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Russia Report: January 4, 2005


4 January 2005, Volume 5, Number 1
ECONOMY
TO SPEND OR NOT TO SPEND?
By Robert Coalson

One of the big decisions facing the Russian government this year is what, if anything, to do with the money that has accumulated in the so-called stabilization fund. The creation of the fund, which is now worth more than 500 billion rubles ($16.7 billion) because of unprecedented global oil prices, was widely hailed domestically and abroad as one of the government's signal economic achievements of 2004.

Recognizing Russia's overwhelming economic dependence on the export of raw materials -- especially energy -- the government created the fund at the beginning of 2004 to accumulate proceeds from high oil prices in a special account that could then be used to ameliorate the economic effects of significant downturns in energy prices in the future. When oil prices are above $25 per barrel, as they were throughout 2004, up to 90 percent of the excess proceeds on oil exports are automatically diverted to the fund. Already by the end of March, Deputy Prime Minister Aleksandr Zhukov was boasting that the fund contained nearly $5 billion.

Despite the windfall from high oil prices, the Russian economy still faces numerous problems that make it increasingly difficult for politicians simply to allow the vast resources of the stabilization fund to sit idle, waiting for a rainy day. As might be expected, left-leaning politicians led the call for using the stabilization fund to resolve social problems. Communist Party leader Gennadii Zyuganov, during this summer's debate over the monetization of most in-kind social benefits, cited the fund in his rebuttal to government claims that social benefits had to be restructured for economic reasons. "The country's huge hard-currency reserves and the stabilization fund deprive the government of the right to speak about an inability to afford benefits," Zyuganov wrote in an open letter to Putin in June. "Rather, it is a case of the government's clear lack of desire to fulfill the norms of the Russian Constitution." Although the government has not made any announcements regarding the use of the stabilization fund for the monetization of benefits, periodic media reports indicate that some regions expect just such a policy. On 29 December, for instance, Regnum quoted Federation Council member Yevgenii Bushmin, who represents the administration of Nizhnii Novgorod Oblast, as saying that his region expects to receive 100 million rubles from the fund for benefits payments this year.

Of course, opposition arguments like Zyuganov's carry little weight in Russia these days, but other voices within the government and the pro-Kremlin Unified Russia party have also been floating ideas for spending the stabilization fund. Prime Minister Mikhail Fradkov told a cabinet session in August that in 2005 the fund "will cease to be a cumulative institution and will become an instrument of active budget policy."

In the wake of a wave of horrific terrorist attacks in August and September that culminated with the Beslan school hostage taking, the government proposed sharp increases in defense and antiterrorism spending, increases which many argued should be covered with financing from the stabilization fund. Finance Minister Aleksei Kudrin -- who has been one of the staunchest figures opposed to spending the stabilization fund, except for the non-inflationary purpose of paying down the country's foreign debt -- conceded in an October interview with "Itogi" magazine that the fund could be used to pay for such things as the creation of an Interior Ministry fingerprint database and other projects that are "an important part of the fight against terrorism."

Union of Russian Entrepreneurs and Industrialists (RSPP) President Arkadii Volskii, one of the Kremlin's most loyal supporters in the business community, told Ekho Moskvy on 29 December that the government's policy of accumulating hard-currency reserves and building up the stabilization fund is inhibiting economic development. He accused government economic managers like Finance Minister Kudrin and Economic Development and Trade Minister German Gref of adhering to a stubborn belief -- "some kind of blockheadedness" -- that "it's good when money just sits there." Volskii said some of the funds should be distributed to business in the form of development loans "so the money works for the country rather than for foreign banks."

Moscow Mayor Yurii Luzhkov, writing in "Trud" on 3 December, made similar arguments, accusing the government of a policy of "accumulation for its own sake." He criticized the government's policy of investing the fund in foreign securities, saying that doing so was tantamount to "supporting the foreign producer, not the domestic producer."

More nefariously, perhaps, political scientist Sergei Markov told utro.ru on 30 December, that one potential use of the stabilization fund could be to "purchase assets" in Ukraine as a way of increasing Russia's influence there in the wake of the 26 December victory of opposition presidential candidate Viktor Yushchenko.

