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Monday, April 17, 2006


The Russian economics ministry today submitted for government consideration a bill to cut development taxes in key resources. While the measure covers mining, logging, and other earthen riches, it is particularly aimed at the all important and ever aging oil industry.

The bill will introduce tax holidays for companies developing new deposits, and major privileges for those working on depleted deposits, in a bid to avert a medium-term production decline in industries that provide much of Russia's budget revenues, particularly the oil and natural-gas sectors. "The bill has been agreed with all the agencies involved and sent to the government for consideration," a ministry spokesman said.

The reduction in oil and gas production growth from 7 percent per year from 2000 to 2004 to this year's rather anemic 2 percent growth is reflective of a sea-change in the character of Russian production: from the relatively easy oil of the Volga-Ural and West Siberian basin to the much more difficult deposits in Russia's offshore Arctic regions and in East and Far East Siberia. Russian oil and gas revenues account for 25 percent of the Russian federal budget (see page 9 of the Gazprom 2004 Annual Report for a peculiar graphical presentation of the importance of oil and gas to Russian finances).

However, Russia may have waited too long to begin developing the latter this difficult these remote riches. Major oil and gas projects -and the pipelines to serve them- are developing slowly and in need of huge capital outlays. By cutting development taxes, Russia hopes to speed the time to market of these hard to access oil and gas deposits. The oil industry and the federal budget are in a race against time.

Thursday, April 13, 2006


Back finally from a long break, and much indeed has happend. One of the most interesting issues in Russian political economy to track is the ever-evolving relationship between statism and free-markets. The history of Post-Soviet Russia revolves largely around that single theme. From mass-privatization through vouchers, 'Loans for Shares', and the Rubble collapse to the destruction of Yukos and the recentralization of the oil industry, Russia has struggled mightly to figure out what level of state involvement in the economy will provide a stable balance of order and freedom.

An interesting wrinkle on this theme has emerged recently regarding Russian entry into the World Trade Organization that reflects Russia's ambivalent position regarding the importance of free markets. According to this piece in the Moscow Times, a tacit quid pro quo has developed linking U.S. company involvement in the development of the giant Shtokman gas field to progress on a U.S.-Russia WTO deal:

Two sources who spoke to senior Russian officials said the implicit quid pro quo has emerged in the last month. "My discussion with Russian officials has clearly suggested that while there is no formal connection" between WTO accession and participation of U.S. companies in Shtokman, "there is an informal understanding that if Russian membership in WTO is blocked, it would be considerably more difficult for American companies to win participation in Shtokman and other major Russian energy projects," said Dmitry Simes, head of the Nixon Center, a Washington-based think tank.

My sense is that while Russia would prefer to be a member of the WTO, it is not willing to trade too much for the honor. It will also be happy to punish companies from countries unhelpful to its cause. My sense is also that the U.S. is playing politics on this one as well. The Bush administration has been very aggresive in many instances to isolate Moscow (with the notable exception of its soft-pedal on Chechnya), and it may feel that it can leverage concessions in Central Asia by playing hardball on trade.

Monday, March 20, 2006


With presidential elections in Russia now just two years away, Russian press is rife with speculation about who will take over the presidency from Putin. The press has dubbed the Kremlin’s efforts to promote a likely candidate as ‘Operation Successor’. As I tried to get a take on this political operation of sorts, several key points have become clear.

First, opposition parties seem to have become irrelevant in Russia’s current political landscape. Second, it is almost unanimously believed that Putin will be able to choose his successor. Third, the traditional conflict between Russia’s liberals and hardliners seems to have faded somewhat, and will not be determinative in Putin’s preference for the next president of Russia. Fourth, despite the fascination in both the Russian and international press with the idea that Putin could somehow stay in power after his two terms are up, Putin himself has shown little interest in engineering such an outcome. Fifth, there is nearly as much speculation about what role Putin will play in Russian politics after 2008 as there is speculation about his likely successor. Sixth, Dmitry Medvedev seems most likely at this point to become the next president of Russia.

  1. Opposition parties have become largely irrelevant in the face of Putin’s popularity, and there seems to be little concern that the absence of a vibrant opposition could be detrimental. In local and regional elections last weekend, Putin’s United Russia won 197 out of 359 seats in regional legislatures. The remaining seats were distributed among dozens of small national and regional parties.

