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Energy Russia makes its turn east a reality with major deal between Gazprom and CNPC

Russia and China Sign $400 Billion Energy Deal


Sanctions Markets take a hit, but so far most companies are coping PAGE 2


Gas war looms... again Can Russia and Ukraine move beyond fighting over pipelines? PAGE 3


Russia: going it alone? More integrated than ever before, can Russia be cut off?


Chinese Premier Xi Jinping and Russian President Vladimir Putin toast the signing of an agreement to provide China with Russian gas.

A $400 billion deal for Russia to supply gas to China could be a game-changer for the energy sectors of both countries. LEONID KHOMERIKI SPECIAL TO RBTH

Ten years of talks between Russia and China over natural-gas supplies were finally concluded during a visit by Russian President Vladimir Putin to China in May, resulting in a colossal 30-year contract worth $400 billion between Russian energy giant Gazprom and the China National Petroleum Corporation. The deal carries hefty geopolitical significance, uniting one of the world’s biggest energy producers with one of its largest consumers at a time when tensions are mounting between Russia and its traditional gas-consumer base, the EU, over the fate of neighboring Ukraine. Discord over Ukraine has prompted European hand-wringing over dependency on Russia for gas, a factor that places limits on the effectiveness of future sanctions. Rus-

sia, meanwhile, has long sought to diversify its consumer base for gas exports, including in Asia. The agreement with China opens up new horizons for Russian energy sales, says analyst Anna Kokoreva of the Alpari brokerage. “Currently no natural gas is being supplied to China from Russia,”she says.“Therefore, the signing of this contract means that Russia has opened a new market.” Gas supplies to China are planned for delivery via the Sila Sibiri Pipeline and will begin in 2018 with a volume of 38 billion cubic meters per year, with a possible increase to 60 billion. Despite the generally positive market reaction to the news, including a bump for Gazprom shares, analysts say that the final price — an average of $350 per thousand cubic meters — is less than Gazprom had hoped for. According to various sources, the company had expected to get $380 per thousand cubic meters, which is the price European consumers pay for Russian natural gas. According to analyst Grigory

Birge of Investkafe, domestic gas prices in China played a key role in determining the price, because the difference between domestic prices and import prices determines the level of subsidies the Chinese government has to pay. Tatiana Mitrova, head of the oil and gas complex at the Institute for Energy Studies at the Russian Academy of Sciences, says that the price was within the expected range. “This contract, as far as we can judge, has been signed at the lower end of acceptable prices,” Mitrova says. “This is first of all a project aimed not so much at maximizing profits, but rather an attempt at diversifying the markets, as well as a desire to achieve regional development of Eastern Siberia.” Mikhail Korchemkin, managing director of consulting company East European Gas Analysis, says that Russia would only be able to break even on supplying gas to China by the middle of the next decade. Russian gas consumers may be the big losers in the agreement, since the financing of the Sila Sibiri Pipeline will require accelerated growth

in domestic natural gas prices to a level equal to the yields received from export sales. The two sides also sketched out future economic cooperation beyond the Gazprom deal. During his visit, Putin proposed a zero mineral-extraction tax for companies extracting natural gas from fields that will be used to fulfill the future contract with China. Igor Sechin, head of the oil major Rosneft and a close Putin ally, says that a natural-gas contract with China was long overdue and that his company may also benefit, since it also plans to supply gas to China through the Sila Sibiri Pipeline. Rosneft has already provided the Ministry of Energy with forecasts for gas extraction from fields it owns in Eastern Siberia and the Far East. An alternative to sending gas supplies to China via pipeline could be delivering liquefied natural gas (LNG) through the planned Vladivostok LNG project. Gazprom is already planning to attract Chinese companies to help with construction of Vladivostok LNG.

Regions Russian authorities hope to shore up the peninsula’s economy with subsidized travel

Kremlin’s Secret Plan for Crimea: Tourism Russia is pulling out all the stops to keep tourism alive in its newest territory. That means discounted vacations to Crimea, plus massive spending on infrastructure.


The Russian government has launched a large-scale effort to boost tourism in Crimea among its own citizens, hoping to sustain the local economy after the Black Sea peninsula became Russia’s newest region in a controversial changeover this spring.



Crimea has long relied on tourism as a central pillar of its economy, drawing millions of people a year to its sunny coastline during the Soviet era. When the Soviet Union fell apart in the early 1990s, Crimea was left in Ukrainian territory, and by 2010 some 60% of visitors were Ukrainian. Now, following Crimea’s tumultuous absorption into Russia, Ukrainian tourism has fallen off precipitously, prompting concern for the local economy. The Kremlin is hoping Russian visitors will fill the gap. But this

A cliff-top palace in Crimea.

could prove challenging. From January through September 2013, 5.7 million tourists visited Crimea, but only a quarter of them came from


Russia. In 2012, the figure was a mere 21%. Having taken control of Crimea, Russia’s strategy for successful integration now rests on making sure the peninsula ups its vacation game. Russian state-controlled companies, which have a history going back to Soviet days of sponsoring vacations for their employees, are already getting in on the action. Crimea’s Ministry of Resorts and Tourism says it expects 8 million Russian tourists a year in the future, including employees of over a dozen major Russian state-run corporations. These include energy sector giants like oil-producer Rosneft, pipeline operator Transneft, gas-producer Gazprom and nuclear energy firm Rosatom. CONTINUED ON PAGE 8

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Politics & Business



Politics The popularity of Putin’s moves in Ukraine has dampened enthusiasm for his opponents

Crimea Undercuts Putin’s Critics

• The Russian economy is likely to go into recession in the second quarter, according to both the country’s Finance Ministry and the International Monetary Fund. Gross Domestic Product is expected to fall to 0.1 % in April-June. It would be the second recession in five years for Russia. • Russian steelmaker NLMK expects higher income in the second quarter of 2014 after reporting an unexpectedly high first-quarter net profit of $174 million. The firm’s second-quarter steel production is expected to remain flat. However, seasonal improvements in demand and costs-optimization mean the company expects further growth in its profitability and income, according to a statement by CFO Grigory Fedorishin.

• Energomash, a leading Russian manufacturer of liquid-propellent rocket engines, is continuing to deliver RD-180 rocket engines to the U.S. under a long-term contract. Energomash CEO Vladimir Solntsev said that both sides are fulfilling obligations under the contract and there was no indication that the agreement would be canceled as a result of sanctions.


• Trade between Russia and the EU fell considerably in the first quarter of 2014. EU imports from Russia decreased by over 9% during the first three months of 2014, compared with the same period last year, according to Eurostat • A bill to create the office of financial ombudsman was send to the State Duma in May. The ombudsman will protect the rights of financial-organization consumers. The ombudsman will consult a client before he or she goes to court if a bank illegally raises interest rates or demands an early debt repayment, or if an insurance company refuses to pay without serious reasons. • Coca-Cola will close two of its juice plants in Russia, according to company spokesman Vladimir Kravtsov. The closings are due to a shrinking market. The juice market fell 5% last year, Mr. Kravtsov said, adding that the company had been considering the move for some time and made the closure decision last year. • According to the European Central Bank, capital flight from Russia has hit $200 billion and may be up to four times higher than admitted by Russian government officials. Mario Draghi, the ECB’s president, said the outflows from Russia have been large enough over recent weeks to push up the euro exchange rate, complicating monetary policy for the ECB. • The family of investigative reporter Anna Politkovskaya has filed a suit asking for 1 million rubles from each of the five men who were found guilty of her murder. Politkovskaya died in 2006 and her murderers were convicted last month.

Protestors took to the streets of Moscow in the winter of 2011-2012; fewer people turn out for marches today.

dubbed“The Bolotnaya Case,”was initiated after the March of Millions. Although an independent international commission that included Amnesty International and Human Rights Watch came to the conclusion that “the violence and disruption of order were largely caused by the actions of the authorities and especially by the police,”only protest participants faced legal repercussions, with 27 people seeing charges pressed against them by the state. Twenty-three-year-old Yaroslav Belousov was sentenced to two and a half years in prison, based solely on police testimony and a video that showed him throwing a lemon into the crowd. On February 24 this year, six defendants in the case were each sentenced to serve between two and a half and four years in prison.

Two years ago, Russia’s opposition movement was in full swing. But as public support for Putin’s stance on Ukraine has grown, the opposition has been increasingly marginalized. DANILA ROSANOV SPECIAL TO RBTH

In May 2012, vast crowds gathered in downtown Moscow for the “March of Millions”protest against Vladimir Putin on the eve of his inauguration for his third term as President. The result was a violent confrontation between protesters and police. Yet today, two years after one of the most significant public protests in modern Russian history, Putin’s approvals rating is rising. It recently hit 83% in the wake of Russia’s accession of Crimea. Some analysts say the March of Millions appeared to be a high water mark for the opposition during its most active period in 20112012. According to sociologist Lev Gudkov, “by winter of this year [2014], willingness to support or participate in protests had sunk to an all-time low since the collapse of the Soviet Union.” In an OpEd in The Moscow Times, opposition politician Vladimir Ryzhkov wrote that the standoff over Ukraine has helped rally support for Putin. The events in Crimea had a“powerful mobilizing effect”that has served to “strengthen the position of the Kremlin so much at a time when economic growth has stopped.” A legal process unprecedented in post-Soviet Russian history,



Navalny’s isolation

Alexei Navalny had been investigating corruption in Russian governmentowned companies for several years and writing about it online before coming to prominence in the 2011-2012 protests in Moscow against election fraud. While many supporters consider him the best chance for the opposition to have a national political leader, others have pointed out his history of holding nationalist views.

