Courtroom Report: August 27, 2010
The trial resumed with Mr. Lebedev telling the court that he will switch the order of the topics and will focus on what he knew about crude oil trading and price formation at YUKOS from 1997 to 1999. He could do so because from May 1997 through April 1998 he was the Deputy Chairman of Rosprom's Executive Committee, supervising budget and planning, trading, and finances. Rosprom was the executive company of YUKOS.
Mr. Lebedev explained that in 1997 Mr. Khodorkovsky invited him to come to work at YUKOS. Mr. Lebedev told the court that he took some time to think about it, because he was involved in interesting multi-national projects and knew what YUKOS was in 1997, and it wasn't pretty. He asked Mr. Khodorkovsky to give him access to important company documents - financial reports, balance sheets and so on. He was not happy with what he saw. According to Mr. Lebedev, the accumulated losses at the beginning of 1997 were about $2.5 billion USD. The most difficult issue was that the figure was not even final. The difficulty was that oilmen had an aversion to accuracy - things like penalties and interest on unpaid taxes were not even included in the financial reports. Mr. Lebedev admitted that it took him about 3 months to make a decision. The final push came from Mr. Yuri Golubev, a YUKOS Board Member whom Mr. Lebedev knew for a long time. Mr. Lebedev explained that he told Mr. Golubev that the company would require some radical breaking and was told in return that whatever Mr. Lebedev decided to do, he will have the necessary support. That was the reason why, when he joined, he was put in charge of all trading and financial issues.
Next, from April through June of 1998, Mr. Lebedev was the Deputy Chairman of the YukSi's Executive Committee. Here, Mr. Lebedev explained that history of the first merger attempt between YUKOS and Sibneft, with YukSi being created as the executive company for the joined entity. Within YukSi, Mr. Lebedev was in charge of refining and trading. Mr. Lebedev explained that the merger did not go through due to the fall in crude oil prices and differences between shareholders.
Mr. Lebedev testified that in June of 1998 OOO YukSi was renamed OOO YUKOS, and in September-October of 1998 was renamed to OOO YUKOS-Moscow. Mr. Lebedev explained that it made sense to ensure there weren't two companies with similar sounding names. According to Mr. Lebedev, there are instances in the indictment where the government does not distinguish between various legal entities - like YUKOS and OOO YUKOS, causing plenty of confusion.
Around that time, upon the advice of foreign consulting firms Arthur D. Little and McKinsey, YUKOS management structure was reorganized. YUKOS-Moscow came to function as the corporate center and strategic planner for the holding, YUKOS-RM handled downstream and YUKOS-EP upstream. From June of 1998 through May of 1999, but actually through February 1999, he headed YUKOS-RM. Mr. Lebedev reiterated that from 1999 he did not work at YUKOS or at any other Russian company.
Mr. Lebedev noted that prior to moving on he needed to provide the opponents - who lacked basic economic understanding - with the price formula from the economic sphere.
P = AC + Pr (-L) or P = E + Pr (-L)
P - price of the product sold; AC - actual cost (cost) of the manufactured product (or sold goods); E - expenses (costs) incurred with manufacturing of the product (or purchasing goods); Pr - profit; L - loss.
The formula being taught in the Russian Federation is:
P = C + P + T, with C - cost (production cost) of the product; P - manufacturer's (company's profit); T - taxes, collections, payments.
Mr. Lebedev testified that these formulas were used within YUKOS, including by him, to determine prices at all stages of the crude oil and petroleum products sales.
Mr. Lebedev explained that Cost Plus and Net Back were the principal methods for price calculation during his time in the company from 1997 to 1999. During that time period Russian Tax Code had no criteria for calculating market price. In 1999, Net Back and Cost Plus were codified in Russia's Tax Code. That, however, did not lead to a system of publically published domestic crude oil prices.
Mr. Lebedev explained the competition between federal, regional and local authorities over a slice of each tax being levied on crude oil companies. The result was a constant fight to have certain tax categories apply only to a particular government level. Mr. Lebedev, after reading a lengthy excerpt from the report compiled by the Audit Chamber, explained that in 2001 the fights over taxes led to the establishment of a natural resources tax and an abolishment of 4 others.
Mr. Lebedev testified that until July 2, 2003, the government was unable to create a Russian crude oil or petroleum products market. A 2006 report by the Russian Academy of Sciences explained the lack of transparency when it came to determining domestic crude oil prices and the fact that there was no Russian crude oil and petroleum products market, still.
