Equal-Distancing of the oligarchs: Did it work?

Graham Stack for Russia Profile

The name Roman Abramovich is back in the headlines this week in Russia -in connection with yesterday’s UEFA cup final in Moscow May 21, where Chelsea, the team he has pumped hundreds of millions into, were unlucky to lose to Manchester United. But coming a week after a new Russian government and Kremlin administration were announced, it was revealing that nowadays political intrigue surrounding Abramovich concerns the Chelsea board and locker rooms. Only a few years ago, Abramovich was regarded as one of the main power brokers in the Kremlin. So what has changed?

Veteran head of the opposition Communist Party Gennady Zyuganov, whose party voted against Putin’s appointment as prime minister May 8, commented in an interview with Vedomosti last week, “Putin started with seven billionaires, and now there are over 100.” But even he did not allege that the oligarchs had a say in last week’s major government reshuffle.

Compare that with the recent past of the Yeltsin era, and a qualitative difference is clear. Yeltsin’s former finance minister, liberal Aleksandr Livschits, recalled vividly in 2004 how the late 90s oligarchs exercised control over government appointments:

“There were three stages in the 1990s. At the start there were simply rich people, for whatever reasons. Then they became magnates at the head of banks. (…) And then these magnates became oligarchs (…) They started to participate in politics, and they laid hands on the holy of holies. In politics, especially in Russia, there is one thing sacred – cadres. Laws, decrees, resolutions are important but — the oligarchs should never have been allowed to determine who was minister, who was deputy prime minister. But they did. And I know about it not from rumours, but from my own experience. They called me in front of them after the 1996 elections and explained how I was to behave, and what I was to do, who I was to report to and what I was to show them. And they answered my question “and what will happen if I don’t” with the words «we’ll remove you». And they did remove me, and not just me.”

Boris Fydorov, another prominent Eltsin era liberal reformer, describes in his memoirs how oligarchs reacted when officials thwarted their wishes. In late 1997, 25% of telecommunications giant Svyazinvest was put up for sale – and the much criticised privatisation authorities got what was generally recognised to be a fair price of $1.25m from an international consortium including Oneksim Bank and George Soros. This despite media oligarchs Boris Berezovsky and Vladimir Gusinsky having laid claim to the asset as their own.

According to Fydorov, Berezovsky’s response by phone was abrupt: “You’re f*******d” – and two days later the infamous «writers’s scandal» began, with Berezovsky’s and Gusinsky’s TV channels relentlessly pounding the government by unveiling ‘proof’ of kickbacks taken by privatisation officials. The scandal lead to a spate of dismissals of reformers, paralysing a government struggling to handle the effects of the Asian crisis, and delaying any coherent response until it was too late.

As distinguished political scientist Philip Hanson has written, by the end of the Yeltsin era «the dominant paradigm in analyses of Russian development was one of state assets ruthlessly plundered by a tiny, grasping elite of business ‘oligarchs’ who had ‘captured’ the state and taken over its functions.” Western journalists and analysts routinely referred to Russia as a kleptocracy.

Some oligarchs more equally distanced than others

Looking back, the astonishing thing about the all-powerful, but permanantly feuding oligarchs of the Yeltsin era is not the extent of their power, but the puniness of their wealth. None of the notorious oligarchs of the 1990s would have ranked among today’s 100 wealthiest Russians.

In 1998, Forbes counted only four billionaires in Russia. Ten years on, in March 2008, Forbes counts a staggering 110 billionaires worth a total of $522bn, topped by Oleg Deripaska, the head of holding company Basic Element, at $28.6 billion.

This begs the question of why the oligarchs lost their grip on the state at the same time they have grown so astronomically in size and number.

The turning point seems to have come 28 July, 2000, when newly-elected president Vladimir Putin met with the oligarchs. Recorded from the now legendary meeting were Putin’s words:

“We will prevent anyone sucking on to political authority and using it for their own goals. No clan, no oligarch should come close to regional or federal authorities – they should be kept equally distanced from politics.”

The phrase ‘equal distancing’ immediately entered Russian political jargon – flavoured with massive scepticism: Putin had come to power principally on the back of the Yeltsin family, the collection of bureaucrats and businessmen including Boris Berezovsky and Roman Abramovich, and was regarded as entirely their creation. Any talk of equal distancing seemed pie in the sky.

Times have changed: Now the criticism levelled at Putin and his friends is not that equal distancing is purely rhetorical, but that it is all too real. Moreover, some oligarchs have been more equally distanced than others: criminal proceedings caused Berezovsky and Gusinsky to flee the country, and Mikhail Khodorkovsky was jailed after crossing swords with the Kremlin behind the scenes.

