Committee for Russian Economic Freedom

After almost 10 years of negotiations with Turkey and Southern European countries Russia finally outmaneuvered EU. Last week Vladimir Putin gave a start to the construction of South Stream pipeline, which will deliver Siberian gas directly to the Southern Europe bypassing Ukraine. Nabucco, a EU pet-project, is now officially dead as well as hopes of Central Asian countries to export their natural gas to Europe.

The total cost of South Stream is estimated to be around 26 billion dollars. This number can only grow as it happened with other Gazprom’s elephant projects. The company won’t see any additional income from this investment, since Gazprom will just redistribute natural gas from the Ukrainian pipelines to South Stream. Nevertheless, the giant will save up to 2 billion dollars a year, a transit fee that Gazprom currently pays Ukraine. These mediocre savings obviously don’t justify huge and risky investments.

South Stream will destroy the value of Ukrainian pipeline system and Azerbaijan natural gaz reserves

In the absence of any substantial financial benefits, Gazprom can long for broader strategic advantages as a result of South Stream.

First, South Stream will help Gazprom to corner the European market by blocking the export of Central Asian gas to Europe. Though five years ago this was a rational strategy for the Russian energy giant, now it doesn’t make a lot of sense. Liquid natural gas combined with shale gas technologies will make European market more competitive anyway.

Second, South Stream will help to reduce the bargaining power of Ukraine, the largest Gazprom’s customer. After North and South Stream will reach their project capacity, Gazprom will be able to shut down natural gas transit through Ukraine. The situation of 2005-2009 when gas supply to Southern Europe was interrupted because of the Russian-Ukrainian conflict over the transit fees and gas price won’t be possible anymore. Again, this achievement doesn’t look as significant as it did five years ago. Ukraine already pays the highest price for Russian natural gas and rapidly cuts its consumption.

In sum, the project, which looked essential for Gazprom five years ago, now doesn’t bring neither financial nor strategic benefits for the company. However, Gazprom and the Russian government fail to recognize changes on the world energy market and still fight with the ghosts of the past. Influential Gazprom’s contractors won’t allow stopping the construction as well. The drop in natural gas prices combined with hopeless investment projects might destroy the monopoly sooner than EU finishes its antitrust probe against the company.

FT

Stephen Jennings is giving up control over Renaissance Capital, once a leading Russian investment bank, to Mikhail Prokhorov’s Onexim Group. In his farewell letter Jennings expressed hope that with the new ownership structure the bank he founded 17 years ago “will be much more part of the ‘system’ in Russia”. Most likely, after Jennings’ departure, Renaissance Capital will concentrate on serving the business of Onexim group.

Financial institutions are in rough waters everywhere in the world. The Russian government took advantage of the financial crisis to tighten its grip on the investment banking industry. When in 2007 state-owned VTB entered the booming investment banking industry, its aggressive recruitment practices were a first blow to the run-for-profit investment firms. Soon after that, the government unofficially instructed state controlled companies, comprising about a half of Russian economy, to hire VTB Capital as a financial adviser for important transactions. Many Russian oligarchs, often dependent from the government, also were advised to work with VTB Capital whenever possible. Besides direct backing from the government, VTB also leveraged its unrestricted access to the government funds to win business from its capital-deprived private competitors.

Jennings quits Russia after 17 years of largely successful work

Faced with decline in revenues, independent investment firms either quit the market or were acquired by state-controlled institutions. In 2011 state-controlled Sberbank acquired Troika Dialog, a leading Russian investment bank. Explaining the deal, Troika Dialog’s founder Ruben Vardanyan admitted that there was no room for non-state controlled banks in the Russian market. Last week, after several years of losses, Stephen Jennings followed the suit.

The alliance of bureaucrats, state-controlled companies and investment banks creates the machinery for structuring high-scale fraud and corruption into legal financial transactions. Now investment bankers can take any risks, knowing that the government will always back them if something goes wrong.

