Ill Neo-Soviet Winds Blowing in Russia’s Telecom Market

Eugene Iladi, writing on Prime Tass:

A new storm is brewing in the fiercely competitive, but lucrative, Russian telecommunications market, threatening the stakes of established operators and the stability of the sector.

The granting of new LTE licenses (Long Term Evolution or 4G technology) is shaping to become a potential battleground between Russia’s so-called “big three” mobile telecom operators, Mobile TeleSystems (MTS), VimpelCom and MegaFon, and two newly established start-up competitors, Osnova Telecom and Red Telecom.

The Russian State Radio Spectrum Committee and the Ministry of Telecommunications are in charge of disposing of the licenses and have come under tremendous pressure to grant the new LTE technology spectrum to newcomer start-ups, such as Osnova and Red, without a public tender. How transparent and fair this process unfolds will determine the shape of the Russian telecom industry and the future of foreign investment in the country. Estimated at nearly $40 billion for last year alone, and expected to grow to $48.5 billion by 2013 according to a Pyramid Research survey, Russia boasts Europe’s largest and fastest-growing telecom market.

EDITORIAL: Another Black Eye for Russia

EDITORIAL

Another Black Eye for Russia

Russia got another black eye on the international stage last week when British Petroleum appointed Bob Dudley to oversee the cleanup of its infamous oil spill in the Gulf of Mexico.  He’s the same fellow who got kicked out of Russia for daring to stand up to the Kremlin in 2008. And now the international press is placing that event before the eyes of a slack-jawed world.  What goes around, comes around, you see Mr. Putin.

Talking Points Memo reports:

EDITORIAL: The End of Political Parties in Putin’s Russia

EDITORIAL

The End of Political Parties in Putin’s Russia

Russia lost not one but three political parties last week.  With none to spare, it was not a loss civil society in Russia could afford to incur. We view it as yet another sign of the apocalypse, and when combined with the Kremlin’s growing threat to bring back KGB spy Vladimir Putin as “president” for life, a truly terrifying one.  We urge the leaders of the Western democracies to realize that the political situtation in Russia today has reached a tipping point, and to take immediate and drastic action before they see a fully-realized neo-Soviet monstrosity materialize once again before their gaping eyes.

Nationalizing the Neo-Soviet Economy

Streetwise Professor illustrates the neo-Soviet nationalization of Russia’s economy. So much for capitalism!

Recent weeks have seen the continuation of the methodical march of Putinism and Russian resource nationalism. BP surrenders Kovytka. Gazprom and the Russian government (is there a difference?) begin making noises about elbowing their way into ExxonMobil’s Sakhalin I project (heretofore largely thought immune to predation). And in today’s Eurasian Daily Monitor, Vlad Socor reports that Transneft–Russia’s oil pipeline monopoly–is squeezing the Caspian Pipeline Consortium through demands for renegotiation of existing deals and demands for new capital, with demands backed up by the old standby–outrageous bills for back taxes.

The craven behavior of BP and Shell in the face of Putin’s predations at their expense has undoubtedly emboldened the Russians to take additional steps. Similarly, the sotto voce responses of the Eurowimps are also music to Putin’s ears. When will Europe awaken to the tightening grip of the Russian python?

The losers here are not just the shareholders of integrated oil majors, or American or European consumers of gasoline and natural gas. Though they may not realize it now, it will soon become apparent to the Russian people that they will be the biggest losers. I have been reading every political economy book that discusses the role of a nation’s resource endowment on its political structure that I can get my hands on. This research emphasizes a theme that I have explored before on SWP, namely that rent intensive economies (notably those with outsized endowments of natural resources) are prone to authoritarianism and dictatorship, and that increasing economic inequality and the suppression of commercial and political activity go hand in hand with growing state control over the natural resource sector. Thus, though the energy boom (and the nickel boom and the copper boom and the aluminum boom and the gold boom) will enrich the “elite” (though referring in that way to the thuggish siloviki who rule Russia sounds discordant) with access to the rents, it will condemn most Russians to a penurious economic future and a deprivation of their civil and political liberties.

To follow Putinism is to watch these theories in action. They describe Russian political developments post-2000 to a “T.” The most depressing thing is that inasmuch as these models characterize stable equilibria as a function of underlying endowments, it is unlikely that Russia will leave this trajectory. Revolution and violence are possible, but the likely results of such an explosion would mainly be (a) much death and destruction, and (b) a replacement of the old set of rent parasites with a new set. So, it is well to wish the destruction of Putinism, it is far harder even to imagine how that can be accomplished.