In the summer of 2013, bloggerturned-opposition-activist Alexei Navalny, who came to prominence after publishing anti-corruption investigations online, was charged with embezzlement and sentenced to five years in prison. His prison sentence was then suspended after PresidentVladimir Putin described the sentence as “strange.” At the time, the opposition figurehead was already a defendant in another court case, in which a firm linked to Navalny and his brother was accused of defrauding French cosmetics companyYves Rocher to the tune of 27 million rubles ($753,000).

Navalny is currently under house arrest and is not permitted to use the Internet or telephone, nor communicate with anyone other than family members and attorneys. The fact that Navalny was not taken into custody during the investigation is unusual in terms of Russian judicial practice: experts theorize that this move is part of a campaign to discredit him. “In light of the Bolotnaya Case court rulings, the legal system’s leniency towards Navalny sets him apart from the protesters,”says Alexander Pozhalov from the Insti-

Foreign policy Russian companies react to sanctions from the West – and prepare for more

Sanctions’ Impact Low So Far While so far the effect of U.S. and EU sanctions on the Russian economy has been fairly limited, banks and payment systems are already feeling the pinch.




billion was taken out of Russia in the first quarter of 2014, a dramatic increase over last year.


More than two months have passed since the EU and the United States first imposed sanctions on Russia in response to its absorption of Crimea.The punitive measures have been accompanied by the suspension of cooperation in the military sphere and the space sector. At the time of this issue of Russia Behind The Headlines going to print, the main impact on the Russian economy has been indirect.The sanctions have rattled investor sentiment, led to a deterioration of the investment climate and increased capital outflows. On paper, Western sanctions against Russia have directly affected a limited number of politicians and businessmen, said to be part of Vladimir Putin’s inner circle. Among them are magnate brothers Arkady and Boris Rotenberg, the former owner of the Gunvor Oil Trading Company Gennady Timchenko, and billionaire Yuri Kovalchuk. Also victim to U.S. government sanctions was Bank Rossiya, owned by Mr. Kovalchuk As a result, MasterCard and Visa International, without warning, blocked the access of Bank Rossiya’s cardholders to their networks. Following the imposition of sanctions, these entrepreneurs began

21% of Russian citizens’ savings are held in foreign currencies, which have taken a major hit in recent months.



• Russian energy giant Gazprom has participated in a tender for a deep offshore license in Tanzania. If the tender is won, the company might develop the field under a production-sharing agreement, with 25% of ownership going to the Tanzania state company TPDC. Gazprom would also have to pay a 7.5% royalty and some bonuses.


• The Yamal LNG project, which will create a terminal for liquefied natural gas in Russia’s Far North, could be delayed because of sanctions. The project relies partly on funding from the EU and investors are exploring the possibility of replacing this financing with funds from Chinese banks.

tute of Socio-Economic and Political Studies. High-profile representatives of the opposition are downbeat about the movement’s future prospects. “The opposition is not doing so well right now,”says Boris Nemtsov, one of Russia’s best-known liberals.“A lot of our comrades are behind bars, some people are wanted by the authorities and some have emigrated.” “The opposition has ceased to exist as an organized political force, because there has been a separation of various political forces,”says left-leaning politician and Duma official, Ilya Ponomaryov. The Russian Opposition Coordination Council, established by representatives of various opposition groups in October 2012, fell apart just a year after its creation as its members fell into quarreling among themselves. According to sociologist Lev Gudkov,“the ideas put forth by the opposition - honest elections, anti-corruption, and electoral reforms – were supported by about half the population at first.” “The numbers dropped off as the Kremlin launched a propaganda rhetoric campaign that stressed concepts such as ‘the hand of the West’ and ‘foreign agents’ [non-profit organizations receiving funding from abroad were required to register as foreign agents – RBTH],” Gudkov says. “These Kremlin accusations neutralized the slogans put forth by the opposition. At some point, the public started listening to the Kremlin, and opinions gravitated toward the authorities.” The situation is slightly different in Moscow, where the number of protest activities has always been higher. On March 15, an anti-war rally against Russian military intervention in Ukraine drew 50,000 people, according to the organizers. “A fairly large group of people who always take part in demonstrations has recently sprung up,” says Ponomaryov.“When it all started, there were only about 500 of them in Moscow. Now there are about 20,000.” “Only about 7% of the population feels shame and indignation when it comes to the actions of the Russian authorities,” Gudkov explains. “A lot of people who had previously sympathized with the opposition now endorse Kremlin policies,” he adds. Those who oppose Russia’s intervention in Ukraine are up against majority opinion and an increase in public activity from opposition groups is not expected in the near future. “As far as I can see, the most reasonable part of the liberal opposition is more likely to concentrate on culture and ideology, and is not expecting much of a political effect in the near future,” says political analyst Mark Urnov.

Bank Rossiya was singled out for sanctions by the United States.

By the end of 2014, the Ministry of Finance expects capital outflow to reach between $70-$80 billion. focusing on their national interests in Russia. Gennady Timchenko sold his 44 percent share in oil trader Gunvor. Bank Rossiya and its subsidiaries completely abandoned foreign currency transactions. Other banks also began to limit their foreign currency exchange activities. The largest bank in Russia, Sberbank, started refusing applications loans denominated in foreign currencies. However, according to Mikhail Zadornov, president and chairman

of the board of VTB24 Bank, foreign currency transactions are an integral part of the Russian financial system. “Russian citizens hold 21% of their deposits in foreign currencies, all payments for imports are carried out in foreign currencies, and there are currency transactions assigned by the economy,” says Mr. Zadornov. Sanctions against Russia have provoked a sharp outflow of capital from the country. By the end of 2014, according to the Ministry of Finance, this outflow will reach $70 billion to $80 billion. During the first quarter of 2014, the private sector has already taken $50.6 billion out from Russia, compared with $27.5 billion in the previous year. “For now, no serious sanctions

have been applied against Russian companies, just against specific individuals. Therefore, there were no serious consequences,” says Vasily Yakimkin, assistant professor in the Department of Finance and Banking at the Russian Academy of National Economy and Public Administration. However, further rounds of sanctions could have a more far-reaching impact, he says. “We can expect that the hardest hit will be the manufacturing sector, the military-industrial complex and the livestock industry,”he adds. According to Anton Soroko, analyst at the Finam Investment Holding, the most negative sanctions for the Russian economy that could be invoked by the U.S. and EU would be a reduction in trade cooperation.


Business & Politics



Pipelines Russia and Ukraine squabble over energy prices, while the U.S. and EU mull sanctions

Ukraine Dispute Spills Into Energy Trade

• The Moskva-City business district in the Russian capital will finally be completed, although the final touches on the district’s skyscrapers will be put into place some 11 years late. Moscow chief architect Sergei Kuznetsov told website that the project is in the “home stretch” and work will be completed by 2018. Construction began in the mid-1990s. • Russia’s Ministry of Finance has updated its draft budget for 2014, taking into account the depreciation of the ruble. The new budget includes an additional expected 800 million rubles in revenue. The year-on-year spending growth plan remained unchanged at 5%.

Threats from Russia to shut off gas to Ukraine are the latest salvo in the conflict between the two neighbors, but it’s not the first time Russia has played this card.

• The investments of the joint Russia-China Investment Fund will reach $1 billiion soon, according to Kirill Dmitrieyev, the head of the Russian Direct Investment Fund. One of the fund’s investments is in a new railroad bridge, linking Russia and China across the Amur River. Dmitrieyev said that the bridge would promote economic growth in the Russian Far East.





• Moscow’s city government is planning to sell off some of the most expensive land in the city for elite, high-rise residences. The land, located on the Sofievskaya Embankment, is located directly across the Moscow River from the Kremlin. Sales of residences developed on the land could earn the developer up to $1 billion. • The Tatarstan International Investment Company, Russia’s only investor in the Islamic Development bank, has decided to move into two new sectors: commodity trading and construction. Trading will focus on grains, oils, petrochemicals and timber, while construction will primarily finance real estate developments in Tatarstan, approximately 600 miles east of Moscow.