As Philip Hanson has written, the decrease in oligarch power is partly due to a more disciplined state apparatus: „Putin has re-established central control over the machinery of state, while economic recovery has strengthened public finances. The state is therefore now a unified and stronger interlocutor, more able to assert itself over private interests.”

According to Richard Sakwa of University of Kent, “three things  changed” for political power shifting from the oligarchs to the Kremlin.

“Firstly, the nature of big business influence changed: now allowed to comment on socio-economic matters within the framework of government policy, but not to infringe on the clear sphere of governmental authority in public; secondly, the structure of big business also changed – with a number of ’state’ oligarchs, including those at the head of state corporations; thirdly, oligarch factions in government are offset and counter-balanced by other factions”

According to Alexander Rahr, one of Germany’s leading foreign policy advisers on Russia: “The answer is very simple: in 1999 Russia was poor and falling apart. The handful of oligarchs of the Yeltsin era were running the Russian economy and appointed ministers and state officials. Eight years later, the overall situation has changed. Russia is a rich capitalistic country and has a huge number of billionaires and millionaires who mainly have risen from the energy sector. They are an indication of Russia’s economic boom, not because of Putin’s policy.”

Rahr adds: “Putin stopped consulting with the oligarchs, as Yeltsin had. They lost access to the Kremlin.”

Although the Kremlin still consults with oligarchs, and on the president’s foreign trips they pack the official Kremlin delegation, even the fiercest Putin critics do not allege that Deripaska, Abramovich or their colleagues dictate policy or appointments.

The opposite is true. Philip Hansen writes that the current dominance of the state over business in Russia has “no parallel” in other similarly situated countries.

This was well illustrated in an interview given by Deripaska to the Financial Times last year. Deripaska ate humble pie, saying all he owned had fallen on his lap from the sky, and he would be prepared to cede his main asset, RusAl, the world’s largest aluminium producer, to the state at any time. This was the polar opposite approach to Boris Berezovsky at his zenith, who notoriously informed the Western press that he and his oligarch colleagues had the right to rule Russia because they owned half of it.

Will current business acquiescence last, as Russian business expands and expands? According to Hanson, one factor leading to the pacification of the Yeltsin-era oligarchs was their massive unpopularity arising from the uncompetitive privatisation by which they came to their assets.

However, among the new billionaires are an increasing number who have built up their own businesses by providing new services to the population: in telecommunications, retail, and now even in the Internet. Yesterday, Russia’s prospective newest billionaire, and the first Internet oligarch, stepped forward – founder and co-owner of the Yandex search machine, Arkadii Volozh, evaluated at $5bn in the run up to an IPO this year.

In the Russia of ten years ago, Volozh would ranked among the richest men in the country – and speculation would have mounted over which government faction he was backing. Yesterday, no one blinked an eye.

Could PM Putin’s teflon scratch?

Graham Stack for Russia Profile

Vladimir Putin seems to have a “Teflon coating”  preventing dissatisfaction with government policy sticking to his personal popularity. His willingness to blame reversals on the government and the prime minister has played a crucial part: his televised castigation of ministers and PMs for laziness, inefficiency and stupidity, has been a staple of the Putin show for the last eight years. Despite the fact that the president appoints both the prime minister and individual ministers, the buck has always stopped one door down from the Kremlin.

Paradoxically, it has always been in the government’s interest to accept the blame, and to indulge in queasy scenes of self- inculpation, because Putin’s personal popularity rating has been the generator of this government’s political power.

Yet there was no visible tension as Putin spoke to the government for the last time in his capacity as president on May 5, thanking its present and past members for the contribution they have made to the “rebirth of the economy, the social sphere and the defense.” This was not surprising, since Putin himself will very soon be sitting with the government as prime minister, and hoping that his “Teflon touch” does not desert him in the traditional scapegoat’s seat.

Still less to eat

But the economic news that broke on the same day will not reassure Putin. It was all about inflation – both out of the government’s control, like food prices, and under it, like energy price liberalization. This scissor-like movement of food prices, rising in the global context with the Russian government unable to intervene, while electricity and gas supplies to domestic customers grow on direct government orders, that could cut right through Putin’s Teflon.

On May 5, the Federal State Statistics Service released figures for the months of January to April that calculated inflation in the consumer basket of staple foods at nearly 15 percent. Moreover, price inflation for a number of crucial products accelerated through April: sunflower oil prices rose by 8.6 percent in April, after growing 4.6 percent in March. The price of bread and baked products increased by 6.4 percent, that of pasta – by 6.1 percent. The price of fruit and vegetables grew by 5.5 percent in April, and all this despite the government having strong-armed retailers into freezing the price of staples during the election season.

