The Moscow Times
Thursday, Apr. 15, 2004. Page 201

Russia Revising Great Game Rule Book

By Catherine Belton
Staff Writer

To hear President Vladimir Putin tell it, the great game of the 21st century
is economic in nature and Russia intends to change the way it’s played.

Putin made the rules of this new game clear in December, when he told the
nation that the greatest danger facing Russia is a weak economy.

“Our biggest threat is falling behind in the economic field,” Putin told the
country in his annual teleconference. “There is a tough, competitive battle
going on in the world. But unlike previously, this battle has moved from the
realm of military conflict to economic competition.”

In this chess game, like those of the past, energy is king. But this time
Russia is exploiting its prowess like never before.

On the eastern front, it has Japan and China locked in a bidding war for
Siberian oil, while in the west it has Europe struggling to deal with its
dependency on Gazprom’s gas, and in the south it is slowly extending its
electric tentacles through state power monopoly Unified Energy Systems.

But what is emerging as a sort of “Putin Doctrine” doesn’t stop there. It
seems to envision Russia as the pivot around which the global oil market
revolves, the power broker that can tip the balance between OPEC and the
United States. And it seems to call for the rapid international expansion of
patriotic companies — both state-owned and private, energy and nonenergy.

In this quest, Putin appears to have the backing of big business.

“If you don’t compete globally, then you are definitely going to lose,” said
Kakha Bendukidze, board chairman of United Heavy Machinery, the nation’s
largest machine-building concern and one of its leading multinationals.

“If you don’t move into foreign territory, global competitors are only going
to come to your market and try to compete with you there,” he said in a
recent interview.

Business leaders, however, are divided over how best to get there — whether
Putin’s way, which emphasizes the might of the state, or a freer market
approach might be better.

But at this stage the debate is meaningless. Thanks to a new and pliant
parliament, and the October jailing of Mikhail Khodorkovsky, Putin, unlike a
year ago, holds all the cards.

Indeed, some see the arrest of Khodorkovsky as part of Putin’s wider
development strategy.

Although the charges against the billionaire were fraud and tax evasion,
some say it was his attempts to challenge the authority of the state that
got him in trouble, particularly his efforts to break the government’s
pipeline monopoly.

By pushing for the building of privately owned pipelines — one directly to
China and another to Murmansk to better supply America — “Khodorkovsky was
pursuing a set of interests … that was a threat to Putin’s state policy,”
a senior U.S. administration official said in an interview in Washington
earlier this year.

In addition, the official said, Khodorkovsky’s attempts to merge his oil
company Yukos with smaller rival Sibneft and then sell a chunk of that
company to a U.S. supermajor like ExxonMobil would have made him
“untouchable.”

“Fundamentally, this was a question about power,” he said. “What
Khodorkovsky was proposing presented problems for both foreign and domestic
policy. … State control over pipelines was both a domestic and foreign
policy lever.”

Now, however, all talk of building private pipelines — or even of selling
an equity stake in a major Russian oil producer to a U.S. company — is
taboo.

“This is not the scheme the United States wants to see,” said Julia Nanay, a
senior energy analyst at Petroleum Finance Corp. in Washington. “It would
like to see lots of private companies, private pipelines and more exports.”

It is worth noting, she said, that since Khodorkovsky’s arrest conditions
have gotten worse for U.S. oil majors that already had a foothold in Russia
— especially ExxonMobil, which lost its license to the giant Sakhalin-3
field late last year.

“All this sees to be eroding the U.S.-Russia energy dialog,” Nanay said.

While these developments may be bad news for Washington, which is anxious to
reduce supplies from OPEC, they have increased Russia’s clout on the world
stage, analysts said.

Playing Both Sides

Strengthening ties with the Arab world while not completely alienating the
United States is a tough task, but it’s one that Putin appears to be
attempting.

In the past, much to the satisfaction of the United States, Russia and OPEC
have been at odds. While Russia has been cranking up exports at breakneck
speed, OPEC has been doing just the opposite, arguing that it needs higher
oil prices to compensate for the United States’ decision to depreciate the
dollar.

But now, in what may turn out to be a pivotal policy shift, Russia appears
to be winding down its export drive. Last month Economic Development and
Trade Minister, German Gref, boldly stated that 2004 would be the last year
of major export growth for the foreseeable future.

Gref said exports will likely surge 14 percent this year to 266 million
tons, but after that growth will be minimal, around 2 percent per year for
several years to come.

Such a move would endear Russia to OPEC and the entire Arab world, analysts
said.

Many analysts expect OPEC to come under increasing pressure over the next
few years as instability in the Middle East grows and individual members
such as Venezuela and Nigeria are pressured into leaving.

So, by reducing export growth, Russia could help the cartel survive, said
Alfa Bank chief strategist Chris Weafer, a former adviser to OPEC who
retains close ties to the organization.

