China is the Big Winner
In spite of the recent decline in crude oil prices, Russians are still paying $3 at the pump, nearly twice as much as the average in America. Why?
It's no secret that Russia's oil and gas industry, which accounts for more than half of Russian export revenues and more than a third of Russian GDP, has fallen on hard times lately. In the final quarter of 2008, at the same time that oil prices plunged worldwide, Rosneft, Lukoil and Gazpromneft also lost access to easy credit from Western capital markets. After briefly surpassing Saudi Arabia as the world's no. 1 oil producer in 2006, Russia's oil output has stagnated and declined somewhat in the last two and a half years.
The Russian federal budget, which had previously anticipated prices at $95 a barrel for 2009, now faces a huge shortfall, with current prices hovering around $45 a barrel. The Kremlin had announced plans to cut oil export taxes to spur new exploration and production in an industry that for decades has provided one of its primary sources of revenue, but these badly needed reforms may end up being postponed. Adding insult to injury for ordinary Russians, drivers across Russia are still paying over $3 a gallon at the gas pump, in spite of the collapse in crude oil prices.
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Russian police watch a demonstration by Khodorkovsky supporters
How Rosneft Acquired Yukos With Chinese Cash
It's often been said in this present economic crisis that cash is king, and the Chinese government is one of the few global players left standing that is still cash-rich. In 2005, when the Russian government auctioned off Yukos oil company assets formerly held by the jailed oligarch Mikheil Khodorkovsky, the state-owned firm OAO Rosneft came up with $10 billion to acquire most of the dismembered firm on very short notice.
The general Western indignation over the controversial prosecution of Mikheil Khodorkovsky, an oligarch who who spent millions to lobby politicians and influence the media in Washington and London, nonetheless obscured some important changes in the Russian energy industry. In Russia, the business media reported that the financing Rosneft used to acquire Khodorkovsky's oil and gas empire came from China, and would have to be paid back with crude oil deliveries to the Chinese for years to come.
While Rosneft replaced Yukos as the largest oil producer in Russia, creating a major player in global energy markets virtually overnight, Beijing shrewdly walked away with a contract for delivery of Russian crude for the next several years locked in at relatively cheap 2005 prices. Now it appears that China is again profiting from upheaval in the Russian energy industry, this time caused not by a power struggle between the Kremlin and an oligarch, but rather the global economic meltdown and credit crunch. With Rosneft unable to obtain cheap credit from bailed out Western banks, China has very shrewdly stepped in by offering Rosneft a $25 billion loan, in return for even more future crude deliveries locked in at today's historically cheap prices.
Khodorkovsky: Setting Aside Mythology, What Really Happened?
It would be an understatement to say that Khodorkovsky's 2005 prosecution remains controversial. Khodorkovsky's supporters, including his Canada-based attorney Robert Amsterdam (who runs a fairly interesting blog), claim that he and his company Yukos were victims of political and self-interested expropriation of assets carried out by the Kremlin. On the other hand, Khodorkovsky's detractors both in Russia and abroad, who have compratively little attention in the Western media, point out that Khodorkovsky only began funding "liberal" political opposition to the Kremlin after his business empire was forced to pay back taxes and stop comitting fraud. In their view, Khodorkovsky may very well have made his fortune in the Nineties like many other Russian oligarchs, but unlike his peers, he refused to accept the new rules that the Putin Administration imposed after coming to power in 2000. Namely, keep your ill-gotten gains, but stay out of politics, and keep your money in Russia, where it can create jobs for Russians, rather than socking away tens of billions overseas in Cypriot and Swiss bank accounts.
Putin Versus Khodorkovsky and the Oligarchs
It's important to recall that the oligarchs, unlike the so-called robber barons of the late 19th century that they were often compared to by Western Russia watchers (such as Anders Aslund), did not create new industries from the ground up. Instead, most expropriated for themselves the most lucrative assets the Soviet Union left behind, often for pennies on the dollar.
