Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Three Factors Which Could Change Business Conditions in Russia

The share swap between BP and Rosneft last month once again drew attention to business conditions in Russia. Due to corruption, political repression, a disregard for the rule of law and a reputation for forcing out foreign businesses through questionable means, President’s Medvedev’s aspiration to transform Russia into a financial center and an environment in which the interests of foreign firms are respected seems laughable. Though these concerns should not be dismissed three factors must be noted:

1. Over the past decade Russia has regained control over many of its natural resources.

2. Moscow has increased its influence in its near abroad (bordering countries in which Russia historically has had a privileged interest e.g. Ukraine).

3. Russia's developing relationship with Germany could help modernize its economy.

These changes could have a major impact on business conditions in Russia over the course of the next decade.

While the United States has been bogged down in Iraq and Afghanistan, Moscow has begun to reestablish itself on the global stage and to reassert control over its former sphere of influence. Russia may not be the superpower it once was, but it is far more powerful than it was in the 90’s. For this reason it no longer has to accept unfavorable terms that it will seek to undo later. For example, in 1996 when Russia was in a period of extreme weakness, Moscow had little choice but to accept Shell’s conditions in order for them to develop the Sakhalin II oil and natural gas project. These terms stated that Russia would only receive its 10% of extracted hydrocarbons after Shell had recouped its costs and a 17.5% rate of return. Within the next eight years the cost of the project doubled, which delayed any pay out to the Russians. In addition to this, Shell did not contribute enough to the local community to satisfy residents generating a great deal of resentment. When Putin came to power and set about regaining control of lost resources, he not surprisingly turned his attention to Sakhalin. Using environmental concerns as an excuse, the Russian Ministry of Natural Resources revoked permits and delayed the construction of pipelines. Shell stood to lose billions if it did not sell off part of its stake, thus in 2007 Shell reduced its stake in Sakhalin II from 55% to 27.5%. Gazprom promptly bought this stake along with Mitsui and Mitsubishi’s shares for 7.5 Billion USD which in the greater scheme of things was a pittance. Not surprisingly this event did nothing to endear Russia to potential foreign business partners. However, from the Russian perspective Sakhalin was merely a case of regaining control of resources it unfairly lost during a period of weakness. Times have changed. Now that Moscow is in a position to dictate favorable terms it is less likely to need to turn to questionable means to protect its interests especially if such actions damages Russia's reputation in the long-term.

Over the past few years Russia has demonstrated that it is willing to cut off supplies of gas to transit countries, such as Ukraine and Belarus, in order to force them to comply with Russian demands. Moscow does this despite the fact that it cuts off supplies to European energy consumers who contribute a great deal to Russia’s GDP. Such an act is ill advised as a primary feature to the Russian economy has been the fact that its European customers have historically been willing to pay a relatively high price for Russia’s energy and natural gas. Angering these customers is not in Moscow’s interest. That said, finding new energy supplies takes time. If Russia regains control over its near abroad, future energy cut offs are far less likely. For this reason regaining control in its former sphere of influence and ensuring that oil and gas pipelines that bypass Russia, such as the Nabucco pipeline, never come online are issues that Moscow wants to resolve before viable alternatives to Russian energy are found. Though pipeline politics are as convoluted as ever, Russia clearly is reestablishing itself in its near abroad. The past few years have seen Ukraine’s Orange Revolution fall apart while the world’s response to the 2008 Russian-Georgian war has demonstrated that the international community will do nothing concrete to help a country like the Republic of Georgia if Russia attacks it.

