Committee for Russian Economic Freedom

Reuters chief Russian financial correspondent Douglas Busvine writes that the price of Russian securities thought to have ties to Prime Minister Vladimir Putin, or to have profited the most under his economic policies, “have sold off hardest” in the days following this month’s rigged Duma election.

Russian companies mostly deeply in the red since Dec. 4 include gas firm Novatek, tied to Putin’s friend and oil trader Gennady Timchenko; potash miner Uralkali, which Suleiman Kerimov, backed by state banks, won control of this year; and gold mining company Polyus, in which Mikhail Prokhorov owns a major stake.

Busvine writes:

With the opposition crying foul over alleged fraud in the December 4 election, which cut the majority of Putin’s ruling United Russia party, investors have slashed their exposure to stocks whose prospects they see as tied to the stability of the regime.

Utilities stocks, like state-controlled Federal Grid Company, InterRao and RusHydro, are also underperforming, as analysts note that the Russian stock market is now trading at roughly a 40 percent discount to its emerging markets peers.

Read the full article here.

Nadia Popova and William Mauldin write in the Wall Street Journal about a Norilsk buyback program that has left thousands of Russian investors out in the cold – literally – as they’ve waited in line for hours to tender their shares. These types of obstacles tend to be common for the emerging investing class:

Even as semi-occupied skyscrapers rise up in Moscow’s new financial district, in hopes of luring large numbers of institutional investors, the country’s individual shareholders and bondholders face logistical issues ranging from required hand-delivered paperwork to limited redress for disputes with brokers or trading partners.

Retail investors often face bureaucratic red tape, and few are prepared for the volatility inherent in the Russian market, which has fluctuated between being the world’s best- or worst-performer in the past decade.

According to Alfa Bank the estimated number of investors participating in the buyback program has dropped from 60,000 to 18,000 due to “constraints at the registrar’s office [that] reminded us of lines that formed in the late 1980s for fresh food.”

Full article here: http://professional.wsj.com/article/SB10001424052970204777904576651081541236992.html.

A Wall Street Journal op-ed urges investors and policy makers to exploit Russia’s position as a declining energy power. Others such as Malcolm Rifkind, chairman of the United Kingdom’s Intelligence and Security Committee and Ian Bremmer, president of the Eurasia Group agree.

With new discoveries of shale gas all over the world from the US to China to Germany, dependence on Russian oil has lessened and should be used to embolden foreign governments to acknowledge Russia for what it is, an authoritarian government solely concerned with its survival. This is Holman Jenkins’ view in the WSJ op-ed. He also asserted the charade behind Russia’s supposed competitive presidential election in 2012.

Bottom line: The world, and Russia, may be living with Mr. Putin for a long time…Don’t bet on Mr. Medvedev. Bet on the crude logic of Russia’s declining energy power, which Western policy should do everything possible to exploit, to deliver better behavior in Moscow.”

Bremmer agrees with the basis of the WSJ op-ed and goes farther to asset that it doesn’t matter whether Putin or Medvedev is elected in 2012.

Despite a handful of people and media publications who see right through Russia’s vexing charade, there is a deep rooted reason why they continue to put on such a show — Russia’s  insecurity complex.”

Increasingly, geopolitical power is closely tied with economic power. And as Russia’s ascendant neighbor China continues to grow its economy and flex its geopolitical muscles, Russia is left on the sidelines cheerleading its energy based economy. Russia’s economy is burdened with not only political stagnation but a weak legal framework that dissuades foreign investment.

Rifkind squarely addresses Russia’s weak rule of law as one of the main reasons investors have stayed away.

The consequences of Russia’s denials are far-reaching. Investors have looked at the Yukos case and subsequent machinations and concluded that Russia is far too risky an investment prospect. The failed sale of a Moscow airport just last month was an ominous sign that the ‘Khodorkovsky discount’ is alive and well.

The main victim of this outflow of capital is the Russian economy, which now rests precariously upon high oil prices. Any drop in the price of crude could lead to major crisis.”

With declining oil prices and increased shale oil discoveries, Russia will have a hard time maintaining their bullying foreign policy and hopefully their corrupt power structure as well.

Reuters summarizes the challenges in doing business in Russia with:

Russia is one of the world’s most lucrative markets but is heavily dependent on energy and commodity exports, plagued by corruption and its political stability rests on one man, Prime Minister Vladimir Putin.

Even with rising oil prices, Russian Finance Minister Alexei Kudrin has forecasted a budget deficit of 2% for 2011. With Middle East unrest as a backdrop, the Kremlin has even stronger incentives to maintain and increase social spending and state pensions.

It is interesting that Reuters links the legitimacy of Putin’s United Russia party to economic growth. Markets hate uncertainty, so despite the lack of democracy in Russia, Putin’s leadership is an economic program that the markets are used to.

Putinomics, however, extracts a heavy toll on the Russian economy. The capital seepage leaking out of the legitimate economy through corruption and the lack of rule of law not only drives away investment (capital outflows were at an all time high in 2010) but levies a heavy toll on Russian investments. Russian energy companies trade at a 40-50% discount from US companies.

Transparency International and Revenue Watch Institute released a study today on oil and gas companies and finds that they must do more in their anti-corruption measures.