These ineffective price controls are about to be lifted, and will cause an additional spike in food prices for May – an inauspicious beginning for the Medvedev-Putin tandem. In an emerging market such as Russia, food prices are potential political dynamite. While inflation is always taxing for the poor, the current global growth of food prices is particularly cruel. On average, food constitutes the largest part of household expenses. However, food can be the sole expenditure of the urban poor, such as pensioners and families with small children, making those who have no access to other sources of income or to garden patches extremely vulnerable. While pensions are inflation-indexed, inflation in food prices far exceeds the overall inflation, the latter having reached 6.3 percent in the first four months of 2008, Rosstat reports.

The Achilles’ heel

Putin was clever enough to excuse himself from the remainder of government proceedings dealing with implementing gas and electricity price liberalization for household consumers that took place on May 5.

Russia’s electricity monopoly RAO UES is due to be dismantled next month, and power generation is set to transmigrate to a liberal’s paradise of competitive markets and unregulated wholesale prices. Deputy Economic Development Minister Andrei Klepach spelled out the implications of this move for domestic consumers: electricity prices for households would increase by 14 percent in 2008, by 25 percent in 2009, by another 25 in 2010 and by 25 percent in 2011. Along with electricity, gas prices are set to rise steeply, with Gazprom set to earn netback parity (equal profit levels) with European prices by 2011. According to Klepach, this means that household gas prices could rise by 25 percent in 2009, by 30 percent in 2010 and by a whopping 40 percent in 2011.

Despite these increases, household electricity and gas will remain cheap by European standards. Russians will basically start paying for things they previously were hardly conscious of having to pay for. Very low demand elasticity will mean that if the price increases are not adequately compensated for by transfer payments, the poor will be hit the hardest once more.

And, come a cold winter, it will all be Anatoly Chubais’ fault, again. The electricity reform is the brainchild of a veteran liberal reformer Anatoly Chubais, who was considered “Russia’s most hated man” due to his Machiavellian masterminding of privatization in the 1990s. Saying that “Chubais is to blame for everything” has become customary in Russia, and he is every nationalist’s and communist’s favorite target.

In 2005, Chubais narrowly escaped assassination by former military nationalist intelligence officers, who used a rocket and a machine gun to attack his car near Moscow. On pretrial detention, ringleader Vladimir Kvatchkov failed to get elected to the Duma, which would have bestowed immunity upon him. Wags quipped that if he had succeeded in assassinating Chubais, he would have gotten elected. Kvatchkov’s trial has been dogged by jury selection controversies, since the state prosecutor claimed that any pensioner whatsoever is ipso facto prejudiced in favor of Kvatchkov and against Chubais.

This goes to show the political iceberg that lurks in the waters of Putin’s premiership. For the past eight years, Putin has successfully avoided being associated with Chubais and “liberal reforms,” not least through hiding behind his government. A freezing of the energy reforms, however, could cause the foreign investors, who have pledged $30 billion to upgrade Russia’s power generation, to revoke their commitment. It could also threaten Gazprom’s gas supply arrangements with Europe and stall Russia’s industrial development, and thus is out of the question.

With economic growth and investment surging, the price scissors created by food price inflation and energy price liberalization are unlikely to derail the Medvedev-Putin presidency. But a rerun of the wave of social and political unrest could see Putin’s “Teflon” scratched, and the man who used to symbolize national consensus as president will become a more divisive figure as a prime minister.

Thermal coal producers are sure-fire winners of Russia’s electricity reform

Graham Stack for business new europe

The jury is still out on the radical reform of Russia’s power generation sector, but with the sale of the state’s last remaining stake in OGK-1 currently being negotiated, one thing is clear: Russia’s thermal coal producers are going to be the winners.

This year has already seen a vital watershed passed: as of January 1, steaming coal is now cheaper than gas following a 25% hike in domestic gas prices. Gas prices for industrial customers are now set to rise sharply to achieve netback parity by 2011, making coal for the first time a considerably cheaper fuel for Russia’s enormous, and rapidly growing, power generation sector.

So it’s no coincidence that 2008 has seen power generators start a scramble for coal: OGK-3 announced April 18 it was acquiring a licence for a nearby coalfield to cover 19% of its fuel needs; in March, Oleg Deripaska’s energy holding En+ said it’s looking to acquire thermal coal assets for around $750m; and OGK-4 has been making similar noises.

