CoD: Putin speaks in Munich

President Putin spoke at the 43d International Conference on Security in Munich, lashing out at the US foreign policies. In his opinion, 'almost all the legal system of one state, first of all certainly that of the United States of America, has stepped over its national borders to be imposed on other states in all the spheres - in economics and in politics and in the humanitarian area.' He urged Western politicians 'not to pose as Lord God'.

Putin's talk was provocative, but it has come in the specific context. First, it occurred before his visit to the Middle East, with expectations to restore Russian positions in this territory and to build new alliances - to which a sparkle of anti-Americanism could greatly assist. Second, the US itself has been making steps that could be seen at least as 'unfriendly' (if not hostile) by Russian community, recently naming Russia among the potential enemies of the US - before this statement, the possibility was kept in mind, with NATO expansion to Eastern Europe and FSU countries, but it was never admitted openly. Third, and probably most important, the self-repositioning of Russia as an 'energy superpower', and proper steps such as renegotiating terms of supplying Europe and renationalizing oil&gas companies, brought the country under the severe fire of critique. Putin administration may have decided that 'attack is the best defence', and so attacked the US for its world policies.

I will not argue whether or not Russian repositioning is appropriate - although it probably is, for the country that lost its political, economic, cultural and military weight, can use the main lever that remains, the terms of supplying its highly-demanded energy resources. Using this lever, Russia now tries to climb back to where it were, maybe not as a world superpower, but at least as a regionally significant power - that cannot be but annoyed by attempts to deprive it of what still its in its domains, e.g. its influence on its close neighbours such as Ukraine. In fact, the US pushed too far - it either had to destabilize Russia to the extent where it ceased to exist when it could in early 1990s (but then the US would have to deal with the zone of tremendous instability in a quarter of Eurasia) or it has to admit that Russia has its right to influence the region (simply because of its size and resource endowment). Now Russia regains its lost legacy, and this will not come without pains, though not another Cold War of course. Putin's speech calls to accept this process.

But there is another dimension to the Munich demarche. I think it is very important what Putin did last Saturday. In fact, he broke tacit rules of diplomatic talks, when things are never called what they are. By passing away the ritual of diplomacy, Putin created a new situation, when political statements can be made frankly (bluntly, as Gates said), at least for a while. He created a situation of institutional disequlibrium so to say, when old communicative formats and templates are no longer acceptable, and new ones have not been formed yet.

This disequilibrium is of course a threat, calling for a stereotype response in the Cold War manner, which many old school politicians still will be able to revoke. It is, however, also a tremendous opportunity to reformat relationships. The US and Europe have to agree that Russia these days is no longer a weak and disoriented state as it were after the collapse of the Soviet Union. They have to accept new role of Russia - its growing wealth, its increasing political power. They also have to accept that the present President, and the policies that he implements, is a consensus of elites. There is a new situation in Russia, and it calls for the new attitude towards Russia, and new communicative formats with Russia. I expect that the US and Europe will be sufficiently sophisticated to get the message, and that it will spin some new common formats.

NoD: Russian Internet Booming

The Russian digital content market reached US$1.7 billion in 2006, a consulting company J'Son & Partners said in recent report (Russian Digital Market Report 2005-2010) based on research conducted in the last quarter of 2006. The company predicts compound annual growth rate (CAGR) of 29 percent and market volume reaching $4.8 billion by 2010.

According to J&P, the growth of content market is driven by the double-digit growth of broadband and Internet, retail development with more and more stores selling digital content, strong growth of digital pay-TV and the high sales in 2006 (more than 50 million units) of digital devices including VAS-enabled handsets, mp3-players, consoles and consumes electronics devices such as computers, set-top boxes, DVD-players etc.

The year has been succesful for major Russian players. Yandex, the leading Russian search engine, have announced their preliminary financial results for 2006. Revenue is reported to total $72m (USD), more than double that reported for 2005.