This is particularly true because Putin is doing the basic blocking and tackling needed to secure an authoritarian regime. The moves to revise the history textbooks provided to Russian primary and secondary students and Putin’s historical revisionism (e.g., his assertions that Russia and the USSR have a pristine record as compared to those blood-stained Americans) represent classical authoritarian moves to control the future by controlling the past. Presenting a unifying historical narrative congenial to the regime and suppressing the voicing of any alternative, more discordant, narrative reduces the costs of maintaining control. Similarly, the harassment and sometimes suppression of any non-state organization that could serve as a focal point for collective action directed against the regime is a traditional means of retaining and strengthening control. The atomization of Russian society, and the replacement of myriad spontaneous and organic links of individuals and groups across society with managed vertical relations intermediated by the state and its creatures (a wheel and spoke vs. a network model of society) cripple the formation of alternative sources of power and influence that can challenge the regime.

Not a happy vision, indeed. But Western nations need to develop a Russian policy based on a sober assessment of current realities, and likely future developments. Happy talk in Kennebunkport, or pitiful plaints about the desire for normal relations with Russia, or craven energy executives opening their wallets just after Putin took their watches, are all manifestations of denial. A denial of the reality of “modern” Russia (which is oh-so-much like not-so-modern Russia, and pre-modern Russia). Until the scales drop from European and American eyes, and they devise policies that deal with realities rather than deny them, Putin will march from triumph to triumph. It is unlikely that Putinsim–which is just a latter-day Russian version of natural resource sustained authoritarianism–can be quashed completely, and Russia transformed into a liberal (in the classical sense) modern state and civil society. However, unified resistance can mitigate its more deleterious consequences (at least for non-Russians.) As long as short sighted, commercial interests drive European policy in particular, however, such resistance is unlikely to arise.

Collective action is needed, but collective action is always difficult due to free riding and rent seeking. The entire justification for a European Union is its purported ability to facilitate collective action on matters of common interest and concern. Insofar as Russia policy is concerned, it has failed miserably in this task. The “interests” of individual states, and more shockingly, individual companies within these states (most notably German and Italian), have precluded any robust collective response to Putin’s march. Until that changes, Putin wins, and Russians (and myriad others) lose.

Thanks for reading La Russophobe !

Communism by Any Other Name Would Still Stink to High Heaven

An editorial from Vedomosti, by way of the Moscow Times. How neo-Soviet can you get?

The problems created for the country’s investment climate by the Kovykta gas field have now been resolved. The delay in rendering a decision on the revocation of the TNK-BP license to exploit the field had provided cause for hope that some kind of unexpected resolution to the conflict between the state and the energy company could be found, but the result was in line with what had long been expected by most analysts. Control over Rusia Petroleum, which holds the license to operate the field, was transferred to Gazprom.

TNK-BP representatives are trying to present the deal in a positive light, and they maintain that the development of the field would have been impossible without the participation of Gazprom. For TNK-BP, the result of the deal can doubtless be considered a success: Bringing Gazprom on board is better than losing its license and the money it has already sunk into the project. The company had already invested more than $400 million. TNK-BP maintains an option to buy a 25 percent, plus one share, blocking stake in Rusia Petroleum, and there is talk of plans for the creation of a joint global venture between BP and Gazprom.

One interesting question is the discount on the value of the assets that Gazprom is enjoying when buying into the project. The controlling stake the company bought in Sakhalin Energy at the end of last year cost $7.45 billion, a price that various analysts said represented a 20 percent to 34 percent discount over the likely market price for the assets. The value of the Kovykta deal is still not clear. What is clear is that the price of strategic deals of this type has very little to do with market factors. Any field that is having problems with environmental regulators, as the experience with the Sakhalin project demonstrated, is going to end up changing hands for a much lower price than one not facing prospect of environmental charges.

The Kovykta deal underlines yet another important tendency. On June 15, without bothering to wait for a decision about the fate of the field’s license, the Industry and Energy Ministry went ahead and issued a statement outlining its ideas for the future of field. Deputy Industry and Energy Minister Andrei Dementiyev said the field would go into production at some point after 2017. That date also occupies an important place in Gazprom’s preliminary plans for the future. In fact, a number of state officials have acknowledged that there is no need to develop the field quickly. All of this comes, of course, after one of the main complaints against Rusia Petroleum’s work at Kovykta was that the development of the field was coming along too slowly.

In another interesting announcement, after the new agreement had been reached, Gazprom deputy head Alexander Medvedev said gas from the Kovykta field could ultimately be destined for China. This was the very same strategy that TNK-BP had proposed to follow, but the company was unable to turn this into a reality — Gazprom holds a monopoly on the right to export gas. Characteristically, the Natural Resources Ministry has also expressed its willingness to work for compromise: After the discussions on the agreement between TNK-BP and Gazprom, the ministry’s press service announced it was expecting an offer from the new owner within the next two weeks. It said it would decide whether to revoke the license for the development of the field after receiving the new proposal.

