'Collective Putin' mismanages Russia's energy sector

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Little will change in the poor management of Russia's energy sector with the return of Valdimir Putin as president of Russia, says Mikhail Krutikhin in an analysis initially published the European Union Institute for Security Studies.

 

Mikhail Krutikhin is an analyst and consultant on the oil and gas industry and politics in Russia. He is a co-founder of and analyst with the RusEnergy consultancy in Moscow and editor-in-chief of the Russian Energy weekly newsletter. 

When Vladimir Putin and Dmitry Medvedev said they were going to swap jobs, they meant just that. Medvedev’s four-year tenure as the president of the Russian Federation has hardly had any noticeable effect on the national energy industry – just as in his previous role as chairman of Gazprom’s board of directors he did little to influence the strategy and practices of the Russian gas monopoly. Both assignments had nothing to do with the actual management of the most important sector of the Russian economy. Rather, the Russian energy sector has been controlled by several clans closely linked to Putin, the current prime minister, since the beginning of the past decade.

The actors involved in those networks, often people who accompanied the prime minister through the various stages of his career in the Soviet security service and the St. Petersburg city administration, form a kind of ‘collective Putin’ and have survived the past four years without difficulty. In this context Medvedev is little more than a pseudo-liberal figurehead disconnected from the centre of the decision-making process. More importantly, the ‘collective Putin’ do not intend to relinquish control of the Russian energy sector in the foreseeable future.

The specifics of the Russian electoral system make it easy for the ruling elite to control the situation. As a result, this nominal change of roles between Putin and Medvedev is not going to affect the shape and structure of the energy industry, nor is it going to ameliorate the investment climate. Russia’s energy sector has been run for years by the same group of people regardless of their formal positions in the government, and they will remain at the helm after the swap. The role of the top state echelon is essentially confined to the protection of close associates, the promotion of legislation favouring their interests, and the perpetuation of a system which is based on loyalty, not efficiency.

Basically, Putin's return to the presidency on 7 May is not going to usher in any significant changes in the way in which the energy industry is governed.

Problems with the energy sector

One flaw of the energy industry is its structure, which is dominated by government-backed monopolies and characterised by discrimination against private businesses, small domestic operators and international players. State-owned companies such as Gazprom or Rosneft, as well as some private companies with close links to the political leadership such as Gennady Timchenko’s Novatek, enjoy privileged access to licences, upstream assets, tax exemptions etc. Foreign investors are able to operate in Russia only if they establish good working relations with members of the dominating clans. The quickest way to be awarded projects and contracts in Russia is to offer those clans stakes in respectable international companies.

Another serious problem is the deeply dysfunctional way in which the energy industry is governed. The absence of public scrutiny allows for uncontrolled redistribution of rents among the actors involved in the networks around the political leadership. Huge showcase projects are launched with little consideration of their economic profitability. For instance, the construction of the Baltic Pipeline System II started in 2009 (completion is envisaged this year) despite criticism even from within the government. The Altai Gas Pipeline project, planned to establish a link between the gasfields in Western Siberia and consumers in northwest China, is similarly contentious for economic and ecological reasons.

The energy industry also suffers from poor quality of management. Since the ascension of Putin and his allies to power in 2000, appointments to important positions in the Russian establishment, including the energy industry, have been made according to two criteria: personal loyalty and the ability to control cash flows. Clearly, professional skills and expertise do not fall into these categories. As a consequence people with little knowledge of the subject area invaded the upper echelons of Gazprom, Rosneft and Transneft management, with devastating effects on management quality.

Cynical rent-seeking is another explanation for erratic decision-making. While private companies in Russia often operate according to market rules, state-controlled entities pursue a policy that is rarely informed by commercial wisdom. As a rule contracts funded through public investment programmes are awarded to companies owned by relatives or friends of key politicians and government officials.

Gennady Timchenko or Arkady and Boris Rotenberg are cases in point. The latter are involved in the construction of the gas pipeline from Sakhalin to the Chinese border near Vladivostok, which provides a striking example of the self-service mentality that reigns in Russia’s energy economy. There are currently no reliable gas deposits to fill it to commercial capacity, and there are no contracts for gas sales to China. Moreover, the government has announced it will subsidise the domestic gas tariffs in the Far East because the gas from Sakhalin is too expensive, and cover Gazprom’s losses. The only beneficiary in this project is a company owned by the two Rotenberg brothers. This is a typical case of nationalisation of costs and privatisation of profits.

