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Friday, December 15, 2006

Russia's Oil Gambit Exposed

Investors Business Daily reports that 25% of Russia's GDP is based on oil and gas revenues, meaning that the Russian economy is totally dependent on them and the Kremlin knows it. Hence, the Kremlin is rapidly moving to nationalize the entire industry.

President Vladimir Putin insists he wants Russia to be a respected member of the community of nations. Why, then, does he keep doing things that remind us of the bad old days of the USSR?

Vladimir Putin insists he wants Russia to be a respected member of the community of nations. Why, then, does he keep doing things that remind us of the bad old days of the USSR?

Russia talks a good game about wanting more trade and investment with the West. But then it goes and does something crazy: seizing the assets of Shell Oil off Sakhalin Island.Why did Putin decide to grab Shell's $20 billion investment? The easy answer is, because he could. A more nuanced response, however, might be that Putin hopes to parlay the world's growing hunger for energy into greater Russian clout -- and to fill his government's coffers with petrodollars.

The fact is, Russia's economy is being fueled by oil production (see chart). In just a few years, oil and natural gas output has spiked a remarkable 50%. Russia proudly boasts of producing more oil than Saudi Arabia.

Much of this growth has been fed by foreign investment. Russia never had the technology to fully exploit its oil and gas reserves; it needed outside expertise. Which explains why Shell was in Sakhalin, one of Russia's most promising offshore oil sites.

But now, the Anglo-Dutch company is being elbowed out of the way by the state-owned energy group Gazprom. Shell has about 55% of the Sakhalin gas field; Japan's Mitsui and Mitsubishi have the rest. After Gazprom's move, Shell will have just 25%, Mitsui and Mitsubishi even less.

In effect, the Russian government is taking over, after Shell, Mitsui and Mitsubishi spent billions and did all the heavy lifting.

This is not an isolated incident. Russia is threatening British Petroleum's Siberian unit with the same bogus -- and vague -- claims of "environmental violations" it used to steal Shell's investment.

The real reason for the seizures is that the Russians think they now have both the know-how and cash to develop their vast reserves. Or as Putin spokesman Dmitry Peskov put it: Russian firms "have the opportunity to be owners by themselves, to attract finance and certain technologies."

Fine, but what about the rule of law? Shell and the others invested in Sakhalin based on the idea it would be a permanent investment -- not that it would be grabbed just as it became productive. And what about the next bunch of investors you want to attract?

In this, Russia is acting more like the Soviet bully it once was than the respected member of the community of nations it claims to be.

But then, much is at stake. Plainly put, Russia's demographics are those of a dying nation. Its population is already shrinking, due to declining birthrates and falling life expectancy -- the latter a first for any developed country.

That augurs a grim economic future and less global clout -- unless, that is, Russia can leverage its energy resources to get higher growth. Which is what it's doing. That augurs a grim economic future and less global clout -- unless, that is, Russia can leverage its energy resources to get higher growth. Which is what it's doing. GDP is growing at a 5% to 7% clip -- "fueled primarily by energy exports," the U.S. Energy Department reckons.

A recent World Bank report estimates that as much as 25% of Russia's GDP is due to oil and gas output -- though that sector employs just 1% of Russia's workers. Separately, the IMF estimates that a $1-a-barrel rise in oil prices boosts Russian revenues by 0.35% of GDP. So oil is slowly replacing the shrinking tax base.

Given this arithmetic, it's not hard to see what Putin's up to. Since 2003, he has jailed oil billionaire Mikhail Khodorkovsky and seized his holdings in Lukoil, Russia's largest oil company. Meanwhile, he has begun gobbling up private-sector competitors to state-owned Gazprom.As a result, about a third of Russian oil is back in government hands. That parallels what's taking place in the rest of an economy that, according to economist Anders Aslund, is quietly being renationalized. He estimates that in 2004, the private sector made up 70% of GDP; in 2005, just 65%. In 2006, another drop is expected.

This gives Putin lots of money to pursue his grand ambitions -- like becoming a major rival again to the U.S., gaining more influence over Europe, forging new ties with Communist China and democratic India, and doing business with rich rogue states like Iran

With corruption and inefficiency eating away at Russia's nonoil sector, Putin thinks he can float his economy and regain Russian glory on oil alone. Maybe. But if oil prices fall as they did in the '80s, Russia will be in big trouble. And companies in the West, once burned, will be a lot less likely to go back in.

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