Russian Investments

Steven Pearlstein
Washington Post Columnist
Wednesday, June 28, 2006 11:00 AM

Washington Post business columnist Steven Pearlstein was online to discuss the Russian energy industry and investments in Russia. He writes that newly minted investors in Rosneft, Russia's energy giant, won't be alone in falling for the Russian con game.

A transcript follows.

Washington Post staff writer Steven Mufson also examined the Rosneft IPO in an article yesterday: Russian IPO Is A Hazy Mix of Oil and Politics .

About Pearlstein : Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

His column archive is online here

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Alexandria, VA: Do you feel the resources in Russia being peddled actually hurts its democracy movements? I've seen few cases where gold rushes bring out the best in people.

Steven Pearlstein: Well, at this point, it doesn't help. Because the money is controlled by the Kremlin and its handpicked allies, and they use that money to cement in place the current political power structure, it slows down the natural development, where increased wealth and democrcy seem to progress hand in hand. Now there is very well established literature saying that in the early years of economic development, incomes become more unequal before they become more equal. But this is a whole different kettle of fish, because the political and economic oligarchs are now one and the same.

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Arlington, VA: As someone who lived twice in the former Soviet Union (Moscow and Kazakhstan), I was continuously shocked by the extent of corruption and how so little of the money being amassed by the oligarchs was invested back into the economy - especially in technology and infrastructure. It has been six years now since I have been back, curious to if that has changed or remains the same? Thanks.

Steven Pearlstein: Well, one of the things that has changed is that many of the biggest oligarchs have been broken or left the country with their money out of fear of being broken by Putin. Now you have a situation where Putin is trying to take up the mantle of the anti-corruption crusade, because he's stacked the decks, economically and politically, in favor of his crowd and wants to prevent activities which siphon off money from his crowd (which gets its money "legally") to some other crowd. After all, if you control the big energy companies, and can use the money they have for any purpose you want, you actually don't want others playing games to get around the system. You ARE the system.

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Springfield, Va.: How are safe is it to invest in Russia, when you hear stories of companies falsely reregistering businesses and real estate titles in new names and then sell the property or cleaning out the business bank accounts. How bad is the curruption, how strong is the rule of law?

Steven Pearlstein: Its is not safe at all, in my opinion. Look, the reason Rosneft is able to float this IPO is because investors think they have a sure thing. And on the surface, it looks good. Why invest in an oil company somewhere else that has to compete in the free market for resources and people and capital, when you can invest in Rosneft or Gazprom and know that every power of the government will be used to create and enhance the economic power and success of the company. If you are an amoral investor -- which is what investors tend to be-- that sounds like good deal. The problem is that the same economic and political oligarchy that is prepared to run roughshod over any competitor or local communities that try to stand in their way can also run roughshod over minority investors. And there's nothing they can do, because Putin and his crowd also have the judicial system in their pockets. The only profits they will allow foreign investors to make will be the minimum necessary to continue attracting the next tranche of sucker money from people with short memories or willingness to ignore obvious warning signs. Anything beyond that necessity they will siphon off for themselves, which is, in fact, the rational thing for them to do.

What we should do on our end isn't to lecture them about how to run their economy. But we should tell our own investors that if they get in trouble, they're on their own -- the cavalry is not going to ride to rescue their investments. And furthermore, we should tell our banks and big financial institutions that they should not make loans to Russian firms, or to investors buying into Russian firms, at least not with government insured deposits. Furthermore, they should be required to have huge amounts of capital set aside as insurance against their Russian investments, reflecting the real risk that they will lose it, just as they did in 1998, during the Ruble crash then.

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Alexandria, Virginia: Mr. Pearlstein: How do you explain James Baker III's law firm, Baker Botts, touting their dismissal of Yukos Oil's $28 billion bankruptcy law suit against Gazprom in a Federal Bankruptcy Court in Houston, Texas as a "landmark victory" for justice against Khodorkovsky, Lebedev and Nevzlin, principal owners of Yukos stock, and their current representation on behalf of the Russian Ministry of Energy and Ministry of Finance against the U.S. Shareholders Coalition on that so-called expropriation through re-nationalization of Yukos Oil's main asset Yugansk? Are you so naive as to believe that James Baker III did not confer with the powers that be at 1600 Pennsylvania Avenue to obtain their approval before taking on a representation involving an expropriation of U.S. stockholder's interest in Russia's crown jewel of oil companies?

