Committee for Russian Economic Freedom

Serfs

Russian natural resource minister Yuri Trutnev annoucned that TNK-BP’s licence to develop the Kovykta gas field will be handed over to the state, where Gazprom has a natural gas monopoly. Although TNK-BP was in discussions to sell Kovykta to Gazprom for $1 billion, the transaction was never comnpleted and it appears TNK-BP will walk away from Kovykta with nothing.

Details of TNK-BP’s travails are covered in a previous post, but it’s worth rementioning that in 2007 the Kremlin passed a law restricting all gas exports to public entities, yes, Gazprom. Although the recent Reuters article touches upon weakening demand for natural gas, it neglected to mention that Kovykta is located in the eastern Russia and TNK-BP was developing those fields for natural gas export to energy hungry China. According to China’s official news agency Xinhua, China’s natural gas consumption is forecasted to more than double over the next ten years.

President Medvedev’s visit to California’s Silicon Valley last week focused on Russia’s ambition to make Skolkovo into Innovation City. But as a Moscow Times op-ed mentions, the President and the government must restore trust in government procedures and laws of the land. Only through the re-establishment of trust can Russia foster the kind of environment entrepreneurs, engineers and venture capitalists need to create and execute new ideas and projects. As an indication of his commitment, Medvedev signed along with other G20 leaders their commitment to combatting corruption and protecting whistle blowers by creating a committee that will eventually draft rules for all G20 members.

While the Skolkovo project renews debate over the successful path of Russia as a state capitalist country versus democratic capitalist nations, financial commentators have renewed interest in Friedrich Hayek, Nobel Prize winning economist. Counter to John Maynard Keyes who wrote about the importance of governmental intervention, Hayek warned against government intervention as it would lead to serfdom. Having experienced serfdom for centuries prior to 1861, Russia is at a political and economic crossroad. Will Medvedev’s commitment to innovation, rule of law and transparency extend to the coming presidential election in 2012, or will a perceived tainted election redirect Russia’s political and economic path towards greater government control and, serfdom?

Zuma Press - Gazprom company worker places a Russian flag on the Nord Stream pipeline last month. The pipeline will run from Russia to Europe.

With the arrival of Ian Bremmer’s new book, “The End of the Free Market: Who Wins the War Between States and Corporations?” the future of the global economy has been set up as an epic battle between state capitalists like China and Russia and free-market capitalists like the US, EU, Japan and Canada.

State capitalists are defined by their domination of strategic assets and creation of wealth that is used to maintain and enrich the political leadership. State capitalists also tilt the marketplace in favor of state-owned companies and put multi-national corporations at a disadvantage through laws and regulations. An example of this from Ian Bremmer in the Wall Street Journal:

In December 2006, the Russian government informed Shell, Mitsubishi and Mitsui that it had revoked their environmental permits as project managers for the $22 billion Sakhalin 2 project, forcing them to halve their respective holdings and give Gazprom, Russia’s natural gas monopoly, a majority stake. This instantly wiped out 2.5% of Shell’s global reserves.

Russia is a model state capitalist as the Kremlin consolidates control over the country’s vast oil and gas reserves and increasingly pressure multi-nationals to sell their companies to state-owned entities. This recently happened with one of BP’s investments in Russia, RUSIA Petroleum.

BP purchased the Kovykta natural gas field back in the early 1990s because of its proximity to China and its enormous reserves. It created a joint venture with local businessmen to create TNK-BP. Before they could make any money, TNK-BP invested hundreds of millions of dollars to develop the infrastructure and pipelines needed to get the Kovykta gas to China.

As the project developed more Russian officials took notice and in 2007 TNK-BP was pressured to sell RUSIA Petroleum to Gazprom, Russia’s state-owned oil and gas company. That same year, the Kremlin passed a law prohibiting private gas exports from Russia, institutionalizing Gazprom’s monopolistic position.

With Gazprom the only buyer of RUSIA Petroleum and government officials dictating not only the pipeline start date but also insisting on a northern, circuitous route, RUSIA Petroleum could not get natural gas to consumers and fell behind on its loan repayments. TNK-BP, which was a creditholder to RUSIA Petroleum, is trying to recoup some of its losses by filing for bankruptcy. It will be seen whether the officials of Russia’s state government give some of TNK-BP’s money back.

Situations such as these make President Dmitry Medvedev’s goal of transforming Moscow into a global financial center and the next Silicon Valley even less likely. Matt Marshall, the only US reporter on a recent venture capitalist tour, was invited to visit Russia as part of the Kremlin’s plan to encourage more foreign direct investment. His critical assessment of Russia’s investment potential is probably not the press the Kremlin was hoping for:

Russia is the sixth-largest economy in the world, but it’s also a country relatively untouched by foreign investors, especially investors in technology. Could Russia potentially be the home of the next massive tech boom?

The short answer is: No way. At least not anytime soon. That’s the conclusion I’ve come to after a week in Moscow, a week in which I took part in the first ever delegation of US venture capital investors to visit Russia.

Now, of course, I’d be delighted if I could report that this Russia is the next India, China or Israel — all places that have seen massive foreign investment in recent years. Russia has among the highest per capita number of students in the world, boasts high levels of mathematics and science education, and being in desperate need of modernization, you’d think Russia would be a gold mine for investors. President Medvedev greeted the delegation, and made clear that technology is needed to diversify from Russian oil, gas and metals — which make up 80 percent of Russia’s total exports. That legacy industry is highly influenced by a group of about 22 so-called oligarchs — many of them exerting their power behind the scenes through corruption. Technology entrepreneurship, if it is fostered, will lead to positive change — there is no question. Everyone agrees.

But investing in Russia can be “insanity.”

The more time I spent in Russia, the more complex the story became (and I’m not the first to say that about Russia). The more I learned — about corruption, the abuses of the courts, the terribly archaic educational system, the choked up traffic, the lack of investment in infrastructure, the cultural penchant for Hobbesian brute leaders, the lack of a truly independent media, and the assassination of journalists when they do show independence — the harder it is for me see a positive short-term future for U.S.-style tech investment for this country.