From the Kremlin's point of view, some of these early and mid-90s expropriations may have been facilitated by foreign partners, who were paid back in natural resources sold at below world market prices (some pro-Kremlin Russian analysts have claimed that one of these shadowy "Western angel investors" in the early Nineties was none other than George Soros, and that there is indeed a connection between Soros' funding of the so-called "Colored Revolutions" in Ukraine and Georgia and his business interests in Eastern Europe). In the 2004 film version of Robert Ludlum's novel The Bourne Supremacy starring Matt Damon and directed by Paul Greengrass, the Russian oligarch character depicted with shadowy CIA connections bears more than a passing physical resemblance to Khodorkovsky.
Cheap Oil and Avoiding a Repeat of the Nineties
Popular fiction and pro-Kremlin conspiracy theories aside, it is definitely not a coincidence that the Russian ruble and banking system crashed when oil hit $10 a barrel (adjusted for inflation, the lowest prices since the Great Depression) in 1998. Nor is it a coincidence that when Putin became President in 2000, he implemented a plan previously outlined in his doctoral thesis, to reassert enough state control over Russia's natural resource revenues to avoid any repeat of the 1998 crash, when the government literally could not pay the most basic salaries or collect enough taxes to function. The return of Russia as a player on the world stage, having overcome post-Soviet economic and political chaos, is central to the story Putin's ruling United Russia party tells the Russian electorate.
Khodorkovsky Was No Martyr
Besides charges of tax evasion and fraud against Khodorkovsky, the Yukos boss chief of security, Oleg Pichugin, was convicted of ordering contract killings against his business rivals, including an attack on a former employee of Moscow Mayor Yuri Lushkov. Khodorkovsky had made powerful enemies both inside and outside of the Kremlin. These are inconvenient facts Khodorkovsky supporters tend to downplay or ignore when portraying the jailed oligarch as a martyr for democracy and property rights in Russia. Khodorkovsky's critics, meanwhile, compare him to disgraced Western corporate executives like Enron's Ken Lay.
The Tipping Point: Why Khodorkovsky Ultimately Went to Jail
Nonetheless, both supporters and detractors of Khodorkovsky could probably agree that the last straw that triggered the oligarch's arrest in 2003 was his attempt to sell Yukos, which at that time represented almost half of Russian oil production, to a consortium of Western oil majors. Some Western government officials reportedly were interested or had foreknowledge of this proposed sale. In his new book, Russophobia: Anti-Russian Lobby and American Foreign Policy, San Francisco State University professor Andrei Tsygankov claims that one of the Western politicians who was monitoring the ongoing negotiations between Yukos and Western oil majors was then Vice President Dick Cheney. Even if Cheney was never actually involved, any high level negotiations between Khodorkovsky and companies like BP, Chevron-Texaco and Exxon were bound to be closely monitored by the Russian security services, given the high stakes involved.
Khodorkovsky and the Perceived Western Encirclement of Russia
From the point of view of some in the Kremlin, arresting Khodorkovsky was drawing Russia's line in the sand against Anglo-American led attempts to gain control over Russian natural resources. In this Russian nationalist narrative, the Kremlin was only provoked to move against Khodorkovsky after years of watching as the U.S., Great Britain and other countries built oil pipelines publically touted as bypassing Russia, established military relationships with the newly independent oil-rich states on Russia's borders like Azerbaijan and Kazahkstan (the latter hosted a rapid deployment of 500 paratroopers from the 82nd Airborne during the Clinton Administration, not during the supposedly cowboy unilateralist Bush Administration), and expanded NATO into the Baltics, where anti-Russian sentiment remains strong to this day.
What Exactly Has the Kremlin Accomplished by Reasserting Influence Over Russia's Resources?
Setting aside the validity of these narratives -- with China trying to lock in oil at low prices through fixed long-term contracts rather than accepting fluctuations like the rest of Russia's customers on the global crude market, one wonders what all of these efforts to reassert state influence over the Russian oil and gas sector actually accomplished. Has the Kremlin actually prevented a hostile foreign takeover of Russia's oil and gas and other strategic sectors, or has it merely delayed the inevitable, and shifted the foreign ownership from West to East? Like Russian Finance Minister Alexey Kudrin's questionable decision to park billions of Russian oil revenues into American agency securities, including paper backed by mortgages issued by Fannie Mae and Freddie Mac, one wonders if the Kremlin should be faulted more for its poor management of Russia's oil windfall rather than for violating Khodorkovsky's civil rights.
