Market Discipline and Economic Rationality Are Two Things Russia Can't Abide

Check this out if you want to see examples of the myriad deformities in Russian energy policy in one brief article. Wasteful use of gas due to domestic price controls–waste that contributes to the release of greenhouse gases, by the way.

The use of state regulatory agencies to exert pressure on a foreign investor; in this case, the mineral rights regulator RosNedra threatening to revoke Hungarian firm MOL’s license unless it captures gas production associated with the output of oil. A threat that would be unnecessary if state firm Rosneft (RNGZY.PK) had followed Yukos’s practice of purchasing of the gas. The involvement of Surgut Neftegaz (SGTZY.PK)–sometimes called Rosneft chairman’s Igor Sechin’s favorite “private” oil company–attempting to take control of MOL. The simultaneous adversarial actions of RosNedra, Rosneft, and Surgut Neftegaz towards MOL suggests that they are playing a triangle offense, with the Hungarians caught in the middle.

In a more economically efficient system, the price of gas would adjust to ensure its efficient use, and eliminate wasteful flaring. This would alleviate Russia’s looming gas shortage. It would also make it unnecessary for the regulator to coerce firms into doing this–and therefore would also deprive it of the cover to use its powers at the behest of state owned firms, and the private allies of state owned firms.

But this is not possible in a natural state like Russia. Prices cannot be allowed to allocate resources efficiently, because it would damage important domestic political constituencies, including individual consumers, but more importantly, industrial consumers and power producers dependent on below-market gas prices. And protections of foreign investors constrain the ability of the state to shift rents around in order to placate other constituencies, so they cannot be countenanced.

The pressures being exerted on ExxonMobil (XOM) represent another example of how the political imperative to allocate rents in the natural state precludes reliance on market mechanisms to allocate resources; the necessities of subsidizing restive Siberian consumers and feeding Gazprom’s (OGZPY.PK) voracious appetites means that something has to give, and that something is a foreign investor.

This is why this attempt to interpret Russia’s adamant unwillingness to sign onto the foreign investor protections in the Energy Charter solely as a response to the Yukos expropriation are simplistic, and wide of the mark:

But everything was outweighed, judging by everything, by just one sole argument. The Energy Charter is the legal foundation for a claim by former shareholders of the YUKOS company against the Russian state. Investors who have suffered from the artificial bankruptcy of the former company of Khodorkovsky are demanding of the government of Russia to pay them back for their losses. In its time, the market had appraised the YUKOS company in the tens of billions of dollars. Correspondingly, the sum of the shareholders’ claims is comparable is size as well.

. . . .

It is possible that the powers would do well to be more consistent. It looks somewhat strange that the development of international relations and questions of economic strategy are subordinate to the logic not of benefit for the country or of society, but lie in the stream of resolution of superannuated conflicts. But, probably, it is not at all the «YUKOS affair» that should be determining the policy of the country, or else it turns out that the tail is wagging the dog, although it should be the other way around.

Yes, Yukos is important, and yes, the prospect of having to compensate the expropriated is one reason why Russia cannot join the Energy Charter. But it could not join even if Yukos had never existed. The energy charter would force an element of market discipline and economic rationality that the natural state that is Russia cannot abide.

The Charter’s provisions on investment protection, transit, and transparency limit the Russian government’s flexibility to manipulate markets in order to allocate rents to maintain a political equilibrium. Khodorkovsky and Yukos threatened that equilibrium, but there are other threats. As a result, Yukos or no, Putin and the Russian elite are perfectly willing to forgo some of the efficiency benefits of more secure property rights and the uses of prices to allocate resources, in order to ensure the distributive and political benefits that government control of resource allocation confers.

That’s the way the natural state works.

Comments

[Jasper M:]

Nice to hear from SOMebody willing to refute at least a portion of teh "BRIC" kool-aid.

Aug 14 07:47 AM

[Dave Wrixon:]

I think you can add "Listening to Americans that don't have a clue what they are talking about" to that list!

Aug 14 08:56 AM

[john s. gordon:]

it seems the KGB thugs are up to their usual tricks.
> jack

Aug 14 09:36 AM

[A Barrel Full:]

At least with oil & gas prices lower, outsiders are starting to be willing to look at Russia as it is, rather than as they wish it to be.

Aug 14 10:03 AM

[Ferdinand E...:]

Energy Charter. What energy charter is this, and if it is the one I think it is, I can't see any reason for the Russians to be interested in it. At least I hope that they arn't.

I remember when the dumbest president in American history, Ronald Reagan, was threatening European countries if they cooperated in the construction of pipelines from Russian/Soviet gas deposits to Western Europe. It was his moronic belief that the Russians could not build compressors without foreign assistance. Unless I am mistaken, the wrong dimensioning of those pipelines cost me a long weekend in Paris.

To my way of thinking the Russians would be doing themselves a favor if they made better use of markets, but if given the opportunity I wouldn't tell them to change their gas policies, or to listen to the completely ignorant arguments from Brussels about 'liberalizing' the electric market.

Aug 14 11:02 AM

[Jason Rines...:]

Well put notsosmart, my previous comments about Russia mirror your own. I don't like how our economy and political system is becoming more like China's though.

Aug 14 01:43 PM

[Jimbo:]

Russia is nothing more than a continuing criminal enterprise. It may take another Century before the situation there gets better. I would never knowingly invest in a company that had interests in that den of thieves.

Aug 14 02:35 PM

[chap08:]

I have personally been the victim of an abuse of shareholder rights in Russia. Even so, I still have a small allocation to Russia. It is a question of being aware of the risks and pricing them in to your investment i.e. keep your exposure small and never be tempted to bid up. On the plus side, for those that think that way, Russia can give you a hedge against higher oil proces for quite a small price.

Aug 14 04:18 PM

[inthemoney:]

> Russia is nothing more than a continuing criminal enterprise. It may take another Century before the situation there gets better. I would never knowingly invest in a company that had interests in that den of thieves.

Ouch. Look who is talking. What do you call US government stealing trillions from its citizens and giving them to insolvent banks. Russia is corrupt I agree, but to say everyone there is a criminal is not only over the top, it is insulting. Is everyone a criminal in Mexico and India as well?

Aug 14 10:32 PM

[John Bowman:]

When glasnost appeared in the Russian bureaucracy decades ago, I told a fellow co-worker that no fundamental change would occur there.

Over and over, to trust Russia is to be foolish.

Aug 15 07:34 AM

[Tony Petroski:]

From the article: "Wasteful use of gas due to domestic price controls–waste that contributes to the release of greenhouse gases, by the way."

When is it going to dawn on the intelligentisia: If greenhouse gases do indeed raise global temperatures, that is useful for some countries and harmful to others.

Russia would be the beneficiary.

Back to reality. An interesting article Mr. Pirrong.

Aug 17 11:06 AM