A Timely Risk:
Gaining Expertise in the Western Siberian Basin
While on vacation over New Year’s Eve 1990, John Fitzgibbons ’87 and his family were among the throngs of celebrating Czechs whose palpable energy and optimism about a new, free future was irresistible and memorable. Struck then by the momentum of an emerging era, John came back to Harvard intent upon studying Eastern Europe and Central Europe during his final 18 months of college. From that point on, John seized opportunities, and parlayed risk and acumen into a business experience rare for a seasoned entrepreneur, let alone an inexperienced 20-something.
John’s coursework in spring 1991 incited a senior thesis proposal about privatization of the Czech economy. While John was writing, several Harvard economics professors were providing technical assistance to the Russian government, helping to formulate aspects of a plan for economic reform. John’s timely research and writing on Czechoslovakia were relevant to the conversations in Moscow. The Russian strategy needed to address the difficult question of how to privatize hundreds of thousands of large companies in the aftermath of hyperinflation, which during the prior two years had devastated the currency and wiped away the savings available to potential indigenous buyers. To add complexity, the government and its advisors believed that economic reforms, such as privatization, needed to be implemented as quickly as possible to minimize the potential of a rollback prior to completion. The government ultimately decided to implement a voucher privatization program, which in many fundamental ways mirrored the program that had been undertaken in Czechoslovakia.
John was hired, initially by the World Bank and then by the U.S. Agency for International Development, to go to Moscow right after graduation (June 1992) and join the team of advisors in the ministry of privatization. He focused particularly on elements of the privatization program that offered opportunities for foreign participation. The year culminated in a trip with the Russian vice prime minister and another aide to London, Frankfurt, New York and Washington to meet with large prospective foreign investors and government officials.
By then, the opportunities John had witnessed emerging in the private sector beckoned. Then 23 years old, and without capital, he started an oil advisory company with Peter Kellner, a Milton classmate, and a third partner. “With such a large resource base, oil was an obvious investment opportunity in Russia, and foreign investors in the oil industry had expressed clear and significant interest in pursuing ways to participate. We concluded we could provide local expertise that many Westerners needed without presuming that we had any more general expertise in the running of their businesses.” Between 1994 and 1996, the company assisted several Western oil companies in pursuing joint venture opportunities in Russia.
By 1996, John felt he had gained enough expertise “to begin to raise capital and pursue Russian oil investment opportunities more efficiently as a principal rather than advisor.” He and his partners amicably went their separate ways, and John began to raise capital. Over the subsequent five years he raised $125 million in private equity from U.S. and European financial institutions and two oil companies. By 2000, his company, Khanty Mansiysk Oil Corporation (KMOC), owned and operated 10 oil fields in the western Siberian basin with more than 500 million barrels of crude oil reserves and 1,200 employees. Production grew to 20,000 barrels of crude oil per day, of which over half was exported to Europe and the remainder sold in Russia.
By this time KMOC had developed into a mature business and John’s focus migrated increasingly to cost of capital concerns. “We had sufficient drilling locations to employ as much capital as we could raise,” John explains, “but we were limited instead by the implied cost of that capital in private equity markets, which approached the returns we were able to generate on our capital employed. Therefore, in an effort to lower our cost of capital, we filed in 2001 for an initial public offering of stock in the U.S. and were ready to begin a mid-September road show when the 9/11 terrorist attack occurred, and the capital markets came to a standstill.” Following the uncertainty that resulted, Enterprise Oil, the U.K. oil company and an existing KMOC shareholder, raised its stake to 30 percent share of KMOC by privately acquiring stock from other KMOC shareholders in transactions that were approved by John and his management team. Shortly thereafter, Enterprise was unexpectedly acquired in a hostile takeover by Royal Dutch Shell. John’s plans to remain aggressive and nimble and to grow quickly were at odds with Royal Dutch Shell’s approach to decisionmaking. Shell indicated to John that it would take its time in deciding what to do with its inherited stake in KMOC, and this created uncertainty and anxiety for the rest of KMOC’s shareholders that quickly proved unmanageable.
Partly because of these conflicting goals, John retained the investment bank Credit Suisse First Boston to explore strategic alternatives. Ultimately, in May 2003, Marathon Oil bought 100 percent of KMOC in a cash transaction that “suited my objectives perfectly. On the day of the close, I resigned as CEO, as did our COO, CFO and general counsel, but Marathon retained the rest of the organization and very few jobs were lost. It was a very satisfying result given my personal interest in seeing the preservation of a company that took many years and much hardship to build. At the same time, the terms of the exit were very attractive for our shareholders.”
In reinvesting subsequent to the KMOC sale, John has geographically diversified his interests, but Russia remains a favorite focus. “I think I gained a certain amount of intuition and learned how to operate in a very high stress environment, following this rather atypical route in Russia during a chaotic time. The lessons learned on the ground by trial and error, and often huge error, proved both valuable and indelible.