Russian gas exports to Europe via Ukraine

Gas imports to Europe from other countries

year, if tighter sanctions are imposed on Russia. Russia, as the world’s biggest exporter of natural gas and second-biggest producer after the U.S., can likewise hardly afford to endanger its energy-export business. Oil and gas receipts make up more than 50% of Russian state revenues, and 70% of the country’s exports. Hydrocarbons are a vital source of income in what is otherwise a stagnating economy. The International Monetary Fund said in April that Russia has already entered a recession, as concerns over the situation in Ukraine hamper investment and growth. “The Russian economy, already slowing because of pre-existing structural bottlenecks, has been further affected by geopolitical uncertainties arising from conflict between Russia and Ukraine,”the IMF said in a statement on its Web site. “Growth is expected to ease to 0.2% in 2014, with consider-

able downside risks.” Russia has taken pains to present itself as a reliable supplier, even while it has continued to squabble with Ukraine over pricing issues over the years. Europe has been utilizing supplies of natural gas from Russian fields in Siberia ever since the Cold War. The flow continued throughout the disintegration of the Soviet Union in the early 1990s. Yet Ukraine’s geographical position between Russia and Europe — as the home of the pipelines — means that disputes between Ukraine and Russia have created challenges for the gas trade over the past decade, after the two countries ceased to be constituent members of the Soviet Union. Gas disputes between Russia and Ukraine have led to shutoffs twice in the past decade, in 2006 and 2009. On both occasions, limiting supplies to Ukraine had an impact on supplies being shipped through Ukraine to European con-

sumers, although both crises were resolved within a matter of days. Until recently, Russia had granted a pricing discount to Ukraine as a result of two agreements. The first extended Russia’s rights to host its Black Sea fleet in Ukraine. And the second was struck with deposed Ukrainian President Viktor Yanukovych in December, after he rejected a trade agreement with the European Union.That decision sparked the wave of protests that eventually pushed Mr.Yanukovych from office and eventually prompted Russia to seize Crimea. Assistant U.S. Secretary of State Victoria Nuland told the House Foreign Affairs Committee on May 8 that a further round of sanctions against Russia would be carefully targeted at sectors that would have limited impact on Western economies. Ms. Nuland said that new measures would focus on areas “where Russia needs us far more than we need Russia,” she continued. The United States gets no gas from Russia – and only a limited amount of oil. That puts U.S. policy-makers in a very different position to their European counterparts. Indeed, the rise in U.S. production over the past decade has prompted a debate in Washington over whether to boost exports of natural gas to Europe in an attempt to reduce EU reliance on Russian supplies. The debate over Europe’s dependency on Russian energy has also exposed differing views inside Europe about how best to approach Russia. German Chancellor Angela Merkel and French President Francois Hollande have both said they would support further sanctions if Russia is not seen as providing support for Ukrainian presidential elections on May 25, although so far no further action has been taken.


Gazprom says it will shut off gas to Ukraine if it does not receive pre-payment for future supplies by May 31.


The dispute between Russia and the West about Ukraine is spilling over into energy relations, as Russian officials threaten to shut off natural gas supplies destined for Ukraine over nonpayment – and Western leaders warn of further economic sanctions against Russia that may hit the energy industry. Russia supplies Europe with about one third of its natural gas, half of which runs through pipelines that traverse Ukraine. The fuel keeps factories humming and electricity flowing throughout the EU. Russia’s natural gas export giant Gazprom is hammering Ukraine over gas debts. Ukraine owes over $3.5 billion, says its CEO, Alexei Miller. As this issue of Russia Behind The Headlines goes to print, Gazprom is threatening to cut supplies to Ukraine as early as June 3 if Ukraine doesn’t switch to a prepayment scheme for future deliveries. “If we don’t receive prepayment for June by May 31, then it is possible Gazprom will reduce gas supplies to Ukraine or provide it with the capacity it has paid for by May 31,” Russian Energy Minister Alexander Novak said at a meeting in early May in Warsaw, between officials from Russia, Ukraine and the European Commission. Ukrainian Energy MinisterYuri Prodan also stated in early May that Ukraine will refuse to pay in advance for gas. Russia has long charged Ukraine less than the prevailing market rate which it charges European countries, in part due to Ukraine’s status as a former fellow-member of the Soviet Union, and later because of special bilateral agreements. In the past, Russia has also accused Ukraine of siphoning off gas that was being transported to European markets. Meanwhile, the U.S. and European states have already slapped limited sanctions on Russia over its involvement in Ukraine’s political turmoil and are threatening to raise the stakes. Those measures hadn’t yet made an impact on the gas trade when this issue of RBTH went to press. Despite these apparent threats, many observers argue that too much is at stake for both sides in the gas trade for either to want to endanger it. Europe’s economy, still fragile in the wake of the financial crisis, could be kneecapped by a disruption in energy supplies. Germany gets 40% of its natural gas from Russia. Stern magazine reported in April that Germany’s economic growth could be reduced by almost a full percentage point this

• The Russian mobile-television market is expected to reach $460 million by 2016, up from $170 million today. Consulting firm J’son & Partners reported that the number of Russians subscribing to mobile-television providers may double in the next two years, from 3 million to 6 million. The growth rate in mobile-television users in 20132014 is projected at 63%. • eBay will start delivering purchases to Russia via local delivery service Russian consumers can buy goods off eBay and have them sent to a U.S. address provided by Dostami. ru. The company will later bring groups of ordered goods from the U.S. in a single package. eBay will direct users from Russia to services and promote the service among its sellers. • Private capital inflow to Russia may increase in May and June, according to the Finance Ministry. “A capital outflow trend has already stopped in many respects. Figures [of capital outflow] were still significant in April, but I won’t be surprised if we see positive capital flow dynamics in separate months of May-June,” said Maxim Oreshkin, head of the ministry’s strategic-planning department. • State Duma Deputy Yevgeny Fyodorov has proposed banning owners of Russian media from opening foreign bank accounts. Fyodorov also suggested qualifying a media outlet as foreign if it is owned by foreigners. Fyodorov said that “the influence of the media on our life is perhaps bigger than that of most government officials.” Government officials are already banned from holding foreign bank accounts.

Banking Amid tensions over Ukraine, Russian banks may get hit with penalties from U.S. regulators

Russian Banks Brace for Penalties Russian banks are bracing for possible stiff penalties after U.S. officials walked away from talks aimed at easing compliance with U.S. anti-tax evasion regulations. DAVID MILLER AND ALEXEI LOSSAN RBTH

eral treaty, individual Russian banks must bring their policies into line with FATCA’s rules or face severe penalties for certain transactions, including a 30% withholding tax on U.S. investment earnings. “The Treasury Department at this point has no intention of restarting negotiations with Russia,” Assistant Treasury Secretary Daniel Glaser told a U.S. Senate Foreign Relations Hearing on May 6, according to a transcript. However, Mr. Glaser noted,“There are individual Russian banks that are able to bring themselves into compliance with FATCA requirements.” Over the past few years, U.S. regulators have been negotiating compliance treaties with foreign countries that will work as umbrella agreements aimed at easing compliance for that country’s banks. If a country does not have a bilateral agreement with the U.S., then its banks must register individually with the U.S. Internal Revenue Service or face sanctions. In an open letter to U.S. Trea-


Russian banks might face costly penalties by U.S. regulators starting as early as July 1, following a decision by the U.S. Treasury Department to back away from talks aimed at easing Russian banks into compliance with the Foreign Account Tax Compliance Act. FATCA, passed by the U.S. Congress in 2010, aims to stop American citizens from avoiding tax payments by requiring that foreign banks disclose information about their U.S. depositors. The disclosure requirements run counter to Russian law, however. The two countries were in talks to resolve the issue – until the U.S. shut down negotiations following the eruption of the Ukraine crisis. Now, in the absence of a bilat-


Russian state bank VTB has not been sanctioned yet.

sury Secretary Jacob Lew, U.S. Senators Carl Levin and John McCain urged that the Treasury Department forego negotiations with Russia if Russia doesn’t change its policies on Ukraine. “The Treasury Department recently suspended negotiations with the Russian Government over how Russia’s more than 800 banks, as well as its other

financial institutions, will comply with FATCA’s disclosure obligations,” the senators wrote. “If those financial institutions fail to register with the Internal Revenue Service… by July 1, 2014, they will be out of compliance with FATCA, and will become subject to a 30% withholding tax on any U.S. investment earnings.” The senators continued: “We should not be negotiating with the Russians to help them avoid FATCA’s sanctions at a time when Russian forces are threatening and continuing to destabilize Ukraine.” Russia’s second largest state bank in Russia,VTB, is among those Russian banks seeking to individually comply with the FATCA system. “Formally,VTB definitely has no right to do this ‘unification with FATCA’. Amendments to the law are needed,” says Ilya Balakirev, chief analyst at UFS IC. “If banks do not link up to FATCA, missed deadlines may result in serious fines,” says Investcafe analyst Mikhail Kuzmin.

Learn how to spend an unforgettable weekend in Russia >>


Special Report




Vladimir Yevtushenkov





We don’t feel the sanctions. We have such close ties to Europe that any attempt to distract each other with sanctions would be expensive for both sides. At the moment the threat of sanctions has not affected Norilsk Nickel at all in a business context. Neither our Western partners, nor ourselves, believe in a scenario in which sanctions will be imposed.

Mikhail Prokhorov

IN A GLOBAL ECONOMY, CAN RUSSIA GO IT ALONE? Russia is far more integrated into the world economy today than its Soviet predecessor was, making sanctions a more challenging proposition than when the Soviet Union faced them in the 1980s. DAVID MILLER RBTH



Confrontation with the West has already become a reality in the post-Crimea era. I would therefore start to draw up my plans from a defensive perspective and would focus on solving a number of obvious challenges. In the critical phase of the Crimean crisis, Russian shares lost more than $62.5 billion in a single day.