It was the same case with Sakhalin-2. The international shareholder and operator of the project, Sakhalin Energy, had to step aside and hand a controlling stake to Gazprom as a result of environmental charges that were serious enough to threaten the suspension of the project. The deputy head of the Natural Resource Ministry’s environmental watchdog estimated that the cost of repairing the environmental damage caused by the project was $50 billion. Japan’s Ministry of Economy, Trade and Industry then announced that, as a result of the inspections, the shareholders in Sakhalin Energy would have to spend an additional $20 billion on environmental protection measures. After Gazprom bought its way into the project, the state approved an environmental protection plan that it said would eliminate all of the environmental risks. No one, of course, is talking about multibillion-dollar payments anymore. The sharp criticism over environmental concerns leveled at Yuganskneftegaz, formerly the main production unit at now-bankrupt Yukos, also disappeared immediately after it was bought by state-owned Rosneft.

The manipulation of prices for oil and gas assets by way of pressure from state regulatory agencies has become part of the standard mechanism for the transfer of property and ownership in Russia.

Thanks for reading La Russophobe !

ZAXI on BP

ZAXI blog offers the following penetrating commentary (as usual) regarding the recent ejection of the BP oil concern from the Russian market by the malignant nationalizing forces of the Kremlin:

It matters not if you spent ages preparing for the final exam. You will still fail without a pencil. And the teacher not only failed to provide a pencil in this case – he threatened to kick the groveling student out of the room for taking too long with the test.

Russian justice has turned so twisted that BP was feigning delirious joy at its handover to Gazprom of the ill-fated Kovykta gas field. BP’s new chief executive called it both “historic” and “powerful.” A host of Western oil analysts in Moscow said BP should feel grateful. Indeed BP and its Russian partner TNK faced the option of simply getting stripped of Kovykta’s license under pretext that the two could not market its gas in time to meet a fictitious deadline. They first needed permission to access pipelines – and the Russian state refused to hook up the stranded field to nearby China by claiming this was not in its plans. TNK-BP may have crammed all it wanted but it was about to go home with a failing grade and snot running down its quivering lip.

So Roland Nash of the Renaissance Capital investment house was nearly right to say the deal “is almost a billion dollars more than they might have otherwise gotten.” TNK-BP did get almost double its Kovykta investment in an actual legal agreement with Gazprom. And it now has the hilarious option of buying back a quarter stake at an “independently verified market price” or by swapping some of its European assets.

But of course Nash was not right. Gazprom could and did steal Sakhalin-2 from Royal Dutch Shell. It is about to illegally bar ExxonMobil from selling Sakhalin-1 gas to China – it wants that right for itself. Yet Gazprom could not simply pinch Kovykta because the B in BP once stood for “British.”

The Kremlin seems to abhor all things Albion except for its gas. Centrica may not have made any of the stories about Friday’s deal but the British Gas owner – seeking buyers because its fields are running dry – is the only reason why BP got any cash here at all. The prospect of Gazprom owning their gas has left Brits feeling understandably queasy. Parliament has proposed legislation blocking a potential deal. Centrica has put out hopeful feelers to gas firms stretching from France to Norway. The Kremlin knows it is not being welcomed with open arms. But Gazprom wants a foothold in Western Europe – perhaps as much for its prestige as its bottom line – and Centrica’s 16 million customers are a start. A small sacrifice on Kovykta in exchange for some whooping endorsements from BP mangers was a bargain in Kremlin eyes.

And has BP whooped. The company has waged war on Tony Blair for suggesting that British business calm its courtship of a Russia that looks to have donned its 1930s garb. It sunk one billion dollars in a Rosneft initial public offering that came up against stern analysts’ warnings. It placed a ceremonial bid in a staged auction for Yukos assets. BP has now offered Gazprom new joint ventures abroad. All this fine work has left BP with the right to still do business in Russia. Vladimir Potanin on the other hand just twiddled his thumbs. And all the Interros boss now has is a 26 percent stake in a Kovykta project that is suddenly worth tens of billions of dollars because of its imminent access to China.

The “baby billionaire” – a title Potanin earned from a fawning Fred Hiatt of The Washington Post in 1998 – learned quickly that silence is golden in President Vladimir Putin’s Russia. He kept everything pilfered under Boris Yeltsin and remains one of the few standing oligarchs without training in the KGB. The Kremlin’s wrath has spared him again. His Kovykta stake was untouched by its campaign against the Russian partners in TNK-BP – confirming that Putin will let the select few who came before him enjoy their wealth.

Not all of it. It seems that Potanin’s Norilsk Nickel has the misfortune of holding rights to a titanium mine that looks just right to Putin’s old Dresden spy partner Sergei Chemezov. He now runs the state military industrial complex conglomerate being forged from the arms exporter Rosoboronexport. Potanin’s titanium mine fits nicely into Chemezov’s plans and the local governor has already blessed the whispered handover – perhaps citing the watertight legal argument that Putin would otherwise sack him.

Potanin’s team has also suddenly discovered that it will have a tough time digging through the titanium mine without Chemezov’s help. It told Kommersant it was willing to “discuss cooperation.” And who would not be after finding themselves sitting on top of enough gas to keep Asia – rather than some impoverished Siberian customers – running for over a year?