The Public Opinion Foundation estimated that Internet penetration in Russia increased to 26 million people by year end, placing it ahead of Italy and France among European countries.

Why it is important: one of the fastest growing sectors, where Russia still has a chance for international leadership.

CoD: Russia's New Economic Doctrine

President Vladimir Putin on Tuesday urged big businesses to diversify away from oil and gas and focus more on value-added products, and he pledged to help Russian firms expand into foreign markets. He said that the time has come to expand the participation of our enterprises in international cooperation and the realization of serious commercial initiatives abroad.

President meeting with big businesses is a usual annual political event in the official timetable since Boris Yeltsin settled to meet with leading Russian oligarchs. Of course they have a flavour of a well-defined ritual, but in a Byzantine-like political life one has to look cautiously for hints. During one of these meetings, four years ago, sparks of conflict between the then-richest-man Michael Khodorkovski and President Putin showed that Kremlin is ready to wage a war that resulted in renowned Yukos deal.

Putin's reign, or whatever one calls his time in power, owns its success to rocketing oil prices. As prices tripled from the start of Putin's presidency, extra gains allowed to postpone painful structural reforms in social sphere, and to delay the necessary diversification of economy. Instead, the vast USD100bln Stabilization Fund has been created which will provide the authorities with an airbag in case oil prices drop, allowing them to postpone these reforms even further.

In fact, inabilty of the current administration to move away from Russia's heavy dependency on oil&gas exports, has been called one of the major failures of Putin's policy. Two main heritages of Soviet era, the enormous defence industry and the country's dependency on oil exports, have created serious economic imbalances that retarded the development (and even provoked recession) in 1990s. Dismantling of the defence industry in early 1990s was swift and painful. Unlike that, oil&gas bloomed - and they did so even more during first half of 2000s.

The recommendation of Putin is hardly a wishful thinking alone. Recent steps of his administration indicate that resources industries, especially oil&gas, are likely to remain, or become, national. He indicates that the private capital can focus its attention on processing and consumer industries: perhaps the balance between state and private businesses has finally been found, with the latter focusing on more dynamic and competitive sectors - where slow-moving state will be unable to compete.

Many will argue, but I view this tendency positively, and I think that this talk of Putin will have its consequences. Large business is pushed out the fattest sectors, but it will look for new harbours and this will help to develop processing industries in rapidly-growing Russia. Government, given this new drive, will be provoked to develop initiatives supporting diversification. Russia finally gets chance to become a more diversified, a leaner, a more up-to-date, processing economy, and not a world's 'resource appendage' as some use to call it.

NoD: Gazprom gets the largest Russian coal company

Gazprom and the Siberian Coal Energy Company (SUEK) signed a letter of intent to form a joint venture to combine their electricity and coal assets. The deal is planned to be coordinated and finalized in the first half of 2007, with Gazprom receiving 50% plus one share and SUEK 50% minus one share in the JV.

The partners intend to work out a detailed strategy for the new company, aimed at establishing it as one of the leaders of Russia's electric power sector, and putting it in leading positions in the world's energy and coal-producing industry. The projected establishment of a JV with SUEK is another step towards Gazprom's establishment as a global multi-profile energy company. The activities of the new venture will also become an important factor for the development and modernization of Russia's coal industry. SUEK is Russia's largest coal miner, accounting for some 30% of energy coal deliveries on the domestic market, and around 20% of the country's coal exports. SUEK is also one of the biggest private shareholders of Siberian and Far Eastern energy companies.

Why it is important:
1. Gazprom confirms its ambitions to become the national champion in integrated energy supplies.
2. This step can be de facto nationalization of the leading coal player and the largest private investor into power generation.

CoD: Russia imposes limits on foreign investments

The Russian Cabinet of Ministers gave tentative approval to a long-delayed bill restricting foreign participation across 40 industries that the government deems strategic, including energy and metals. Investors and analysts cautiously welcomed the proposal, which would for the first time establish the rules under which foreigners will be allowed to invest in strategic projects.