Moscow is now taking control over Belarus, which is of importance as it is a transit country for Russian oil and natural gas. Due to regional geopolitical and economic realities Russia was always likely to take control of a significant portion of the Belarusian economy. However events in Europe have hastened this process. Prior to the December elections, Poland tried to convince Belarusian President Alexander Lukashenko to hold free and fair elections in exchange for greater access to funding from the European Union. Warsaw believed that it would gain greater prestige in the EU by demonstrating that it could help steer a state that is under heavy Russian influence into a greater alignment with the EU. The Poles thought everything was working fine until Lukashenko used their offer to convince Moscow to eliminate its oil export tariffs and to lock in natural gas prices for all of 2011. Warsaw was humiliated. Now Poland is doing what it can to undermine Lukashenko as, politically speaking, it wants to demonstrate that it will not tolerate such an insult from a country as weak as Belarus. Though it remains to be seen how effective these sanctions will be, the whole European Union saw Warsaw get burned by Minsk. Such an action undermines Lukashenko’s already questionable credibility. This works well for Moscow as these factors will force the Belarusians to seek Russia’s assistance. Further weakening Minsk’s bargaining position is the fact that to get the oil tariffs eliminated and the gas prices locked in for the year it signed all seventeen documents to create the Unified Economic Space which is a customs union between Russia, Kazakhstan and Belarus which Russia will dominate (Though Minsk agreed to the Customs Union in July, it was only in December that the oil tariff and gas price issues were resolved). The end result is that Lukashenko handed over a great deal of control of the Belarusian economy to Moscow in exchange for short term, albeit much needed, economic assistance.

A prospect which must concern Moscow now is the potential that gas extracted from shale will radically reduce Europe’s demand for Russian gas. This is a real concern but several factors that can delay this shift must be taken into account. First, building the infrastructure to extract and distribute this gas will not happen overnight. Secondly, there are a variety of environmental concerns (e.g. contaminating water supplies) associated with such extraction and environmental impact assessments which will address these concerns will take time. Finally, many countries have signed contracts with the Russians. They will need to wait until these contracts lapse before seeking a new deal.

Despite the potential delays in shale gas reducing the price of the commodity as a whole, Russia must realize that such a shift is coming. For this reason it needs to make its economy less dependent on primary commodities. Russia is not in a position to do this without foreign partners. Therefore Moscow must take steps to demonstrate that it is a reliable business partner and that Russia is a safe place to invest. Though this is not to say that Russia will not revert to its old practices if the game changes yet again we must keep in mind that this has not happened yet and is not likely to happen in the immediate future.

The Germans appear to feel that investing in Russia is worth the risk as Berlin has been developing a better relationship with Moscow, particularly in the energy and transport sectors. Berlin certainly has interests in pursuing this relationship. The European Union, which is a major market for Germany goods, is in an economic crisis. As an exporter, Germany is concerned with accessing new markets and ensuring a steady supply of resources. Germany receives 40% of its energy from Russia who in turn can use this income to purchase German products, thus, Berlin has an interest in maintaining good relations with Moscow. In addition to this, Germany’s population is declining while its need for labor is rising. Despite this reality Berlin has no desire to encourage immigration as this is a controversial issue in Germany. By investing in Russia, Germany gets the benefit of having the labor needs for its manufacturing sector met without having to endure the domestic problems associated with encouraging immigration. Moscow, in turn, gets an influx of capital as well as German technical expertise which can help develop the Russian economy beyond being one based largely on primary commodities.

The energy and industry divisions of Siemens are an example of a German company who is very active in Russia. Per Siemen’s website, during fiscal year 2010, it had 3,300 employees based in Russia with sales totaling 1.2 Billion euros. New orders are valued at 2.6 Billion Euros. Between the fact that the orders doubled and actions from Moscow to make obtaining working papers easier, it is likely that the number of Siemens employees working in Russia will rise. In terms of transportation Siemens has partnered with the locomotive division of Russia’s SINARA Group in order to modernize the country’s railroads.

Despite successes such as this other major deals have encountered difficulties. For example, the French energy company Areva pulled out of a joint nuclear venture with Siemens and Russian state nuclear company Rosatom. Rosatom is one of the only companies that can offer services similar to Areva. Moscow also allows spent fuel to be sent back into Russia. For these reasons Areva views Rosatom as a threat and thus has been using a non-compete clause in a contract with Siemens to stall a joint nuclear venture between Germany and Russia. Given that such a venture would have a major impact on the nuclear energy industry and Russia’s economic development this case is worth watching.

Moscow has demonstrated that it can exploit foreign firms if their presence is not in the Kremlin’s interest. However, given that Russia has reestablished itself to the point that it no longer has to consent to the types of bad deals that it had accept in the 90’s the likelihood of such actions are decreasing. Russia knows that it needs to change its economy and that it cannot do this quickly or without foreign technology and expertise. At the end of the day foreign and economic policy is dictated by interests. Many of Russia’s interests have changed. It is essential for political and business leaders to recognize this new reality rather than stay rooted in a post cold war world view.