Little change in Russia's energy strategy

In 2009 the Russian government adopted a new Russian Energy Strategy to 2030. However, the document does little to address the various problematic issues besetting the energy sector. Based on the assumption of perpetually growing international demand, the document stresses the importance of energy security and pledges huge investments mainly from private sources in the expansion of production capacities as well as infrastructure and energy efficiency.

It would be mistaken, however, to assume that this document has an impact on the shape of the energy industry and the challenges it faces. It contains some general statistical data, a loose collection of hypothetical assumptions and a long laundry list of strategic guidelines with few practical implications. In private, experts working on the Energy Strategy 2050 admit openly that this new version will be equally unrealistic in its assessments and forecasts because governmental control and censorship do not allow for an open discussion of the problems undermining Russia’s energy sector.

The approach applied in the document is one of censorship and taboo. Evidently the absence of a critical debate results in a total lack of ideas on how to restructure the industry and establish a competitive and liberal environment.

Moreover, the document does not contain any serious calculation of the amount of investment needed to achieve the goals it identifies, nor does it explain where the money should come from. It does not draw a clear picture of the future production costs for oil, gas and electricity and of the respective market prices. Nobody in the government is making an effort to find answers to these crucial questions.

The attitude of the political leadership reflects this lack of strategic considerations. Contradictory official statements on any possible aspect of energy policy are a regular feature of Russian politics. Unfortunately, Russia’s external energy relations are not immune to this kind of arbitrariness. Offers to Europe to expand the pipeline system that links Russia and Western Europe are followed by threats to reroute export flows to Asia if Europe shows discontent with the prices for Russian natural gas – and vice versa.

Such erratic changes of attitude can be tactical, but in many cases they also show the incompetence of the Russian leadership. When Russian officials said they would liquefy all West Siberian gas, close the taps on Europe-bound pipes and sell LNG in North America, they were bluffing: the price of gas in the USA at that moment was about $110 per 1,000 cubic metres while Gazprom was selling gas in Europe at the average price of $250.

Moreover, the ‘shale revolution’ was making the United States a net exporter of gas instead of a net importer. When Gazprom chief executive Alexei Miller claimed that the volume of Russian gas exports to Asia would equal the sales to Europe, he was bluffing: there is neither sufficient demand on the Chinese side, nor does Russia dispose of enough available resources to reach parity. However, when the prime minister declares that Russian production of natural gas will reach 1 trillion cubic metres a year, he displays an absolutely unrealistic view of the industry’s capacities.

In many cases, apart from inflicting significant damage on the federal budget, decisions in the energy industry harm Russia’s national interests at the regional and international level. Disputes over energy-related issues have in recent years seriously strained relations with countries such as Turkmenistan, Ukraine, Lithuania, but also the EU. It needs to be stressed, however, that it is not Gazprom that is being exploited as a political weapon by the Russian state. On the contrary, very often Russia’s foreign policy interests are sacrificed to keep Gazprom happy.

Medvedev’s attempts at reform

Medvedev did show dissatisfaction with the situation and even stood up to Putin on some occasions. Unlike the prime minister, who tirelessly promotes Russia as a perfect place for foreign investors, Medvedev has several times stressed the negative business climate in the country.

This view is widely shared by Russian and international experts. It is clear that something radical has to be done about the energy industry – and about the Russian economy as a whole – to make it a worthwhile place for investors. As international rankings demonstrate, corruption in Russia is not an occasional occurrence but a systemic illness and the situation has only got worse over the past four years.

The market reaction to the news about Putin’s imminent return to the Kremlin was revealing. Expectations of capital flight from Russia immediately soared: in 2010, the outflow of capital was estimated officially at $38.8 billion. In 2011, as the Bank of Russia predicted, it would exceed $70 billion.

Medvedev’s timid attempts did not suffice to clean up the mess the ‘collective Putin’ had made of the national economy. It is true that in April 2011 the president ordered the removal of cabinet members from the boards of directors of state-backed corporations. But he did not dare attack Gazprom, where Putin’s protégés are firmly entrenched. Although some ministers have in fact since given up their posts in the economic sector, no action has been taken with regard to the appointment of their puppets to the same offices. The departure of Deputy Prime Minister Igor Sechin from Rosneft certainly does not mean the end of the company’s privileged status and priority access to mineral licences and tax reductions.

Hence, despite public statements and criticism, and some timid attempts to tackle some of the challenges, Medvedev’s policy has not had an impact on the tacit power structures embedded in the Russian energy sector, nor has it succeeded in reducing the sector’s interdependence with the political establishment. In fact, Medvedev has proved to be part of the problem rather than the solution."

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