Many of those I will never forget.” Among other endeavors, John is today chairman and CEO of Integra Group, which is a new company “embarking on a roll-up consolidation of the Russian oilfield services sector. We expect to complete several acquisitions of Russian oilfield drilling companies over the next couple of years.” He is also the chairman of Atticus Publishing, which publishes children’s books and reference books—half with Russian content and half with Western content translated into Russian—for what John calls “a very interesting market opportunity: a large population with an extraordinarily high literacy rate that is just now earning sufficient discretionary income to begin spending on non-staple goods such as books. Among a market of avid readers, the book penetration has historically been very low, and we are participating in the correction of that imbalance.”
The saga of Russian democratization continues to fascinate the world, as does the defense and critique of the economic reform program that resulted in such concentration of wealth in the hands of a few. “During Yeltsin’s administration there was always talk of a communist rollback,” John recalls. “In its concern over a communist election victory, I think the West lost sight of the fact that relatively free and fair elections in the first place was a huge victory for reformers. After forcing the Communist Party to have to openly campaign for support in competitive elections, the fact that it campaigned so effectively and challenged reformists in power was an ironic achievement for the reformers. While the elections may not have been fully free and fair by Western standards, the peaceful transfer of power from Yeltsin to his successor was historic, and I believe there will be a similarly peaceful transfer to Putin’s successor.”
John points out that under Putin both stability and the perception of stability have significantly increased, thus diminishing perceptions of political risk based on expected political volatility. The degree of repression is a concern, particularly recently, and “questions about whether Putin is resorting to strong-arm tactics to enforce civil law or consolidate his personal power are legitimate,” John feels.
“Russia is at a stage of development where a firm hand is needed. The difficult question is how much is too much, and when are too many civil liberties sacrificed in the name of political stability?”
In John’s opinion, Putin’s stewardship of the economic reform program has been impressive, but at the same time, the wind has been at his back, especially with regard to the commodity price cycle. “Over his tenure, commodity prices have been high enough that he has avoided having to make many structural changes and spending cutbacks that would have been socially wrenching and quickly eroded Yeltsin’s popularity. Nevertheless, fundamental and effective reforms have been implemented, and hopefully these will remain in place as Russia inevitably confronts more fiscally constraining circumstances in the future.
“When I first got to Russia the expectation of violence (uprisings) prevailed, in response to inadequate means to distribute food, support industry or pay the military. None of that happened, not even in 1998 when Russia went through a cataclysmic economic crisis,” John says. While violence in the private sector was more likely, and did happen, John believes treatment of that in the world press has always been exaggerated. His experience was similar with regard to corruption. His company, by choice and by law, was completely compliant with the U.S. Foreign Corrupt Practices Act. His approach was that he would rather absorb any opportunity cost (i.e., walk away from any opportunity) rather than break the law, but “somewhat unexpectedly my opportunity cost was essentially zero,” he said. “We were never pressured to give bribes; we never saw organized crime. Perhaps the oil industry is too high profile and too politicized to be targeted by organized crime, which was probably focused on small cash transaction businesses. We simply never saw them.”
Business planning for John’s ventures involved forecasting challenges that carried huge fiscal risks. In the early 1990s, there was little fiscal and tax transparency. “When we started, there were two taxes levied on our business; by the end, there were 15. For a while, the government introduced new and often contradictory taxes each year, but during the late ’90s they focused on making their unwieldy system efficient. Their strategy was to optimize compliance and absolute tax receipts; they opted for a simple and low burdensome flat tax—one that stimulated compliance. The Russians that we hired used to be very focused on avoiding taxes; it was a real priority for them and a real problem for us. The tax reform completely changed their attitudes, causing them to insist on the opposite—full onshore compliance. This was a great benefit to employer, employee and country.”
There is legitimate criticism, John acknowledges, that the voucher privatization system created a concentration of wealth, that billionaires emerged within a couple of years. Isn’t that a sign, critics point out, that the plan was corrupt and exploited, that the shock therapy and acceleration of privatization was wrong because it created such social and economic inequity?
John argues that the economic advice from the Western team was largely correct. He points out that economic theories—always logical, intuitive and neat—must always be tailored to political and social realities, which were unprecedented in post-Soviet Russia. Russia was trying to do things that made sense from an economic perspective, but the environment lacked the infrastructure to fully implement privatization. “Given the inevitability of emerging wage and wealth disparity, which exists to different degrees in every free market, would it have been possible to undertake privatization and other reforms slowly—to drag them out over many years and potentially through political turnover?” John asks, “Had privatization not been quickly completed, then other longer-term macroeconomic reforms would have had to have been undertaken with government resolve alone in the absence of any private sector support and pressure. The private sector became a potent political constituent that introduced critical balance of power. Given the lack of understanding among Russia’s new political constituency, it seems almost impossible to imagine that all of Russia’s progress over the last 15 years could have been possible without a vibrant private sector. Privatization both created that vibrancy and ensured the irreversibility of the broader reform momentum. Without these reforms, the alternative economic deterioration would have been worse for everyone. In this context, the emergence of wealth disparity could be viewed as an acceptable tradeoff.”
As recent events have demonstrated, much hangs in the balance in Russia. Putin’s course of action, how he manages the dynamics of power, opposition, individual rights—the critical system of law now under stress and moving into new territory—will speak volumes to an international community whose attention is riveted. For investors like John, the adventure continues.
Reach John at jbf@brkln.com.
Cathleen Everett
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