Besides that, monopoly in financial services could be useful in punishing bold businessmen. Recently VTB-Capital refused to underwrite bonds for National Reserve Bank just several days before the issue should have taken place. Alexander Lebedev, the politically active owner of the National Reserve Bank, had to sell his assets and cut financing of Novay Gazeta, the last but one newspaper not controlled by Kremlin.

Having access to the most intimate information about their clients, investment banks could be instrumental in tightening control both over business and corrupted officials. No surprise that nowadays all major Russian companies prefer to work through their own investment firms. Igor Sechin recently hired several prominent bankers in order to create one for his Rosneft. Likewise, Gazprombank is in charge for most of its parent company financial transactions.

Open and competitive financial markets could have foster the diversification of the oil-dependent Russian economy by enabling the flow of money from cash rich natural resource industries to new sectors of the economy. Alas, Russian investment banking is becoming both fragmented and monopolized. The quality and availability of financial services for Main Street will deteriorate, limiting the investment and economic growth.

Bloomberg

State controlled Rosneft acquires TNK-BP, a joint venture between a group of Russian oligarchs and BP. The newly formed company will become the largest publicly traded oil producer, controlling up to 50% of the Russian crude oil output.

The major cause of the Soviet Union collapse was the central planning system’s failure to meet even the basics needs of the country’s population. In contrast, the Putin extraordinary popularity rests on the rapid economic growth of 1999-2007, resulted from the market reforms and privatization of 90s.

BP's CEO Bob Dudley finally exits Russia with money

Now the Putin team destroys the foundations of his regime. The de-facto nationalization and monopolization of the energy sector has already cost a lot to the Russian economy. The country’s oil industry rapid rise stumbled after the de-facto nationalization of YUKOS, once Russia’s biggest and most efficient oil company. During the last ten years state-controlled Gazprom, which has an exclusive access to the world-largest natural gas reserves, has failed to develop any new large natural gas field and faced a decrease in production.

Even if they act in the best public interest, government officials have neither instruments nor proper motivation for supervising the sophisticated corporate structures. As a result, the huge cash flows of state-controlled companies become an easy prey for managers and insiders. They make fortunes on generous contracts and illogical M&A activities of such companies as Russian Railways, Transneft, VTB, Gazprom, Rosneft and many others.

When there is little room for further oil price increases, the production growth is an obvious way to sustain the country’s economic development. The energy sector opening to the international majors and private initiative would have brought new tax revenues and prolonged the Putin team dominant position in the Russian economy and politics. However, it looks like the opportunity to get access to the TNK-BP’s multi-billion cash flows outweighs all rational arguments for a new policy in the energy sector.

FT

Novatek's key shareholder Gennady Timchenko knows how to explain the advantages of competition

During the VTB Capital investment forum “Russia Calling!” Vladimir Putin not only criticized Gazprom for corruption, but also stated: “We should change the economy of the company and provide access to transport systems, first of all to gas pipes”.

Russia’s president withdrew his unconditional support of Gazprom at the difficult time for the company. The European Commission attacks the monopoly within an antitrust probe. Igor Artemyev, the long-standing head of Russia’s competition regulator, criticized Gazprom as “an ineffective company” and offered his help to the European authorities. New energy Minister Alexander Novak promised to allow western majors owning oil and natural gas licenses in Russia’s Arctic waters. Meanwhile, Novatek, the second largest natural gas producer in Russia, found a way to export its natural gas, undermining Gazprom’s monopoly on the European market. Gazprom’s margins were simultaneously hit by multi-billion discounts the company had to offer to its largest European clients and almost twofold increase in the mineral extraction tax. The monopoly declares that it will abandon the development of new natural gas fields because of the tax increase, making the government responsible for the projects that Gazprom wasn’t able to develop for many years.

The new tone of the President and bold statements of his ministers might demonstrate the shift in the Kremlin’s energy policy. Though the concept of “energy superpower” maximized Gazprom’s profits in the recent years, it undermined Russia’s energy industry long-term competitiveness at the time of rapid changes in the world’s energy market.