What’s more, Weafer said, by deliberately slowing down exports over the next
few years, “the entire Arab world will see Russia as a significant ally and
Russia’s political influence in the Arab world will increase.”

Russian oil majors are already capitalizing on the warming ties. LUKoil in
January became one of a handful of foreign firms to gain the rights to
develop a potentially huge gas field in Saudi Arabia. Notably, no U.S. firms
were awarded the same rights, as they are reportedly finding it increasingly
difficult to gain a foothold in the kingdom.

Oil Is Not Enough

At the same time Russia is attempting to maximize its oil clout, it is
making an aggressive attempt to grow other sectors of the economy and help
its captains of industry gain strategic positions on global markets.

“I think there is a gradual revolution taking place in foreign economic
relations,” said Bendukidze. “There is a growing recognition in the Foreign
Ministry and in the Economic Development and Trade Ministry that they need
to support Russian businesses abroad, including attempts to make investments
outside Russia.”

One recent development that could ease the way for global expansion is a new
law that simplifies rules for transferring cash out of the country for
investment purposes. The law, which Bendukidze helped draft, will come into
force this summer.

The move could help speed up the global expansion of companies like
Severstal, which recently snapped up Michigan-based steelmaker Rouge
Industries for $286 million, and Norilsk Nickel, which at the end of last
month made the biggest foreign acquisition of any Russian company to date —
its $1.16 billion purchase of 20 percent of South African gold miner, Gold
Fields. But with currency laws still tight, most of the money that Norilsk
used for the purchase had to come from U.S. Citigroup.

But Russian companies still face many disadvantages when they compete for
contracts abroad, one of which, according to Bendukidze, is the cost of
capital.

Russian corporates still face higher borrowing costs than their competitors,
partly because Russia has no analog to the huge export-financing schemes run
by government agencies such as Eximbank in the United States or Hermes in
Germany.

“A significant part of world business is built on export financing,”
Bendukidze said.

“The state gives money and ensures against political risks … But in Russia
there are practically no accessible cheap export financing credits,” he
said. “How can we get projects in such conditions?”

Back to the Future

One region where Russian companies do have the upper hand, however, is in
the republics of the former Soviet Union — and several are moving
aggressively to take advantage of it.

“Russian companies have a lot of capital and a competitive advantage, so it
is hardly surprising that many of them are starting to try to join up the
dots in the former Soviet Union,” said Roland Nash, chief strategist at
Renaissance Capital.

Leading the way are state-controlled giants like Gazprom and UES. Gazprom is
seeking to use its influence as a major supplier and payer of transit fees
to Ukraine and Belarus to gain major equity stakes in each of the two
countries’ pipeline networks. And UES, under CEO Anatoly Chubais’ “liberal
imperialism” slogan, has been seeking to recreate Russia’s monopoly on
electricity production and distribution in former Soviet space.

UES has already bought stakes in electricity assets in Armenia, Kazakhstan
and Georgia, and Chubais has said he wants to move into Bulgaria, Latvia,
Lithuania and Slovakia. The power monopoly is also in talks to rent an
international power grid that connects Armenia, Georgia, Iran and Turkey.

With U.S.-dominated NATO moving troops to Russia’s borders, Moscow is
countering by taking control of key infrastructure assets.

“Former Soviet states can’t afford to ignore Russia’s wishes,” Weafer said.
“At the end of the day, Russia can just turn the lights off. You can’t run
an electricity cable from Washington.”

But it’s not just state-owned companies that are active in the former Soviet
Union. Private companies like Russian Aluminum, the world’s second-largest
aluminum producer, have been active in the region for years and are looking
to expand.

“This is the return that Putin is getting from helping grow a stronger
economy,” Nash said. “The greater the economic clout of Russian companies
there, the more political clout.”

Russian companies seem to be having a rougher ride in former Soviet
satellite countries, however, as both NATO and the European Union creep
closer.

LUKoil, for example, was recently barred from participating in the
privatization of major Polish refinery because of fears such a strategic
acquisition would revive Russia’s influence in the former Warsaw Pact
nation.

Poland is one of eight former Warsaw Pact countries that will join the
European Union on May 1, making it harder for Russian companies to do
business with their former Cold War allies, analysts say.

In the meantime, Russia is seeking compensation for the expansion. In a
recent letter to the EU, Russia forwarded a list of 14 demands, including
one to raise quotas on Russian steel imports.

The EU may be Russia’s biggest trading partner, but Russia certainly has a
trump card to play. For the foreseeable future, Russia’s greatest tool for
making the West listen to its concerns is its vast energy reserves.

“There’s no doubt about it,” Weafer said. “In the old days of the former
Soviet Union, Russia’s political clout was measured by the 14,000 nuclear
missiles it had pointing west. Now it’s measured by the pipelines it has
pointing west.”