We do not have any specific requirements on the part of the Ukrainian regulator; we are engaged in very constructive dialogue; we continue to work with Ukraine and we do not feel any particular pressure.



We thought there would not be any kind of struggle for us in the financial environment, as was the case in many other fields. Unfortunately, experience has shown us that these triggers can be activated when someone feels that certain political goals need to be achieved.

Will Exxon leave Sakhalin?

The standoff over Ukraine has pushed tensions between Russia and the West to levels not seen since the Cold War. Yet as the U.S. and Europe ponder a range of measures aimed at isolating Russia – in an echo of NATO’s Cold War strategy of containment against the Soviet Union – a key difference has muddled the strategy: today’s Russia is far more integrated into the world economy than its socialist predecessor was. Russia, the EU’s third-largest trade partner, provides some 30% of the bloc’s natural gas. Russian companies have billions of dollars’ worth of shares trading on exchanges in London and NewYork, with large minority investors from the U.S. and Europe. American oil giant ExxonMobil has bet big on Russia, swapping assets and forming a strategic partnership with Russian oil champion Rosneft. All of which adds up to a multibillion dollar question for Western policymakers and Russian officials alike: How far could sanctions against Russia actually go? “I don’t believe in a scenario of full political or economic isolation,” former Russian Finance Minister Alexei Kudrin said in a television interview on Russia’s REN-TV. “I don’t think it will go that far.” Yet Western officials have warned that Russia may face broad-reaching sanctions in areas like energy, finance, arms and manufacturing, even as Russian leaders have sought to downplay the threat. Russian Economy Minister Alexei Ulyukayev told Bloomberg Television in May that broad sanctions

a hard look at the role of Western companies in Russia. “If something like this continues, then of course we will have to consider who’s working and how in the Russian Federation, in the key sectors of the Russian economy, including energy,” Putin said on April 29.

Hitting Economic Growth

Russia’s most important role in the global economy is that of a colossal producer of oil and gas. Russia is the world’s number-one exporter of natural gas and the numbertwo exporter of oil, and foreign

Yet if Russia’s integration in the Western business world has complicated any efforts to impose sanctions, it also makes Russia potentially more vulnerable. The result is that both sides have a great deal to lose. Ex-finance minister Kudrin estimated that sanctions might reduce Russian GDP growth 1% to 1.5% this year. “That’s not a catastrophic loss, because Russia has

“The urge to teach someone a lesson seldom inspires sound policy,” wrote Robert Paarlberg in 1980.

Western officials have warned that Russia may face broad-reaching sanctions in areas like energy and finance.

firms have pushed hard for access to these reserves. Exxon’s partnership with Rosneft includes 30% ownership of the Far Eastern Sakhalin-1 oil and gas development, as well as plans to jointly explore and develop Arctic oil fields. Royal Dutch Shell owns a 27.5% stake in the Sakhalin-2 oil and gas field, where it has partnered up with Russian natural-gas exporter Gazprom. U.K. energy firm BP owns an almost 20% stake in Rosneft, and signed an agreement with the Russian firm as recently as May 24 to explore for shale oil in Russia. As tensions escalated in the Spring, Russian President Vladimir Putin said sanctions could prompt his administration to take

been through even more difficult moments in the recent past,” Mr. Kudrin says. Still, Russia has little interest in further isolation, Mr. Kudrin adds. “We as a country – and our leadership, I hope – feel where the line is, where there will be significant damage to the economy,” Mr. Kudrin says, adding that he hoped the line would not be crossed.

Oil and Gas

Grain Embargo Revisited? Soviet enterprises were by definition non-commercial and the Soviet economy was geared towards self-reliance. In 1985, only 4% of the Soviet gross national product came from imports and exports. Much of the Soviet Union’s foreign trade was done with countries that were al-

ready part of the socialist sphere. When the Soviet Union invaded Afghanistan in 1979, the then U.S. President Jimmy Carter declared America would boycott the 1980 Olympics in Moscow, and ordered a round of economic sanctions. The result was the 1980 U.S. grain embargo of the Soviet Union, which had negligible impact on the Soviet economy and seemingly no effect on Soviet policies. Latin America and Europe stepped in to fill the supply gap, and the war in Afghanistan dragged on for a decade. A glut of grain in the U.S. caused domestic prices to drop, hurting U.S. farmers. President Carter’s successor, the vehemently anti-communist Ronald Reagan, lifted the embargo in 1981. Writing about the embargo in a 1980 edition of Foreign Affairs, the political scientist Robert Paarlberg concluded:“The urge to teach someone a lesson seldom inspires sound policy.” Today, U.S.-Russian trade remains small, although the EU is Russia’s largest trading partner. In May, Russia finally ended a decade of negotiations and agreed to provide China with $400 billion in natural gas over 30 years. The deal gave Russia“breathing space,” Keun-Wook Paik, a senior research fellow at the Oxford Institute, told the Associated Press. “Russia – and Putin – can demonstrate it’s not completely isolated because of the Ukraine crisis. … Russia has demonstrated that [it has] a very reliable strategic partnership with China.”

Russia, China Plan Nicaraguan Canal Russia has signed an agreement to construct a new canal linking the Atlantic and Pacific Oceans. Analysts say the move by Moscow may be as much about politics as economics. YURI PANIEV SPECIAL TO RBTH

against entire economic sectors are “like a nuclear weapon – nobody uses it.” Indeed, some Western policymakers have said that any moves against Russia must be carefully tailored. Assistant U.S. Secretary of State Victoria Nuland told the Foreign Affairs Committee of the U.S. House of Representatives that further sanctions would be targeted to limit damage to Western interests. “The idea here is to use a scalpel rather than a hammer,”Ms. Nuland said.

Russia and Nicaragua are planning to co-operate over the next several years on the construction of the Interoceanic Grand Canal, a new alternative to the Panama Canal that will take advantage of a route rejected by U.S. engineers more than a century ago. Deeper, wider, and longer than its rival in Panama, Russian analysts say the new canal will challenge U.S. control over the region, although they are divided on its benefits for Russia. The project was discussed during Russian Foreign Minister Sergei Lavrov’s recent visit to Managua. A source close to parties present at the talks told RBTH that the Nicaraguan authorities expect to start construction at the end of this year, according to a timeframe set out in a tripartite agreement signed between Nicaragua, Russia and China. The main advantage of the new route will be its size. With a planned depth of 72 feet and a width of 65 feet, the canal will be

suitable for large-range ships with a deadweight of up to 270,000 tons. By comparison, the Panama Canal is 69 feet deep and only 40 feet wide. Two ports, an airport and an oil pipeline are also to be built as part of the project, which is expected to cost around $40 billion. The main investor is China’s HKND, which has received a 100year concession for building and operating the canal. The construction will be carried out by workers from China and Central America. According to the aforementioned source close to the talks, Russia will provide not so much economic and organizational assistance as military and political support. One of Russia’s primary roles will be to guard the construction site. To that end, the Nicaraguan authorities have signed a special agreement with Moscow that will allow Russian warships and aircraft to be present in its territorial waters for the first six months of this year – and also to carry out patrols of the country’s coastline in the Pacific Ocean and the Caribbean Sea until June 30, 2015.

Benefit to Russia? For Russia, the deal has primarily political benefits, according to Sergei Pravosudov, who is head of the Institute of National Energy.



Sanctions will not prevent us from developing our own technologies. It is a challenge. Take the jackal. When it is cornered, it can even attack a lion to save itself. We are being backed into a corner. If we can find our own way out, that’s good. It’s like that old joke – even when you’ve been eaten, you have two ways out.

A poster shows the planned route of the Transoceanic Canal.

“America controls the main points that sea routes run through, the Panama and the Suez canals, as well as major trade routes going via Singapore, Gibraltar, etc. Therefore the emergence of an alternative waterway is a direct challenge to the U.S.,” Mr. Pravosudov says. Emil Dabagyan, a leading research associate with the Institute of Latin America at the Russian Academy of Sciences, also points out the American angle in Russia’s involvement. “The U.S. will lose a considerable amount of control over a territory which, thanks to the Panama Canal, has been under its control for the past 100 years,”Mr. Dabagyan says. However, other Russian experts think differently. In particular, political analyst Konstantin Simonov says that the

project is a very risky one. He points out that the canal is of interest not so much to Russia as to China, which needs it in order to export and import goods by a shorter route. Russia has its own Northern Sea Route, which allows ships to travel to Europe and Asia via the Arctic, he says. According to Alexei Rei, head of the sector research center at the Russian Academy of Sciences’ U.S. and Canada Institute, expanding the opportunities offered by the Northern Sea Route is among Russia’s immediate interests.“From the point of view of the economy, it may even be more advantageous than the construction of the Nicaragua Canal,” he concludes. The Nicaragua Canal is expected to be partially open for operation as early as in 2019, with full completion of the project scheduled for 2029.


Special Report



BRICS countries establish alternative IMF, World Bank A group of emerging economies plans to create an alternative to the International Monetary Fund, at a time when the agency’s bailout of Ukraine has cast a spotlight on the organization. OLGA SAMOFALOVA VZGLYAD


Russia is turning to its BRICS partners in its quest to create a new financial system that is not dependent on the West.


$27 billion is the value of U.S. imports of Russian goods in 2013. The U.S. exported $11 billion in goods to Russia.

