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PubliusPundit.com: WHEEL OF MISFORTUNE: SHELL RUSSIAN ASSETS MELT AWAY

Melting Shell

By Kim Zigfeld

RIA Novosti recently reported that from January through September of this year Russia received about $17.4 billion in foreign direct investment (FDI) and slightly more, about $17.9 billion, in the form of international financial organizations’ loans and trade credits.

At about $2 billion per month, we can project that Russia will have no more than $24 billion in FDI by year’s end. Russia is a nation of about 140 million people. That means that Russia has an annual per capita FDI of roughly $170 per person.

Virtually all of this investment is attributable to investment in Russia’s energy sector, specifically foreign attempts to get a piece of Russia’s oil and gas reserves, and exists only because the price of oil has risen dramatically. Moreover, these are the Kremlin’s own numbers; in other words, it’s the most FDI Russia possibly could have, and is likely a vast overstatement.

Russia ranks #123 on the Heritage Foundation’s Index of Economic Freedom. Only 35 countries in the world have lower scores for economic freedom than Russia. Poland ranks #41 on the survey. In 2005, Poland received $7.7 billion in FDI. Its population is less than 40 million, one-third the size of Russia. Per capita, Poland had over $190 in annual FDI, 12% more than Russia. Having no oil or gas assets to speak of, virtually all of this investment is targeted towards the real Polish economy, businesses that provide jobs and have real meaning to ordinary people, and it doesn’t depend on the vagaries of the oil market. Still, even at its relatively puny level, the amount of cash hapless foreigners have been willing to thrust blindly into the Russian market has been cause for concern as an indication that the world was still to some extent languishing in a rose-tinted haze where Russia is concerned.

Now there are signs that the world is waking up to the reality that investing in Russia, even the energy sector, is a fool’s errand. Bloomberg analyst Matthew Lynn recently sounded a strong warning against further investment in Russia based on the Kremlin’s relentless assault on the foreign oil companies who invested in exploration of Russia’s oil reserves located on the far western Sakhalin Island, especially Royal Dutch Shell. Lynn writes:

Anglo-Dutch oil company Royal Dutch Shell Plc has been threatened with lawsuits from the Russian government, which is tightening its grip on the country’s energy industry. The treatment of Shell is the most shameful episode so far. Shell’s development of the $22 billion Sakhalin-2 oil and gas field off Russia’s Pacific coastline is one of the biggest foreign investments made in the country since the collapse of the communist regime 15 years ago. Sakhalin-2 is the only major oil and gas field in Russia that is wholly foreign-owned, so it was only a matter of time before Russian President Vladimir Putin decided to bring it under state control. The government plans to lodge a claim of at least $10 billion in environmental damages against Shell. State-owned energy company OAO Gazprom is now conveniently positioning itself to buy half of the project. Shell has brought its offshore-drilling techniques to the Sakhalin-2 field. It has invested a huge amount of capital. Now, it looks as if the company will be harassed until it agrees to sell a big chunk of its assets to Gazprom, no doubt at a knock-down price. This way of doing business might be normal in some countries. Yet it has no place among major companies from developed nations. It is an outrageous maneuver by Putin and the Russian government. One wonders why U.K. Prime Minister Tony Blair has flown off to make another doomed attempt at bringing peace to the Middle East when he could be deploying his self-proclaimed diplomatic genius to help one of his country’s biggest companies.

He concludes: “Russia’s treatment of Shell should serve as a warning. The country may soon become a no-go area for global companies. It is developing a narrow-minded economic chauvinism that even the French would find embarrassing. The best response from big business would be to stay away. Sure, you can make a quick buck in Russia. The trouble is that you can lose it just as fast if the government bullies you out of what you have created. Until Russia starts playing by the rules as part of the global economy, foreign investment should be shifted elsewhere.”

In other words, it’s theoretically possible for a corporation like Shell to make money by going into a casino and plonking its cash down on the Wheel of Fortune. But Shell doesn’t do so, for obvious reasons, and it’s time the world realized, as Shell is undoubtedly now doing, that Russia is no different than a gambling casino when it comes to FDI. In fact, in some ways it’s worse: After all, very few actual casinos have access to the Soviet Union’s Siberian prison colonies.