The "fix" was in between the two powers that be (Kremlin and White House)after Khodorkovsky's proposed sale of his majority stock holdings in Yukos to U.S. oil interests, ExxonMobil and ChevronTexaco, went awry. What a coup that would have been with U.S. oil postured in Russia as the owners of Russia's largest, most profitable crown jewel in the energy sector. The Kremlin's reaction was, and is, justified and was, in fact, at the end of the day supported by the U.S. Government. U.S. oil interests would have had a measure of control over Russia's domestic and foreign energy policy and PRICES, I might add.

A time for Truth and Reckoning, Mr. Pearlstein. Yukos Oil was acquired in rigged privatization schemes (loans for shares) with money laundered through our banks, lest you forget the Bank of New York money laundering scandal of the late 1990s, for the pittance sum of $310 million. That money was looted from the former Soviet Communist Party under the watchful eye of Boris Yeltsin and the blind eye's, as the case may be, of William Clinton, or more accurately Albert Gore and Strobe Talbott.

$30 billion seized on trumped up tax charges you say? No, dear Mr. Pearlstein, those tax charges were not trumped up. President Putin is not the dishonest broker you portray him to be. One need but to revisit those offshore money laundering havens where an estimated $48 billion of Yukos' earnings have been entrusted into the safekeeping hands of Khodorkovsky and Lebedev's partner Nevzlin, currently residing under Israeli protection.

Rosneft's IPO on Yugansk is a long overdue Time of Truth and Reckoning. It is a safe investment, as safe as the investment James Baker III's client ConocoPhillips is prepared to invest in Gasprom's largest ever gas field if they remain on Gasprom's shortlist. Little doubt that they will not be shortlisted-kudos flow to those who know the end game.

Karon von Gerhke-Thompson

Steven Pearlstein: Well, that was impressive. Look, nobody, including me, is saying that Mr. Khordorkovsky was any saint. Yes, he stole the company from the Russian people originally. And maybe some way, legal way, should have been found for recapturing from Yukos the value of the people's oil for public use. But once a country authorizes the offering of public shares in a company to global investors, you have to weigh the benefit of doing that to the benefit of having reliable flows of foreign investment. In this case, there was no balancing. Khordorkovsky was sent to Siberia and the company renationalized, with no compensation to investors, foreign or domestic.

I can't speak to Baker Botts, although I am sure you are right that he wouldn't have avoided using a back channel if it benefited the firm or its clients.

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Washington, DC: If Putin and his policies are so deplorable, why is he so popular? What alternatives are there? The communists? Zhirinovskij?

Steven Pearlstein: Don't get me wrong. I'm not suggesting we interfere in the internal affairs of Russia. I am suggesting that we make it very hard for an unreliable country in terms of its international financial dealings to tap into the global financial markets, which normally operates according to certain rules. Russia doesn't play by those rules. And until it does, we should make it hard for them to pick the pockets of our investors.

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Fairfax, Va.: What does the IPO say about the integrity of the LSE? How deeply has it checked out the company??

Steven Pearlstein: They have not, I believe, agreed to list the shares. They're still evaluating. To me, there's no question they should say no, as should all the U.S. exchanges.

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Washington DC: I was in Moscow and Murmansk 3 months ago and I saw first hand how far Russia is from becoming an economic power. The corruption, lack of functioning banking or legal institutions and the decaying infrastructure will take many years to correct, notwithstanding Putin's disingenuous attempt to convince the world otherwise.

Steven Pearlstein: Thanks for that first hand view.

