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Tuesday, October 23, 2007

Russia Getting Nationalized

// Unlimited Rosoboronexport
Oct. 19, 2007 - Kommersant by Yakov Pappe, Ekaterina Drankina - Rosoboronexport is the federal agency entrusted with ‘pinpoint’ nationalization, while neither industry sectors, nor enterprises, nor grounds, are determined in advance. Consequently, the intermediary in armaments trade is becoming a gigantic multi-profile structure with unclear development logics and unlimited appetites. The cycle’s last article is devoted not to an industry or a sector acting as an object of federal expansion, but to one of its leading enterprises, Rosoboronexport (which is now transforming into Russian Technologies state corporation). Much is entrusted and allowed to it. Besides creating Helicopters of Russia company and participating in the aircraft engine building consolidation, Rosoboronexport’s activity spread onto car building, non-ferrous metal industry, iron industry, and other sectors.
AvtoVAZ: For the Success of a Hopeless Affair
Last five years have somewhat clarified the absolutely vague situation in the car industry. Most enterprises have either disappeared, or started reviving due to the actions of new owners and management or to the partnership with foreign car makers. For instance, Moskvich went bankrupt, while UAZ reached the level of the world’s best producers in car cost-effectiveness. It is still unclear about AvtoVAZ, the Russian car industry’s largest and most complicated enterprise. For many years, the factory surrounded by shadow and overtly criminal structures, having an extremely intricate management and sales system, was losing its positions on the market under competitors’ pressure. Ruble’s depreciation in 1998 gave just a short period of respite to the factory. Yet, that period was not used well. Until recent years, the factory was under indisputable control of Vladimir Kadannikov’s team (Kadannikov was director general, and then the chairman of board). That team possessed a surprising tenacity. Even Boris Berezovsky, whose plans to take over AvtoVAZ went quite far, had to retreat. AVVA (All-Russia Car Alliance) company, which he created, owned AvtoVAZ’ blocking shareholding (32 percent), but eventually became the factory’s subsidiary. Another subsidiary, COAFK (the Automobile Financial Corporation’s Central Department) had been the factory’s large shareholder (20 percent) as well. Thus, the ‘enclosing’ asset ownership scheme, which later became so popular in Russia, was for the first time implemented on a large scale in AvtoVAZ. It was ruled simply: the subsidiaries and the management issued proxy cars to Kadannikov personally, and he voted with the dominating parcel at the board meetings. The system prevented outsiders from getting close to the factory, and secured control for the conglomerate of managers, dealers, and suppliers over the flows of production-generated profits (officially, however, the factory has almost always been unprofitable). Yet, no one spoke of developing or simply restructuring the factory. AvtoVAZ would go bankrupt just like Moskvich, if not for its larger-scale production and a very large, though not transparent, sales and service network. SOK Group of Samara became more and more important for AvtoVAZ with years. It produced car spare parts in its own factories, supplying them to AvtoVAZ and the dealer network, and participated in distributing the produced cars. That fact further complicated the actual relations between the factory’s authority and property. Experts believe that the authorities insistently offered to Oleg Deripaska to take charge of the factory in the early 2000s. However, the businessman chose to ‘save’ GAZ after taking a closer look at the situation. In 2005, Rosoboronexport’s team was entrusted with the anti-crisis work for AvtoVAZ. Formally, it went absolutely simply. AVVA and COAFK issued proxy cards for voting with their shareholdings not to Kadannikov, but to those chosen by the government. Then, a new board of directors and a new management of the factory, already out of Chemezov’s team, were elected in full accordance with the strict corporate procedures. For Rosoboronexport, AvtoVAZ is the first challenge on its new industrial arena. The challenge is difficult, but not too risky. Apparently, if the task is failed – there will be no punishment, because hardly anyone believes in the success. Meanwhile, at least some success will give hope that the authorities might ‘grant’ more interesting assets as a reward. Anyway, there is no reason to decline the challenge: a functioning enterprise of national importance with a nearly $4-billion production generates considerable financial flows even if it is low-effective. So, the matter needed a qualified management team. However, the first two attempts to create that team failed. The first Director General, Igor Esipovsky, was obviously not a large-scale figure enough. The second Director General, Vladimir Artyakov, was promoted to become the Samara region’s Governor. The current president of AvtoVAZ Group is Boris Aleshin, former deputy prime minister, and then head of the Federal Industry Agency. Rosoboronexport head Sergei Chemezov had to undertake the functions of the director board chairman. Certainly, it was impossible to achieve impressive success in just two years with all that management ado. Yet, something has been done. Most odious partners were replaced by more civilized ones. The car lineup is undergoing changes (although according to the former management’s