Rosneft's defenders here would interject that the company did not sell assets to the Chinese, as Khodorkovsky was proposing to do, but only raw materials. In Russia you are free to sell the milk, but the State will not allow you to sell the cow when it must collect some of the milk for its own purposes. There is also nothing uniquely Russian about this policy among the world's top oil producing nations. America's allies Saudi Arabia and Kuwait also require all production sharing agreements to be done in partnership with the State. The question remains though, if a future Russian government finds that it cannot honor the current agreed upon price with the Chinese, what collateral does China have to collect on the debt owed by Russia?
When Will Washington Wake Up and Realize that the World Has Changed?
On the other side of this equation, those few Cold Warriors left in Washington who still believe that Russia and the U.S. are playing a new "Great Game" over access to natural resources and military bases in former Soviet Central Asia ought to think again. If there has been a "New Cold War" between the U.S. and Russia, it looks like China is coming out the winner hands down. When cash-strapped Russian state oil firms see little alternative to selling China their crude oil at potentially below world market prices, when America has to send Secretary of State Hillary Clinton to kowtow in Beijing, pleading with Chinese leaders not to stop buying U.S. Treasury debt, the global balance of power has clearly shifted East.
Worst Case Scenarios: Russia and America Versus China
A future Russian government could, of course, tear up the contracts established by Rosneft in recent years, and tell the Chinese to stick them where the sun doesn't shine. That may invite a response from a future Chinese government, which will certainly notice that Russia's Far East bordering China is rich in natural resources and largely unpopulated. Promoting emigration into this area without firing a shot might give millions of unemployed Chinese men something to do. A future American government could also default on the trillions in U.S. Treasury debt owed to China, particularly once servicing interest on the national debt becomes the largest single item in the whole U.S. federal budget, bigger even than spending on national defense and Medicare.
The consequences for both nations of such radical scenarios are frightening to contemplate. Even so, there is enough fallout from the global economic crisis to make Washington's aging Cold Warriors reevaluate their worldview. It remains doubtful that they will change their attitudes until a new post-Cold War generation takes charge, without the baggage of the past. Hopefully though, Washington's rising Russia hands will know the difference between the Russian word for "reset" and "overload".
China, Russia, and Obama's "Financial Unilateralism"
When U.S. President Barack Obama's spokesman was asked last week how he would respond to China's very publically expressed concerns about the safety of its U.S. dollar denominated assets, he dismissed Chinese Premier Wen Jiabao's public concerns about how much money the Obama Administration and Congress are planning to print in the next two years. "There's no safer investment in the world than in the United States," White House press secretary Robert Gibbs reassured reporters.
The Chinese, however, already know that their U.S. Treasuries and other holdings, which are denominated in dollars, could lose tens or hundreds of billions if the Obama Administration's big spending plans create 1970s style double digit inflation. This is what prompted Luo Ping, Director General of the China Regulatory Banking Commission declared during his recent visit to New York, when he said, "We hate you guys...once you start issuing $1-2 trillion [in new debt], we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do." An inflated dollar would also damage the already crisis-depleted Stabilization Fund of the Russian Federation. The value of the ruble, currently hovering around 34 rubles to the dollar after peaking at 24 last summer, would then become even more questionable. The Russian finance ministry would not be able to easily shift its currency basket from dollars to euros, British pounds, and yen when the sinking dollar drags those currencies down as well.
After ushering in a new regime in Washington that claimed it would listen to the world after eight years of alleged unilateralism and arrogance, it appears that when it comes to how America's spending and borrowing affects the global economy, the Obama Administration prefers to cover its ears. The rest of the world, after all, was supposed to be represented by the social democratic countries of Western Europe, which greeted Obama like a rock star during his unprecedented speech in Berlin during last year's presidential contest. During his successful campaign, Obama hardly said anything about countries like China or Russia, and certainly didn't mention that they could probably care less about carbon credit "cap and trade" or the other "green" parts of his agenda.
The troubling questions still remain though: how exactly can America afford to fight a new Cold War with Russia, one of its biggest creditors, and which regime has benefitted the most from the rivalry between Washington and Moscow these past few years?
Charles Ganske is a former financial advisor with Merrill Lynch and the editor of Russia Blog.
The views expressed here are his own.
Click on Russia and China's Financial Warning to the West: Is Anybody Listening? to read more on this topic.