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Date: Mon, 2 Jan 2006 From: James BeadleAfter a year of successful PR – in which Russia appeared to grasp the cost-benefit consequences of the Yukos affair, and even the lengthy process that would be required to restore its image – 2006 has kicked-off with a monumental faux pas. The Ukrainian gas dispute looked dangerous from its outset, as Russia aggressively positioned itself in a corner from which it would lose face by backing down. Putin himself weighed in early, and later struggled to distance himself from Miller and Fradkov to avoid taking a fair share of responsibility. Too late though – as the deadline rolled around, Russia was still entrenched in its original position. Putin’s “last minute” overture, a three month reprieve on a 450% price hike, was no more likely to succeed than Yushchenko’s suggestion of another ten days negotiating. To summarise, Gazprom is demanding that Ukraine pay market price for its gas, a hike from $50 per 1000m to $230. Russia knows full well that that Ukrainian economy is gas dependent and inefficient (as is its own), so it clearly understands the ramifications of a 450%+ price hike. Indeed, reforms to raise domestic prices provoked enormous debate in Russia. Ultimately, the president interceded to prohibit excessive price increases, and even the EU accepted that Russia should be free to raise prices gradually, a major concession in its WTO accession agreement. There is little ground to consider a one-step 450% price hike as either reasonable or purely economically motivated. What is confusing is that Putin has blundered so spectacularly. Not only is he in the process of taking over the G8 under the banner of Energy Security, but his entire strategy to return Russia to its former glory is based around its reliability as an energy provider. The only logical explanation is that Russia remains under the control of a mix of corrupt and incompetent managers. Certainly it is conceivable that Putin wishes to punish Ukraine for breaking free of its control, but it is difficult to imagine that he would have risked his central strategy for such a trivial issue. Far better for Russia to have bargained hard and then compromised – playing the generous big brother role and convincing the world that Russian energy is reliable (an outcome that may yet be attempted). Instead, Russia appears to be undoing all of the progress made this year, and much of that made since the Putin took power. Cutting off energy supplies is in many ways comparable to debt default. In the same way that the market remembers every default for all time, so it is with energy supplies, doubly so in the modern, energy sensitive world. Yesterday’s decision will never be forgotten and will permanently weigh on Russia’s potential as a 21st energy supplier. This is not to say that Russia is about to collapse, simply to acknowledge yet another inflection point where it has chosen the least beneficial alternative. It may be no coincidence that the president’s economic advisor, Andrei Illarionov, highlighted missed potential in his end of year presentation, right before resigning from his post. Where to now? The gas cut is going to hurt the Ukrainian economy, but so long as Yushchenko successfully can deflect responsibility to the Russians, he will milk the opportunity to rally some patriotic sentiment ahead of spring elections. Even if he capitulates and accepts Gazprom’s demands in full, it is Russia that comes off as the bully. Most likely, both parties will now begin to work with a fresh sense of urgency and arrive at a fair compromise, either hiking prices over time, or settling on a median level. It is wholly unreasonable that Ukraine be obliged to pay more for its energy than the Baltic States with their higher incomes and EU security. Little will change on the ground as a result of this crisis, the consequences will remain subtle and intangible: Even Gazprom’s share price is unlikely to be affected, it is so large and inefficient that cash-flow valuation is all but impossible, and necessarily allows for enormous fluctuations each year. The company remains a buy due to the potential for gain as domestic shares are liberalised and index-tracking funds accumulate positions to sustain their portfolio balance. Longer term, things are less clear; state-run companies are not renowned for the efficiency gains that could be expected if Gazprom were a private enterprise. Gazprom will remain the government’s cash-cow, a necessary part of any model portfolio, but fundamentally repressed. The Ukraine gas issue, meanwhile, will hopefully be resolved swiftly. However, Russia has begun 2006 in an ominous manner. One can only hope that Putin comprehends the scope for self-inflicted damage swifter than in the Yukos case. Russia faces enough challenges raising its quality of living and international status, without shooting itself in the foot during the New Year festivities. |
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