plans). At the same time, the ambitious projects for creating new car models have been suspended. It must be good, because AvtoVAZ has had no opportunities to independently produce a competitive car. The new management also attempted to close down the joint venture with GM, created by the old management on the conditions later proclaimed not profitable enough. After a while, the JV resumed work along new, allegedly better, conditions. Meanwhile, AvtoVAZ is traditionally looking for new foreign partners and new foreign models for assembly work. Magna of Canada is viewed as the main partner now. A car worth under $12,000 is being developed together with the company. AvtoVAZ is also undergoing the first stage of the project aimed at getting rid of the ‘enclosing’ asset ownership scheme. The factory invited Troika Dialog, one of Russia’s stock market leading teams, to help implement the project. AvtoVAZ has already placed offers for buying the shares of the enterprise itself and of its subsidiaries from the minority shareholders. After they are bought out, the subsidiaries will be merged with the parent company. Consequently, their shares will become treasury stock and will be discharged. So, AvtoVAZ will form a normal property structure, while Rosoboronexport and partners will become the official owners of the controlling stock, which will enable the factory to start looking for an important foreign or Russian investor. Also, the current management is not making any extra-ambitious plans now. They admitted it is inevitably necessary to reduce the production of VAZ models, and hope to compensate the production fall by carrying out the assembly of foreign car models in AvtoVAZ facilities under JVs or license agreements. That way seems to be the most realistic one. By the way, Rosoboronexport’s appetites in car industry were not limited to VAZ only. About 2 years ago, the federal agency suggested it should buy out the state shareholding in KamAZ and create a certain unified structure on the basis of the two car industry giants. However, the government delays selling its shares, while KamAZ management headed by Sergei Kogotin is gathering the controlling interest in their hands. However, AvtoVAZ Group’s president Boris Aleshin said several days after assuming office: “I still believe that the merger of AvtoVAZ, KamAZ, and GAZ is an inevitable process.” Yet, Aleshin added right away that “the issue of corporate merger is preliminary yet”.
VSMPO-Avisma: Good Thing, Better Buy it
Apparently, the situation with the world’s largest producer of titanium products, VSMPO-Avisma, is directly the opposite. There is nothing except Rosoboronexport’s private interest covered up by rhetoric in the process of changing VSMPO-Avisma’s owner. VSMPO-Avisma is nearly the only Russian high-tech enterprise which is economically successful and which is the world’s leader in its sector – making titanium products. It is one of the few such producers in the world. Most VSMPO-Avisma’s products are exported, approximately at halves to Boeing and Airbus. By the way, some of their key models, like Boeing 787 (dreamliner), cannot be effectively produced without the supplies of Russian titanium. The enterprise owes its post-Soviet success mainly to its Director General Vladislav Tetyukhin and to Board Chairman Vyacheslav Bresht. They managed to save the production and to establish relations with foreign partners in the period when domestic cooperation in the former USSR collapsed. They also united the two enterprises which existed separately in the Soviet times. First is VSMPO (Verkhnesaldinskoe Metallurgic Production Association, the Sverdlovsk Region). It produces final output. Second is Avisma (of Berezniki town of the Perm Region). It supplies titanium sponge. The tandem’s control over the company was first endangered in 2003, when Renova, controlled by Viktor Vekselberg, began buying up the company’s shares on free market. After two years of counteraction, Tetyukhin and Bresht reached agreement with Vekselberg on ending the conflict and on fixating the status quo: the first two have about 30 percent of shares each, while the third has over 13 percent. At the same time, a ‘Russian roulette’ option was launched. It means each participant can offer to the others to buy out his shares at a certain price. If the other participants refuse to buy, the one who makes the offer acquires the right to buy out their shares at the same price. Vekselberg launched the option in 2006 in hopes that Tetyukhin and Bresht will not find the money to buy out his shareholding. However, they borrowed the sum and bought Renova’s package. Vekselberg disputed the loans’ correctness, unleashing litigation. Here is when Rosoboronexport interfered, saying there is nothing to argue about because it will buy all three packages of shares of the “strategically important defense-industry enterprise”. That is precisely what happened by early 2007. Reportedly, the shareholders behaved differently. Tetyukhin agreed at once and consequently kept his position of director general and 4 percent of shares. Bresht tried resisting, but received a tough explanation that he’d better not do it. Consequently, he seized being the shareholder. Moreover, he received less than the market price for his package. Out of Renova’s package, 2-3 percent went to portfolio investors, and the rest was bought by Rosoboronexport. It now owns 66 percent. There are no economic grounds for nationalizing VSMPO-Avisma. Political reasons are unclear and doubtful. The declared pretext is obviously absurd. On the one