Interros will likely be booted from Kovykta in the long run if BP is ever allowed back in. Gazprom would not stand losing its majority stake and considering Potanin’s chumminess with Putin he can expect another handsome reward. But the future of TNK-BP itself looks grim. Putin has made clear his displeasure with the Russians involved in the arrangement – “I am not even going to talk about how they obtained the permit” for Kovykta in the early 1990s – if not with Potanin. And all the Kremlin really needs is BP’s technology rather than the remnants of a joint venture that Putin blessed in 2003. That fall Kremlin ceremony marked the apex for Western involvement in Russia. Pages of ink were spilled hailing the country’s rise to prominence almost five years to the day after an economic implosion saw investors stampede for safer shores. Those articles reversed course weeks later when the arrest of Mikhail Khodorkovsky sounded the starting gun to the Yukos campaign.

One may now frown at BP’s naive enthusiasm at spotting a potential cash cow standing untended off the upper-left coast of Lake Baikal. A super-giant gas field that maps place just inches from China – the temptation was there. And BP could argue that others have also looked into Putin’s eyes and claimed to see something warm and fuzzy. Now energy analysts use stock phrases to insist that the Kremlin has done its work – the old deals have been “renegotiated” and all Western firms now operate under defined if subservient terms. It is safe to bet on Russia again.

Perhaps. But someone should first report the good news to ExxonMobil.

Thanks for reading La Russophobe !

Economist: YUKOS Was Beginning of End for Russia

The Economist says that the creation and seizure of Mikhail Khodorkovsky’s “Yukos” oil firm represented the beginning and the end of freedom and democracy in Russia:

IT WAS the first “smart” office building in Russia, self-sufficient and stuffed with the latest technology, a showcase of Russian capitalism and built to serve as the headquarters of Yukos, the country’s biggest oil company at the time. The pearl-tinged tower was insured against earthquakes, storms and floods. It was even insured against police raids—but, alas, not against political change. In April 2003, when the company moved in, someone counted the steps between landings: 13, an unlucky number. A few months later things started to go wrong.

This week Yukos’s office building was the last of the company’s main assets, after its production units, refineries and petrol stations, to be sold in a series of staged bankruptcy auctions. Most of Yukos has ended up with state-controlled Rosneft, now Russia’s largest oil company, run from a low-rise office within shouting distance of the Kremlin. All that now remains of Yukos is a number of lawsuits filed by disgruntled shareholders demanding compensation from the Russian state. In a few weeks a clerk will cross out Yukos’s name from an official register and Russia’s first-ever private oil company will cease to exist as a legal entity. Rubbing out the stain that the destruction of Yukos has left on Russia’s political and economic landscape, however, will take a lot longer.

At the very least, the Yukos affair changed the shape of the Russian oil industry, giving the state control over energy resources and doubling its share of crude output to more than 50%. But the legacy of Yukos’s destruction goes beyond oil. If the emergence of Yukos epitomised Russia’s transition from a planned economy to the wild capitalism of the 1990s, which for all its excesses thrived on private initiative, its destruction was a turning-point towards an authoritarian, corporatist state.

What triggered the attack on Yukos and its main shareholder, Mikhail Khodorkovsky, is still a matter of argument. Was it Mr Khodorkovsky’s political ambitions, or his plans to sell a large chunk of the company to Exxon Mobil? Was it his intention to build private pipelines, or the cupidity of the new elite? It was probably all of the above. But what has become clear over the past four years is that Yukos’s fate was sealed once Vladimir Putin became Russia’s president in 2000.

“If the Yukos case had not happened, it would have to have been invented,” says Rory MacFarquhar, an executive director at Goldman Sachs in Moscow. The case partly reversed the legacy of the 1990s during which, through a series of mostly rigged auctions, control of natural resources passed from the discredited Communist party to a group of oligarchs supportive of Boris Yeltsin’s regime. It was unusual by any country’s standards. Mr Khodorkovsky, a businessman and former Young Communist League activist, was one of the prime beneficiaries. His bank arranged the auction of Yukos and ended up as the sole bidder. Any potential rivals had been warned to stay clear and he got the majority of Yukos for a song.

The privatisations successfully dislodged the Communists from the commanding heights of the economy, but also created a lasting sense of injustice in Russia. So when Mr Khodorkovsky began to behave like an independent and legitimate owner of Yukos, negotiating its sale and financing the political opposition, Mr Putin was furious.

The president’s desire to curtail the political and economic influence of the oligarchs was understandable. Mr Putin could have levied a windfall tax on the oligarchs, or renationalised the energy companies and compensated shareholders. Instead, he used the legal and tax systems to bankrupt a healthy company and pass the prize from one elite to another—this time, a group closely tied to the KGB, the Soviet Union’s former security service.

Russian tsars often banished disloyal aristocrats who prospered under a previous reign and expropriated their wealth. What was new with Yukos was Mr Putin’s pretence that all this was legal. That eroded democratic institutions and further discredited the law by using it as a political instrument. An attack late last year on Royal Dutch Shell (allegedly on environmental grounds) and an earlier economic blockade of Georgia, which was attributed to health regulations, were part of a pattern that began with Yukos.