In October, Industry and Energy Minister Viktor Khristenko proposed several possible uses for the stabilization fund, including a federal program for the development of civil aviation and a guarantee fund to attract investment to the housing and municipal-services sectors, strana.ru reported.

Perhaps in response to opposition from Kudrin and Gref, Khristenko has changed his tactics a bit. On 2 January, he told RosBalt that "indubitably we cannot touch the funds that go into the stabilization fund." He added, however, that the government in 2005 could create "in addition to the stabilization fund" a sort of "development fund, the resources of which could be used to fund strategically important projects that are capable of exercising systematic influence on the development of our economy." Although, Khristenko did not say where the money for this development fund would come from, Kudrin told ITAR-TASS on 1 November that he will propose reducing the amount currently set aside for the stabilization fund by raising the threshold beyond which profits are diverted into the fund from $20 per barrel to $21.50 per barrel.

Such concessions notwithstanding, Kudrin, Gref, and presidential economics adviser Andrei Illarionov have so far presented a united front advocating spending the stabilization fund only on reducing Russia's foreign debt. Any domestic use of the fund, Illarionov has stated, threatens to spawn inflation and endanger the government's macroeconomic program.

In the wake of the vocal opposition of these liberals to the government's actions regarding Yukos over the past 15 months, the battle over the stabilization fund could be the issue that ultimately pushes them out of the government. As economist Vladimir Mau told "Vedomosti" on 30 December: "A sharp political battle has already evolved around the 'cheap money' in the stabilization fund. Pressure to use the fund's money given high oil prices will only grow and will only become more difficult to resist."

ENERGY/FOREIGN POLICY
RUSSIA, CHINA, AND THE POLITICS OF ENERGY
By Roman Kupchinsky

Is Russia positioning itself to become China's major supplier of oil and gas in the near future? This frequently asked question took on new significance on 21 December when President Vladimir Putin, explaining the "perfectly normal" procedures implemented during the auction of Yukos's main production unit, Yuganskneftegaz, told reporters in Schleswig, Germany, that China's National Petroleum Corporation (CNPC), would participate in some unnamed fashion in "working with Yuganskneftegaz assets."

Putin's statement was elaborated upon on 30 December by Industry and Energy Minister Viktor Khristenko, who said CNPC could be offered a 20 percent stake in Yuganskneftegaz, the "International Herald Tribune" reported.

The 100 percent state-owned CNPC is China's largest oil-and-gas company. It accounts for 79 percent of oil supplies on the domestic market and holds a 95 percent share of the domestic natural-gas market and a 40 percent share of the market for oil products.

With Yuganskneftegaz now safely in the hands of Rosneft, a Russian state oil company, Putin seemed willing to discuss doing business with CNPC. Putin's vague and noncommittal statement that Gazprom and CNPC have agreed on cooperation in the energy sector and the two partners were to determine the way CNPC is to participate, as the AP reported on 22 December, did little to clarify matters.

However, when Chinese Prime Minister Wen Jiabao promised early last year to invest $12 billion in Russia's energy infrastructure needs by 2020, the Russian side did not commit itself to his proposal nor to building a proposed $2.5 billion pipeline from Siberia to Datsin, China, which the Chinese government has been aggressively advocating.

Russian news agencies offered little new information on Russian-Chinese energy cooperation and the joint statement adopted at the end of Wen's talks in Moscow in September was blandly noncommittal: "The two countries will take measures to implement cooperative projects in oil and natural gas, including the construction of pipelines between China and Russia," the joint statement stated flatly.

Russian-Chinese cooperation in the energy field has been uneven. China, with the fastest-growing demand for energy in the world, faces the strategic need of reducing its dependence on Middle Eastern, African, and Southeast Asian oil, for which it is obliged to pay delivery premiums. For over a decade, China has increasingly sought to buy a larger share of Russian oil and gas, but a number of factors seem to have been thwarting these efforts.

For one thing, the majority of Russian natural gas is pumped from west Siberian gas fields to Europe and CIS countries. The gas enters the old Soviet pipeline system, which has been used since 1968 when the first Russian gas deliveries began to Western Europe. Building a new pipeline network in the direction of China is an expensive and politically sensitive proposition for the Russian leadership. While the Chinese side has offered to bear part of the financial burden of this construction in return for gas, political factors seem to be delaying any firm decision.