hand, there is not an owner capable of depriving Russia of its technologies developed over the years and its competence in the titanium industry while there is stable demand. On the other hand, even with CIS natural gas wars in mind, one should have an over-excessive imagination to think that Russia might someday use titanium supplies to the U.S. and Europe as a political argument. It is also hard to state that Rosoboronexport will make a priceless positive contribution to managing the titanium company. An observer loyal to state regulation might have supposed that Rosoboronexport could secure budget support for expanding the production of titanium sponge, for instance, which is essential for VSMPO-Avisma. Yet, there is no urgent need to draw budget funds here. The company which has export orders until 2030 worth almost $20 billion in total can easily obtain any loans necessary for its technical development.
Special Steel, Composites, Hereafter
Under the same win-win slogan “Everything strategically important – under the state control!”, Rosoboronexport disclosed in 2007 its further plans. First, it wants to create Russian Special Steel Holding, which is to unite Russian producers of special steel and alloys. Alloys are produced by a number of small enterprises independent of major metallurgic companies. Their independence is partially due to the current lack of sufficient demand for alloys, -- neither domestic, nor foreign. However, it must be just temporary. So far, Rosoboronexport managed to gain control over two enterprises: Red October Volgograd Factory and Stupino Metallurgic Production Association. Moreover, the federal agency has officially declared it is interested in Kulebaksky Metal Factory in the Nizhny Novgorod region. Rosoboronexport now formally owns 25.3 percent of Russian Special Steel. Its partners here are Troika Dialog and Red October’s former owners, -- Midland Group offshore of Alex Schneider and Eduard Shifrin. Sergei Chemezov said that after the holding is formed in 2008, Rosoboronexport will own 50 percent, and the rest will be among the former owners of its constituent enterprises. Rosoboronexport needs to take into account two circumstances while estimating the new project’s prospects. On the one hand, the issue of special steel and alloys is becoming important and will remain such for many years more. On the other hand, there are strong competitors. First, it is one of the major metallurgic enterprises Mechel Group, which includes famous Izhstal. Second, it is ESTAR (Electric Steel of Russia) company, created by State Duma deputy Vadim Varshavsky. It includes two special steel enterprises: Zlatoustovsky and Nytvinsky metal factories. Mechel and ESTAR are quite tough competitors, and their positions now look more preferable. However, Rosoboronexport, due to its administrative resource, might eventually become the leader in the sector, either by means of buying most profitable assets from the competitors, or by establishing a certain system of agreements with them. Moreover, Rosoboronexport deserves the credit for having not just the administrative resource, but also a vast experience as trader. As for Russian Composites, Sergei Chemezov said that about ten enterprises will be merged to create it. Rosoboronexport might need luck here: the USSR was behind the developed countries in that sphere, and the last 15 years have not improved the situation. Naturally, it would be wonderful if that lagging behind reduced at least a little. Other projects are at a more advanced stage. For instance, the JV with Inter RAO—Industry and Energy Company, which will supply energy, and TS-aero (Fuel-Filling Airport Service) company, which accumulates fuel in airports. Rosoboronexport’s share is 50 percent in each JV. Besides, it is worth mentioning some subsidiaries of Rosoboronexport’s subsidiary Oboronprom. They are Oboronpromstroi and AutoComponents Industrial Holding. At last, Rosoboronexport also has a blocking package in Motovilikhinskie Factories, the major producer of oil-and-gas equipment and artillery systems. There are rumors the asset will be the first stone in a new holding’s foundation, and the holding will be producing either tank armor or rocket artillery. On the whole, Rosoboronexport’s expansion logic is absolutely unclear for an outsider. Does it exist at all? However, each step looks quite reasonable from the viewpoint of specific short-term interests. Using its administrative resource and covering up by patriotic rhetoric, the agency expands in a growing number of industry sectors. Consequently, it is transforming into something like multi-sector tycoon groups of Russia’s 90s, state industrial holdings in some west-European countries of the mid-20th century, and the Soviet heavy industry ministry of the 30s. Chemezov is now changing the name and the legal status of his empire. In late September, the president is to introduce to the State Duma the law on creating Russian Technologies state corporation. It will be a non-commercial organization which will also include Rosoboronexport itself and the assets it now controls. It is hard to tell yet what this shift of dress will bring. However, the new name and status formally justify the acquisition and the following sale of any assets, maybe except for just the Big Theater. Beside the economic risks accompanying a holding like that, there also are some dragon’s teeth hidden there. In fact, the Russian state is not strong enough yet to create super-powerful structures subject neither to economy legislation, nor to the country’s government.