Mr. Lebedev explained "net back" calculation from the refining. He noted that YUKOS had to send approximately 70% of its crude production for refining, with the first priority being to ensure petroleum products supply for various Federal agencies, including Defense Ministry, Interior Ministry, FSB and others.
Mr. Lebedev went over the details of calculating Transneft shipping charges and asked the court to consider the distances involved between where YUKOS was located in the regions and where crude oil was being delivered to. As he spoke, a slide showing YUKOS and destinations over a map of Europe and Russia was projected on the courtroom's wall.
Mr. Lebedev explained that YUKOS-EP calculated the price at which production subsidiaries would sell their crude oil using "cost plus," while YUKOS-RM calculated the purchase price using "net back." After internal analysis, resulting price was used in the purchase agreements for a specific period - usually a month. Mr. Lebedev, after describing in more detail the steps involved, noted that the recommendation for this type of price determination was made by YUKOS consultants, PwC among them.
Mr. Lebedev explained that Yuganskneftegaz, in the late 1998 and early 1999, was getting "real" 250 rubles per ton, while the competitors may have listed higher prices, but paid their companies in "candy wrappers." So what was better - real cash or worthless "candy wrappers" of higher face value? Mr. Lebedev reminded the court about people being paid through barter - cereal, matches and so on. "Those people stood on the side of the road trying to sell that stuff to get some cash." According to Mr. Lebedev, that was the problem YUKOS encountered at Tomskneft - previous management made various agreements to trade crude oil for products, not sell it for cash.
After a short recess, Mr. Lebedev noted that one of the performance criteria in the crude oil industry is the cost of production of one ton of oil. Mr. Lebedev testified that by 2002-2003, YUKOS became the leader, having the lowest cost per ton. But, even during the tough 1998 and 1999, YUKOS could not simply include whatever production cost it wanted in the price at which crude oil was being delivered for refining. He asked the court to imagine what would have happened if he was negotiating a delivery of petroleum products with the Defense Ministry or FSB and told them that he will use Rotterdam pricing as part of the cost. "They would have shot me right on the spot for committing high treason!" Mr. Lebedev exclaimed.
Mr. Lebedev told the court that the prosecution was acting in bad faith when they were accusing him of hiding price manipulations. Mr. Lebedev explained that anyone could open the financial reports of a company like Yuganskneftegaz and, by dividing revenue by the total tonnage, calculate the sales price and the cost. He reminded the court that PwC never withdrew its certification of the financial reporting of any of the YUKOS production subsidiaries. He told the court that the government did not even make an effort to do things right - if they wanted to discredit the alleged embezzler they should have cast doubt on the financial reporting of the alleged victim, not the other way around. [We remind our readers that if PwC withdrew certification from the Yuganskneftegaz, Samaraneftegaz and Tomskneft financial reports, the withdrawal would have had extremely negative consequences to the current and presumptive owner of these production subsidiaries - Rosneft. -Eds.] Mr. Lebedev noted, once again, the absurdity of the prosecution asking about the amount of profitability of the alleged embezzlement victims, how that profit was allocated and why weren't dividends being paid. Indeed, Yuganskneftegaz's sales profitability in 1997 - 1999 averaged over 16%.
Mr. Lebedev explained that while production subsidiaries were turning a profit, YUKOS was suffering losses. Most of those came from the corporate center and from refining/sales segments. The latter was his responsibility.
Mr. Lebedev reminded prosecutor Smirnov that sales profitability should not be compared with other indicators of profitability. There were 8 different profitability indicators, with sales profitability being only one of them.
Mr. Lebedev asked the court to note the average contract price at which Russian crude oil was being exported from 1998 through 2004. Mr. Lebedev showed a slide with a graph of crude oil price averages located on a background showing the price comparison to the oil company's operation. A dark blue indicated bankruptcy, light blue - stagnation, light green - stabilization, and pink - growth.
Mr. Lebedev explained that YUKOS was crediting the Russian Federation's use of petroleum products by going deeper into debt on a holding level. Mr. Lebedev remembered that YUKOS was actually robbed by regional governors, who used local law enforcement to break into petroleum products storage facilities to take the diesel fuel, because the farmers needed it for their farm equipment but could not pay. Mr. Lebedev explained that to objectively examine the 1998 and 1999 situation - not by just listening to testimony of Mr. Rybin - the court needed to question some of the government officials who were actively involved in the situation during that time period.
The trial will resume on Monday, August 30, 10:30 Moscow Time.