Could Russia contribute to America's energy security? In the wake of the Yukos affair, doubts have been raised about the country's business climate, growing government intervention in key sectors of the economy, and Russia's reliability as a partner in strategic economic sectors. Given the high stakes involved, it is imperative to read Russia "right." With the world's largest deposits of natural gas and third-largest proven reserves of oil, Russia has the potential to make a major contribution to global supplies. Unfortunately, at a time when attention should be focused on an accurate evaluation of the extent of Russia's reserves and the challenges of getting Russian oil and gas to world markets, many discussions still focus on political risk.

To help make sense of Russian policy in the natural resource sector, we can turn to a fairly comprehensive statement from Russia's President, Vladimir Putin, about Russian energy policy. In the years before he was appointed Prime Minister and then elected President, Mr. Putin defended a Candidate of Sciences (kandidat) dissertation at the St. Petersburg Mining Institute (in 1997)    Neither the thesis nor the summary Avtoreferat have been publicly available since Mr. Putin's appointment as Prime Minister. Several people who claim to have read these works state that the thesis deals with three main subjects: the ways natural resources can contribute to the regional economy; strategic planning; and the development of port facilities in St. Petersburg and Leningrad Oblast to facilitate resource exports. and subsequently (1999) published an article in the Institute's journal outlining his views on a natural resource policy for Russia. While we have no way of proving the extent to which these writings influenced subsequent policy, developments since the arrest of Mikhail Khodorkovskii are in important ways consistent with the views expressed in Mr. Putin's article.

Mr. Putin's was the lead article in an issue of the journal devoted to the fuel and energy complex. His basic message is that Russia's mineral resources, and particularly its hydrocarbons, will be the key to the nation's economic development for the foreseeable future. To guarantee the most effective exploitation of Russia's enormous mineral wealth, the state must regulate and develop the resource sector. This can be best facilitated by fostering large firms that will be capable of competing on equal terms with Western transnational corporations. While the policies should rely on market mechanisms, the interests of the Russian state and people (and  Russian corporations) must be protected.

Mr. Putin's Article

Mr. Putin's article begins with the premise that sustainable economic growth in Russia requires reliance on the country's rich mineral resource endowment. If developed economies grow at a rate of 2-3% per year, Russia requires 4-6% annual growth to catch up. Achieving this level of growth is possible if Russia establishes large financial-industrial corporations capable of competing with Western multi-nationals in energy and natural resources. Along with fostering these large firms, the state must regulate the extractive complex using "purely market methods."

Russia will need to rely on its mineral resources at least during the first half of the 21st century, and possibly longer. Used effectively, the resources can be the basis for Russia's entry into the world economy. Therefore, the sector is crucial to the entire life of state, supporting industry, providing 50% of GDP and 70% of export revenues, and creating conditions for modernizing Russia's military-industrial complex. The large number of "company towns," in the sector gives it a crucial role in preserving social stability.

Mr. Putin recognizes some limits on what may be expected even if the resource sector performs well. The sector cannot finance the development of domestic processing industries, nor can it employ everyone: the low share of labor costs and high cost per worker means the extractive industries by themselves cannot generate an overall improvement in living standards.

Mr. Putin repeatedly emphasizes that restructuring the resource sector to improve its performance is the most important issue for Russian economic growth. Enormous investments will be needed just to maintain current production levels. The gas industry is the best positioned among energy sector branches, but 60% of its pipelines have been operating for more than 20 years [published in 1999], which is nearly two-thirds of their projected useful life. Integrating the processing industry with the extractive industry is one key to improving conditions. The most promising way to accomplish this is by creating large financial industrial groups (FIGs). These companies will allow Russia to move away from reliance on outmoded technologies and they will be able to raise capital on Russian and international markets to locate and develop new deposits. These new companies must take the lead in building up the economy, providing revenue and jobs, and promoting economic integration within Russia, with the CIS and with the world economy.