IMF Forecasts Global Economic Downturn

IMF Managing Director Rodrigo de RatoOct. 23, 2007 - Kommersant - Lower housing prices in the United States and malfunction of financial markets may result in the global economic downturn, IMF Managing Director Rodrigo de Rato warned Monday when speaking before the Board of Directors. ”We still do not know the full effects of the decline in the housing market and the subprime problems of the US economy. Further disruption in financial markets and further falls in housing prices could lead to a global economic downturn,” de Rato said. The existing risks will pose even the greater threat if a new crisis is triggered, the official cautioned. ”Some emerging economies that have relied on external financing to fund large current account deficits could be tipped into crisis by a combination of reduced demand for their exports and tighter financial market conditions," the official said, specifying that prospects of low-income countries would worsen as well. Another risk, de Rato went on, is that the central banks may falter when opposing the inflation that is accelerating in the states because of the higher crude and food prices. “All of these risks make action on already agreed policies more urgent,” de Rato said, emphasizing that the leading nations should acknowledge that the mere changes in exchange rate wouldn’t suffice to correct global dis-balances.

Friday, October 19, 2007

Crisis in Russian-U.S. relations spells trouble for Europe

10/17/2007 - MOSCOW. (Nikita Petrov for RIA Novosti) - In some respects, the current crisis in Russian-U.S. relations is reminiscent of the October 1962 Cuban missile crisis, when the Soviet Union had deployed nuclear-tipped missiles in the immediate proximity of the U.S. borders. However, U.S. President John F. Kennedy and Soviet leader Nikita Khrushchev managed to reach a compromise at the last moment, preventing an all-out nuclear war. This time, Washington has decided to deploy 10 Ground-Based Interceptor (GBI) missiles near Warsaw, the capital of Poland, and a 360-degree X-band radar not far from Prague in the Czech Republic, that is in direct proximity to Russia. Last week, U.S. Secretary of State Condoleezza Rice and Secretary of Defense Robert Gates visited Moscow and negotiated with President Vladimir Putin, Foreign Minister Sergei Lavrov and Defense Minister Anatoly Serdyukov in the two-by-two format. But, just as analysts had predicted, the talks did not produce any substantial results. It is obvious that the Bush Administration will not renounce the missile defense program aimed at shielding the United States and Europe from so-called "rogue states." Moscow argues that Iran will not develop ballistic missiles capable of hitting North America and most European countries in the next 20 to 30 years. Washington is unconvinced. At a recent summit with George W. Bush, Vladimir Putin proposed that the United States use Russia's Daryal early-warning radar in Azerbaijan and the Voronezh-M facility, now being constructed near Armavir in the North Caucasus, in place of the Czech radar. U.S. experts who have assessed the Gabala radar's potential know that it completely scans Iran and several other regional countries, and are ready to use this facility, but they insist that it be included in the European missile-defense system. Moscow cannot agree to this because it is convinced that the interceptor missiles and the Czech radar are intended to impair the Russian nuclear deterrent by shielding Europe from the Topol, Topol-M and RS-18 (SS-19 Stiletto) inter-continental ballistic missiles deployed in the Tver, Ivanovo, Kaluga and Saratov Regions of Central Russia. It is clear that 10 GBI missiles would not stop a retaliatory strike in case of war. But the United States cannot guarantee that it will not deploy additional missile interceptors and early-warning radars. Moreover, Washington is hinting that it will expand, beef up and overhaul the European missile-defense system. This would directly threaten Russia's security and defense capability. The Russian leadership has repeatedly warned the United States and its allies that it would be forced to respond to the deployment of U.S. missile-defense elements in Europe, and that it would retarget ICBMs against installations it identifies as potential threats. Moscow could also deploy Iskander-M theater-level missiles near the Polish border. Last week, Vladimir Putin told Condoleezza Rice and Robert Gates that he was quite worried about the future of the 1987 Soviet-U.S. Intermediate-Range Nuclear Forces (INF) Treaty, which must assume a global nature. The Russian leader said this objective must be accomplished because Moscow would otherwise find it difficult to abide by the INF Treaty's provisions at a time when other countries, including those in direct proximity to Russian borders, were actively developing similar weapons systems. Military experts understand that Russia may withdraw from the INF Treaty banning nuclear-tipped missiles with a range between 500 and 5,500 km, if the United States goes ahead with its plans. Consequently, Washington and the European Union are facing the prospect of another era of nuclear confrontation. The 38-day Cuban missile crisis was a critical moment in the nuclear arms race and the Cold War. At the time, the world was tottering on the verge of an abyss. Soviet and U.S. diplomats, politicians and generals realized that it was pointless to hold each other hostage, and that both sides would have to negotiate on all pressing issues, and avoid using military force. The events of October 1962 paved the way for detente and convinced both countries that they were mutually vulnerable and must therefore reduce strategic offensive arms. In the long run, Moscow and Washington signed a number of arms-control agreements, including the history-making Anti-Ballistic Missile (ABM) Treaty in 1972. Unfortunately, the present-day conflict was triggered by the Bush Administration's unilateral decision to withdraw from the ABM Treaty. However, any confrontation similar to the Cuban missile crisis would lead both countries down a blind alley. Mutual security interests simply cannot be disregarded. The White House would make a mistake if it tried to engage Russia in a new arms race in order to undermine its economy. Moscow now has enough weapons for a cheap and asymmetrical response to current challenges. No one would profit in the event of such confrontation; and Europe would be the main loser if Russia withdrew form the INF Treaty and retargeted its nuclear-tipped missiles at U.S. missile defense elements in Europe.