Second, the former strategy of Yukos was aimed primarily at exporting oil to Western Europe by pipeline and to the United States via tanker. China initially played a relatively minor role in the company's strategic plans. This changed when Yukos's then CEO Mikhail Khodorkovskii decided to try to revolutionize the Russian oil market by building a private oil pipeline to China. The Yukos-led plan to build the Angarsk-Datsin pipeline met with fierce opposition within the Kremlin, and Khodorkovskii was prevented from pursuing it. The future of the Angarsk-Datsin pipeline remains undecided and likely will until the Kremlin decides upon a game plan for the new owners of the bulk of the Yukos empire.

As an alternative to the pipeline, Yukos began shipping Russian oil to China by rail tanker cars, which turned out to be both an expensive and low-volume method of supplying Chinese needs. Yukos currently pays about $160 in transport tariffs and export duties for each of the 650,000 tons of oil it ships to China each month, including 400,000 to CNPC and 250,000 to Sinopec, a large Chinese refiner.

With Yuganskneftegaz now in the hands of Rosneft, it remains to be seen how the Russian government will honor Yukos's Chinese contracts.

A Russian gas industry study prepared in July 2004 concludes that demand for natural gas in the Asian-Pacific rim will increase from 370 billion cubic meters in 2005 to 651 billion cubic meters in 2020. In the same period, European demand for gas is expected to increase from 440 billion cubic meters to 647 billion cubic meters.

The study forecasts that in 2020 Russia, taking into account its purchases of gas from Central Asia, will be able to deliver between 35 billion and 38 billion cubic meters of gas to Asian-Pacific-rim countries, mainly China, Japan, and South Korea, out of a total of 273 billion to 281 billion cubic meters of gas exports. The bulk of Russia's Gazprom gas, however, will be going West -- to Europe and the CIS countries.

The delivery of gas to China is projected to go via a 1,420-millimeter pipeline from the Kovytka gas field, with proven reserves of 2 trillion cubic meters and the capacity to produce 36 billion cubic meters per year, to Blagoveshchensk on the Chinese border, a distance of almost 2,000 kilometers.

Russian planners see eastern Siberia, with known reserves of 6.6 trillion cubic meters, as rapidly becoming the gas center of Russia, with regional production in 2020 reaching 110 billion cubic meters per year.

The first deliveries of 20 billion cubic meters annually of natural gas to China are scheduled to begin in 2010 along with 10 billion cubic meters to South Korea.

Projections, of course, are susceptible to sudden revisions and rely upon political stability in both Beijing and Moscow. The Yukos affair can serve as an example of how unexpected Russian domestic policies can disrupt projected oil deliveries to China. How such factors might influence China's growing need for Russian gas is difficult to forecast, but a downward revision of the quantity of such shipments is certainly not impossible.

Commenting on the rising demand for energy in China and the impact this might have on the world, Britain's "The Guardian" wrote on 27 December:

"Whatever production arrangements OPEC might agree to, stronger demand will push up the cost of crude and other commodities. Research by Alliance Bernstein found that China was responsible for 79 percent of the increase in global steel production in 2003, and consumed 37percent of the world's cement. It is installing 150 gigawatts of electricity generating capacity, double the UK's total capacity. Every global downturn of the past 30 years has been associated with soaring energy costs, so watch the price of crude carefully."

If the Russian government is betting on rapidly growing Chinese demand to drive up prices of oil in the future, then it could be in for a surprise. Recent reports that Saudi oil reserves could increase by 77 percent and top 461 billion barrels in a few years might work against Russian hopes of reaping the profits of China's burgeoning energy market.

REGIONAL POLITICS
GOODBYE TO ALL THAT
By Julie A. Corwin

Russia wound up its latest -- and last -- batch of gubernatorial elections on 19 and 26 December with the expected results. A bevy of incumbents and candidates supported by the current party of power was reelected by the usual means -- physical attacks, last-minute court decisions disqualifying their opponents, and the dissemination of compromising materials in the media.

The percentage of votes cast "against all" candidates rose to new levels, suggesting that at least some voters will not miss the short-lived experiment with electing regional executives that President Boris Yeltsin launched some 11 years ago.