Opinion polls similarly indicate that Putin’s United Russia party has few viable rivals. In October 2005 a poll showed that of the 37 parties registered in Moscow, only 17 will run in the next Duma elections, set to take place in December 2007. However, only five of them have a real chance to overcome the 10 percent threshold to serve in the body, and it is possible that only three will end up with seats. According to a poll taken last month, if Duma elections were held in February, 47 percent of the country would have supported the United Russia party, 17 percent would have supported the Communist party and just 9 percent would have voted for the conservative Liberal Democratic Party. The nationalist Motherland Party and the liberal Yabloko Party polled just 4 percent each.

The outlook for the opposition in the 2008 presidential election is even bleaker. When queried about their choice for Russia’s next President, 6 percent of respondents said they would vote for Communist Party leader Gennadi Zyuganov, 3 percent for Liberal Democratic Party leader Vladimir Zhirinovsky, 3 percent for former Prime Minister Mikhial Kasyanov, and just 1 percent for Sergei Glaziev from the Motherland Party.

Clearly, Putin’s United Russian party is in a position to retain power in the 2007-2008 federal elections.

  1. Putin is widely, if not unanimously, perceived as Russia’s kingmaker. Putin received over 70 percent of the vote in 2004, and he still enjoys immense popularity. Putin is perceived as a decisive and pragmatic leader –especially in contrast to his predecessor, Boris Yeltsin—and he is credited with improving the nation’s economy while still protecting Russia’s traditional spheres of influence in Central Asia and Eastern Europe. This perception will certainly increase if, as seems likely, the Orange Revolution in Ukraine is overturned this month in federal elections there and the pro-Russian candidate Viktor Yuschenko wins the presidency.

Speculation in Russia is thus not about who will win the presidency, but rather about who Putin will choose as his successor.

  1. The conflict between the liberals and siloviki, while still important, does not, at least yet, seem to be a driving force behind Putin’s choice of a successor. Since his election in 2000, Putin has had to balance two primary forces within the Kremlin, the pro-Western, liberal reformers, who are largely comprised of the nation’s oligarchs and business tycoons, and the siloviki, the nationalist faction made up of military leaders and former KGB. Putin has maintained the peace by drawing both advisors and policies from both camps. Moves toward greater economic participation with the West have satisfied the oligarchs, while policies to counter U.S. influence in Central Asia and an aggressive stance vis-à-vis Chechen militants have mollified the latter.

Putin’s recent appointment of Dmitry Medvedev and Sergei Ivanov as deputy Prime Minters was largely seen as reflective of this balancing act. Ivanov, who retained his post as Defense Minister, gives the siloviki a powerful promoter the government. Medvedev, who retained his chairmanship of state energy giant Gazprom, is a pragmatic reformer along the lines of Putin.

The appointment of the two officials was also believed to reflect Putin’s preference for who might succeed him as president. Neither Medvedev nor Ivanov has a natural political constituency and their appointments are considered ‘trial runs’ at leadership and an opportunity to gain a wider following. The youthful Medvedev (he is only 40 years old) especially has lacked the capacity to gain a public following from his prior position as head of the Presidential administration in the Kremlin. Although prime ministers in Russia are more managers than executives, the two presidential hopefuls will have an opportunity to involve themselves much more extensively in domestic issues than was previously possible.

However, both candidates are pragmatists in their support for the liberals and siloviki. Neither is an ideologue and either would likely be acceptable to liberals and siloviki alike. As long as Ivanov and Medvedev are the presidential front-runners, the schism between the two groups will not be determinative of which receives Putin’s eventual support.

  1. There is very little talk of a constitutional amendment to allow Putin a third term. Putin has said nothing to suggest he supports such a measure. Absent a constitutional amendment, there has been some speculation that a reunification of Russia and Belarus could provide the structural conditions for Putin to assume the presidency of such a new federal structure, although the unification itself seems unlikely, and the terms under which that unification could take place extremely speculative.

While unrelated to the issue of Putin retaining the presidency, there is also interesting speculation that Putin may resign just prior to the December 2007 Duma elections in order to combine the parliamentary elections with the Presidential elections scheduled for March 2008. This would help ensure that United Russia wins both the majority in the Duma and the presidency. The other oft repeated argument for this move is that it would be seen in the West as a boost for democracy in Russia.

  1. The question of what position Putin will have after 2008 is the subject of nearly as intense speculation as the question of who will succeed him. Because the Russian political system –partly as the result of Putin’s own reforms—gives such a preponderance of power to the president, no other political position seems powerful or substantive enough for Putin to assume and retain influence. Putin himself noted at a press conference recently that the post of Prime Minister in Russia is a technical position and should remain that way. He further noted that successful development of Russia’s economy necessitates a dominant executive branch.