Thursday, October 04, 2007

The Times Gave Floor to Western Admirers of Putin

Oct. 04, 2007 – Kommersant - Britain’s The Times released an article, Vladimir Putin Rescured Russia from Disaster: So Let’s Just Leave Him Be, on October 4. The author is Norman Stone, once the professor of Modern History at Oxford, and now the head of International Relations Department at Bilkent University. Similar to most observers worldwide, Stone stakes on Russia’s current prime minister as Putin’s successor, predicting that Putin will remain influential in time of the nominal president. Putin is finding a way to hang on to power, Stone wrote. “He can put himself forward as deputy for the reigning party, then become prime minister, and push forward, as nominal president, a man in his mid-sixties whom he can control,” Stone predicted, pointing out that this practice would hardly be new for Russia and emphasizing that Putin “has been a very successful leader of the country.” ”Not so long ago, Russia was being written off,” Stone said. Nowadays, however, the reality is different, and not only thanks to skyrocketing prices for crude but also because of Putin’s policy, which, amid other things, ensured the economic upturn and stabilization of the situation in Chechnya. ”So if Putin thinks that he has done well by his country he is not wrong, and masses of ordinary Russians agree. Now, Russia is recovering, and is back on the world’s stage. Why should a successful president be held back by some constitutional formality?” Stone posed a rethorical question. Stone reminded that referendums were held in former republics of collapsed Soviet Union for successful and popular presidents to stay in office and advised to Putin not to fear the criticism of Europe.

Net private capital outflow from Russia in 3Q07 hits $9.4 bln

MOSCOW, October 3 (RIA Novosti) - Net private capital outflow from Russia in the third quarter of 2007 totaled $9.4 billion, the Central Bank of Russia said on its Web site Wednesday. Net capital outflow from companies in the non-financial sector was at $10.1 billion in the reporting period, while net capital inflow by banks was $0.7 billion. In the first quarter of the year, capital inflow was $13.5 billion. In the second quarter, net capital inflow hit a record $52.7 billion, with banks accounting for $36.8 billion and the non-financial sector $15.8 billion. Net private capital inflow in the first nine months of this year was $56.8 billion. Net private capital inflow in 2006 was $40.1 billion, as compared to $0.1 billion in 2005. Prior to 2005, private capital inflow was negative