Five elections were held on 19 December and another three 26 December. In six of the eight races, incumbents were reelected. In the remaining two regions, the incumbents in question had either been eased out or forced out prior to election day. Communist Governor of Bryansk Oblast Yurii Lodkin was disqualified shortly before the first round, and unpopular incumbent Ulyanovsk Oblast Governor Vladimir Shamanov was lured to Moscow with a better job offer.

Not only incumbents but also representatives of the pro-Kremlin Unified Russia party fared well in these two sets of elections. Five of eight winning candidates were aligned with Unified Russia. But upon closer examination, the tally might be less impressive than it first appears. The party had a difficult time electing its handpicked candidates, while the ones it supported only nominally did well. For example, in Khabarovsk Krai, incumbent Governor Viktor Ishaev won a third term by a hefty margin: 85.3 in the first round on 26 December. But he secured the central party's support only on the eve of the first round, "Vremya novostei" reported on 21 December. Prior to that, the party's unofficial and the president's official envoy to the Far East Federal District Konstantin Pulikovskii has been waging a multiyear struggle against Ishaev.

Meanwhile, in Ulyanovsk, Dimitrovgrad Mayor Sergei Morozov, who was supported by Unified Russia, won with 52.8 percent of the vote but only after his close competitor, local dairy magnate Sergei Gerasimov, was disqualified just before the second round. Gerasimov had only 40,000 fewer votes than Morozov in the first round. According to RFE/RL's Ulyanovsk correspondent on 23 December, print media controlled by the oblast administration published disparaging materials about the relationship between presidential envoy to the Volga Federal District Sergei Kirienko and Morozov. The publications also hinted that it would be better to vote "against all" candidates in the second round and wait for Putin to appoint a new governor for the region. Whether it was because of such exhortations or frustration with candidates who did make it on to the ballot, the electorate responded. The percentage voting for "against all" was unusually high at 25.2 percent.

The Communist Party managed to hold on to two governorships, but not without a struggle. Kamchatka Oblast Governor Mikhail Mashkovtsev, who won a second term on 19 December, was facing criminal charges for months leading up to the election. Local police dragged him into the prosecutor's office a week before the first round to review materials in his case. In Volgograd, incumbent Governor Nikolai Maksuta suffered not just the usual verbal blows from bruising debates with political competitors. He actually sustained a concussion when struck by the falling clapper of a church bell during a visit to a local church. While he was at the hospital recovering and receiving three stitches to his head, his house was burgled. Unknown thieves stole jewelry and other expensive items and even drank up the governor's supply of cognac, according to "Nezavisimaya gazeta" on 27 December. According to "Izvestiya," the governor's press service issued a report on the day of the election saying that the incidents involving the governor "could be the result of purposeful actions by his political opponents."

Russia's last gubernatorial election for the foreseeable future will take place on 23 January in the tiny Far Northern Province in Nenets Autonomous Okrug. There, current Governor Vladimir Butov is fighting multiple legal cases in order to be able to seek a third term. Butov, however, has much experience with the law. According to "Politicheskii zhurnal," No. 35, Butov's name has come up in several criminal cases over the course of the past four years, and during that same period several okrug prosecutors have resigned.

POLITICAL CALENDAR
January 2005: President Putin to visit Poland for the 60th anniversary of the liberation of the Auschwitz concentration camp.

23 January: Gubernatorial election in Nenets Autonomous Okrug.

1 February 2005: Former President Boris Yeltsin's 74th birthday.

1 February 2005: Date by which dedicated, all-volunteer peacekeeping brigade to be set up. Unit will be available for international duty by 2006.

16 February: Kyoto Protocol, an international agreement intended to curb the emissions of gases widely believed to contribute to global warming, comes into effect following its ratification by the Russian Federation.

24 February: President Putin and U.S. President George W. Bush to hold a summit in Bratislava, Slovakia.

May 2005: Commemoration of the 60th anniversary of the end of World War II.

2006: Russia to host a G-8 summit.

1 January 2006: Date by which all political parties must conform to law on political parties, which requires at least 50,000 members and branches in one-half of all federation subjects, or either re-register as public organizations or be dissolved.

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