The Federal Security Service will be one of the agencies that will screen foreign bids. The bill would allow the government to reject foreign bids for stakes of more than 50 percent in Russian companies across 40 sectors that have "strategic importance for national security." The president would retain the right of veto in certain cases.

Industries are in eight categories, related to military, space and "special" equipment, metals and alloys, aviation, nuclear energy, natural monopolies and significant deposits of mineral resources.

The recent cases such as pushing British Petroleum subsidiary out of Kovykta gas field, or pushing Shell, Mitsui and Mitsubishi out of Sakhalin-2 gas field, have been seen as scandalous in the West. Obviously, following its changed doctrine of national security, Russian government decided to deprive multi-national companies of their leverages upon Russia. As deals such as Sakhalin-2 were struck during 1990s, they were signed on terms evidently disadvantageous for Russia - and it would be surprising if Russia were not to renegotiate them at some point.

This ground is well understood, but the way transactions were handled was hardly appropriate. I already commented on the abuse of 'environmental' argument. Russian government need to call duck a duck, and to call renationalization what it is. Russia had to put formal regulations for the things that already occur. Investors are comfortable once they know the rules; they cannot play by the rules modified any time - this makes their time horizon short, and their behaviour predative, and this is exactly what Russian government tries to confront. So the list of restrictions should be highly welcomed, as long as it does not change too often.

NoD: Interros owners to split assets

Two owners of the US$15 bln worth holding decided to split their assets.

Mikhail Prokhorov will resign as CEO of Norilsk Nickel and divide his assets in holding company Interros with longtime business partner and Interros president Vladimir Potanin, Interros said Wednesday. Prokhorov, who should pocket $7.5 billion from his Norilsk shares alone, said he intended to create an electricity holding that would be part of Interros. Potanin will buy out Prokhorov's blocking stake in Norilsk and other assets within Interros to ensure "a new level of freedom in carrying out executive decisions," Interros said in a statement. It was not clear who would replace Prokhorov at Norilsk, but Potanin would be the de facto head with a stake of around 55 percent. The statement said Potanin had been nominated to the company's board of directors.

Prokhorov said he "seriously" intended to apply himself to the business of traditional and alternative electricity production. A 35 percent stake in a U.S.-based producer of electric fuel cells, Plug Power Inc., will go to Prokhorov as part of the split, as will Smart Hydrogen, a joint alternative-energy venture between Norilsk and Interros.

Prokhorov was famously engaged in the recent scandal in the Alpine ski resort, when police taken him into custody for investigation of the suspected prostitution ring. This could be one of the reasons which triggered separation between Prokhorov and Potanin, as the latter tries to maintain his image of a respectful businessman.

Why it is important: Along with the recent split of assets in US$8 bln worth MDM Group between Andrei Melnichenko and Sergei Popov, this sets an interesting trend for crafting new ownership structure in Russian large-scale business.

NoD: Tehran proposes Russia to make 'gas OPEC'

Russia spent last year strenuously denying reports that it was participating in the creation of a cartel of gas suppliers to the EU. Now, however, the idea has received an unexpected boost from Iranian leader Ayatollah Ali Khameni at a recent meeting with Russian Security Council secretary Igor Ivanov.

Commenting on the message sent to him by President Putin and the idea of partnership between Russia and Iran, the ayatollah unexpectedly initiated a discussion of creating a "gas OPEC ." "Our two countries, in helping each other, can create an organization based on cooperation in the gas sphere, along the lines of OPEC," the Iranian state news service IRNA quoted Ayatollah Khamenei as saying. IRNA did not report Mr. Ivanov's answer, and there is a reason for that. The idea of a "gas OPEC" is explicitly Russia's, but Russia consistently denies reports that the Kremlin has plans to create a cartel uniting the countries that supply gas to the EU .

