Summer 2007 and its Possible Significance

Clearly it is a slow day in Yuzhno-Sakahlinsk, and I am writing what is tediously the third oil and gas blog post of the day.  At least this one is related to Russia.

There will come a time in the next decade when historians will look for a point at which Russia changed from being the post-Soviet chaotic Russia of the 1990s and early 2000s into the Russia which will be a feature of next two decades.  At present, there is much debate about what sort of Russia that will be, with some in the west fearing an aggressive, revamped USSR sending bombers into British airspace, using secret agents to knock off meddlesome political opponents in London, and cutting off gas supplies to Europe, while others – mainly Russians – cling to the idea that Russia will become rich, powerful, stand shoulder to shoulder with the USA, and become a force to be reckoned with in the world.

As for me, I was asked the other day on a web forum what I thought would happen in the middle-term future.  My answer was as follows:

It’s so hard to say, as Russia is and has always been impossible to predict. It is likely that overall standards of living and real wages will continue to improve, and at a continued rate for a while, before the rate of improvement slows down as it reaches a point closer to where Russia “tops out” on its potential. This point will be a lot lower than what is present or possible in most European countries, because of the seemingly permanent problems which Russia faces: rampant alcoholism, a collapsing population, low birthrate, terrible public health, high levels of organised, semi-organised, and unorganised crime, a public which is content to wallow in its own misery, and expects nothing of its own leaders save a good dose of west-bashing every few months, etc. 

It’s a bit flippant, as I was writing at an informal venue, but this is pretty much what I think is in store for Russia in the next decade or more, and this view puts me very much in the minority of those who think about these things.  Going back to my point about historians, I think that the year 2007, and perhaps the summer of 2007, will be marked as the point where Russia set itself on a course for permanent mediocrity or steady decline when everything looked as though things were going to get so much better. 

The kick-off point will be when the Russian government exerted its power to take majority ownership of the Sakhalin II oil and gas project in April 2007.  This was followed shortly in June 2007 by similar pressure being put on TNK-BP to hand over the major stake in its Kovytka field to the Russian government, and in August 2007 it was looking increasing likely that the Exxon-led Sakhalin I consortium would be forbidden from selling its gas to anyone other than Gazprom.  These three actions, added to Gazprom’s decision made in October 2006 to develop the massive Shtokman field in the Barents Sea on its own, signalled that the era of foreign management of Russia’s hydrocarbon reserves was at an end, and that for the forseeable future – meaning the next 25 years or more – the Russian government would be firmly in charge of producing all its own oil and gas; foreign companies, if they have a role at all, will be minor investors and subcontractors.

Despite Russia attracting a lot of inward investment in areas such as retail and banking, its economy is still very much dependent on oil and gas revenues, and this is unlikely to change in the future.  The manner in which foreign businesses are treated in Russia in terms of the bureaucracy they must negotiate, discrimination they face compared to Russian companies, and in some cases the open hostility directed towards them from arms of the state, suggests that Russia is basing a large portion of its economy on selling oil and gas.  This leaves them wide open to fluctuations in the oil price, and relies on the Russian government – having chosen to follow this path – having the knowledge and ability to develop and manage the oilfields.  As I’ve said before, only one other national oil company has managed this properly, and aside from both knowing a thing or two about snow and ice, Russians are not Norwegians.  This point has not been lost on the nameless author of a good article in this week’s Sakhalin Times, who writes:

As much as some in the establishment may not like to read this, the fact is that foreign companies brought a great deal of professionalism to Sakhalin. Pay scales were introduced that were unimaginable in Sakhalin or any part of Russia. Infrastructure and corporate social responsibility were also products of oil companies in Sakhalin.
This professionalism was accompanied by a sense of social responsibility and concern towards the environment.

In the summer of 2007, the Russian government backed themselves to deliver what no other country has yet managed: a route to prosperity based almost entirely on a nationalised oil and gas industry.  When scholars of the future write about the next chapter of Russia’s history, they might well start it off from this date.  

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14 Responses to Summer 2007 and its Possible Significance

  1. mitya says:

    although i agree with much of what you write, tim, i don’t understand your conclusion: because russia is hostile toward foreign companies, therefore the country is basing its economy on selling oil & gas? if you’re saying that a country that wanted to diversify its economy would be more friendly toward foreigner investors, well, you’re shooting yourself in the foot by pointing out all the international investment in retail and banking. those industries should grow, gaining from the same “professionalism” that benefited o&g (as you pointed out). i would also note that the russian government at the very least pays quite a bit of lip service to diversifying the economy: note the $4.3bn pledged to develop high-tech industries in the country, as just one example.

    one mistake you may be making is that of thinking that the government fundamentally cares about a “route to prosperity.” to me, i think the steps we saw this summer reflect the government’s realization that energy resources represent the best peaceful foreign policy lever out there, and the nationalizations you mention represent their efforts to consolidate power for those ends. prosperity would, of course, be a good thing, but great power status is more important in their minds.