While many have speculated that Putin could head Gazprom after he leaves the presidency, this speculation seems more driven by the media’s fascination with both Putin and Russia’s business elites than anything else. Putin himself, trained as a lawyer, says that in neither character nor training does he feel himself to be a businessman.

There has also been some speculation that Putin could head the Russian Supreme Court in order to help bolster legal institutions in the country. While such a position might be a better fit to Putin’s formal education, it is difficult to imagine that heading up the 19 member body would befit someone whose tenure as President has been marked by selective application of the law to achieve political ends (as in the Yukos case, for example).

It seems most likely that whatever position he takes up after 2008 will be one from which he can still exert influence on Russian political and economic development –assuming, that is, that his choice for President is elected and is willing to govern in cooperation with Putin’s powerful influence.

  1. Given all these factors, Dmitry Medvedev seems like the obvious front-runner to succeed Putin. Like Putin, he is an economic liberal with a pragmatic conception of the role of state power in the evolving capitalist landscape in the country. As Chairman of the Board of Gazprom, he has both a clear conception of the importance of the oil and gas sector to the state, and also of the role that the state plays in economic development of the nation. His appointment as first deputy Prime Minister late last year affords him to gain the one thing he is missing –a public and popular persona. The first deputy Prime Minister is in charge of agriculture, education, and social programs, issue which will allow him –given sufficient state support—to become widely recognized as not only an oligarch, but also someone who has a clear sense for the condition and needs of ordinary Russians.

Medvedev also is said to be modest in his aspirations, making it more likely that he would be willing to govern in cooperation with Putin’s continued presence in the Russian political scene. Putin seems to have made the selection of Medvedev more likely by his recent criticism of the military’s failure in several high-profile army hazing cases. These comments make less likely that the other Presidential front-runner, Sergei Ivanov, could gain the popular support necessary to take the presidency.

The first 15 years of Russian democracy have been tumultuous ones, made more placid in the past several years by booming oil revenues. Should those fortunes reverse, either through a collapse in oil prices or a precipitous decline in Russian production, the popularity of Putin and his ability to prosecute ‘Operation Successor’ could diminish as well.

Regardless, the development of Russian capitalism and democracy still faces immense challenges. The next Russian president will face a daunting civil and political landscape. As one Russian commentator recently noted:

People see clearly that they are robbed at privately-owned as well at state enterprises (being underpaid as much as three or four or even five times). They still demand not fair collective agreements and worthy salaries, not improvement of working conditions, but a free ticket, free medicine, cheap gasoline, costless accommodation, a hotel voucher to a sanatorium. Judging by the questions and wishes, put forward by the citizens in spite of almost 15 years of adopting capitalism, we mostly remain ‘Soviet people’ that construe the government as the large ‘Social Provision Department’, and the president as a ‘do-gooder’.

Tuesday, March 14, 2006


Russian Energy and Industry Minister Viktor Khristenko lent an interesting insight yesterday into Moscow's thinking on the role of the state in Russia's energy sector. Responding to U.S. Deputy Energy Secretary David Sampson's contention that the state's hand in the sector was hampering Russian supply growth, Khristenko said:

Market reforms are not an end in themselves, but an instrument to raise the efficient and reliable function of world energy. . . . An inalienable part of that process is the regulatory role of government in . . . eliminating the risks of energy insecurity.

Russia in particular needs both foreign capital and technical assistance to explore and develop frozen reserves in East Siberia and the Arctic. Russia's recentralization of the oil industry, however, isn't helping that cause. There is significant uncertainty in the investment community about just what the 'rules of the game' are for foreigners looking for a piece of Russia's large energy pie.

Russian online news service Kommersant summed up Khristenko's comments at the conference thus:
According to Khristenko, an alternative to competition of energy strategies could be “establishing a global system of power engineering, which will ensure the stream deliveries of energy to the population worldwide at the economically reasonable prices.”

Therefore, Russia’s proposals to the G8 summit could be as follows. Russia doesn’t think it is possible to improve the out-of-balance condition of the energy demand/supply through some private companies. Instead, it calls for introducing regulative actions of the state. The biggest consumers and producers of energy resources are expected to provide the state guarantees to each other concerning coordination of mutual interests. The interests of national companies should be naturally taken into account.
It is hard to fathom what Khristenko might mean by "establishing a global system of power engineering" but I bet it goes over like a lead balloon at the G8.