After a bogus trial conducted by servile judges, Mr Khodorkovsky was sent to a Siberian prison camp and Yukos was broken up and pushed into bankruptcy through ever mounting back-tax claims. The figures did not add up. In December 2004 Yuganskneftegaz, the main production unit of Yukos, was sold in a rigged auction for $9.4 billion to a front company registered in a grocery shop in a provincial town, which was then bought by Rosneft. (When Rosneft came to float its shares on the London Stock Exchange, the same asset was valued at close to $60 billion.) The sums kept changing, but the formula stayed the same: the tax bill always ended up exceeding the value of Yukos’s assets.

By the time Yukos’s last assets were auctioned (undervalued by about 25%, says Al Breach of UBS, a Swiss bank) there was a sense of inevitability rather than outrage. Russian and foreign energy companies such as TNK-BP and Italy’s Eni and Enel took part to ingratiate themselves with Rosneft and Gazprom, the gatekeepers of Russian resources. Big foreign banks bent over backwards to earn the Kremlin’s favour. The government “left enough crumbs on the table” to keep foreign businesses happy, says Mr MacFarquhar.

High oil prices kept everyone quiet. They also meant that Russia felt no immediate pain from the destruction of Yukos. The management of state oil companies may be less efficient and less transparent than that of private firms, but when prices are high they still make a lot of money. Shareholders have filed lawsuits in international courts, claiming that Russia has violated the European energy charter to which it had signed up. Russia retorts that it never ratified the document.

Yevgeny Yasin, Russia’s former liberal economics minister, argues that the Yukos affair has done enduring damage to Russia’s long-term prosperity because it is harder to create wealth without property rights and the supremacy of law. The affair broke the rule of the oligarchs but resulted in a fusion of political and economic power, concentrated in the hands of the Kremlin. Its chiefs must think they are invulnerable. But so did the oligarchs and the Communists before them

Thanks for reading La Russophobe !

The Last Nationalization Domino Tumbles

The Moscow Times reports that having nationalized the oil and gas industry, the Kremlin is now moving on the last remaining area of private ownership, minerals.

Vladimir Potanin’s buyout of CEO Mikhail Prokhorov’s blocking stake in Norilsk Nickel and other assets within the Interros holding company could well lead to state control over the company, one of the country’s last few strategic assets in private hands, analysts said Thursday.

The change in ownership appeared largely to be a surprise to the market, but comes just weeks after Prokhorov was detained by French police during an investigation into a prostitution ring and could be linked to it in some way, analysts said. Under the deal, Potanin, one of the country’s most politically savvy oligarchs who has taken care to stay loyal to the Kremlin, will have a stake of about 55 percent in Norilsk. Potanin and Prokhorov will split their shares in other Interros assets, including Polyus Gold, the country’s largest gold miner.

Shares of Norilsk on the RTS rose 5.74 percent to $175 on Thursday.

Where Potanin will get an estimated $7.8 billion to take over Prokhorov’s share of approximately 27 percent in Interros was not immediately clear. Interros gave no financial details of the buyout in its statement on the issue Wednesday. “There is absolutely no funding now,” said Rob Edwards, metals and mining analyst at Renaissance Capital, referring to estimates that Potanin would need to raise extra cash for the deal. While it is unclear exactly where Potanin will get the money to acquire Prokhorov’s share, it should be very straightforward for him to finance the buyout through loans, said Chris Weafer, chief strategist at Alfa Bank. Servicing the debt could put more pressure on Potanin, however, and may lead to the buyout being a short-term one, with someone else stepping in over the next few months to take over the debts and assets, analysts said. Potanin may also wish to cash in some of his assets, which could lead to higher dividends or share buybacks, Deutsche UFG said in a note to investors Thursday. In any case, Potanin’s move “is not the endgame but one in a chain of events,” Edwards said.

Weafer agreed that the investment was short term rather than long term. The state or a state-controlled buyer, such as diamond monopoly Alrosa, will likely take control — first of a blocking share and later perhaps of a controlling one, he said. Norilsk, the world’s largest nickel producer, is a key strategic asset over which the state would like to have influence, Weafer said. In a note to investors Thursday, Renaissance Capital said it believed control over Norilsk Nickel would never be allowed to shift to a non-Russian or non-favored group.

Thanks for reading La Russophobe !

Russia Kills the Oily Goose

Writing on American.com Leon Aron, a resident scholar and director of Russian studies at the American Enterprise Institute as well as the author of “Yeltsin: A Revolutionary Life” (St. Martin’s Press) and of the forthcoming “Russia’s Revolution” (AEI Press), explains that Moscow’s attachment to statist economic policy is undermining its bid for global energy dominance. By re-nationalizing its energy sector, Putin’s regime is slaying its largest golden goose.

