Political stability in Russia has been dependent on the centralization of power in the Kremlin. The Putin government's efforts to control the production and export of oil from Russia and Central Asia is an integral component of centralization.
By controlling both oil production and exports, Russia can strongly influence international oil prices. Maintaining high international oil prices is critically important to economic restructuring in Russia and long-term political and social stability. Ongoing political centralization in Russia will prevent any significant decline of international oil prices 2004, underpinning Russian asset values.
President Putin's centralization project has tamed the country's oligarchs and extended the government's power over Russia's media, law enforcement agencies, electoral commissions and the judicial system. Moscow's increasingly autocratic tilt has not gone unnoticed in Washington.
Secretary of State Colin Powell, who visited Russia last week, voiced the Bush administration's concerns in an article published in Izvestia in which he lamented that 'certain developments in Russian politics and foreign policy in recent months have given us pause.' The political developments are undoubtedly the centralization that has weakened Russia's oligarchs.
The foreign policy developments are Putin's efforts to increase Russia's influence in Central Asia. In the Izvestia article, Powell further surmised that civil society in Russia was underdeveloped and political power was not 'fully tethered to the law.'
As learned in the years prior to Putin's presidency, the restructuring of civil society and the legal system cannot occur in an unstable political environment. Political stability, or heightened autocracy in Russia, must precede the development of these institutions. Washington is well aware of this.
The real concern of the Bush administration is not civil and legal weaknesses, it is the role of centralization in reasserting government control over Russia's enormous natural resources, particularly oil.
In the past several years, the Kremlin's grip over oil production and export has slowly tightened. Foreign direct investment in oil production through production sharing agreements (PSAs) has been shunned by the Putin government. Oil export via pipeline is controlled by the state-owned pipeline monopoly, Transneft. The government has considerable direct and indirect influence over Russia's second largest oil producer, Lukoil, and natural gas giant, Gazprom.
The arrest, last October, of Yukos Chairman Mikhail Khodorkovsky, which raised strong rebuke from Washington, further elevated the government's indirect role in oil production. Yukos is Russia's largest oil producer and one of the largest oil producers in the world.
Khodorkovsky's arrest has quashed efforts by Yukos management to sell a stake in the company to a major foreign oil company. Investors have become increasingly alarmed by Moscow's growing resistance to foreign influence over oil production and export. But why would the Putin government resist foreign investment in the most lucrative sector of the economy?
Russia is the world's second largest oil exporter. With global oil demand and supply tightly balanced and spare production capacity severely limited, Russia can control international oil prices. In order to do this, Moscow must contain domestic production and exports, hence efforts to strengthen its influence over the oil sector.
Russia has more to gain from restraining oil production and exports, thus supporting high international oil prices, than from foreign investment, which would lead to increased production, exports and lower oil prices. Moscow's motivation for ensuring international oil prices remain high is the vast restructuring that must occur in Russia's non-commodity industrial sector.
This restructuring, as well as enormous infrastructure investment required to ensure that economic growth remains stable, can only be funded by Russia's budget, the revenues of which are oil dependent. The Putin government will increasingly control domestic and regional oil production and exports, supporting an average oil price (WTI basis) of around $32 per barrel in 2004, up from $31 per barrel in 2003.
Rapid economic growth in China and India in recent years has been a key factor in tightening the balance of oil supply and demand. Demand for oil in both of these countries has been increasing at a rate of about four percent annually over two times the average rate of oil demand growth globally.
The high degree of energy price subsidization in China And India suggest that the modest increase in international oil prices expected this year will not significantly impact economic growth in these countries. The main impact of continued high international oil prices will be on fiscal accounts. In Korea, firm international oil prices are also not expected to appreciably alter economic performance.
Ongoing economic weakness fed by geopolitical, domestic political and social instability will limit oil demand growth and the impact of high international oil prices on the balance of payments. As in Korea, economic weakness in Japan will limit the impact of oil prices on the economy. In the rest of Asia, the sustained strength of international oil prices will restrain economic growth potential by an average of about 0.5 percent this year.
Moscow's oil policies strongly conflict with political aims in Washington. Facing presidential elections in November, the Bush administration would like to see international oil prices decline to boost U.S. economic growth. In the long-term, Washington would like to open Russia's oil sector to foreign investment in order to lessen Moscow's ability to dictate international oil prices.
Finally, the U.S. would like to minimize Russia's ability to control oil production and exports from the Caspian region. Russia's continuing presence in Georgia, integral to Caspian oil exports, and its influence on Lukoil, a significant producer in the Caspian region, gives Russia this control. Relations between Moscow and Washington will continue to fray.
Russia's benefit from firm international oil prices will far outweigh this fraying and the negative implications for foreign direct investment. Firm international oil prices will underpin Russian asset values this year.