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  3. Jacob says:

    Many countries use state companies to run their oil and gas resources. I’m not very sure, but it seems that is the case with Brazil, Mexico, Venezuela, Bolivia, Saudi Arabia, Iraq, Iran, Libya, etc. etc.

    So the Russian government taking control of the oil industry isn’t an anomaly.

    Much of these state run operations are probably poorly run, and they produce less than private, efficient companies could. But it’s a matter of degree – they still produce oil, and sell it, and earn money. The margins in oil are huge, enough to pay off government corruption and inefficiency, and still leave some profits.

    The case of Russia is by no means unique. And they’ll end up where those other countries are – not a big power.

  4. Tim Newman says:

    if youre saying that a country that wanted to diversify its economy would be more friendly toward foreigner investors, well, youre shooting yourself in the foot by pointing out all the international investment in retail and banking.

    Russia is hostile towards all foreign companies, including those in the non-energy sectors such as retail and banking. Sure, there is major investment into Russia outside the energy industry, but this is in spite of the Russian government, not because of it.

    these industries should grow, gaining from the same professionalism that benefited o&g (as you pointed out).

    They will indeed, but only to a point, a point which is falls far short of where they could be were the Russian government to treat the foreign companies differently. Note that I did say that Russia will continue to get richer and living standards will improve, my post was describing why I think Russia will not realise its potential.

    i would also note that the russian government at the very least pays quite a bit of lip service to diversifying the economy: note the $4.3bn pledged to develop high-tech industries in the country, as just one example.

    I may be being overly sceptical here, but most of this money will not end up where it is supposed to. I know Russia pays lip-service to diversifying its economy, but it appears to be just that: lip service. Running a business in Russia, especially an international one, is a nightmare. I am a General Manager of a branch of an international company in Russia, and believe me it is a nightmare to figure out what laws actually apply, never mind how to comply with them. Until this changes, Russia’s economy will be heavily dependent on energy exports.

    one mistake you may be making is that of thinking that the government fundamentally cares about a route to prosperity.

    Indeed, you may well be right, throughout all of your last paragraph. We’ll just have to wait and see.

  5. Tim Newman says:

    The case of Russia is by no means unique. And theyll end up where those other countries are – not a big power.

    Exactly. They’ll plod along somehow, improving slowly as they go, but never realise the potential people are talking about achieving now. At some point, historians or commentators are going to ask why this happened: I’m having fun trying to put a date on it.

  6. Marco Borg says:

    “Russia Is Finished,” proclaimed Jeffrey Tayler in his article in the May 2001 issue of The Atlantic Monthly. Not only is it finished, “as a Great Power,” but cannot expect any better future than that of “Zaire with permafrosta sparsely populated yet gigantic land of natural resources exploited by an authoritarian elite as the citizenry sinks into poverty, disease, and despair.” It is doomed irrevocably by its own history, religion, and the character of its people.”
    The above written in 2001 seems typical American-idiotic now but news about Russia has long been a string of doom-and-gloom clichs strung into a story. It is mostly the work of American and British writers who should look at “gloom” stories nearer home.(America’ largest cities in effect are clusters of
    brutal buildings populated by Third World peoples and Britain has a cluster of cities from Birmingham to London soon to have a South Asian majority. The tipping point is about 6 years from now, and in Bradford and Leicester English people are perhaps already a minority. Almost one of every two “British Moslems” want Shariah law and one in six approves of 9/11 )
    Tim Newman obviously loves the Russians and has first-hand experience so his views must be treated with respect. Yet…
    1. Population. In the last 3 years Russia’s birth-rate has risen and death-rate has fallen. Latest forecast is for deaths and births to equalise by 2011. They are aware and are doing something about it.
    2. Russia and Fate of Oil-States. There is no comparison. Russia’s traditional high-quality graduates,amazing software developers, space technology, armaments etc . This is not Saudi or Venezuela. Brazil is thriving, will thrive. Southern Brazil is like Italy or Spain. Florianopolis is heaven.
    3. Corruption. At street-level well, obviously one cannot bribe a British bobby, yet at the Establishment level- Berezovski appears on British TV, writes in the British national newspapers about “democracy” . Not to mention Lords-for-sale…
    4.Investment. It takes more than a few rude words to keep companies from investing in a country if the Board decides to invest. Just now because of weakness of American securities Russian entities are being offered loans at amazing favourable rates. There is also the well-known fact, especially in armaments, that the Russians can develop amazing technology with little investment.Hence the Americans endeavours to harness Eastern Europe to NATO, to create a captive market.
    5.Energy’s Place in Russia’s GNP. Always overstated in the West. Latest figures are not much more than 12% certainly less than 20%
    6.The Future. Well Russia’s GNP has been increasing at near 7% per year for the past 8 years, W.Europe’s around 1.5% Even if Russia’s base is, say, 100 units to the others 250, parity would be reached in 18 years. Real average wages in Russia have been increasing at 12% (above inflation)
    Goldmann Sachs identified the BRIC countries (Brazil,Russia, India and China) as the contries where the action is taking place, and will take place in the next 25 years. I believe it to be so.
    Tim, I’ve read all your articles since you moved to Sakh.and even before. Keep up the good work.