New pragmatic policy has its influential beneficiaries. Among them is Novatek, a raising natural gas producer, where Putin’s old friend Gennady Timchenko owns 25% stake. Natural gas ambitions are also declared by Igor Sechin, another Putin’s old friend and Rosneft’s CEO. In sum, new energy policy will create opportunities for the president’s friends, boost government’s income and, perhaps, improve relationships with the European partners. It remains to be seen whether competition among Putin’s friends is enough to foster economic growth in Russia.

Gazeta.ru

September’s research of Gaidar Institute for Economic Policy analyses the rebound of Russian economy after 2008-2009 crisis. The institute concludes that the economic growth model of 2011-2012 doesn’t work anymore and warns of the threat of a new banking crisis.

Central Bank Chairman Sergei Ignatiev needs to choose between supporting economic growth and preventing banking crisis

Consumer spending was the major contributor to the economic growth in Russia during the last two years. More than quarter of household consumption was financed by consumer credit. However, banks don’t have resources for further expansion. Their clients prefer buying dollars and transferring them abroad instead of depositing money in Russian banks. The Bank of Russia became the major provider of liquidity, but recently it tightened its monetary policy.

The inevitable contraction of consumer credit will lead to the economic slowdown. Furthermore, several indicators point to the mounting risk of a full-scale banking crisis. The share of liquid assets in total banks assets has dropped below the level of September 2008, when a previous banking crisis happened. At the same time the “credit deficit” – the difference between banks’ loans and deposits – almost equals the amount of liquid assets. In sum, Russian banking system is ill prepared for the worsening of economic conditions.

Banks will be one more time bailed out with the government’s funding and boost of liquidity from central bank. However, the loose monetary and fiscal policies won’t trigger the much-needed growth of investments, but will fuel inflation. To speed up the economic growth, the government should commit to structural and institutional reforms, restoring the private property rights and guaranteeing fair competition to all economic agents.

Gaidar Institute

During APEC summit in Vladivostok, Vladimir Putin actively promoted railways as a convenient route for the Asian goods to the European markets: “Baikal-Amur Mainline and Trans-Siberian line allow to halve both cost and time of transportation”.

Old friends always have something to talk about

Meanwhile, the average speed of moving goods by Russian Railways decreased by 10% in 2011 and the monopoly faced numerous charges from its underserved clients. In 2012 it failed to transport flawlessly oil, the major Russian good. In 2003-2012 the total length of the main lines in Russia contracted; no new lines were constructed in 2011. At the same time, the average cost of moving of one tone of goods for one kilometer by railways in Russia is approximately two times higher than the cost of moving goods by railways in US.

However, the company is in good hands. Vladimir Putin’s old friend has been managing the monopoly since 2003 first as a senior vice president and since 2005 as a president. After more than ten years of reforms, the company still doesn’t control its costs, can’t attract private capital and depends on the government subsidies. Nevertheless, the board compensation grew by astonishing 37% in 2011.

The major achievements of the monopoly’s president Vladimir Yakunin are not in the company itself, but nearby. The business of Russian Railways privileged partners is thriving. According to the Reuters Special Report, Andrey Yakunin, the son of Russian Railways president, is one of such success stories. While Vladimir Putin keeps public attention on building new routes from Asia to Europe, his friends are safe to make their business.

US News

Gazprom's CEO Alexei Miller listens attentively to his real boss

Gazprom announced the freeze of its Shtokman project, shortly after Total and Statoil withdrew from the joint venture with the Russian natural gas monopoly.

The de facto cancelation of the ambitious Shtokman project means that in the next twenty years investments will flow into liquefied natural gas (LNG) terminals and shale gas development projects in North America and Europe, not into Russian Arctic natural gas fields. For example, Israel, which just recently discovered a vast natural gas reserves, already on the way to bring them to the market.