The Shell saga can be viewed as the end of a war which was declared by the Kremlin when it arrested the founder of the Yukos oil company, Mikhail Khodorkovsky, on trumped-up tax charges just after Khodorkovsky started being talked about as a future presidential candidate (Khodorkovsky was summarily railroaded into prison and will spend a decade freezing in Siberia; compared to others who dared to challenge the Kremlin, like Alexander Litvinenko and Anna Politkovskaya, he could be considered lucky). The saga can also be viewed as the formal beginning of Cold War II between the West and Russia. Robert Amsterdam, one of Khodorkovsky’s lawyers, uses stronger language than Lynn to describe the Kremlin’s actions against foreign investors and condemns not only the Kremlin but the weak-kneed Western press that has failed to adequately report the Kremlin’s actions:

In reviewing the media coverage of Shell and Gazprom’s “business negotiations” over the Sakhalin-2 natural gas project this week, one would be led to believe that these were fair and equitable talks, held by two partners within a constructive and rules-based framework. This obscene characterization by the Canadian press in particular is a travesty – a euphemism used to conceal a crime of appropriation without compensation. The fact is that we should all know we are dealing with state-sanctioned criminality here, and while a corporation is held a gunpoint by the opportunists of Gazprom and their friends in the Kremlin, and the media does the business and political community a great disservice by reporting the story the way many of them they are. What we are really witnessing here is essentially a hostage-taking, not business negotiations. We would be closer to reality if we imagined armed troops storming the Sakhalin-2 platforms and pipeline routes – rather than businesspeople sitting at a negotiating table. Can we just call a spade a spade, please?

Amsterdam points out that while some western investors have been eager to access potential profits in Russia’s energy sector, Russian’s own firms have been pulling up stakes in the country for some time now while the KGB has tightened its chokehold on the nation (as Publius Pundit previously reported). Amsterdam writes:

However, this enthusiasm to take on Russian risk is incongruous with the bearish behavior of many Russian firms, which seem to be hedging their bets on future instability in Russia and displaying their unease with the upcoming elections. One of the most high profile of these firms is Sistema, which is seeking a large stake in Deutsche Telekom in exchange for control over MTS – Russia’s largest mobile phone operator. This Russian eagerness to sell their own risk and move their money outside of the country is widespread, demonstrated by other major deals such as Severstal’s failed move on Arcelor, the Vneshtorgbank stake in EADS, and the move of record numbers of IPOs to New York and London. While it is not yet clear what these reverse flows mean for the future of the Russian economy, we should all pay very close attention to these kinds of incongruities. There is a long history of opacity and misinformation in Russia, in regards to both macroeconomic data and production figures from the energy industry – the main engine of growth. Combine this with the demonstrated inability of banks such as ABN AMRO and DKW to clearly communicate political risk to their shareholders, and you have a potentially dangerous situation.

There are two fundamental realities on FDI in Russia, either one of which alone should be more than enough to scare off even the most risk-happy venture capitalists. One is the fundamental, systemic corruption that pervades all levels of Russian society, the absence of the rule of law. Only now are the consequences of this reality becoming fully apparent to the West, although the warning signs have been obvious for a long time (we here at Publius Pundit have been sounding the warning call for months now).

The other fundamental reality on Russian FDI is still less well understood: that it simply isn’t in the Kremlin’s interests. In a “normal” country like Poland, foreign investment is a godsend, and it would certainly be good for Russia’s people, too. But the interests of Russia’s people and those of the Kremlin are, as they have always been, diametrically opposed. The regime exists in a permanent state of conflict of interest with its own people. FDI would create centers of power in Russia that would become independent of the Kremlin’s control. Inevitably, those centers of power would turn into centers of dissent, calling for legal reform and other measures to rein in the arbitrary, lawless actions of the Kremlin that are bad for business. They would also seek to uplift the condition of Russia’s population, which would be their workforce. It’s hard to believe, but just as the Kremlin is capable of seeing FDI as a threat, it’s also capable of seeing any other action that could make the population healthier and stronger as a bad thing. A sick, terorrized population is much easier to control than a healthy, questioning one — and the Kremlin simply doesn’t have the resources to effect the kind of totalitarian measures in effect in the glory days of the USSR. Not yet, anyway. For now at least, it has no choice but to keep the population weak and isolated from foreign influence as best it can, in order to maximize the mechanisms of control that are available to it.

But the Kremlin’s fear of Royal Dutch Shell, and Anna Politkovskaya, can also be its undoing. The weakness it confirms by acting against them is conclusive evidence that a window of opportunity is open for the West to challenge the neo-Soviet regime before it can consolidate its government and consign the world to another decades-long cold war conflict that could explode into disaster at any time. Action would also save the Russians from themselves, since the Kremlin’s crazed policies will ultimately destroy the Russian regime just as they brought down the USSR. Russia is a pale shadow of the USSR, and the cloud-like states that would replace Russia after such a debacle could create a crisis that would make Africa look like a 4-H project.

Kim Zigfeld publishes the Russia blog La Russophobe.

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