Wednesday, October 03, 2007

Oil for Food

Sep. 24, 2007 Kommersant by Sergei Minaev - International oil prices set a new record last week, exceeding $81 per barrel. Just like in the 1970s when oil grew in price for the first time, Russia increases oil export and exchanges petrodollars for import. Russia has been among the oil extraction world leaders since the very beginning of oil extraction. The first oil deposit was discovered in Pennsylvania in 1859. U.S. oil extraction reached 1 million metric tons annually by 1873. Extraction in the Caucasus (including Baku deposits) reached the same level in 1889. By 1904, 6 million metric tons annually were being extracted in Pennsylvania and 5 million tons annually – in the Caucasus. However, oil export was not the basis of tsarist Russia’s economy. Oil was used just for producing kerosene, and was relatively inexpensive on the international market. In the 1930s, rich oil deposits were discovered in the Middle East, primarily in Saudi Arabia. They were developed by U.S. companies. Yet, the USSR remained an important oil-producing state as well. Moreover, the Bolsheviks gave considerable attention to increasing the oil extraction. “The foundation for a new powerful oil base was created in the area of the Ural range – in the Ural region, Bashkiria, and Kazakhstan,” said Joseph Stalin at the Communist Party’s 17th congress in 1934. However, oil export was not the basis of the Soviet economy then, primarily because oil was still cheap on the world’s market, which U.S. companies saturated with Saudi Arabian oil. Only after the Arab oil embargo in 1973 had oil become a desired and expensive product. Saudi Arabia speedily nationalized the oil extraction industry, and everything changed for the USSR. In 1960, Soviet oil production made up 3.1 million barrels daily. In 1978, the USSR became the first oil power in the world, leaving the U.S. and Saudi Arabia behind, and extracting 11 million barrels daily. The development of West Siberia’s oil-and-gas deposits played the key role in that process. Between 1976 and 1980, “the Siberians, inspired by the Party’s appreciation, […] more than doubled the extraction of oil (including gas condensate), and increased the natural gas extraction by 4.3 times, committing one more heroic deed for the motherland’s sake,” said Nikolai Tikhonov, chairman of the Council of Ministers, at the Communist Party’s 26th congress in 1981. “Extraction of oil (including gas condensate) in the north-west of Siberia made up 31 million metric tons in 1970, while it exceeded 312 million in 1980. In the same period, natural gas extraction grew from 9.5 billion to 156 billion cubic meters,” said the Communist Party Central Committee’s Secretary General Leonid Brezhnev. One third of the extracted Soviet oil was exported. Yet, it was rarely exported to Socialist states: they could pay only by low-quality consumer goods, and not by convertible currency. Petrodollars received from capitalist buyers became a real basis of the Russian economy. Moreover, the rise of oil extraction strengthened the USSR’s credibility. Western creditors reasoned that the oil extraction world leader, which is also a totalitarian state, cannot fail to pay its debts. The USSR began experiencing difficulties with the fall of international oil prices in the 1980s. Consequently, the entire Socialist economy went downhill. “Oil extraction industry, especially in West Siberia, needs considerable improvement. The region should provide two thirds of the USSR’s oil extraction by the end of the five-year period. Failures in that sector caused difficulties in the economy. The Oil Industry Ministry, GlavTyumenNefteGaz and its enterprises turned out to be unprepared for working in the circumstances of lowering well flow rates at large oil deposits. It is necessary to overcome the current retardation as soon as possible. The party and the government gave considerable aid to oil producers. The success now depends on the ministry’s organizational work and its determination to unconditionally implement the tasks […] and on mobilizing staff teams. Local party and administrative bodies are to play an important role in securing the planned amounts of oil extraction,” said Nikolai Ryzhkov, chairman of the Council of Ministers, at the Communist Party’s 17th congress in 1986. The party and administrative bodies obviously failed the task, and the USSR collapsed. It is not that petrodollars were not counted on in post-Soviet Russia of the 1990s. Oil remained the most important export product. Yet, it became clear that petrodollars will not last forever. The year of 1998 confirmed it, when international oil prices fell down to $10 per barrel. A new era of high oil prices began after 1999. Oil prices grew by more than thrice between 1999 and 2007. The prices reached almost $80 per barrel in 2006. Last week, they topped $81. Russian authorities proudly pointed out the success of oil extraction and export. At the OPEC conference in Vienna last week (where the cartel decided to expand production by 500,000 barrels daily), Russia’s Deputy Minister of Industry and Energy Andrei Reus said that Russia raised oil extraction up to 480.02 million metric tons last year, and became the first in the world by the amount of oil production. Compared to the previous year, the growth made up 2.1 percent. Oil extraction in Russia grew by 2.9 percent more in the first seven months of 2007. Reus said that Russia now refines 46.2 percent of extracted oil and gas condensate on its own territory. At the same time, the Federal Customs Service announced that oil export from Russia to non-CIS states grew by 4.4 percent in January-July 2007 and made up 128.4 million metric tons. The oil price reached $474.7 per metric ton in June, kept growing and made up $507.1 per ton in July. The volume of oil products export to non-CIS countries increased by 3.1 percent in the seven months of 2007, as compared to January-July 2006, including the export of jet fuel (grew by 25.4 percent) and of residual oil (grew by 10.3 percent). The cost and volume of oil export to CIS states increased by 10.1 percent