  7. Marco Borg says:

    Tim,you speak Russian, are married to a Russian and actually work in Russia in a place which was considered the end of the world though not far from the Workshop of the World where they actually make things whilst we in W. Europe provide only “services” now which consists mostly of speaking on the phone using the Internet and philosophising about this and that, mostly about “celebs”
    Yet you still fell into the habit of using cliches about Russia such as Russia “sending bombers into British airspace, using secret agents to knock off meddlesome political opponents in London, and cutting off gas supplies to Europe” Well they haven’t sent bombers into British airspace but if America can fly bombers in international space so can the Russians. And why would someone with an amazing 85% popularity at home knock off an unknown, a zero, and not his owner who by his own admission has spent $400 million trying to topple Putin. As for “stopping oil to Europe” Russia is actually building pipelines directly to its clients bypassing transient countries. Our fear should be that Russia redirects its oil to Asia. And indeed Russians shouldn’t look up to W.Europe with a mere 1.5% growth rate, not knowing a thing about electronics except of course where to buy them, with a declining population, and whose politicians accept the invasion of millions of illiterate Moslems from the fag ends of the world who increasingly talk of conquering them.
    The world is changing fast. Oil companies with no oil will not count for much in the future. Expect a hostile bid for Exxon within the decade from Rosneft, Gazprom or any one of the top 3 Chinese oil companies. I looked at the Investment Chronicle yesterday, listing the largest 20 companies of the future and mostly they are from the BRIC countries. Unlike you I do not speak Russian but expect that Russia will have a great future, with or without Putin. And the area stretching from Abkhazia to Crimea will be the place to live.

  8. Tim Newman says:

    Yet you still fell into the habit of using cliches about Russia such as Russia sending bombers into British airspace, using secret agents to knock off meddlesome political opponents in London, and cutting off gas supplies to Europe

    Marco, in using the above cliches, I was paraphrasing what “some in the west” say about Russia: this was not my own personal opinion.

    Oil companies with no oil will not count for much in the future. Expect a hostile bid for Exxon within the decade from Rosneft, Gazprom or any one of the top 3 Chinese oil companies.

    I’m not aware of any Chinese oil company being in control of vast reserves, and certainly none are in any better shape than Exxon or BPon this measure. And what will Rosneft of Gazprom be buying when they make this bid? Most of the expertise will have moved on by that stage, and those that remain will probably not transfer to a Russian company. The corporate experience of Exxon will not be transferred, and will be lost. And the complex management systems which Exxonhave developedwill remain gathering dust on the shelf as the purchaser will have no idea how to implement it. Yes, it is likely that the days of Exxon, BP, and Shell are numbered, but it does not follow that Gazprom or Rosneft will assume their crowns. More likely, they’ll drive the industry into stagnation, possibly ruin.

    Unlike you I do not speak Russian but expect that Russia will have a great future, with or without Putin.

    I have no problem with this, many people are convinced Russia will have a great future. I don’t, and I have listed my reasons why.

  9. Marco Borg says:

    Thanks Tim for clarifying the paraphrasing bit. You know, before your blog and “The Sakhalin Times” all info. about Sakhalin was a load of clichs – Chevov’s description, freezing cold, advice from a non-Russian oil company against any pregnant expatriate having her baby delivered on the Island etc. The Russian (or Chinese)companies will make a bid for Exxon only to score a point. It would be refused by any American president. I think you’re being too pessimistic about Gazprom and the rest of the new “Seven Sisters” China’s CNPC operates in 22 countries, soon to be 30. while Petrobas is a global leader in finding and producing oil from deep waters. As regards Gazprom “The Investors Chronicle” of 7-13 Sep. says that “It’s sale of natural gas are as large as Saudi’s sales of oil in heating equivalent. How can consumers justify paying Gazprom $2.50 a million BTU for clean fuel (gas) and yet pay Saudi four times as much for a much dirtier fuel(oil)? ” I appreciate your reasons for not believing in Russia’s future and I will state whilst my conclusion is quite the opposite. It’s basically resources, education,pride,lack of political correctness and state-controlled TV. And also they have whatever system produced the leadership generated by Putin(KGB?)