The so-called BRICS countries – Brazil, Russia, India, China and South Africa – are setting up alternative versions of both the IMF and the World Bank in a bid to increase their own financial stability, as well as to boost their international economic clout. The group foresees establishing a currency reserve pool as a stand-in for the IMF, as well as a BRICS Development Bank modeled after the World Bank. Both may be operational as early as 2015, according to Vadim Lukov, Russian Ambassador at Large. Brazil has drafted a charter for the BRICS Development Bank, while Russia is drawing up intergovernmental agreements, Lukov said. The BRICS countries have also agreed on the amount of authorized capital for the new institutions: $100 billion each. “Talks are underway on the distribution of the initial capital… and on the location for the headquarters of the bank. Each of the BRICS countries has expressed a considerable interest in having the headquarters on its territory,” Lukov said. It is expected that contributions to the currency reserve pool will be as follows: China, $41 billion; Brazil, India, and Russia, $18 billion each; and South Africa, $5 billion. The amount is intended to reflect the size of each country’s economy. IMF reserves currently stand at about $370 billion and the agency comprises 188 countries. Voting power in the IMF is based partly on each member country’s relative size in the global economy. That gives the U.S. the loudest voice, with 16.8% of the vote, compared to Russia’s 2.4% and China’s 3.7%.

BRICS Development Bank The BRICS Development Bank, seen as an alternative to the World Bank, will grant loans primarily for infrastructural projects. The bank will predominantly finance projects in countries outside the group. “Loans from the Development Bank will be aimed not so much at the BRICS countries as for investment in infrastructure projects in other countries, say, in Africa,” says Ilya Prilepsky, a member of the Economic Expert Group. “For example, it would be in BRICS’ interest to give

4% is how much of the Soviet gross national product came from imports and exports in 1985.


is how much of Russia’s GDP came from exports in 2012, according to the World Bank.

Russia Mulls Fostering Competition for U.S. Ratings Agencies cess credit and expand their businesses, boosting economic growth. Mr. Vedernikov says both RusRating and Dagong are known for their long-term activities on assigning ratings to corporate and sovereign issuers in “hot” credit markets, such as China and the United States. Another option might be to cooperate with ARC Ratings, the international consortium of ratings agencies from Portugal, India, South Africa, Malaysia and Brazil.

Russia hopes to foster a credit ratings agency alliance with China, Brazil, India and South Africa that can vie with the likes of U.S.-based Standard & Poor’s, Moody’s and Fitch. KIRA EGOROVA RBTH

But is anyone listening?


A certain amount of grumbling was to be expected. This Spring, U.S.-based ratings agency Standard & Poor’s downgraded Russia’s long-term debt, partly due to sluggish economic growth but also because of possible consequences that could result from further sanctions against Russia by the United States and the European Union. Viewed from Moscow financial circles, the move carried a stinging irony in a country that often sees itself as being dictated to by the winners of the Cold War: here was a Western ratings agency downgrading Russian credit, because of moves that Western governments might take to hamper the Russian economy. The change prompted Russian officials to ruminate publicly about the need to foster more competition to the major ratings agencies, all of which are based in the United States. “We need to think about creating our own credit-rating agencies at last, so as not to depend on credit-rating agencies biased towards foreign governments,” Federation Council Speaker Valentina Matviyenko said, according to the news agency Interfax. Now, Russia is reaching out to the other BRICS countries – Brazil, India, China and South Africa – in an attempt to link their national ratings agencies and form a unified alternative. So far, details are scarce. The RBC-Daily newspaper cited unnamed sources saying the new

A downgrade by S&P prompted talk of supporting an alternative agency.

Analysts said the main benefit of alternative ratings agencies would be helping smaller players access credit. agency could be based on a partnership between the Russian rating agency RusRating and China’s Dagong Global. The project, which aims to set up a single, common agency, has already been named the Universal Credit Rating Group.

“The ratings, which the Universal Credit Rating Group could start assigning to Russian companies, could gain a degree of recognition in foreign investment circles approaching that of the ratings which have been assigned by the American Three,” says Vadim Vedernikov, deputy director of the Research and Risk Management Department at UFS IC. Analysts said the main benefit of supporting alternatives to the dominant U.S. ratings agencies would be helping smaller players in the BRICS economies to ac-

Despite a near-term hit to both Russian bond prices and the ruble exchange rate, the downgrade by Standard & Poor’s might have a limited impact on Russian markets, analysts say. “Major investors are no longer guided only by the ratings agencies,” says Maxim Shein, an investment analyst at BCS. Analysis by Bloomberg News of agency-ratings changes found that about half the time, yields on government bonds fell when a change by Moody’s or Standard & Poor’s indicated they should climb, according to data from 314 upgrades, downgrades and outlook changes that date back to the 1970s. “The negative rating steps taken by Fitch and S&P are not accompanied by any significant deterioration of the situation in the banking system,” says Maxim Petronevich, deputy head of the Center for Economic Forecasting. “Limits on raising funds from abroad are likely to remain unchanged.” “A monopoly has formed on the global stage in this segment,” says Anton Soroko, an analyst at the FINAM investment holding. “In this situation, the development of alternative appraisers will be a long-term benefit.”

It is expected that contributions to the currency reserve pool will be: China, $41 billion; Brazil, India, and Russia, $18 billion each; and South Africa, $5 billion. The amounts are intended to reflect the size of each country’s economy. a loan to an African country for a hydropower development program, where BRICS countries could supply their equipment or act as the main contractor.” Analysts say the BRICS Development Bank has a political significance, too, allowing member states to promote their interests abroad. “It is a political move that can highlight the strengthening positions of countries whose opinion is frequently ignored by their developed American and European colleagues,” says Natalya Samoilova, head of research at the investment company Golden Hills-Kapital AM. Yet the creation of these alternative groups by no means indicates that the BRICS countries will quit the World Bank or the IMF, at least not in the near future, says Prilepsky.

Currency reserve pool In addition, the BRICS currency reserve pool will be a form of insurance, a cushion of sorts, in the event that one of the member countries faces a financial crisis or a budget deficit. The need for such protection has become evident this year, when developing countries’ currencies, including the Russian ruble, have taken a beating. One way the currency reserve pool may assist member countries is by resolving problems with their balance of payments, by making up for shortfalls in foreign currency. Assistance may be given in the case of a sharp currency devaluation, or massive capital flight due to a softer monetary policy by the U.S. Federal Reserve System. Internal problems in a member country’s banking system may also trigger assistance. If banks have borrowed foreign currency and are unable to repay the funds, the reserve pool may be used to honor those obligations. “A large part of the [IMF] fund goes toward saving the euro and the national currencies of developed countries. Given that governance of the IMF is in the hands of Western powers, there is little hope for assistance from the IMF in case of an emergency,” says Russia’s Ambassador Lukov. “That is why the currency reserve pool would come in very handy.” The currency reserve pool may also help the BRICS countries build economic ties without using the dollar, points out Natalya Samoilova. This, however, will take time. For now, it has been decided to replenish the authorized capital of the Development Bank and the currency reserve pool with U.S. dollars. The IMF and World Bank were established in 1944. The IMF aims to ensure the stability of the global monetary system. The World Bank makes loans to developing nations to boost growth and fight poverty.


Money & Markets



Investors Slow growth and politics hit Russian stock prices, while some investors see bargains

Severstal: A Bright Spot in the Russian Metals Sector Dinnur Galikhanov SPECIAL TO RBTH


A combination of low leverage, ongoing operational enhancements and reduced CAPEX has turned Severstal into a solid cash generator.

Severstal’s strong financial standing has been confirmed by interest from debt investors: a few weeks ago, Fitch upgraded Severstal’s credit rating to BB+. Administrative cost reductions, and lower production costs. For instance, 2014 G&A costs are expected to decrease 20% compared to 2012, from around $750 million to approximately $600 million. In the mid-term, the company has also restricted its capital expenditure to $1 billion a year. However the best confirmation of the success of Severstal’s strategy is the reaction of its peers, who are trying to emulate Severstal’s achievements by implementing similar steps at their own plants. These peers have fallen behind for various reasons, including ongoing large-scale projects and financial constraints, but they are trying to catch up fast. As for the recent speculation in the press over the fate of Severstal’s U.S. assets, they were not a complete surprise. The company has shown an ability to move fast when it sees an opportunity to buy or sell assets. It did not flinch when it was forced to sell a number of its loss-making U.S. assets when steel markets crumbled in 2008-2009, despite having to record a significant loss in the process. This time the setting is different: in addition to economic uncertainties, the political landscape is also becoming challenging, with Russia’s relationship with its Western counterparts deteriorating as a result of recent events in Ukraine. Russian companies may be forced to review their global footprint and in some cases even consider retreating to within the national borders. Should this scenario play out, Severstal, once again, is likely better placed than many of its peers to withstand that challenge. The two plants it operates in the U.S. are among the most modern steelmaking facilities in the country and, most importantly, they are among the few still making money. This should make the task of finding potential bidders reasonably straightforward. While we do not believe that the current political challenges will necessarily force Russian businesses to relinquish their interests in the U.S. or Europe, Severstal may be among the proactive if selling its U.S. plants generates value for shareholders, allowing it to pay dividends or deleverage the balance sheet. The company has invested around $3 billion in its U.S. plants to date. We believe that this time it may be able to see a reasonable return on its investments in the U.S. Dinnur Galikhanov is a senior analyst in metals and mining at ATON equity research in Moscow.