and 14.7 percent accordingly in January-July 2007 as compared to the same period of 2006. The volume of oil products export grew by 78.8 percent, including the export of car gasoline (by 69.8 percent), of jet fuel (by 75.6 percent), of diesel oil (by 61 percent), and of residue oil (by 3.2 times). The USSR’s transition to oil-based economy in the 1970s caused considerable import growth. For instance, most modern equipment was bought. However, that equipment could often be found rotting away in the backyards of Socialist enterprises; but some part of it was used. For instance, it is owing to the 1970s oil boom that Russia now has telephone connection (the multiplex equipment was bought from Finland). Bread import began back in the 1960s (a special foreign trade enterprise with a misleading name ExportKhleb [ExportBread] was created for that purpose). However, really large supplies of grain were secured by expensive oil: cereals and grain legumes worth $1 billion in total were bought from the U.S. in 1977, and the USSR spent $1.7 billion on it in 1978. Very often, Soviet citizens did not know that the basic food products like raw meat (if it somehow appeared in stores) were of foreign origin and were acquired by means of exporting oil that drastically went up in price. When international oil prices fell, the import fell as well, leading to empty stores in the period of the USSR’s collapse. The monetary-financial crisis of 1998 also led to a catastrophic decrease in import. However, now it is all right both with oil export and with the inflow of imported goods, due to the current growth of international oil prices. The Federal Customs Service’s latest data says that Russia increased goods import from non-CIS countries by 49.7 percent, up to $101.055 billion, in January-August 2007, as compared to the same period of 2006. Goods import from non-CIS states grew by 32 percent in August 2007, as compared to August 2006. In comparison to July 2007, import grew by 2.4 percent, or by $358.1 million. For instance, the import of raw sugar grew by 16.8 percent up to 2.316 million metric tons in the seven months of 2007: $732.1 million (instead of $835.5 million last year) was spent on sugar. All sugar was imported from non-CIS states. White sugar import made up 81,500 metric tons worth $39.1 million (instead of 65,600 tons worth $29.6 million a year before). Import of frozen and fresh meat to Russia grew by 20.6 percent (up to 746,200 metric tons) in January-July 2007, as compared to the same period of 2006. The total cost of purchases made up $1.825 billion (instead of $1.214 billion a year earlier). In non-CIS states, 724,800 metric tons of meat were purchased, worth $1.767 in total. Fish purchases made up 438,600 thousand tons worth $709.4 million (337,200 thousand tons worth $466.3 million a year earlier). Just like in the 1970s, the authorities avoid underlining the fact that Russia’s economy is more and more built on the principle “more expensive oil in exchange for import, including food”. Moreover, the current authorities copy their Soviet predecessors in saying that it is necessary to develop most modern types of industrial production and to create Russia’s own high technologies. However, Russia’s import is growing so rapidly that the authorities have to mention it sometimes. Then they directly point out the import’s positive impact on the economy: foreign goods influx allows filling Russia’s growing consumer market, satisfying the growing investment and consumer demand, tightening the domestic market competition, and slowing down inflation in Russia. For all these blessings, Russia should thank the international oil market.
A lot has been done to get away from the dependence”
President Vladimir Putin: “Oil prices certainly have impact on Russia’s economy. You know, it was created not by us and not in recent years. It was created by the entire history of the Soviet Union’s economy development… Yet, a lot has been done in the last year-year and a half to get away from the dependence. In fact, the tax sphere underwent revolutionary changes. The economy was liberated from red tape. Other market laws were adopted. I think they gave a good momentum to the economic growth.” (November 11, 2001, at a press conference with representatives of Moscow offices of U.S. mass media). Prime Minister in 2004-2007 Mikhail Fradkov: “The country’s economic potential is strengthening… The oil-and-gas sector’s contribution to the growth of Russia’s economy will be decreasing, and that of machine-building, communications and science – increasing. The economy should go towards diversification.” (August 17, 2006, at the government’s session). Deputy Prime Minister Alexander Zhukov: “The dependence of Russia’s economy on world oil prices is becoming weaker. Economic growth is more and more linked to the inner economy’s development, to the growth of citizens’ incomes.” (August 27, 2006, at a press conference). Economic Development and Trade Minister German Gref: “New tasks set to the Government include diversifying the economy and achieving rapid economic growth by means of the diversification, despite the current international oil prices.” (September 11, 2006, at the international economic forum in Kazan). Finance Minister Alexei Kudrin: “Russia’s economy is now less dependent on the international oil prices’ fluctuations. Before, oil price growth by $1 or by $10 seriously affected Russia’s GDP. The GDP fell when oil prices fell. The dependence is less now. We are building our own financial system, less dependent on oil.” (April 23, 2006, at a briefing in Washington). Head of the President’s Expert Department Arkady Dvorkovich: “Russia’s dependence on oil prices is strongly exaggerated, and will be decreasing with each year. Just a quarter of Russia’s economy growth was secured by means of favorable oil prices last year. The growth was also due to the development of Russia’s financial market, services sphere, and to the increased activity of Russian and foreign investors. Even if oil prices fall drastically, there are no grounds for a crisis in Russia.” (May 28, 2003, at a press conference).