RUSSIA’S OIL WOES

The idea that Russia is a new “energy super­power” is all the rage in Moscow, thanks in part to President Putin’s vigorous salesmanship. The coun­try holds between 6 and 10 percent of the world’s known oil reserves and exports around seven mil­lion barrels a day—second only to Saudi Arabia. Last summer, the Kremlin pushed hard to make energy security the centerpiece of the G8 summit in St. Petersburg. Lost in the crash of cymbals, however, is Russia’s uncertain ability to keep up with growing world demand—or even to maintain its current level of production, after a dazzling run from 1999 to 2004. While there are several reasons for concern, the underlying problem is sadly familiar in Russian history: a state ideology is poised to undermine the country’s progress at precisely the time when Russia seems on the verge of a breakthrough.

The government’s campaign to take control of energy firms began in 2004 with the selective prosecution of Russia’s largest and finest private oil company, YUKOS. In a series of blatantly rigged trials, Russian courts found YUKOS guilty of corporate sins and tax violations, including the nonpayment of a tax bill far exceeding the company’s profits. The company was bankrupted, and its most productive unit, Yuganskneftegaz, was sold through an intermediary to the state-owned Rosneft. YUKOS’s founder and principal shareholder, Mikhail Khodorkovsky, is serving a sentence of nine years’ hard labor at a prison camp in eastern Siberia. Soon thereafter, another leading private oil company, Sibneft, was purchased by the state-owned natural monopoly, Gazprom. In 2004–2005, the state’s share of oil production increased from 10 per­cent to 30 percent.

By re-nationalizing its energy sector, Russia is slaying its largest golden goose. Between 1999 and 2004, the much maligned “oligarchs,” as the young tycoons who became fabulously rich in the privatization of the 1990s are often called, invested over $36 billion, or 88 percent of their net profits, in “greenfield” exploration, drilling, and modern technology.[1] Helped along by the cheaper ruble and an overhaul in the companies’ corporate manage­ment (which became leaner, more transparent, and responsive to the markets), the private sector’s oil production grew by 47 percent. Trillions of rubles were paid in taxes to the Treasury and, for the first time in post-Soviet history, dividends went to the shareholders.

By contrast, during the same five years, extrac­tion by state-owned companies was up by a mere 14 percent.[2] But ever since “acquiring” most of YUKOS, Rosneft—which was an obscure firm about to be put up for sale when Putin’s confidant and deputy chief of staff, Igor Sechin, took over as chairman—has aggressively continued to buy oil assets. Gazprom has been on a shopping spree of its own: in just the last three years it has spent $18 billion on acquiring “non-core” businesses outside the gas field (such as Sibneft, for $13 billion)—more than it has invested in exploration and production since 1996.[3]

Thus, some of the most productive assets of the Russian oil industry have been transferred from the most transparent and efficient companies (YUKOS and Sibneft) to the least transparent and efficient (Rosneft and Gazprom). The result? After an average growth of 8.5 percent between 2001 and 2004, in the last two years, the growth in oil production has dropped to 2 percent.[4]

Russia’s largest deposits of hydro­carbons lie thousands of miles away from the terminals that can carry them to world markets. The state-owned pipeline monopoly, Transneft, operates over 29,000 miles of pipeline. But of the seven million barrels a day that Russia produces for export, only about four million are shipped via the pipelines.[5] The rest have to be transported much more expensively and slowly, by rail. This year, Russia’s production may exceed its total shipping capacity by between 220 and 294 million barrels.[6]

The Russian pipelines are not only short of what’s needed, they are also old. Two miles in three were laid over 20 years ago. Breakdowns and leaks are becoming increasingly common. Last year’s survey of the 1960s-era “Druzhba” (Friendship) pipeline, which carries 1.2 million barrels a day to Eastern and Central Europe, found almost 500 “damaged points.”[7] Last July, 11,000 gallons of crude leaked from the Druzhba near Russia’s border with Belarus, briefly shutting down the route and sending world oil markets up to about $75 a barrel.

Four years ago, a consortium of the largest Russian private oil companies offered to build a pipeline that would have carried one million barrels a day over 960 miles from the main fields in west­ern Siberia across the White Sea to the terminals in Murmansk, the only northern port in Russia that does not ice over in winter. The project, estimated at about $4 billion, was to be financed entirely by private capital. By that time, however, economic re-centralization was becoming the dominant state policy, and the Kremlin turned down the construc­tion, in effect vetoing private pipelines in Russia.

With some of its key potential domestic inves­tors expropriated, scared into selling, or forced to reduce their investments because of the increasingly uncertain business climate, Russia needs a massive infusion of foreign capital in order to continue devel­oping its energy sector. Here too, however, statist ideology trumps the country’s long-term interests.

As-yet-unwritten laws (which are understood as effective constraints on firms in the country) limit foreign ownership in joint ventures to 25 percent and bar companies of which foreigners own more than 49 percent from participating in the largest oil fields.