The resource sector is too important to be left entirely to market forces: "Regardless of whose property the natural resources and in particular the mineral resources might be, the state has the right to regulate the process of their development and use." In doing this the state acts in the interests of society as a whole, and also helps property owners to resolve their conflicts through compromise:

Unfortunately, when market reforms began the state lost control of the resource sector. However, now the market euphoria of the first years of economic reform is gradually giving way to a more measured approach, allowing the possibility and recognizing the need for regulatory activity by the state in economic processes in general and in natural resource use in particular. . . .A contemporary strategy for rational use of resources cannot be based exclusively on the possibilities of the market.

Ensuring rational resource use, guaranteeing environmental protection and  providing long-term economic security are beyond the capacity of markets.  "In Russia, as a consequence, it is necessary to implement this principle of rational resource use by an organic combination of market mechanisms of self-regulation and support for rational resource use and conservation."

Given the serious mistakes during Russia's initial market reforms, the country now requires multiple forms of property corresponding to its diverse stages of technological development. While Western countries have moved beyond the resource-intensive "third" stage of development, Russia has reached the stage of "resource-conserving innovative technology" only in some military-industrial production. This brings Mr. Putin to what may be the most important passage in the article for an understanding of evolving policy: "the basic strategic tasks for the natural resource bloc involve achieving the transition to a rational combination of administrative and economic methods of government regulation in the sphere of resource exploitation" [emphasis added].

Mr. Putin concludes with several lists of priority tasks for simultaneously strengthening the state and improving performance in the resource sector. First priorities entail providing a legislative basis for the sector, including laws for licensing and fee-based exploitation: conservation and renewal; closely delimiting property relations; and establishing state reserves of valuable resources.

"In terms of a general conclusion it follows that existing socio-economic conditions, and also the strategy for Russia's exit from the deep crisis and restoration of her former power on a qualitatively new basis demonstrate that conditions in the natural resource complex remain the most important factor in the state's near-term development."

In sum, Mr. Putin emphasizes the importance of the resource sector for Russia's economic and geo-strategic revival; notes the need for mixed forms of property without specifying the optimal mix; asserts the primacy of state interests; and advocates fostering large, vertically integrated firms that will further with those interests.

Implications

Do Mr. Putin's academic publications have any bearing on Russian policy? In his address to the Federal Assembly on April 25, 2005, in the context of noting the need for legislation clearly delimiting security requirements so that Russia could attract foreign investment, Mr. Putin called for pre-emptive control "by national, including state capital" over defense industry production and strategic natural resource deposits, as well as infrastructure monopolies. In July 2005 Gazprom CEO and Putin deputy Alexei Miller told the Financial Times "that the company wanted to become one of the largest integrated energy companies in the world, spanning oil, gas and electricity." Dmitry Medvedev, Chairman of Gazprom's Board of Directors and head of the Kremlin administration, made a similar statement following the acquisition of Sibneft, noting that Gazprom "will not only become the world's largest natural gas producer, but also one of the world's biggest energy companies" (RIANovosti, September 29, 2005). In October 2005 Prime Minister Fradkov extended the industrial policy model to railroad rolling stock, stating that consolidation in the industry should be viewed as preparation for effective global competition rather than as creating a monopoly.

Invoking the need for vertically integrated enterprises capable of competing with Western multinationals is a call for "national champions." The concept appeals both to those who want to see Russia occupy an important place in the world and to those in a position to benefit financially. Thus the interaction of two related processes may help to explain events since the arrest of Mr. Khodorkovskii. Mr. Putin wants the Russian state to be in a position to exert strategic control over the energy sector with limited recourse to non-market methods. Actors in business and the government bureaucracy want the material benefits. Mr. Putin may not have foreseen the conflicts that would erupt when Rosneft first resisted being merged with Gazprom to create Russia's national champion and then competed successfully with Gazrpom to acquire Yuganskneftegaz, Yukos' largest production asset. This put Rosneft in a position to play the role of a national champion in the oil industry, but left Gazprom without major oil assets and with less than majority government ownership. Gazprom's subsequent acquisition of Sibneft solves the ownership issue, gives the firm a role in oil as well as gas, effectively creating a second national champion.