Monday, October 01, 2007

Russia Beginning To Feel the Heat

Jeroen Ketting © Moscow News09/27/2007 – Moscow News By Rebeccah Billing Sustaining economic growth in Russia cannot be achieved through oil and gas export revenues alone; Russia is currently three to five times less efficient in its energy usage than Western European neighbors, with increasing economic implications. As a land swamped with natural oil and gas resources it is understandable why energy efficiency has not been high on the agenda for Russia. But it seems that the country's complacency in this area could soon come back to bite it. Russia's domestic fuel consumption is steadily increasing in step with the rise in GDP. Thus, in order to meet both its domestic needs and its export obligations, urgent action must be taken in the Russian heat and power sectors. But although the need for change is great, the incentives remain low; competition between companies involved in energy generation, distribution and consumption is weak and the government strictly regulates pricing. One company trying to make headway on the challenging issue of energy efficiency in Russia is Lighthouse Energy Investments (LEI). The Moscow News talks to its director Jeroen Ketting.
MN: What made you set up this Dutch-Russian joint venture? What business potential did you recognize in Russia? Ketting: I looked around at the situation in Russia and I saw that Russia uses three to four times more energy per produced dollar of GDP than other industrialized countries, and industrial production and thus energy consumption is increasing. But 50 percent of industrial equipment installed is old and inefficient and the energy infrastructure (generation and distribution) is deteriorating. Moreover, Russia has a lot of gas and oil reserves but its capacity to produce and to transport oil and gas are limited. With increasing domestic and international demand and with existing export commitments Russia's energy household is stretched to its very limits.  Plus tariffs are increasing. This means that there is an increasing margin and need for energy efficiency in Russia; increasing demand, stagnating supply, rising tariffs and inefficient generation, distribution and consumption. When you combine that with the rising tariffs the financial argument to save energy becomes stronger and stronger.
MN: Russia has copious energy resources and enjoys the status of a major global supplier of fuel and energy, but does it recognize the necessity to devote more attention to enhancing energy efficiency?  Ketting: Energy efficiency is a political issue of minor priority. This means that formally the government recognizes the need for enhancing energy efficiency but in practice very little effective action is undertaken. Also among big business the need for energy efficiency is not sufficiently recognized. In a country where money is easily made selling off national assets on the cheap the understanding that a ruble saved is a ruble earned is still far away.
MN: What do you think about the efficiency of Russia's home utility services (ZhKH), particularly in the heat consumption segment? There is definitely a lot of room for improvement in this area. What concrete steps do you think should be taken to optimize it? Ketting: The efficiency in the heat segment of Russia's ZhKH can be improved considerably. About 80 percent of all gas fired boiler-houses, producing heat, operate at between 60 percent and 80 percent of their capacity. Due to poorly maintained heat transportation and distribution networks, another estimated 30 percent of generated heat is lost during transportation to the end user. But also on the side of consumption there are great inefficiencies. Just consider in how many apartments people still open or close their windows in wintertime to regulate the temperature. In this area there are a number of concrete steps that could be taken: on the side of consumption: individual metering, thermostatic radiator valves, insulation of apartments and control and regulation of heat within apartment blocks.  On the side of Distribution we need to replace all substations, reduce water leakages, insulate distribution piping and introduce variable flow pumping. In terms of generation: boilers need rebuilding along with other measures. Regulations also need to be radically revised so that consumers pay on the basis of actual consumption, tariffs are improved and there is liberalization of the market. There also needs to be a creation of fiscal incentives at the consumer level and of legislative framework favoring energy efficiency and energy saving in the entire energy value chain.
MN: Tell us a few words about the major projects you have executed for ZhKH. Ketting: Lighthouse Energy Investments initiates, funds and manages medium-sized energy efficiency investment projects in Russia. We capitalize on the considerable potential for energy savings and resulting financial gains in Russia. In the area of ZhKH Lighthouse initiates, operates and finances decentralized heat and power generation projects for industrial end users of heat and Municipal District heating companies. Recently, LEI built a privately owned 2.2 Megawatt boiler house in a municipality of the Moscow region. With this boiler house LEI generates heat that it sells to the local district heating company. LEI is also involved in energy efficiency projects and energy performance contracting. The main aim of energy performance contracting is the implementation of the whole spectrum of energy-saving measures on a long-term contractual basis between the client and LEI whereby the latter's profit is an agreed percentage from the total amount of the saved energy resources. Lighthouse also works with large Russian gas distribution companies to reduce natural gas leakage from the gas distribution stations in the gas distribution network.
MN: How economical and mindful of energy-saving policies are Russia's heat generation companies? Have you been approached for advice or assistance by some of them in order to optimize their operations? Ketting: As I explained, the heat generators in Russia do not operate in the most economical way imaginable. Most of the district heating companies (DHC) depend to a large extent on municipal budgets and cannot operate independently financially. Top management of these DHCs are often political appointees with little understanding of the specific business they are in. Interests are short-term or at best limited to the moment of the next elections. But occasionally we are approached by the DHCs for assistance. 
MN: You conducted a major survey for International Finance Corporation to identify investment opportunities in energy efficiency in Russia. What were the main conclusions you arrived at after studying the market? Ketting: Energy efficiency saves money and resources, increases living standards and reduces environmental harm. More importantly, it is relatively cheap, creates immediate results and does not offend any high level business or political interests. The need and potential for energy efficiency has been recognized by as well the EBRD as the IFC. Both IFIs have earmarked considerable resources that can be invested in energy efficiency. The IFC aims to encourage investment by providing financial institutions with roughly $100 millions for loans to companies investing in energy efficiency. The EBRD directly invests in large scale energy efficiency projects.
MN: You have also been active in the Joint Implementation project as part of fulfillment of Russia's obligations under the Kyoto Protocol. Could you brief our readers on the project and your company's role in it? Ketting: The Kyoto Protocol is an agreement under which industrialized countries will reduce their collective emissions of greenhouse gases by 5.2 percent compared to the year 1990. This may not sound like a lot, but remember that, compared to the emissions levels that would be expected by 2010 without the Protocol, this limitation represents a 29-percent cut. The goal is to lower overall emissions of six greenhouse gases: carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, HFCs, and PFCs - calculated as an average over the five-year period of 2008-2012. National limitations range from 8 percent reductions for the European Union and some others to 7 percent for the United States, 6 percent for Japan, 0 percent for Russia, and permitted increases of 8 percent for Australia and 10 percent for Iceland. One of the projects we are involved in concerns a DHC that after investing in the improvements listed above can sell Emission Reduction Units within the system of the Kyoto Protocol. Another project aims to reduce the leakage of methane from a large gas distribution network. However, in Russia the legislative and institutional framework necessary for the proper implementation of projects under the Kyoto protocol is not yet in place.

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