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Arlington, VA: Mr. Pearlstein,

I agree with you about the gullibility of individuals investing in this Russian oil venture. However, at the Geopolitical/strategic level, Kasparov is correct in theory, but obviously Russia will get whatever investments it takes to keep their oil and natural gas flowing to those that are addicted to it. Almost in a tie with Saudi Arabia as the world's top oil producer, Russia has the world's largest natural gas reserves. Russia directly supplies a third of Europe's and Japan's fossil fuels and that alone would be enough investment pressure to keep it flowing. Ignoring the political and geo-strategic issues, Russia is particularly appealing as a potential fossil-fuel resource provider since although their production has likely peaked, their internal consumption is not likely to grow much, if at all, leaving a good percentage as exportable. Russia's population is expected to fall 22% in the next 50 years

Of course, Putin, who spent his post-KGB years at the St. Petersburg Mining Institute writing a dissertation entitled "Toward a Russian Transnational Energy Company", intends to take advantage of this for the benefit of his country. His dissertation thesis: Russia should use its vast energy reserves for geostrategic advantage. In my opinion, he will have no trouble gaining this advantage due to the incredible value contained in the concentrated energy of fossil fuels and the way in which the world has become dependent on it. Do you agree ?

Steven Pearlstein: Look, if Russia wants to nationalize its energy assets and run them through a single, national oil company, it wouldn't be the first country to do so. Most Middle East countries do that, along with Mexico, Venezuela. But, for the most part (the jury is still out on Venezuela), these country and companies behave according to the global rules of doing business, including honoring contracts and allowing for impartial resolution of disputes, etc. If Russia wants to move to that model, fine -- but not by expropriating the investments already made and giving every indication that they will be arbitrary and capricious in the future.

This is tough stuff, but remember: Russia needs its customers as much as its customers need Russia's energy resources. You don't benefit in the long run doing business with snakes.

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Chicago: Most of the time Russia seems like a rational economic actor seeking to increase market share and more or less spend capital to increase production. Then it pulls a stunt like cutting off Ukraine's gas supply and probably Georgia's sending W. Europe into fits of worry. Since both Rosneft and Gazprom are Kremlin controlled, I think we can regard them as similarly motivated entities.

My question, how can we sort through Russia's economic goals versus its political goals, which seem to come into conflict from time to time? How willing will it be to use its power over energy supplies to further foreign policy goals?

I agree with McFaul. Khodorkovsky came by Yukos through criminal behavior and was among the most violent early-era oligarchs. The problem really is that Russia's plague of rent seekers will be with it for another century or more.

Steven Pearlstein: Yes, that is the problem, and it probably will take decades for arrive at a business environment condusive to longterm investment by outsiders. That's why we're rushing it by lilsting their companies on our exchanges or welcoming them into the G-8 or the WTO. They aren't ready.

Now you may ask why I don't say the same thing about the Chinese. And while some of the problems are similar, like the lack of democracy or considerable state meddling in the economy and rampant corruption, I think the real situation is quite different. China is moving quickly in the right direction, acknowledges many of its problems and is trying to fix them. More to the point, the government has not conspired with cronies of the political leaders to expropriate assets owned by foreigners. and the reason is simple: they now have so much at stake in being able to participate in global product and financial markets that they wouldn't benefit, even in the short run.

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Fairfax, Va.: Thank you for your response to my question regarding the London Stock Exchange. I would then ask what the IPO says about J.P. Morgan Chase, Morgan Stanley, ABN AMRO Rothschild, Dresdner Kleinwort Wasserstein and Goldman Sachs?

Steven Pearlstein: Its says they are amoral. It says they care more about themselves than the investors whose interests they are supposed to be representing. And it exposes, once again, that they are really looking out for the interest of issuers, not investors. They will argue that, by disclosing all the risks, they've done their job, and its up to the markets to price those risks. I say there ought to be a threshhold for standards of doing business and if a country or a company doesn't meet those threshholds, they won't lend their good name to an offering. That's the way the world used to work, and why the Morgan or Goldman name really stood for something beyond huge profits for their own executives and investors. Now its purely buyer beware.

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Alexandria, VA: Real Estate has seen a huge increase in Russia. Do you think there is a bubble there or is there still some opportunity to make money in Russian real estate?

Steven Pearlstein: I can't claim any particular knowledge. It obviously reflects the growing wealth of the country, and urbanization, in which case the runup may be somewhat justified. But it probably also represents the arrival of a lot of speculative money into the market, both domestic and foreign, and that is more worrisome.

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Arlington, VA: Didn't our President peer into Putin's soul and find him straighforward and trustworthy ?

Steven Pearlstein: Depends on what your definition of trustworthy is.

