Russia is one of the few places where Australian juniors are still afraid to tread. Many entrepreneurs remember Star Mining and the Sukhoi Log debacle. Yet the world’s biggest country is benefiting from the “flight to risk”; a handful of British mining juniors and even some mid-cap South Africans have dipped their toes in, while the global oil industry is clambering to get a piece of the action. Australia is remote from Russia and so may not be the ideal base for an enterprising junior, but logistical difficulties haven’t kept locals from working in West Africa or South America. There is no doubting Russia’s mineral endowment and exploration potential. So are Aussie mining juniors missing one of the biggest opportunities of our time?
Russia’s economy appears strong, with 10% economic growth in 2001, 6% in 2002 and almost 7% forecast or this year. Until recently, the stock market was booming – its October peak was 79% higher than the start of the year. The country is politically stable and President Vladimir Putin looks certain to win re-election next year. To cap it all, the investment rating agency Moody’s recently upgraded Russia’s foreign debt to investment status (the first time ever) and praised the country’s fiscal policies. Standard & Poor’s and Fitch, the other big names in the ratings market, have maintained their grades below investment level. Perhaps their analysts have longer memories; Russia reneged on its foreign debt only five years ago.
Appearances, however, can be deceptive. The economic strength is founded entirely on the strong oil price and a handful of large oil companies. Almost 65% of the stockmarket’s capitalisation is in oil and gas companies. Outside the oil and gas sector, Russia’s exports are actually falling.
Russia has the largest hydrocarbon reserves outside the Middle East and its oil production now rivals Saudi Arabia’s. Yet the country’s living standards remain low as much of the oil profits leave the country. Russia has suffered up to US$30 billion of capital flight per annum over the last five years. That money enriches western economies and governments, not Russia. Lack of investment arising from both capital flight and weak laws protecting private property suggest the non-oil economy will continue to wither. In as little as 10 years, much of the industrial base could be too old to compete. The domestic market is also suffering, with the population shrinking by around 1 million people per year. This is partly due to ill-health (AIDS and tuberculosis are widespread) and partly to Russia’s extremely low fertility rate.
Corruption and organised crime are part of daily life. Politics is corrupt, with 93 of the Duma’s 450 members under criminal investigation at the time of their election. Parliamentary immunity means a seat in the legislature is de rigueur for serious corporate criminals. Russian officials are estimated to gain US$40 billion per annum through corruption with one commentator suggesting the country now has 10,000 organised crime groups operating protection rackets.
Russia has failed to significantly diversify its economy. It lacks a credible banking sector and the country is now as dependent on hydrocarbon exports as many of the OPEC states. Some analysts fear that Russia’s oil and gas wealth will cause the same strangled development as we see in most OPEC nations. Far from enriching the entire country and funding widespread economic development, history (and many academic studies) shows us that easy oil wealth tends to accrue to the ruling class, corrupt the bureaucracy, stifle other entrepreneurial activity and worsen social cohesion.
None of this has stopped the global oil industry. BP recently completed a merger with the mid-ranking oil company, TNK. ExxonMobil and ChevronTexaco are vying to complete a similar deal with Yukos, Russia’s largest oil producer. Negotiations are on hold while the largest shareholder and former CEO of Yukos fights tax evasion and fraud charges from his prison cell. His arrest in late October on what are widely seen as politically-motivated charges sent a shock wave through the investment community and appears to have ended the stock market’s bull run this year. As with many shocks, this one will pass.
The Russian economy appears strong, but it has weak foundations. Investors have short memories where emerging markets are concerned and too often believe that “things have changed”, when in fact only the players are different. Russia is in the grip of robber-baron capitalism and its weak institutions are incapable of performing a “nation building” role. Like many OPEC states, oil and gas wealth may actually be hindering the country’s development. With such a poor structural outlook, most western mining companies will continue to avoid Russia. Only the big oil and gas companies, which have the money and political backing to take on the oligarchs and the Russian government, seem to have any chance of success.
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