A cartel would be minimally profitable for both parties, especially for Gazprom. At the present moment Iran supplies practically no gas to the countries of the European Union and to the EU's neighbors; the only country in the region currently receiving minimal supplies from Iran's gas network is Turkey. The majority of Gazprom's supply links with key countries in the EU, including Germany, France, and Italy, are through long-term contracts in which the price of the gas is pegged to the price of oil. Controlling gas prices through a pricing cartel would be effective only if the EU follows through on its threat to limit future long-term contracts.

An energy union cum geopolitical alliance of Russia, Iran, and Algeria does appear to be in the works. The possible liberalization of the EU's gas market has the potential to be used to exert pressure on Russia, in which case Russia could hit Europe back with the threat of a gas cartel as a warning not to step too far out of line in its struggle against the westward expansion of Russia's gas empire.

Why it is important:
1. A potential for powerful restructuring re one of the most important fuels of 21st century.
2. Potential closer alliance between Russia and Iran, which is geopolitically important in the view of unfolding conflict between the US and Iran.

CoD: Corruption in Russian Central Bank

Kommersant, Russia's leading paper last week published a letter in which a Russian banker Alex Frenkel, charged with ordering the killing of a senior Central Bank regulator, accused the CB of accepting bribes for entering banks into the deposit insurance system.

Frenkel accuses that the Central Bank has been abusing law on protection from money laundry and terrorist financing. The main statements of Frenkel are that:
1. Central Bank of Russia (CBR) differentiates between various commercial banks, selectively including some of them into the national system of deposit insurance and effectively eliminating others.
2. Doing so, CBR acts highly selectively, using the vague legislative grounds. Moreover, CBR disregards higher authorities, e.g. decisions by the court, when applying money laundry law to eliminate lawful banks that attempt to go against its authority. Central Bank argues that other authorities are ‘insufficiently competent’ to understand its grounds for judgment.
3. Thus, CBR actually only imitates fighting with ‘money laundry’.
4. This situation has been created by CBR on purpose. It is a consequence of illegal activities of certain CBR personnel.
5. In the short term, CBR officials are interested to control markets that very much specific to Russia, e.g. market for ‘cashing’ (converting money from accounts into banknotes).
6. In the long term, the scheme may also be inspired by foreign banks that interested to seize Russian banking market. In order to ‘clean up the space’ for their entry in the next few years, CBR has to make global impression that Russian banks are generally ‘dirty’. This will allow Central Bank to keep the society and the government out of its activities

Russian banking system is one horrible place. In 1990s, it served mostly as ‘deep pockets’ of then oligarchs that wanted to transfer money more securely from/to their industrial assets. In 2000s it started slowly to build up its retail services, although the progress was slowed down by definitely low trust of population (resulting from poor experiences in 1992, 1998, and 2004, years of banking crisis). However, competitive-wise, the banking system hardly stands the chance against large international banks.

Notably, many of my familiar bankers confirm that allegations of Frenkel are mostly true, at least in terms of the way in which scheme is crafted. The market for specific transactions such as money transfers abroad or ‘cashing‘ is enormous. There are parties that would be interested to control such markets. Of course authorities in charge know everything, and of course they understand that many of these activities are not really illegal, they are just poorly regulated. Being concerned more with personal well-being than with public good, and operating in the sphere that is poorly understood by common public, such authorities would use

However, the statement that the scheme is truly inspired by Western banks is doubtful. This is a risky move (in terms of reputation) for foreign bankers that will be able to capture this market anyway within next few years, as Russia will join WTO.

An interesting aspect: could this set of allegations come not as a banker’s protection, but as an attack on the Central Bank? Many of current events in Russia can be seen in terms of battle for power between different ‘clans’ from St. Petersburg. Sergei Ignatiev, head of CBR, belongs to the same group as Anatoly Chubais – and it may well be that other parties would like to weaken their position and take over the strategic spot in the Central Bank. This could be especially important in the view that the Central Bank controls an enormous US$ 90 bln Stabilization Fund of Russia – and it is more than simply a political question where the money could be invested.