Russian markets have been pummeled by poor GDP growth and political headwinds. Yet some fund managers say they are finding deals.

MICEX Reactions to Political Events


Sanctions. Conflict in neighboring Ukraine. Sagging economic growth. And let’s not forget capital flight. These are just some of the reasons why Russia’s stock market is having a rough year. Not too long ago, Russia was watching a rising tide lift most of its boats. Russian stocks returned at least 8% in 13 out of the past 18 years, and often more than 20%. Not so in 2014. This year’s unpredictable political headlines have combined with longstanding concerns over a slowing, resource-dependent economy to push Russian companies’ valuations to among the lowest in emerging markets. The RTS index has dipped as low as 26% this year, after the dollarbased index fell over 5% in 2013. During May the index recovered some lost ground, and was down about 3% year-to-date as this issue of RBTH was going to print, on May 27. Now, some bargain-hunters are returning to the market for the first time in years as the Russian investment case shifts from a general growth story to one of value-based stock picking. “During my last trip to Moscow, I ran into several investors who were very excited about the low valuations on the Russian market,” says one Helsinki-based portfolio manager. “One group of U.S.-based value guys cut all of their Russia exposure in 2008 and hadn’t touched anything there since. Until now.” However, he notes that the politicized nature of Russia’s market performance means that only the most nimble investors will be able to take advantage of the discount. “Private investors are clearly interested and are putting money to work. Institutional investors are far more conservative – even negative – on Russia, as they may have to explain their investment decisions to non-investor board members concerned by the possibility of additional sanctions,”he says.“There is an element of career risk.” Despite the political fallout from the crisis in Ukraine, many asset managers agree that the effect of sanctions on the broader Russian

Putin informs EU colleagues on switching to prepaid gas supplies only for Ukraine on June 1 (MICEX index slowed down or dropped slightly)

Ruble Value Change Since January


ost of the metals industry still faces an uncertain future, with growth stalling in key economies like China and the EU, cost pressures rising and industry profitability under strain, both in Russia and globally. Russian steelmaker Severstal has remained one of a handful of bright specks in the dimming landscape of the Russian metals sector. The company recently reported first quarter 2014 financial results which demonstrated that, despite the tough operating environment, it remains what we here at ATON regard as the most efficient and profitable Russian steelmaker, with a consolidated earnings before interest, tax, depreciation-and-amortization (EBITDA) margin of nearly 18%. As with the rest of the steel sector, the burden of debt still hangs over the company, with a gross debt of $4.4 billion at the end of the first quarter. However, strong free cash generation and nearly $900 million in the bank put the company in a good position to weather the challenges that the ongoing slump in steel markets may pose. Moreover, a combination of low leverage, ongoing operational enhancements, and reduced capital expenditure has turned Severstal into a solid cash generator, allowing it to increase dividend payments. The company is the only Russian steel firm that reliably pays quarterly dividends. This leadership has been reflected in the company’s share performance. Despite the fact that its Global Depository Receipts remain down around 8% year-to-date, the shares have performed better than Severstal’s peers, whose capitalization has shrunk 20-30%. Severstal’s strong financial standing has also spurred interest from debt investors. A few weeks ago Fitch upgraded Severstal’s credit rating to BB+ with Stable outlook, citing an improvement in the company’s profitability thanks to greater production efficiency and successful deleveraging. Severstal is indeed reaping the benefits of the operating efficiency and cost saving initiatives it has been implementing since it completed its large scale growth and modernization project about three years ago. According to the company, these initiatives should continue in 2014 resulting in further General and

Russian Stocks: Abandon All Hope, Or Time to Buy?

drive the market after short-term headline risk fades,” says Arbat’s Yulia Bushueva. However, with economic performance expected to remain sluggish throughout 2014, investors will do well to adopt an increasingly bottom-up approach when looking at the Russian market. “An active stock-picking approach is needed in the absence of general economic growth,” says Pavel Laberko, a London-based fund manager at Union Bancaire Privée. Mr. Laberko indicates an improving trend in dividend payouts among Russian companies as a major value driver. “Dividends and share buybacks have become the preferred mechanism for shareholders to extract

market will likely be limited. “Sanctions only pertain to certain companies. There is no systemic effect on the Russian market,” says Yulia Bushueva, a managing director at Moscowbased Arbat Capital.“The Russian government’s reaction will be the factor to watch. As long as they respond logically and proportionally, the market will be okay.” The U.S. and EU have sanctioned only a handful of Russian companies to date, none of which are publicly traded. “Russia is still a good long-term bet, as long as it’s not subject to Iran-style sanctions,”says Tom Adshead, portfolio manager at Moscow-based Verno Capital. “Indicators like GDP, inflation and banking-sector growth will

value from companies, says Mr. Laberko. “With stock prices falling, dividend yields are becoming even more attractive.” At the time of writing, the dividend yield for stocks on the MICEX index stood at 4.2%, compared to 3% for the MSCI EM benchmark. But value investors should also study the Russian indices’ trading patterns, which can exhibit significant momentum shifts. Over the past two years, investors in the Russian market have favored a constant-mix strategy, maintaining set allocations through buying additional stocks during market corrections and taking profits when prices recover, Gazprombank strategist Erik DePoy said in an e-mail. “On three occasions last year the RTS Index was down 10% to 15% following external shocks, but in each case the market managed to rebound, particularly in response to increases in aggregate dividend payments,”Mr. DePoy says.“There appears to be a floor beyond which algorithms screening for deep value regularly pick up the most egregiously underpriced names.” This dynamic can lead to outsized momentum swings on the Russian market, where foreign investors control an estimated 70% of free float. “When Gazprom – Russia’s most liquid name – fell to a post-crisis low in July 2013, deep value investors rushed in to pick it up at a dividend yield of 8%, which then touched off a 40% momentum rally,” Mr. DePoy says. A Moscow-based director for a European asset manager confirms the role of dividends as a driver, but notes that the evolution in dividend payouts has not been uniform across the market. “The initiative by state-controlled companies to increase dividend payouts has been a source of disappointment. Many investors suspect that companies such as Gazprom could delay dividend rises in order to fund new capex projects,” he says. In 2011, Russia’s Ministry of Finance announced a program to raise dividend payouts in state-controlled companies to 25% of net income under International Financial Reporting Standards (IFRS). State oil champion Rosneft has already enacted the new standard, while Gazprom has been fighting the change, citing capital expenditures to secure new reserves and spending on this year’s Sochi Olympics. However, some investors remain sanguine about additional capex. “It’s true that Gazprom’s capex have risen from about 100 billion rubles to over a trillion rubles per year in the past decade, but half of this figure was spent on new pipelines – huge projects which have a useful life of 50 years or more,”says Manoj Tandon, head of research at Pzena Investment Management, a New York-based value investor with over $26 billion in assets under management. “What more can they spend on? The company’s free cash flow upside is huge,” he says.

Companies Russian energy major posts world-class profits as its stock price continues to languish

Gazprom Beats Apple in EBITDA Gazprom was the world’s most profitable firm in 2013 by a measurement known as EBITDA, but its share price has lagged behind. ANNA KUCHMA RBTH

Gazprom, Russia’s natural-gas giant and the world’s biggest gas exporter, earned two new feathers in its cap this spring. First was a deal to finally open Chinese markets for pipeline exports, following a decade of negotiations, with a 30-year contract worth $400 billion. But the energy firm also announced it had become the world’s most profitable company in 2013, if judged by a metric known as EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization. Gazprom’s consolidated accounts for 2013 showed the company rose from third to first place in terms of EBITDA, rising 22% to 2.01 trillion rubles ($61.4 billion). That compares to Petrochina ($57.78 billion), ExxonMobil ($57.48 billion), and Apple ($55.76 billion), according to figures provided by Gazprom. In terms of net profit, Gazprom was the world’s fifth-largest company last year ($35.62 billion) and in terms of revenue, the 16th ($106.4 billion). Analysts polled by Moscowbased business dailyVedomosti attribute Gazprom’s rise in EBIDTA

to record-high gas supplies to Europe, which grew 16.3% last year, while the company’s share of the market expanded from 26% to 30%. At the same time, gas prices remained practically unchanged. Accounting for 40% of the company’s earnings, Europe is the main market for Gazprom, Sergei Vakhrameyev, an analyst with Ankorinvest, told Vedomosti. For all this, Gazprom shares still languish far behind those of companies with comparable earnings. The firm is not even ranked among the world’s top 100 companies by market capitalization. As of April 29, Gazprom was only in 110th place, with a capitalization of about $85 billion. By way of comparison, ExxonMobil’s capitalization on April 29 stood at $436 billion, while the world’s most valuable company, Apple, stood at $512 billion.