Monday, March 13, 2006


While the forced renationalization in December 2004 of Yukos’ Yuganskneftegaz was the loudest (and messiest) of the Kremlin’s push to gain control of Russia’s oil industry, it seems to be part of a still ongoing trend. It will be instructive to review the bidding on just where the renationalization plan stands, and where it may go next.

Following the collapse of the Soviet Union, enterprising and opportunistic oligarchs moved quickly to secure control of Russia’s major oil producers, combining them with the refining assets that had served the companies during the communist era. A cadre of powerful conglomerates took control of the country’s oil exploration and production, including Yukos, Lukoil, Sibneft, Slavneft, Tynumen Oil Company (TNK), Slavneft, Surgutneftegaz, Tatneft, and Bashneft. Only Rosneft remained in the state’s portfolio.

The country’s dominant gas producer, Gazprom, and its pipeline monopoly, Transneft, also remained in state hands. However, it is not surprising that these latter two entities remained in Kremlin control. Two-third’s of Russia’s enormous gas production is used for domestic consumption. In order to manage important subsidies of natural gas to Russian customers during the tumultuous decade after the collapse of the Soviet state, it made good sense for Gazprom to remain an arm of the state. Similarly, given the importance of Russia’s pipeline system for oil and gas exports -and the importance of oil and gas exports to the Russian economy- it made sense to keep Transneft in state control as well.

When the Kremlin moved in late 2003 to dismember Yukos, the consensus view was that it was for political, not economic, reasons. Yukos founder and CEO Mikhail Khodorkovsky had made little secret of his political pretensions and Russian President Vladmir Putin acted swiftly and brutally to quash his would-be rival by levying over $30 billion in back taxes. Khodorkovsky now languishes in a Siberian prison camp, while Yukos’ major production asset, Yuganskneftegaz, auctioned off at price well below its market value, is now owned by state oil firm Rosneft.

Yukos’ remaining production assets have been struggling to cover the rest of the tax burden, and until last week it seemed that the trimmed down company might survive. With its politically dangerous founder in prison, the company appeared to be of little threat to Putin. Last week’s events, however, make clear that the Kremlin won’t rest until the company is fully dismantled. If bankruptcy proceedings against the company commence, it is likely that even more of its assets will end up in state control.

The Kremlin, however, has also moved –albeit more civilly- to control other important oil assets. While the government’s plan at the outset seemed to be to incorporate Yuganskneftegaz into Gazprom, thereby giving the gas behemoth significant pull in the oil industry, the move failed for a variety of political and legal reasons. However, in October 2005 Gazprom purchased Sibneft, Russia’s fifth largest oil producer. Combined with Gazprom’s original oil assets, the purchase turned the gas company into a significant petroleum producer. Between Rosneft (including Yuganskneftegaz) and Gazprom (including Sibneft), the Russian state controls the country’s second and fifth largest oil companies, as well as the 50 percent of Slavneft owned by Sibneft.

Russian Oil Production in January and February 2006 (million tons)



















*State owned company

The state, however, may not be stopping there. Rumors have surfaced recently that Rosneft may be eyeing a purchase of Surgutneftegaz, Russia’s fourth largest oil conglomerate. The company has long had close ties with the Kremlin and would integrate relatively easily into state run Rosneft. While Rosneft is cash-strapped following its purchase of Yuganskneftegaz, it is planning later this year to go public in Russia’s largest ever IPO. The offering is expected to garner as much as $17 billion for the company. What better to do with cash on hand than purchase another oil major. The a Rosneft-Surgutneftegaz combination would put the company far ahead of Russia’s current leading producer, Lukoil.

In addition, the Kremlin is also rumored to be interested in taking control of Slavneft and the half of TNK-BP held by Alfa and Access/Renova. While no concrete plans for takeover have surfaced, the prospect is clearly worrying to those who fear increased state dominance over the oil industry. If both of these moves come to pass, the state share of Russian production would be truly immense.

What effect these moves would have on Russian production is unclear, primarily because the future character and stability of the Russian state is unclear. The prospect of Russia wielding its oil power similarly to its wielding of its natural gas power is undoubtedly unsettling to Russia’s primarily European customers. On the other hand, future Russian production may depend on development of risky and expensive projects in East Siberia and the Arctic shelf. To the extent that the state is capable of longer time horizon’s and greater capital commitment to such projects, Russian dominance may turn out to be beneficial in the long run.

Regardless, the coming year will tell us a lot about the future of Russia’s oil industry and thus about the Russian state.