Gazprom is coal’s best friend

All this comes against the backdrop of Gazprom pushing from all sides to reduce the amount of gas used in power generation in order to free up volume for politically important exports. Gazprom is making plain it will obstruct the expansion of gas in power generation wherever possible. A new gas-fired power block at CHP Northwest was finally switched on in May one and a half years after commissioning due to Gazprom’s refusal to supply gas. And in Kaliningrad, the construction of a second gas-fired plant for Kaliningrad’s CHP-2 has been abandoned altogether for the same reason. The plants that have signed five-year gas supply agreements with Gazprom have complained bitterly that the terms are punitive, containing among other things up to 200% price penalties for any over-consumption of gas.

But this is overshadowed by the looming impact of Gazprom’s power generation joint venture with coal mining concern Suek, that finally got the go-ahead from the Federal Anti-monopoly Service (FAS) on February 28 after a year of wrangling. The FAS, the Ministry of Economic Development and Trade, and soon-to-disappear electricity monopoly UES itself had all opposed the merger of Gazprom’s extensive power generation assets with Suek’s. The effort was doomed, since the FAS was part of first deputy prime minister Dmitry Medvedev’s remit – who, apart from being president elect, is also chairman of the Gazprom board. The Gazprom-Suek venture now unites 41% of fossil-fuel generation capacity, and its owners control 40% of the power sector’s coal supplies and 85% of gas supplies – constituting market dominance that puts the very emergence of a competitive market in question.

However, Gazprom’s strategic goal in power generation is not to extract monopoly rents, but paradoxically to repress demand for gas by shifting from gas to coal wherever possible. “Gazprom’s OGK-2 and OGK-6 currently use 60-70% gas, but can also take coal,” says Renaissance Capital’s Vladimir Sklyar. “Gazprom will switch them. They are also building new coal-fired capacity for TKG-11 and -12.”

An exception is Gazprom-owned Mosenergo, the power giant that serves Moscow. It is gas-fuelled, and for environmental and logistics reasons, coal is not an option. Gazprom has obligations to invest $5.4bn in an additional 4,500 megawatts (MW), increasing output by 40% through 2011 – and is openly refusing to fulfil these, despite spiralling demand in Moscow. UES publicly lambasted Gazprom in a statement on April 24 for “the failure of the company’s board of directors to approve a range of projects, which must be realized in the next two to four years,”

The shift to coal has been blessed on the highest political level. A year ago, President Vladimir Putin declared in his last parliamentary address that the reduction of gas in the power generation fuel balance was a strategic priority. This priority was subsequently fixed in the $30bn investment programme for generation capacities spun-off in the course of restructuring: 30% of 57 gigawatts worth of new generation capacity to come on stream 2008-2014 will be coal-fired. This despite the fact that coal-fired facilities cost 30-40% more than gas-fired, meaning the total new capacity built with the money will be less.

So Gazprom effectively hijacked the initial aim of the great electricity reform – to introduce competition and increase generation capacity – with its own agenda of freeing up gas for export. And the winner is coal. Coal use would have risen anyway due to price liberalization causing gas prices to overtake coal, but now demand for thermal coal is set to soar. The share of coal in Russian power generation is set to grow from 23% in 2007 to 29% in 2010 and 37% by 2015 – at the same time that Russian power consumption is expected to grow at 5% per year. This means that demand for thermal coal will almost double from 2007 to 2015, from approx 130m tonnes to 250m tonnes, predicts Deutsche Bank.

Steppes are paved with coal

“There is a vast amount of steaming coal in Russia and it’s not expensive to get at,” says UralSib’s mining expert Kirill Chuiko. According to Chuiko, Russian steaming coal production has increased at an average 3.3% per year over the last six years, but there is still massive under-utilisation of capacities after the collapse of the 1990s. In 2006, total coal production amounted to only 70% of its historical Soviet peak.

And even when capacity is reached, Russia has the second largest (after the US) coal reserves in the world. Mine life is often long, and many companies have options for adjacent fields, meaning that production expansion is inexpensive. High quality reserves and plenty room for modernization also mean costs will stay low.

So thermal coal looks set to roll – and all the more now that it has friends in high places. On March 13, reports indicated that a sharp cut in coal mining taxes was on the cards, which would be “positive for all coal mining companies in Russia, including Mechel, Raspadskaya, Belon, Kuzbassrazrezugol, and Yuzhny Kuzbass,” said UniCredit analysts.

“At the same time,” Unicredit added, “the news is somewhat strange, as coal mining companies do not appear to need support during a period of high prices.” Unicredit concluded dryly: “We believe that Gazprom is lobbying for the change.”