Rothschild starts buying Gazprom’s relatively cheap shares have therefore begun to spark investor interest. In the first quarter of 2014, Rothschild Investment Corporation increased its investment in Gazprom American Depositary Receipts sevenfold, to $1.7 million, according to the statement that the corporation filed with the U.S. Securities and Exchange Commission. “For a dynasty which has for many years been a symbol of wealth and power, this is not a significant amount. It is more of a sig-



Apple will have to work on its earnings to catch up with Gazprom.

nal that the situation on the Russian market may still improve,”an analyst with the brokerage firm FBS, Kira Yukhtenko, told the newspaper Vzglyad. In the first quarter of 2014, Gazprom shares fluctuated between 120 and 145 rubles ($3-$4 at the current exchange rate). For comparison, after the 2008 crisis, the

company’s stock lost 74% of its value and was priced at 84 rubles. Then the price began to rise and reached 247 rubles in 2011, after which it fell again. Gazprom shares continue to be undervalued, Yukhtenko said. Reporting from Vedomosti and Vzglyad was used in this story.








Fyodor Lukyanov EXPERT


he conflict between the views and aspirations of the major world-players triggered by the events in Ukraine is already affecting the fundamental principles of geopolitics that have existed for the past two decades – and there is no end in sight. In Ukraine, the situation is at a stalemate. The collapse of the political system has created a power vacuum that is sucking in foreign powers that are acting in their own interests. Through the entrenched confrontation in Ukraine, Russia is entering into a relationship with the West similar in psychology to that of the Cold War. Inertia reigns for the moment. But soon, a restructuring of the system of international relations and an adjustment of the economic model against further integration into global markets will be necessary. It is not clear how accurately the Kremlin has calculated the economic impact. But in deciding what actions to take in Ukraine, it is clear that the response of the West was taken into account and that the damages were estimated to be tolerable. Moscow’s goal is to rigidly fix the“red line”that was drawn in the post-Soviet period, and to dramatically improve its global status on the

eve of the formation of the new world order. It is clear that Russia will not back down on the Ukrainian issue. The Kremlin’s decisiveness in Crimea not only demonstrated its seriousness, but also largely blocked any path of retreat. Lowering the stakes now appears impossible. The European Union is bewildered. It cannot find its natural position in the conflict surrounding Ukraine. Power politics is not part of its profile and in no way can it take an independent position. The United States is now forced to immerse itself completely in Ukraine. The reason, of course, is not in Ukraine itself, but in the fact that the U.S. has met with tough and uncompromising resistance to its positions for the first time in many years. Until the events in Ukraine, the U.S. considered Russia a headache, but not a fundamental problem. Now, even if the U.S. does not consider Russia a proper rival, it must at least consider the country a contender. Washington will not be delving far into Ukraine’s murky internal politics, so its wish for Kiev is a perhaps imperfect but democracy-loving government that rode into power on a wave of a resistance to tyranny. By using sanctions against Moscow, Washington expects to force a change of course in Russia’s behavior. The chance of this is negligible. Pressure would have to be significantly ram-

ped up to have any effect, and that would lead only to a more comprehensive containment. Sanctions against Russia may have effects that were not clearly understood before. For the first time, the United States has clearly demonstrated that it controls the world economic system: the Visa and MasterCard payment systems can “shut off” financial institutions, and global IT companies are willing to terminate relationships with “undesirable” clients. Using this method with Russia forces other major global powers to make difficult choices. They must ask themselves to what extent they can rely on global economic and communications systems if it is so easy for dominating powers to shut off access when it suits their interests. The sanctions against Russia could therefore result in a fragmentation of financial and communications systems and lend a further impetus to the multipolar restructuring of the world, both politically and economically. Looking at the staggering scale of these issues, it is almost laughable to recall the smallness of how it all began. Was Viktor Yanukovych even capable of imagining the Pandora’s box he would open when he postponed signing an agreement of association with the EU? Fyodor Lukyanov is the chairman of the presidium of Russia’s Council on Foreign and Defense Policy.



Russians are not especially concerned about the cooling of relations between their country and the West as a result of tensions over Ukraine, according to a recent survey. In a poll conducted by the Levada Center, 55% of respondents said they were somewhat bothered or not bothered at all by a possible rupture in diplomatic relations between Russia, the U.S. and the EU. A similar number were bothered a little or not at all by the idea of the breakdown of relations between Russia and Ukraine, or by the economic sanctions that have been imposed on Russia from the U.S. and the EU. The number of those who responded that they were either not very concerned, or not at all concerned, has grown steadily over the past few weeks. When asked the same questions in early March, only 39% of respondents said they were not bothered by the prospect of international isolation. When asked if Russia should distance itself from the West in March, 61% of respondents said no. By the end of April, that number had decreased to 41%. The poll was conducted between April 25 and April 28. More than 1,600 people from 130 towns and cities in 45 Russian regions participated. It has a margin of error of +/- 3.4%.

EXCLUSIVELY AT RUSSIA-DIRECT.ORG Quarterly Report: From Brain Drain to Brain Gain After the fall of the Soviet Union, Russia became a net exporter of brain power. This RD Quarterly examines the leading factors behind the brain drain and looks at Moscow’s strategy for a future brain gain. It also gives 10 specific recommendations on how Russia can become more attractive to top talent from around the world.

May Monthly Memo: New Space Race

Andrei Ilyashenko ANALYST



he contract for Russian gas supplies to China that was signed during Russian President Vladimir Putin’s visit to Shanghai is of an impressive scale. The timing of the deal is also to Moscow’s advantage: it came as the West was stepping up sanctions against Russia over the events in Ukraine. However, these external circumstances should not be allowed to overshadow the main point made by the agreement: a major shift has been made in Russian foreign policy and the country is returning to the Asia-Pacific region. While the deal is being presented as Russia’s success, if not a downright blessing, much less is being said about the benefits for China. Beijing is ready to pay $400 billion for Russian gas over a period of 30 years. But this is just part one of a megaproject to improve China’s energy security over the long term. The contract covers supplies from gas fields near Lake Baikal to the volume of 38 billion cubic meters a year, and according to Putin, this contract opens the way to new talks on gas supplies to China from fields in West Siberia. With this agreement, China resolves the problem of meeting its domestic gas requirements for decades to come. The country’s own reserves are insufficient and LNG imports are both more expensive and more vulnerable, because they are delivered by sea. China also reaps some geopolitical benefits from the deal. With this agreement it is China – not Japan or South Korea – that is creating a gas-distribution system in Northwest Asia. China’s ability to hold its own against U.S.


As relations between Russia and the U.S. worsen, the potential for a new space race is becoming more realistic. Read this monthly memo to find out which areas are key in U.S.-Russia space cooperation and which of these might be strong enough to withstand the current atmosphere of mistrust over Ukraine.

Why Most Russia Experts Don’t “Get” Russia pressure in the region is even more stable, following this major tie-in to Russia’s energy resources. Taken from this perspective, the Russia-U.S. spat over Ukraine looks like a minor episode in a global struggle for spheres of influence. This kind of deal is exactly what President Putin was speaking about at the APEC summit in Vladivostok two years ago when he said: “We shall be strengthening the energy security not only of Russia, but also of the countries that we cooperate with, of the whole region.” At the same time, this policy has broader goals. Right after the contract with China was signed, Mr. Putin told journalists: “This project’s implementation will see us create what will be,


with no exaggeration, one of the biggest construction sites in the world over the next four years...Total proven recoverable reserves at these fields come to 3,000 billion cubic meters of gas and, in fact, the reserves there are even higher. They ensure us guaranteed supplies for 50 or so years, and I want to stress that this includes supplies for the domestic market, too.” Adding that this scale of work will allow Russia to upgrade the whole of its Siberian infrastructure, Mr. Putin said: “This is a big event in the gas sector, not just in Russia. It would be no exaggeration to say it is a major event for the entire global energy sector and certainly for Asia.”

The geopolitical system is entering anew a reality of revived polarization and a low-intensity, hybrid form of warfare between Russia and the West. Against the background of these dramatic changes, U.S. Russia experts once again must admit the limits of their understanding of Russia’s political movers and shakers.

Andrei Ilyashenko is a political analyst for the Voice of Russia.

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Fashion Today’s designers are inspired by the order of the past

detailed descriptions of the cut, color, ornament, material and even the measurements of these outfits were published in the texts of the laws. Every tsar personally approved and adjusted uniform designs as he saw fit.


Stripes, caps, boots


Each educational institution and government department had its own uniform, which came in several versions: formal, everyday, day off, winter and summer. For example, officers in the heavy cavalry guard had five or six uniform changes: rank-and-file soldiers of the same regiment had three different uniforms. Within each government department the uniform differed depending on the wearer’s class and rank. In addition to the coat, headwear came in different shapes and with fur trimming of various colors. There was even variation within a single government department and for identical positions. Workers who served at the “headquarters” dressed differently from those who worked for “representatives in the provinces.” The shoes were black laced boots. High boots were permitted only with a double-breasted jacket, greatcoat or frock coat during missions. Soviet historianYakov Rivosh wrote of the uniforms:“Distinctive insignias based on rank were the same for all the ministries and government departments. They were fastened to the stripes or the shoulder straps. “There were stripes on all types of formal clothing, except the justacorps and uniform dress coat. The stripes bore the emblem of the ministry or government department, just like the one on the cap, but smaller. All the medals and a ribbon (the oldest of the orders possessed) were worn on the dress uniform, along with a sword, white gloves and a white vest that was not visible.” The dress coat worn by senators, which was sewn with golden thread, was worth one month’s salary for a minister. The coat’s prestige was so great that even merchants and manufacturers, who were far removed from government service, envied it.