Considering Gazprom’s export monopoly and company’s exclusive access to the Russian gigantic natural gas reserves, the company’s top-management (and in fact Vladimir Putin, personally nurturing his favorite “national champion”) bears all the responsibility for the industry’s stagnation in the recent years. In 2000s, Gazprom underestimated the new technologies prospects, namely LNG and shale gas, and put all bets on building pipelines to its traditional European customers. As a result, a natural gas giant is loosing its share of the European market and failed to make any sizeable deals with China, the largest natural gas importer.

A competition of several global companies within Russian energy sector would have helped to avoid strategic oversight. Many natural gas fields could have been brought into operation during the Putin’s decade. Market competition would have provided reliable information about costs and prices in the natural gas sector. The income of a narrow group of shadow beneficiaries of the Russian energy sector might have been lower, but the sector’s output, employment and contribution to the country’s GDP could have been much higher than they are now.

Reuters

Russian GDP contracted by 0.2% in July. In the opposite, inflation picked to 7% on the yearly basis, 1% above the government’s target.

According to Andrei Belousov, Minister of Economic Development, 6% of GDP growth is needed for social stability

New statistics demonstrate that even oil price of $114 per barrel can’t help Russian economy to grow. Within its current economic model, Russia needs not just high oil prices, but constantly growing oil prices. The reason for the July’s GDP fall was the stagnation of the net export and investments, but above all the slowdown of the households’ consumption.

To combat inflation, Central Bank of Russia might raise interest rates thus nocking the economy further down. In its turn, the increased government spending might bring nothing but the spike of inflation. Economy can be in stagflation for quite long before the government dares to break the vicious circle with the painful structural reforms.

However, the July spike in inflation could be caused by the coincidence of several temporary factors such as unusual drought, ruble’s devaluation and the utilities tariffs rise. But the GDP figure is much more serious. Most likely, the government will have to forget about forecasted 4% of economic growth, to say nothing about desired 5-6%, and fight for a mere 2%.

RIA Novosti

Putin boosts pensions at the expense of younger generations

The Russian government failed to deliver a strategy for a new pension reform, missing the deadline set by the President of Russia.

Ministers, responsible for the economic and financial policy, haven’t reached a compromise on the future of the Russian pension system. There is no easy solution to a pension crisis, since Putin has promised not to raise both the retirement age and the mandatory pension contributions while radically increasing pensions.

To resolve the current pension crisis, the government is considering to abandon the mandatory funded pension scheme, introduced only a decade ago. According to Mikhail Dmitriev, the head of The Centre for Strategic Research,  some government officials propose liquidation of non-state pension funds and spending already accumulated savings on current pensions.

The dismantling of the mandatory funded pension system will hit mainly middle class: citizens younger than 45 years with income higher than average. These people live in big cities, rarely vote and are unlikely to vote for Putin and his party anyway.

Since the Russian parliament rubber stamps all proposals of the government, there will be no public discussion of the new pension reform. Non-transparent decision making procedure as well as radical options under discussion will undermine people’s fragile trust to pension system and once again increase risks of investing in Russia.

The Center for Strategic Research

Deputy economy minister Andrei Klepach raised capital outflow estimates

Last week Ministry of Economic Development of the Russian Federation doubled its estimates for net capital outflow from Russia in 2012. The new official forecast is about $50 billion.

Huge capital outflow is not a surprise for Russian economy. The news is the officials’ tone on commenting the issue. Less than two months ago they pledged a capital inflow in the second half of 2012. Now they adopted more gloomy view on the future economic conditions. Wisely enough, the government economists don’t want to be responsible for the country’s inability to attract new investments. External conditions on the global markets and the Russia’s lack of competitiveness almost guarantee stagnation of investments in the foreseeable future.

Deputy Finance Minister Alexey Moiseev explained in his recent interview to Vedomosti, a Russian business daily, that capital outflow is a normal and even positive process. Capital outflow triggers national currency devaluation, which increases the ruble-nominated government’s incomes from export duties and improves the competitiveness of domestic business. In line with that, the Central Bank of Russia recently intervened heavily on the currency market when the ruble was gaining value, but stayed cool when the national currency was falling. In their turn, the market expectations for continuing devaluation stimulate further capital outflow.

Chicago Tribune