The Russian Front: Oil, Putin and Prosperity

September 29, 2005 - Minyanville.com

Putin's time ends in 2008. Will Russia's begin? I don't follow Russian markets and recently I discovered that I don’t understand the psyche of Russian people (that discovery was made after talking to my high school buddies that still reside in Russia and my capitalistic dialect is not understood well there). I don’t even have a decent inventory of hard liquor at home, a disgrace by any Russian standard (or so I've been told). And please don’t be misguided by my Russian first name and “sophisticated” Russian accent when I talk about the country.

However, I want to point out a very important but lost headline: Putin will not be running for re-election in 2008. The Russian Constitution allows the president to serve only two terms and Mr. Putin’s second term ends in 2008. Mr. Putin’s consolidation of power over the last several years--which has left the country less of a democracy and more akin to a pre-Gorbachev Russia--had convinced many that he’d seek an amendment to the Constitution to allow a third term. His decision not to amend the Constitution increased my respect for Mr. Putin exponentially--considering he is close to possessing absolute power. And as we know absolute power corrupts absolutely.

The outcome of the 2008 election scares me a little. It’ll scare me even more if oil prices return to their long-term average. The devil we know now is better than devil we don’t (though I’m not calling Mr. Putin a devil, just an expression, Mr. Russian President). Though from a western perspective, Mr. Putin’s actions were very questionable to say the least. To a certain degree we know where he stands.

Russia’s recent prosperity, funded primarily by the western world, has been driven by high energy prices. According to the CIA World Factbook, oil, natural gas, metals, and timber account for more than 80% of Russia’s exports, thus leaving the country vulnerable to swings in world energy prices.

A turn away from this prosperity could prove to be dangerous and create an even more volatile economic situation. Hungry people are not famous for making rational decisions. Arguably that is how Hitler came to power in Germany. Though on the surface this statement appears eye catching, it is a reality of Russia. I remember the time when Zherinovskiy (not much different from Hitler on many levels) ran for president opposing Yeltsin in early 90s, and he received a very large vote count, considering how extreme his positions were on political and ethnic issues.

Russia has a chance that a country gets every 30 years or so to reinvent itself. If it captures this opportunity and reinvests huge inflows of funds from oil exports into developing other industries (and Russia has plenty of engineering talent to do so), it may come out stronger at the end.

Maybe this is my Russian skepticism talking, but Mr. Putin still has two years to change his mind, as he is only 52 years old - an infant in political years (ask Senator Byrd). A large terrorist event (god forbid) happening between now and the 2008 election would certainly provide justification for him to change his mind and amend the Russian Constitution.

Why do US investors care what happens in Russia? A fair question. Political stability in Russia will insure a stable flow of energy resources out of Russia. Russia is still the among the largest nuclear powers. Russia engulfed in political unrest will be a feeding ground for terrorists looking to get their hands on nuclear weapons.

Vitaliy N. Katsenelson, CFA Copyright Minyanville.com 2005