Cover Story : Only For The Brave

The stakes are high, and so are the risks. So why are multinationals still buying into the Russia story?

Project financing consists of financing assets on a long-term basis and, as such, is similar to long-term lending. Repayment of the debt is accomplished by the long-term cash flow of the project, without a full guarantee from the shareholders. The trend is for projects to grow larger and larger, Rousseau says, noting that BNP Paribas coordinated a group of 36 commercial banks that committed to $100 million each for the $3.6 billion bank facility for the Qatargas II project financing that closed in December 2004. The $9.3 billion project, a joint venture of Qatar Petroleum, with a 70% stake, and ExxonMobil, with 30%, will deliver liquefied natural gas from Qatar to the UK. One innovation in the structure of the deal is that the participating banks will rely on the price of natural gas instead of oil in calculating cash flow.

The weather outside was sunny; the mood inside anything but. More than 1,000 businessmen, politicos and financiers had gathered in early April in the shadow of Londons Westminster Abbey for their annual get-together on the state of the Russian economy. In recent years, the talk at the Russia Economic Forum increasingly has centered on the opportunities for making money out of Russias booming markets. This year, it was worries about a return to centralization that were top of the agenda.

Little wonder: The Yukos affair is nearing its end, with major shareholder Mikhail Khodorkovsky likely to face a long stretch in prison and his company effectively renationalized. A recent decree made it clear that only majority Russian-owned companies would be allowed to bid for key oil fields.

April brought more bad news for would-be investors in Russia. The governments anti-cartel body blocked a bid by Siemens of Germany for a 73.5% stake in turbine-maker Siloviye Mashiny. The agency said the move would give Siemens too tight a grip over the turbine market; others pointed to the decree passed a week before by the Duma state parliament, which declared a foreign takeover a threat to the countrys national security.

Siemens shrugged off its disappointment, but there was little hiding the dismay among the delegates at the London Forum when news filtered through that Anglo-Russian joint venture TNK-BP had been hit with a claim for $1 billion in back taxes.

For some time now it has been clear that the Kremlins approach to Russian economic life was a balancing act between conservatives and liberals; last months event seemed clearly to indicate that conservatives were in the ascendant.

Putins maverick economic adviser Andrei Illarionov described the new orthodoxy as an interventionist model, characterized by extremely incompetent intervention in economic life by state officials.

That new mood has taken its toll, in the form of a falling investment rate and capital outflows. In 2004 some $7.8 billion left the country, according to official statistics. Industries that should be booming are suffering from underinvestment, say analysts. Most worrying are clear signs of falling production in key oil fields as equipment begins to wear out.

The tax bill slapped on TNK-BP is particularly worrying: The joint venture was widely viewed as a template for foreign participation in the Russian economy and was explicitly rubber stamped by the Kremlin. Robert Dudley, TNK-BPs CEO, said his companys experience would be a test of whether Russia could integrate with the world economy.

As Global Finance went to press, BP CEO John Browne was flying to Moscow to talk to President Vladimir Putin. Thats not the only bridge-building Putin has been doing with the business world. In March he met leading businessmen, reportedly telling them the government would not revisit privatizations that happened more than three years ago. That put in the clear most of the Yeltsin-era loans-for-shares deals that created Russias present-day oligarch class.

Economics minister German Gref points to the privatization of telco Svyazinvest as evidence that his liberal reform program still has legs. Even the rather messy merger between state gas monopoly Gazprom and Rosneft can be viewed in a positive light. Because the Russian state ends up as (just) the majority shareholder in the newly merged entity, it is expected to lift restrictions on foreign ownership of Gazprom stock.

That will boost the companys standing in major emerging market indexes, likely prompting a flood of overseas buying. And there is still money to be made in Russia. The countrys economy is still growing at a fair clip: GDP expanded by 7.1% last year, and despite some worries over inflation ticking up, the macro climate remains sunny. Thatand a booming world market for most commoditiesis translating into profits for an increasing number of brave overseas buyers. Mid-April, London-based gold miner Peter Hambro Mining said 2004-2005 earnings were up by half, largely on the back of increased production at its Pokrovskiy, Siberia, mine.

But if natural resources continue to be the chief motor for the countrys economy, consumers are increasingly taking the burden onto their own shoulders. A growing middle class has spawned a mini-boom in the retail sector and associated financial services. The advance of Swedish retailer IKEA and Germanys chain of Metro supermarkets is well documented; analysts argue that consumer businesses are not viewed as strategic by the conservatives in the Kremlin. While retail operators have to negotiate local politics, they are less vulnerable to attacks from the center.

Other growth sectors include cinemas, gaming and telecom. Certainly, stock market investors still seem willing to take a bet on Russias prospects. In February cell phone holding company Sistema successfully floated its shares on the London Stock Exchange. Overseas investors are prepared to weather political risk, it seems, when potential returns are rich enough.