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Washington, DC: Should we also discourage investment in Ukraine, where the judiciary is under the control of oligarchic clans? And what about Georgia, where known organized crime bosses are allowed to be elected to parliament? I get the feeling that your purportedly 'rational' assessment of Russia as a risky destination for investment is cover for the good old fashioned Russia-bashing that people can't seem to get enough of in this town.

Steven Pearlstein: Not Russia bashing at all. What you say about Ukraine and Goergia is probably also reason for not investing there. But when I last checked, I didn't see any companies from those countries trying to float a $10 billion IPO on the London Exchange.

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Bethesda, MD: How confident are you in the Ruble? I've noticed Russia's inflation level has been double digit for a number of years- is the currency under pressure and at risk of collapse as it was in the late 90s or do you view it as sustainable given the current commodities boom and growing hard currency reserves?

Steven Pearlstein: Not sustainable. 1998 all over again.

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Arlington, VA: "But, for the most part (the jury is still out on Venezuela), these country and companies behave according to the global rules of doing business, including honoring contracts and allowing for impartial resolution of disputes, etc."

I agree this is how it has been, but this has been in place because there has been a (or many) swing suppliers that made for much less desperate energy addicts. We see now with Russia, Venezuala, Iran etc, that the countries with supply to export are to varying degrees using the leverage to get what they want. Hopefully, it won't work, and it will not work if you are correct and we (the world) can just shun the energy product that these countries have. I hope you are correct.

Steven Pearlstein: Me, too.

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Arlington, Virginia,: Dear Mr. Pearlstein,

While I agree with many of your arguments about the lack of governance in Russian companies, you seem to be mixing politics with business too much. Those who are going to invest in Rosneft's IPO think that there is money to be made, and they are probably right, regardless of the quotes that you cite. (One will need to check Rosneft's share prices in a couple of years to know for sure.) So your title about gullibility may not be quite accurate. And your proposal to "force" Rosneft to withdraw its stock offering is quite interesting and rather extreme. With the same success and on the same rational you may want to suggest "forcing" other companies - including those from China, Latin America, etc. - not to do public offerings. I will be interested to see the reaction to such proposals. Not sure you will have much luck with it.

Nadia

PS A disclaimer: I am Russian, currently living in Washington, and while I am not happy about all things going on in Russia, I keep being amazed by some extreme points of view that I hear here and read in the US press. You get quite different views when you talk with US businessmen who are actually working in Russia.

Steven Pearlstein: Look, I know a number of lawyers and business people who have done very well doing business in Russia. But there is a difference between high rolelrs investing in a hedge fund like Hermitage and listing shares on the LSE for small investors to buy. There's also a difference between western banks ledning a billion dollars to a U.S. corporation and lending a billion dollars of depositors money, insured by the U.S. government, for some hedge fund to buy into Gazprom. There is a middle ground between denying Russia all access to western capital, which I don't propose, and limiting the types of capital that can flow.

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Washington, D.C.: Not to be an apologist for Russia -- Putin's pursuit of state/crony capitalist is creepy & about as non-transparent (from a standpoint of having clear rules-of-the-game) as can be. However, in Rosneft's case, the sad truth seems to be that, even if it's badly mismanaged, and even if certain political decisions may trump shareholder interests, the fact that it's sitting on so much oil, given global energy demand, seems to guarantee returns, short of Sechin, Putin & their ex-KGB coterie falling completely out-of-power. So is it a bad investment in this case?

Steven Pearlstein: I'll be a bad investment if markets start to tank and they figure out a way to give a raw deal to minority shareholders. And if you think they're above doing that out of some western notions about fairness and the rule of law, you're not paying attention. They'd cut you out without a moment's thought. And if you were in Russia and standing in their way, they'd send you to a camp in Siberia. Literally.

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Washington, DC: David Remnik hosted Charlie Rose a few weeks back. The discussion on that episode turned to how Putin might "legalize" the wealth he has accumulated before leaving office. Some speculate that amount might be in excess of $12 billion. Your thoughts?

Steven Pearlstein: Whatever David Remnick says is always wise.