Ukrainian-born writer Nikolai Gogol famously penned“The Overcoat,”an allegorical tale of a petty bureaucrat who loses his social standing. The story symbolizes the role of the formal coat and uniform in Russia, where it was not merely a garment but also a symbol of dedication to one’s country. In 1722, Peter the Great approved the Table of Ranks, a groundbreaking register of civil and military positions that systemized the Russian bureaucratic machine in the European manner. Every rank had a corresponding uniform, which made it possible for anyone to precisely identify a bureaucrat’s job and his position in society. The clothes made the man: for young men, this was one of the most important arguments in favor of employment. Even lowly newspaper vendors wore special clothing: a long, doublebreasted coat with a peaked cap and a distinctive small bag slung over the shoulder. The uniform also helped improve the government’s image. In donning clothing that was familiar to Westerners, the Russian bureaucrats ceased to appear as half-savages in the eyes of foreigners. Peter the Great himself wore a uniform of exceptionally domestic making. In fact, the uniform catalyzed the establishment of a textile industry in Russia, spurring the development of clothing production. Huge government orders for ready-to-wear uniforms stimulated the shift from the smallscale artisanal production of fabric and garments to full-scale manufacturing. The Russian empire was the country of the uniform. From the college to the government office, all working men or students wore a uniform that was approved by the tsar. Charts with

Examples of 18th-century uniforms (above); M.A. Ostrovsky, a 19th-century bureaucrat (below).


14 is the number of ranks in Peter the Great’s table, a formal listing of all military and court positions.

9 is the number of buttons required on a bureaucrat’s dress coat, called a justacorps.

The universal use of uniform came to an end with the dissolution of the monarchy. Today, only workers in some military departments and judicial agencies wear uniforms. However, the uniforms of the Tsarist era have made something of a comeback of late, inspiring designers like Russian Anastasia Romantsova. In creating her fall/winter pre-collection for 2014–2015, Romantsova turned to the motif


Thanks to Peter the Great, anyone in Imperial Russia could determine a person’s rank by taking a look at their clothes. And now the stripes and emblems associated with that era are making a comeback.


In Tsarist Russia, the Clothes Made the Man

of the Russian dress uniform, using ribbons and orders on starched collars along with other flashy elements of the coat. Furthermore, bureaucrats are now more frequently acknowledging the uniform’s powerful ability to discipline and unite. “Police officers wear the same uniform and they are recognized. The bureaucratic administration that services the government should also be recognizable. They should wear tasteful outfits,” says Dmitry Malov, a deputy in the Troitsky District Assembly, in an interview, proposing that all Chelyabinsk Region bureaucrats be dressed in identical, but stylish, uniforms. The overcoat’s triumphant return would seem to be imminent.

The Kremlin’s Secret Plan for Crimea: Tourism

T R AV E L 2 M O S C O W. C O M PATRIARSHY BRIDGE AND CATHEDRAL OF CHRIST THE SAVIOR The Patriarshy Bridge was built in 2004. From one side, visitors see the Kremlin and the embankment of the Moscow River, while on the other side are views of the Central House of Artists and the famous Red October, a former chocolate factory. that is now a trendy neighborhood of galleries and restaurants. The observation deck offers panoramic views of the famous House on the Embankment and the Zamoskvorechye Merchant District. Tours on the deck are available only as a part of the group by prior arrangement 8 (495) 637 28 47. Address: 15 Volkhonka street (subway station Kropotkinskaya)

Tourists explore the ruins of a basilica at the National Preserve of Tauric Chersonesos in Crimea.

ganization (ICAO) has already advised European operators to avoid flying through Crimean airspace, prompting the cancelation of flights to Simferopol from European airports, includingVienna and Riga.The most drastic step would

TOWERS OF MOSCOW-CITY The new Empire and Federation Towers, located in the business district close to the city center, are some of the tallest buildings in the Russian capital. From the terraces of Moscow-City, you can enjoy the views of the Moscow River and the western part of the city. Impressive views of Moscow open up to those who take the high-speed elevator to the 58th floor of the new terrace of the Empire Tower (238 meters). The observation platform of the Empire tower is accessible only with a tour group. Tickets are 600 rubles ($17) and can be purchased at or by telephone at 8 (499) 272 48 46. Address: 6 Presnenskaya Naberezhnaya (subway station Vystavochnaya)

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be to remove the international flight code of the Simferopol airport off the ICAO and IATA registers, as was done with other controversial destinations including the Sukhumi airport in Abkhazia and Ercan airport in North Cyprus.

BOLSHOY KAMENNY BRIDGE (GREATER STONE BRIDGE) Built in 1938, this bridge connects Borovitskaya Square with Bolshaya Polyanka Street. From here, see the soaring panoramas of Moscow, from the majestic Red Square to the restored Cathedral of Christ the Savior. Address: Kremlevskaya naberezhnaya (subway station Borovitskaya)

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FERRIS WHEEL AT THE ALL-RUSSIA EXHIBITION CENTER Fans of extreme heights will enjoy great views of Moscow from the 75-meter-high Ferris Wheel at the All-Russia Exhibition Center from closed or open cabins, tickets 300-350 rubles ($9-$10). Address: All-Russia Exhibition Center (subway station VDNKH) 73 m

IVAN THE GREAT BELL TOWER Get a bird’s eye view of Moscow by climbing up the 80-meter-tall bell tower of Ivan the Great – “the first skyscraper of the capital,” built in the 16th century. The belfry is located in the heart of the city – on Cathedral Square inside the Kremlin. Visitors are able to view the exhibition and access the observation deck, which provides a wonderful view of the Kremlin and the old streets of Zamoskvorechye District. You can access the tower by using your ticket to the Kremlin Museum. A ticket costs 500 rubles ($14). Address: Kremlin, Sobornaya square (subway station Okhotny Ryad)

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The European Union has already closed its Crimean Tourism Diversification and Support Project, which was launched in 2012 and had previously been allocated nearly 5 million euros. The Russian authorities have so far proposed several solutions to these problems. The first move was to subsidize airfares to compensate for the loss of rail traffic. At 7,500 rubles ($216) for a round-trip, a plane ticket from Moscow to Simferopol is affordable for the majority of the Russian middle class. Three weeks after Aeroflot subsidiary Donavia announced discounted prices on flights from the southern Russian city of Rostov-on-Don to Crimea, tickets on the route were sold out. Donavia has already carried more than 5,000 people to Crimea’s Simferopol airport from Rostov-on-Don since opening the route less than a month ago. Anna Minina says many Russians would now go to Crimea out of a sense of patriotism. Tour operators are including Crimea on their priority destination lists, thanks to fresh demand. In April, the business weekly Kommersant Dengi conducted a poll asking about potential vacations to Crimea. Nearly 45% of respondents said they had never been to Crimea, but now planned to go. Only 8.5% said that they had been before and would not go again.

OSTANKINO TV TOWER Ostankino Tower’s observation deck has been open to visitors for over 40 years. From a height of more than 340 meters, tourists will be treated to great views of northern Moscow and the Moscow Region. This observation deck can be visited through guided excursions by appointment only. The excursion lasts about one hour. Registration is by phone at 8 (495) 926 61 11, and a ticket costs 980 rubles ($28) Address: 15 Akademika Koroleva street, bldg. 2, entrance 2 (subway station Alekseyevskaya)


These companies are ready to sponsor incentives for their employees to take holidays in Crimea. Oil major Rosneft, for example, has offered its staff Crimean tours at discounted prices, while gas giant Gazprom will promote Crimea as a destination for its employees, along with others such as Turkey. Anna Minina, managing director of the Otpusk 2.0 travel agency, says the Russian government will also promote Crimea as a vacation destination in other ways, including subsidized trips for categories of citizens entitled to state benefits.“This year Crimea will be visited by schoolchildren, retirees and other categories of people entitled to benefits. This will ensure demand and keep the resort busy, even if not 100% [full],” Minina says. Geography itself presents a challenge to Russian tourism in Crimea. Previously, most Russians traveled to Crimea by train. But the rail lines run through Ukraine and, as of mid-May, a train schedule from Russia through Ukraine to Crimea had not been approved. Additionally, Ukrainian authorities are encouraging international aviation organizations to drop flights to Crimea. The International Civil Aviation Or-



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SPARROW HILLS AND THE MOSCOW STATE UNIVERSITY MAIN CAMPUS One of the most popular postcard views of the Moscow is from the lookout platform on Sparrow Hills. The platform provides stationary binoculars for free for tourists. The views are especially beautiful on a clear day and late at night when the street lamps illuminate the city. The upper floors of Moscow State University’s main building offer an even more breathtaking visage of Moscow. To schedule a visit call 8 (495) 939 29 76. Address: Universitetskaya square (subway station Universitet)

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RBTH for the Wall Street Journal  

New issue of RBTH supplement inside the Wall Street Journal

RBTH for the Wall Street Journal  

New issue of RBTH supplement inside the Wall Street Journal