NoD: Russia will eliminate intermediates in energy supply

Russia will expand its oil-and-gas transporting network to reduce its dependency of energy-transiting countries, President Putin said after his meeting with German Chanceller Angela Merkel. Conflict with Ukraine over price of gas in late 2005, and conflict with Belarus concerning gas and oil transition and gas prices in 2006, have put under threat the provision of secured energy sources from Russia to Europe. Russia will speed up in laying underwater pipes to Germany and pipelines to the Pacific ocean that will allow it to ship fuels directly to its consumers. Germany, which is also a Chairman in EU and G8 this year, confirmed that it is ready to support these projects to eliminate dangers related to renegotiation of supply terms with countries such as Belarus.

Further last week, Tranneft claimed it is ready to build an oil pipeline bypassing Belarus with an annual capacity of 50 million tonnes. The proposals were submitted to the government in early January, when Russia stropped transporting oil via Belarus. Last year, 78.8 million tonnes of oil was piped via Belarus to Europe, while another 20 million tonnes were supplied to Belarusian oil refineries. From Russia, oil passes to Belarus via the Unech station on the two countries' border. According to Transneft source, the company offers to build a northbound oil pipeline from Unech along the Belarusian border via Velikie Lugi and then to Primorsk. According to industry watchers, the project cost will be around $2-2.5b.

Why it is important: Russian expansion to foreign energy markets will not be contingent upon its closest neighbours. For the sake of its energy security, the EU is ready to leave Russia with larger lever upon Ukraine and Belarus.

CoD: Gazprom pushes TNK-BP out of Kovykta

Russia's environmental watchdog has found violations by a subsidiary of oil major TNK-BP that controls the licence for the massive Kovykta gas field in Siberia, the Kommersant daily reported. Last year, TNK-BP subsidiary RUSIA Petroleum extracted only 33.8 mln cubic metres of the nine bln cubic metres of annual gas extraction required by its licence, Kommersant said. TNK-BP is 50-pct owned by British oil major BP and 50-pct owned by Russia's Alfa Access Renova. The paper cited a source close to the deal as saying that Gazprom wants to acquire a 74.4 pct stake in RUSIA Petroleum. Currently RUSIA Petroleum is 62.4 pct owned by TNK-BP, 25.8 pct owned by the Russian group Interros, and 11.2 pct by the administration of Irkutsk province, where the field is located, the paper said. Kommersant said TNK-BP wanted to retain 33 pct of RUSIA Petroleum.

Environmental allegations have become a powerful tool for Russian authorities, used as a leverage when ownership is renegotiated. The recent acquisition of control stake in Sakhalin-2 from Shell and Japanese companies was one example when this tool was applied succesfully.

There are several issues which I would say are is problematic in this respect.

First, real concerns for environment are undermined by this practice. Technologies, whether in energy, mining, or processing industries, were always environment-unfriendly in Russia. By closing eyes on most environment damaging cases such as in plants across Ural, and applying environmental laws selectively whenever the government wants to get its share in energy-related projects, the Russian government shows that environmental problems are interesting only whenever they can be used as casus belli, as a reason to wage war. Any actions of environmentally concerned activitists will be seen in this frame.

Second, just because 'everyone is guilty' in terms of environmental violations, the government shows that it can find its reasons to renationalize any asset it finds interesting. Practices applied selectively, such as with Yukos blamed for tax payment violations, or with Shell and TNK-BP blamed as environment law violators, will act to the further detriment of trust in Russian business environment. It appears that robber entrepreneurs of 90s had the most appropriate strategy for Russia, stripping assets of anything valuable and rarely investing.

Finally, as I already have suggested, this is just another evidence that Gazprom becomes more powerful than the government itself. Acts pushing foreign investors so violently out of most profitable projects may be to the company's current interest, but obviously against the interest of the country. That Russian authorities are not concerned with country's reputation and perception of such deals inside the country itself is to me a sign that the state is getting run in the interest of Russian energy giant, not vice versa.