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Washington DC: Your column notes that Rosneft's prospectus outlines both the risks and opportunities to potential investors. Isn't that a sign of greater transparency? Even Bill Browder remains a cheerleader for Russian investment, despite his visa issues. The Russian IPO can only serve to further integrate the energy sector, and the country, into Western norms. The issues that the US faces in its relationship with Russia are multifold: encouraging democratic and economic development on Russia's own terms, working with the country on Iran, continuing a successful partnership on securing nuclear materials, and taking a long-term view for a secure and abundant global energy supply. Your piece reads too much like the US (as usual) imposing itself on the world.

Steven Pearlstein: I think I was pretty clear that I don't want to get into imposing our way of doing things on Russia. They have a difficult development path out of their communist path, and this one may be the right one, for all I know. But that's a different point than saying we should let this rigged ecoomy and business system tap into global financial markets right now. I think you can see the distinction.

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Vienna, VA: Which is worse, investing in Russian oil company or Chinese bank?

Steven Pearlstein: Russian oil company. And by the way, is any Chinese bank listed on the LSE or NYSE?

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Washington DC: My compliments to your colleagues Peter Baker and Susan Glassner on their excellent book "Kremlin Rising". I do not work for the Washington Post or know either author I just think the book is excellent.

Steven Pearlstein: I'll pass that along.

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Washington, DC: I hear a lot of diversity of opinions about investment in the Russian energy sector. I would point out a story that ran in the Moscow Times about a month ago (http://www.moscowtimes.ru/stories/2006/05/26/002.html) that falls in line with a lot of reporting these days that the Kremlin is seriously considering the nationalization of Sakhalin LNG ventures. Surely, such a move would effectively destroy any remaining confidence in FDI ventures in the Russian market. But what concerns me is that this is part of a larger issue that involves centralized control of any portion of the economy that involves the creation of wealth. The civilian economy in Russia today is confined almost exclusively to the redistribution of existing wealth. Am I wrong in seeing a disturbing trend toward a centralization of production decisions?

Steven Pearlstein: Not wrong at all. And the Sakhaliln projects, 1 and 2, were what I was referring to in the column today about the government simply declaring that it was now going to be in charge of supposedly 50-50 joint ventures.

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Washington, DC: A previous writer mentioned the dramatic increase in real estate prices in Russia. I think it is important to consider that this explosion is speculative real estate is taking place almost exclusively in Moscow (Saint Petersburg is experiencing a small taste of it), and is driven by the amazing accumulation of all of Russia's wealth into that one city. Real estate outside of the two major cities is virtually valueless.

Steven Pearlstein: Thanks. That's useful.

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Washington, D.C.: I hear what you are saying about Rosneft, but what do you think about investing in about Luk Oil and Surgutneftegaz; they certainly have yielded tremendous profits in the past few years.

Steven Pearlstein: To repeat: If Putin and his pals have the power to take your profits away from you, and they do, what makes you think they won't do it. Because they're nice guys. Because they already have enough to live well? Because they really like foreigners? Give me a break. The only reason they won't steal it is because they fear they might not be able to get your money in the future. But with the oil money now pouring in, that may not matter. The reality here is that they don't believe in the rule of law. That's what makes the inevstment in Lukoil and others look like such a good investment, because the willingness to ignore the rule of law looks to cut in your favor. But the sword is two-edged, and it can cut against you just as easily.

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Washington, DC: A question re: the reference in your article today: Who in the U.S. business community is really calling for Russia to be readily admitted to the WTO? Not only most of the press I've seen, but also most of the correspondence I've seen to the U.S. government from all sorts of business associations & Congress, all seems to be calling for the Administration to take a deliberate approach & a harder line, and not to cave in on issues ranging from intellectual property rights to abuse of food safety rules, to the growing role of state companies that is now being seen spreading beyond the Russian energy sector. Other than relatively small groups of companies that might already be active there, I know of no broad-based associations that are really "out-in-front," pro-Russia.

Steven Pearlstein: The "deliberate" approach comes from particular industries with particular concerns, like intellectual property. But there remains a large group here who believe that if you don't go forward with trade liberalization at every opportunity, then it is the same as sliding back, and any backsliding will only give the anti-free trade movement encouragement. They also argue that Russia will start to behave better once you invite them into the tent. So you see all the caveats these days (as long as they do this, that). But those caveats are very narrow. They don't go to the heart of the problem, which is that this is not a market economy that's ready for prime time.

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Steven Pearlstein: That's it for today, folks. See you next week.

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