Is this a good thing? It is profoundly disturbing that many people who wish Russia well are characterized as anti-Russian for raising inconvenient questions. In the energy sector, these questions are important not only to Russia. Tight supplies make waste, inefficiency and corruption in any supplier nation a factor in global energy security. Russian leaders who note that state control of energy resources is the norm in most countries rarely explore why this is the case. Is it because state oil and gas companies are more efficient than private enterprise? Or is it because governing elites have found that natural resources provide unparalleled opportunities for both populist policies and predatory behavior in the name of protecting the national interest?

Some countries have managed to turn their natural resource sectors into healthy components of knowledge economies. Yet the pathologies of the "resource curse" remain perniciously difficult to avoid. Lilia Shevtsova recently suggested that all of the elements of the resource curse are now present in Russia. Steve Fish dismisses rentier, repression and modernization effects in the Russian case, but finds that high levels of corruption do correlate with the oil and mineral wealth. This tracks with the findings of Montinola and Jackman that OPEC membership and corruption are closely linked. Perhaps more important, they also point out that industrial policy is associated with heightened levels of corruption, and that attempts to foster national champions almost invariably invite abuses. Some of the most pertinent parallels for the Russian case are in Terry Lynn Karl's work on Venezuela, where manifestations of the Dutch disease included the decline of productive industries and agriculture; rapid growth in services, transportation and other non-tradable's, a boom in speculative activity; and significant in-migration from poorer neighbors.

The evolution of Gazprom and Rosneft as "national champions" would elicit more enthusiasm if their selection were based on their competitive abilities or represented a reward for their having carried out significant restructuring. Winning non-transparent insider battles over the redistribution of valuable oil assets is hardly an indication of their capacity to operate efficiently. Guaranteeing preeminence in a stable environment is rarely an incentive for any corporation to undertake the difficult work of restructuring. Gazprom was already a bloated and unaccountable behemoth. Adding lucrative oil production facilities, restoring state control (51% of the shares), and going to global markets to raise billions in new capital are not likely to encourage greater efficiency. Some foreign investors will undoubtedly celebrate the dismantling of the "ring fence" that has limited outside investors to expensive ADRs. But if no shareholders are in a position to demand change and Russia's national champions remain insulated from competitive pressures, reform is not likely. While protecting particular interests in the short run, this is likely to undermine Russia's longer-term economic security.

It is not clear whether Mr. Putin personally prefers one national champion, two, or several. In his article he refers to inter-branch complexes and financial-industrial groups in the plural. He might well regard the infighting that has produced two "champions" (thus far) as inevitable and perhaps as positive in that it fosters a form of competition and leaves some levers in the hands of the President. Establishing one or more large, vertically integrated Russian energy enterprises appears to have been a prerequisite for regularizing relations with foreign partners and investors.

Will doing business in the energy industry in Russia now be "normal?" In his meeting with oil industry executives during his visit to Washington in September 2005 Mr. Putin certainly sought to convey this impression, suggesting that there are no fixed limits restricting foreign ownership in the Russian energy sector. A delegation led by Fuel and Energy Minister Viktor Khristenko in late October reiterated Russian interest in cooperative projects, and a long-awaited list of Russian "strategic resources" made public in October proved less restrictive than many had feared. With the creation of national champions, the Russian leadership may now be willing to expand the regions open to foreign participation beyond the technologically difficult continental shelf and to accept greater foreign ownership in energy firms.

Even if some restrictions are removed, the battles within Russia pitting energy industry executives and their bureaucratic supporters against each other and against foreign players will continue to be fierce. While intense competition and government involvement are hardly unusual in the energy industry, in Russia the final arbiter is an individual rather than the market or another institutional mechanism. Mr. Putin's article makes it clear that his concept of Russian state interests will remain paramount. American Congressional reaction to the bid by the Chinese National Offshore Oil Company (CNOOCO) to acquire UNOCAL demonstrates the intense political concern that foreign control of energy assets can provoke. Mr. Putin's government is more united in its resistance to foreign involvement that might hinder state control in Russia's energy sector. The blend of market and administrative measures employed in regulating Russia's energy industry remains subject to adjustment.

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