  10. Tatyana says:

    Er, mr.Borg.
    You believe in Russia future because they have KGB?

    What kind of idiot economically challenged journalist wrote that article, I wonder. Price in a marketplace is not determined by goodwill of consumers.

    As to delivering a baby on Sakhalin…why don’t you conduct an experiment – ask on the street any Russian woman of child-bearing age, if she had a choice, where would she go into labor, on the Sakhalin or any rural American hospital. They might surprised you with total lack of national pride.

  11. Glenn says:

    The russian economy is still basically aiming to exploit mineral wealth, but doesn’t seem to be investing in any other productive capacity of the economy or even in hiring in expertise to modernise practices in oil and gas etc. Which is a shame – there’s probably much to be made from some innovative practices and scientific expertise. But to be successful this needs to be backed by things like a thriving base of technology entrepreneurs and venture capitalists etc. Russia can’t hope to become an advanced market economy – it just isn’t putting in place the mechanisms to get this to happen.

    Norway is an example of a successful state run oil sector – but they know themselves that they can’t rely on oil forever, and are acting to do something about it. Pity the russians aren’t doing so much it seems.

    Russia may build up foreign reserves and capital from oil and gas receipts – but how much is being invested in the russian economy? probably not much. Its either lining the pockets of oligarchs or being invested in expensive english football teams!

  12. Marco Borg says:

    Tatyana,you’re right that journalist was an idiot, typical of the time but they exist even now. I do not know what it is that makes America and Americans think that other countries should be like them. As a European i feel more at home in Russia and Ukraine than I do in the States.Also once the sub-prime securities affair has run its full course and the dollar ceases to be the primary currency of exchange, (and that even before oil sales trading in non-dollars, which will also happen, anyway.) then there will be less talk of what Russia should do and more of what America (and Britain) should have done. Our “transparent” financial systems enabled hedge fund managersto award themselves tens of millions of dollars whilst leveraging unsound(near fictitious) securities to an nth degree. Just now Western banks are offering BRIC countries amazing rates whilst refusing to help other Western banks (in UK Northern Rock yesterday).And the model of a company with state control and private investment has been very successfull in Taiwan, China, Dubai etc.
    Tatyana, I wouldn’t advocate a KGB system but it has indeed happened that a KGB man has been the salvation of Russia , praised by Solzhenytsin, no less. He had to cope with a Russia owned by 10 or so evil oligarchs who after bleeding Russia dry were in the process of obtaining control of TV and so control the people’s minds.
    Glenn, the thinking behind not using a lot of the taxed income from oil was a) to provide a reserve so that there won’t ever be a run on the rouble and b) not to increase inflation. Like you I wish that Putin had made an example of the first oligarchs. Khodorovsky of Yukos wasn’t too happy that Putin was going to tax the oil companies near 80% on the margin above $28 a barrell and tried to bribe all politicians to vote against the tax. (Which was reported in the West as funding opposition parties) I hope that they will eventually be brought to justice.
    Tim, your bit about “students being the same everywhere” was very atmospheric and reminded me of my time in Hanover (though I am Southern European) many years ago. Last Friday I came across a different kind of student on my way to Ealing from Chiswick by train – about fifteen 17-year-old girls wearing fun but designer gear (eg tiny gold shorts over black leggings and high heels)on their way to a party. They crowded around me because I had a fashion magazine.They didn’t know how much their school fees amounted to but said that the club to which they belonged cost as much as their school fees and that they were booked before they were even born.

  13. Sergei says:

    You are absolutely right about everything in this pont, Tim.

    The current high level of oil prices has masked the need for Russia to continue to make the reforms needed to make the economy internationally competitive.

    Oil and gas will become a much smaller part of the Russian economy (they will be lucky to have the same oil production ten years from now as they do today), and the non-resource portion of the economy won’t have developed enough to pick up the slack.

    Marco, calling Putin (the man who believes that the collapse of the Soviet Union was the greatest tragedy of the twentieth century) the “salvation of Russia” is a sick joke.

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