominent FIG with its own sizeable energy asset––practically the whole of Russia’s gas industry. Ever since the times of Boris Yeltsin, certain groups (especially Alfa and the group of Berezovsky-Abramovich) were commonly called “the Family” because of their connections with members of Presidential family; they were also nicknamed “men from Moscow” or “people from Old Moscow”. Currently it seems this term is quickly losing its relevance especially now when Berezovsky’s former ally Roman Abramovich has alienated himself from the disgraced oligarch. Criminal cases that were initiated by law enforcement bodies against representatives of Yukos confirm that another re-distribution of power is under way between the largest FIGs in Russia. This process can be partially explained by the fact that both “men from St. Pete” and Alfa regarded the merger of Yukos and Sibneft as a threat. They believed that the new giant would disturb the balance of political and economic power in Russia. Oil companies are aware that the potential of expanding business on the basis of ongoing fields is not very great. In a few years they will need to access new oil and gas provinces in Eastern Siberia, Barents Sea and Sakhalin. New projects will require huge funds, and companies loyal to Putin will probably try to persuade him that production sharing agreements might be a good idea after all. It will give the government an additional instrument of influencing the oil companies by awarding PSAs to the most obedient allies. Private oil and gas corporations will probably retain a niche in the industry but they will have to abandon the practice of tax minimization through legal loopholes and start supporting government-sponsored mega-projects. The government is likely to demand a more active backing of pro-Kremlin political movements, charitable financing of cultural and social programs, etc. 4.2. Deterioration of Russian companies’ market performance The Russian government’s campaign for raising taxes will certainly affect the performance of domestic companies. In the second half of 2004, the new scales of the export tax on crude oil and refined products are preliminary estimated to increase the overall fiscal load on Russian oil companies by $1.5-2.0 bln, depending on world prices. From January 1, 2005 a new scale of the mineral extraction (severance) tax (MET) will be in place. This tax is levied on all oil produced in Russia. In addition, the government is considering differentiated MET rates for various types of reserves. It may result in further decline of the performance of Russia’s most successful oil companies that operate high-quality reserves. The goal of the government’s fiscal policy is to take away as much as possible of additional profits oil companies get because of high world prices. Before the recent amendments of tax laws, the state received about 64% of incremental oil revenues for prices exceeding $25 per bbl. Starting on January 1, 2005, the government’s take will reach 86%