Saturday, March 11, 2006


A strange scene unfolded Friday in the Moscow boardroom of OAO Yukos, once Russia’s mightiest oil conglomerate. Anatoly Nazarov, head of Yukos Refining and Marketing and the most senior manager remaining in Moscow (most of the team is safely ensconced in London), told a stunned management assembly that he was siezing control of the company and would no longer take orders from Yukos CEO Steven Theede.

According to a letter obtained by the Moscow Times, Nazarov told employees that the company was on the verge of bankruptcy, which, of course, came as news to no one. Yukos has been staving off bankruptcy since it was dismembered by the Kremlin in 2004. However, the letter went on to say that the company had been hit by a number of new court cases recently, which showed that “Yukos was constantly under attack by raiders of all flags.” Nazarov urged employees not to forget that “we live and will live in Russia, and should carry out our work only in a legal framework, not forgetting the interests of society, the state and the company.”

While Nazarov failed to elaborate, the cryptic claim concerning foreign flags may have been a reference to a suit filed Friday with the Moscow Arbitration Court by a group of foreign banks to declare Yukos bankrupt. Yukos owes the group of lenders approximately $480 million.

Nazarov’s move came amidst a widening company investigation in which Stanislav Vinokurov, head of Yukos’ domestic sales and financial arm, Yukos Trading House, was fired on suspicion of arranging unauthorized discounted sales to an unnamed third-party trader. The sales reportedly cost the company $50 to $100 million. When Theede directed Nazarov to appoint a Theede loyalist, Roman Khomenko, as the new head of Yukos Trading House, Nazarov refused. Instead, Nazarov rehired Vinokurov, promoted him to first Vice-President, and staged his mutiny.

But it gets worse. Khomenko on Thrusday was being questioned by Russian prosecutors as part of a “widening criminal investigation” about which no details are available. Yukos Chief Financial Officer Frank Rieger, currently in London, was issued a similar summons last week but is afraid that a trip to Moscow may lead to his arrest. A company source said Vinokurov's father was a senior Federal Security Service officer in Samara, and suggested Nazarov was trying to gain protection from the FSB in return for reinstating Vinokurov. Several other Moscow based managers have been issues summonses as well.

Yukos said that company management is reviewing the situation and will make a final decision soon on how to handle it. Yukos’ website makes no mention of the affair, but a webpage on company management updated last week bears an ominous message. “Under Construction.”

Wednesday, March 08, 2006


Cambridge Energy Research Associates (CERA) is well known for its optimistic production and reserve assessments. So what do they make of the decline in Russian production growth from the 8.5 percent mark achieved from 2000 to 2004 to last year’s 2.5 percent growth? They attribute the slowdown to the demise of Yukos, the “forced sale” of Sibneft to Gazprom, and high taxes on Russian production.

Konstantin Kovalenko, a research associate in CERA’s Moscow office told Petroleum Economist this week that between 1998 and 2004 Yukos and Sibneft output increased by 92 percent and 96.5 percent respectively. Following the forced transfer of Yukos main production asset Yuganskneftegaz to state owned-Rosneft and the purchase of Sibneft by state owned Gazprom, production the two companies’ output declines contributed 55 percent to the overall drop in Russian production growth. In Sibneft’s case, once the state’s purchase plan became clear, Sibneft cut back on investment in new fields and withdrew large amounts of money in dividends.

The other primary cause for Russian production growth declines is the steep tax scheme levied on Russian production. The Russian state takes a cut of about 50 percent in production and export taxes on revenues above $25 per barrel. However, the rate rises to two-thirds when the price hits $50 per barrel. According to Kovalenko, “90 percent of everything above $25 per barrel goes to the government.”

While the investment climate and taxes can no doubt did have a significant effect on production, the CERA analysis (at least as described in the Petroleum Economist article) doesn’t quite tell a complete story. Left unclear is whether or not Yuganskneftegaz’s production actually fell, or was simply transferred to Rosneft’s ledger. To the extent that the latter is the case, the dissolution of Yukos would not explain Russian decline.

As far as taxes go, the explanation makes sense only if the tax rate was revised upward to the current high levels in 2004; otherwise the taxes themselves wouldn’t explain the decline. Some other variable must be at work to explain the change.

All this is not to say, however, that Russia wouldn’t do itself a huge favor by ceasing its predatory accumulation Russian oil assets and revising taxes to make production more lucrative. Death and taxes may be certain, but they are no friend to production growth.