Moreover, Russia has begun to pressure the existing foreign operators of oil and gas fields into renegotiating their agree­ments. Last September, the author­ities were suddenly so concerned about environmental and ecological “violations” that they threatened to halt the construction, led by Royal Dutch Shell, of the world’s biggest liquefied natural gas plant on Sakhalin Island in the Far East. Known as “Sakhalin-2,” the project is the larg­est direct foreign investment in Russia, estimated to cost Shell and its Japanese partners $20 billion. Projected annual output is 70 million barrels.

At the same time, pressure was also brought to bear on ExxonMobil’s offshore Sakhalin production (“Sakhalin-1”) just as it was about to start shipping. That project was expected to cost $17 billion and produce 88 million barrels of oil annually. There is no Russian participation in Sakhalin-2, while Rosneft has only a 20 percent stake in Sakhalin-1. Now that oil and gas are so much more expensive than when the original deals were struck, the Kremlin wants a larger share of profits—or all of them.

It is now widely assumed that the government will pull the license of Russia’s second-largest oil company, half-owned by the British, unless the three principal Russian owners agree to sell their shares to Gazprom. That firm, TNK-BP, is develop­ing the Kovykta, a giant gas field in eastern Siberia. The latest addition to the Kremlin’s hit list is Russia’s largest remaining private company, Lukoil, one-fifth of which is owned by ConocoPhillips. The company, which pumps 18 percent of Russia’s daily production, has been charged by the Ministry of Natural Resources with unspecified “violations” in the development of oil fields and is threatened with the recall of almost two dozen licenses.

These moves are bound to make foreign direct investors think twice before going into Russia—and if last July’s float of Rosneft’s shares on the London Stock Exchange is an indicator, harvesting stock markets might not work either. Intoxicated as they were with high oil prices, investors’ response to the largest initial public offering in Russian history (and the sixth-biggest in the world)[8] was less enthusias­tic than Moscow had hoped for. The interest from international institutional investors, such as insur­ance companies, was weaker than an offering this large would normally produce.[9] The three biggest accounts belonged to the entities clearly seeking to refurbish their Kremlin loyalty credentials: BP (10 percent of the offering), the Malaysian state oil com­pany Petronas (9 percent), and the China National Petroleum Corporation (4 percent). The offering produced half the revenues expected.

By choosing re-centralization and re-national­ization over liberal reforms in energy markets, and opting for state control over direct foreign invest­ment, Russia may stop itself from raising enough capital to sustain the current level of energy pro­duction and transportation, much less to expand it. “Energy superpower” is likely to become an even more distant dream than it is today.

Thanks for reading La Russophobe !

Russia adds insult to injury on Sakhalin-2

The Financial Times reports that the Kremlin has only just begun to steal:

Royal Dutch Shell and its two Japanese partners are to be made to share the burden of the huge cost overruns of Sakhalin-2, it emerged on Thursday, in news that cast a less favourable light on their deal to cede control of the project to Gazprom.

Just days after confirming that Russia would pay the companies $7.45bn to establish its controlling stake in the project, the government said it would require the three foreign owners to meet $3.6bn of the additional costs of Sakhalin-2 themselves.

Jonathan Wright of Citigroup said: “It depends on what you expect for oil and gas prices, but my figures suggest an internal rate of return for the project of 11 per cent. That’s above the cost of capital, but not sufficiently above it, given the region and the risks involved, to be able to say this is an attractive project.

“This news is definitely not making a good project turn bad, but it is making a difficult project slightly worse.”

He added: “This looks like payback for the negotiations last year, when Gazprom reached an agreement on taking a stake in the project, only to be told the following week that the costs had doubled.”

Details of the extra costs to the three companies – Shell, Mitsui and Mitsubishi – in a confidential agreement apparently leaked by the Russians, show the three companies will have to increase risk exposure and reduce the value of this month’s deal.

Earlier this month, they ceded control of Sakhalin-2 to Gazprom, Russia’s state-backed gas giant, after months of sustained attack by government agencies on aspects of the project such as its rising cost and environmental record.

Shell, which owned 55 per cent of the project, Mitsui and Mitsubishi halved their stakes and offered Gazprom 50 per cent plus one share. On the day the deal was signed, the Kremlin said environmental issues would be resolved and agreed to a doubling of the cost to $20bn.

Sakhalin-2 is governed by a production sharing agreement that allowed foreign shareholders to recoup costs fully before sharing profit with the Russian state.

But it emerged on Thursday that foreign shareholders would recoup only about $15.8bn and have to put up $3.6bn themselves. Gazprom, as a new shareholder, would be exempt from this cost increase.

Andrei Dementyev, Russia’s deputy minister for energy, told Vedomosti, a business daily partly owned by the Financial Times, that “foreign investors should take engineering risks upon themselves”.

Shell declined to comment on the agreement. Observers say that Russia, by leaking the information to the media, was adding insult to injury.

The Russian government has now set its eyes on Kovykta, the massive gas field in Eastern Siberia controlled by TNK-BP. Alexei Miller, Gazprom chief executive, on Thursday met with Victor Vekselberg, one of TNK-BP’s Russian shareholders, to discuss “co-operation” between the companies.