The companies evaluated represent 60 percent of global oil and gas production. By disclosing anti-corruption measures and key organizational and financial data, especially on a country-by-country level, companies demonstrate their commitment to stop the misappropriation of revenues. In particular, detailed publication of fiscal payments allows citizens to hold governments to account.

Russian Deputy Prime Minister Igor Sechin (left) with BP Chief Executive Robert Dudley and his predecessor Tony Hayward in August 2010 Photo: AP

It’s well known how Putin, Inc. treats its enemies, but the latest WikiLeaks revelations offer startling new details on the rough treatment it accords even its friends. The Telegraph published secret US diplomatic cables showing that current BP Chief Bob Dudley was tossed from his prior post leading the energy company’s Russian unit, TNK-BP, following a boardroom “coup” in 2008, and decided to “move around” from country to country” amid threats orchestrated by Rosneft Chairman Igor Sechin.

On January 14, 2010, Dudley and Sechin joined in praising their latest transaction under which BP would swap five percent of its shares, worth about $7.8 billion, for a 9.5 percent stake in state-controlled Rosneft. Perhaps, as the Telegraph reports, Dudley was forced to set his fears aside and cut a deal with his enemy because BP finds it necessary to look for new business ventures with Putin in light of American anger over the firm’s oil spill in the Gulf of Mexico last year.

Davos 2011

News out of Davos that the Moscow regime has struck mega mega oil and gas deals with BP and Exxon Mobil has heightened a sense among other potential investors that Russia may not be worth the risk. In their agreement with Igor Sechin’s state-controlled Rosneft, BP even turned its back on long-time Russian partners TNK, which took action yesterday in a London court to protect its interests.

Exxon Mobil also doesn’t seem to have a problem in doing business with Sechin and others who built Rosneft by stealing the assets of Yukos and sending its chairman Mikhail Khodorkovsky to a Siberian prison.

Despite an attempt by President Medvedev at Davos to promote investing in Russia, the corruption tax on investment flows directly to the Kremlin. As these two deals demonstrate, the Kremlin orchestrates deals to enrich themselves, adding resonance to Medvedev’s own words to Russian business leaders on December 29 that the country’s investment climate is “very bad.”

As Mikhail Khodorkovsky recently said to the International Herald Tribune and others,

It is obvious that those who can truly be called “oligarchs” – those who have combined state power and big business in one individual – were created by none other than Vladimir Putin and are his comrade-in-arms. The rest of the “Forbes faces” – and indeed a significant part of small business as well – have agreed to pay tribute to the bureaucracy in one form or another…Russia is a sovereign state, but to support deception to demonstrate respect for its corrupt officials, is amoral.

Reuters recently released an article outlining three key risks in Russia: the variable price of oil, political shake up in the Kremlin and further insurgency attacks. Though the world’s largest energy producer, Russia’s manufacturing, construction and retail industries continues to contract as domestic consumption and foreign investment continues to lag, increasing the economy’s dependence on oil prices for growth.

Prime Minister Vladimir Putin remains popular and the driver behind the co-governance team with President Dmitry Medvedev. Despite highlighting their differences and indicating Medvedev’s intentions of political and judicial reform, Reuters notes that Russian markets would rebound only if Putin remained in place. The maintenance of the status quo despite Russia’s world renown for government corruption and weak rule of law seems curious. With foreign investors, such as IKEA, Hermitage Capital, and now HBK investments scaling back or pulling out of Russia due to corruption and extortion, why would the markets value Russian companies more if the status quo remained?

And how does the continued expropriation of private business by government officials add to Russia’s economic capital?

The extraction of Russia’s economic and natural resources by the politically connected few leads to only self-enrichment. Perhaps this self-enrichment would be tolerable if the proceeds were reinvested in Russia and the Russian people, but this is rarely the case. What Russia needs is investment to update oil and pipeline infrastructure, capital to encourage innovation and a stronger rule of law to benefit all Russian people.

Russia’s most famous political prisoner, Mikhail Khodorkovsky began his spirited defense yesterday against his Kafka-esque second trial. The government charged Khodorkovsky and his business partner Platon Lebedev with stealing 2.5 billion barrels of YUKOS’s crude oil or a third of the United States’ entire annual consumption of oil.

The trial is also viewed domestically and abroad as a test of Medvedev’s commitment to ending “legal nihilism” and his power and control within the Kremlin. Medvedev even started a national anti-corruption drive this March. According the Associated Press,

The trial is considered a test of whether President Dmitry Medvedev, himself a lawyer, is serious about reforming Russia’s judicial system. In other cases, judges have come forward to complain they face political pressure.

Only time will tell if Medvedev makes good on his words.

Mikhail Khodorkovsky shares his thoughts with NEFTE Compass on the future of Russia’s oil reserves, the need for Russia to develop alternative energy technologies and Russia’s role in the shifting oil and gas geopolitical landscape in light of alternative energy developments. Khodorkovsky posits that countries will lessen dependence on one supplier or a group of suppliers as more competition in the form of alternative energies begin to play a role. These changes will not only bring about new technological and economic realities, but improve and preserve human life as well.

Russia may very well experience an obvious reduction in the role of rents from the realization of hydrocarbons in the country’s budget. Russia needs to diversify its economy given the competitive challenges posed by a growing China, and, in the future, India.

NEFTE Compass is a leading weekly oil and gas publication focused on Russia, Eastern Europe, Central Asia and the Caspian Sea.