The Jamestown Foundation’s Vladimir Socor takes the West to task for making facile, rose-colored assumptions about Russia as an energy partner:

The Kremlin’s confiscatory assault on Royal Dutch Shell and threats to other Western energy majors in Russia on Black Tuesday, December 12 (see EDM, December 13) is the latest in a series of moves disproving Western wishful thinking about Russia’s energy policy.

That wishful thinking burgeoned, ironically, in the wake of the January 2006 Russian gas supply cutoff to Ukraine, which rippled downstream in a number of European countries. While the “wake-up call” for coordinated Western energy policies resounded mainly in the editorial pages after that crisis, most Western governments and energy corporations embraced the set of illusory assumptions that are now being laid to rest by Moscow’s own actions.

Assumption One during 2006 held that Russia and Western consumer countries would benefit through strategic relations of “reciprocal access.” Namely, access by Western energy majors and “national champion” companies to Russian oil and gas deposits in return for Russian companies’ acquisition of Western infrastructure, distribution systems, and direct access to Western consumers. However, by the year’s second half, Russia embarked on a policy of excluding Western investors (most notably in the super-giant Shtokman gas field) and, by the year’s end, threatening confiscatory measures against existing Western projects in Russia (Shell, ExxonMobil, BP) under tax or ecological regulatory pretexts. Meanwhile, turning the “reciprocity” into unilateralism, Russia’s state energy companies rapidly acquired infrastructure and production assets in the West as well as in countries that traditionally supply the West with energy.

The year’s Assumption Two, equally popular and partly related to the first, spoke of “mutual dependence.” It held that the West’s growing dependence on Russian supplies is not particularly risky because it is offset by Russia’s dependence on revenue from Western importers of Russian energy. As the year wore on, this Western postulate shattered against Russia’s active planning for construction of oil and gas pipelines leading to the Asia-Pacific region, setting the stage for Moscow to play Western against Far Eastern consumers in a none-too-distant future. Moreover, the “mutual-dependence” assumption blithely ignored Russia’s advantage as a single-actor exporter versus a multiplicity of eager, uncoordinated, and often competing Western buyers, with ample scope for manipulation by Russian state companies. Mutual dependence might become possible between the European Union collectively and Russia, if the EU develops a common energy policy, which however does not seem to be on the cards for now.

Assumption Three during 2006 held that Moscow cannot afford to exclude or mistreat Western energy companies because Russia’s state companies do not have sufficient means to invest in energy projects on Russian territory. However, Moscow successfully challenged that proposition through the Initial Public Offerings of Gazprom, Rosneft, and other state companies, which quickly raised multibillion-dollar investment funds on Western capital markets. Those IPOs launched a process of transferring Western resources to Russia for energy projects under the Russian state’s discretionary control, and without a real say by Western consumer countries regarding future production levels or the export destinations. When Russian President Vladimir Putin announced the go-it-alone policy on Shtokman, he did so with the argument that Russia does not need to invite Western investors, as it can raise the necessary capital on Western financial markets. The Kremlin took that argument one step further in December by embarking on what is, in fact, a forcible divestment of Western energy majors involved in Russian projects.

The year’s Assumption Four clings to a hope that Russia’s ratification of the Energy Charter Treaty and signing of the attendant Protocol would help the West overcome its collective vulnerability on energy security. It envisages, primarily, that Russian state pipeline monopolies would provide transit of oil and gas from third countries via Russia to Western consumer countries. However, Moscow’s actions during the year showed how risky this proposition is. The Russian government shut off energy pipelines repeatedly in 2006, not only to Ukraine and Georgia early in the year, but also to EU member country Lithuania (adding to the earlier oil pipeline shutoff to Latvia); it blocked access for oil from Kazakhstan via Russian ports or pipelines to EU member countries; conclusively thwarted the Odessa-Brody oil transport project, which was an EU priority; it is attempting to kill the Nabucco gas transit project, also an EU priority; and is blocking the expansion of the Caspian Pipeline Consortium (CPC) line, threatening to transfer its section on Russian territory into Transneft’s control and imposing extortionate terms of transit on the ExxonMobil, Chevron, and other companies on that pipeline.

Thus, the idea of relying on Russia for transit under the Energy Charter Treaty and Protocol has been shown during 2006 to entail unacceptable risks. This idea is partly an excuse for not pursuing direct Western direct access by pipelines to the eastern Caspian basin. Moscow’s refusal to adopt the Treaty and Protocol is a blessing in disguise for the West and should re-focus attention on access to the Caspian basin.

Moscow actively cultivated that set of Western assumptions during most of 2006; but apparently felt strong enough to dispense with parts of that discourse in the latter part of the year, and to resort to overt bullying by the year’s end. The comfortable assumptions about Russia’s energy policy in 2006 should now come to the end of their 12-month lifespan.

Thanks for reading La Russophobe !