Export of Russian Capital Turns into a Flight

30.08.2010 — Analysis

Mechel, a mining and steel company, specializing in coal, steel and power production, began to purchase foreign facilities several years ago. At present, in addition to Russian factories, it owns coal strip mines in the USA, ore operations in Kazakhstan, metallurgical production facilities in Romania and Lithuania. Experts assume that Mechel has influence on the owners of the Estar Group that owns the British MIRsteel plant.

Late in August, mass media informed that Igor Zyuzin, owner of Mechel, intends to acquire three blast furnaces from Cosipar or to set up a joint venture with this company. The Russian metallurgical company is tempted by sizeable reserves of iron ore in Brazil and by the location of the factory that is close to the ocean, simplifying the delivery of coal from the USA and shipment of pig iron to Great Britain for processing.

The arrangement, though logical in business terms, calls in questions from experts. They believe that the intended production chain is aimed at loading MIRsteel, which has actually been idle for more than two years. Thereby, experts want to know whether it is proper to provide jobs to foreign workers, when modernization of metallurgical operations results in mass redundancy of employees in Russia.

A manager of the Novolipetsk Metallurgical Works OJSC explained to RusBusinessNews that the geographic factor is a determinant in the metallurgical business: the factories located close to ports have an advantage a priori. Chinese manufacturers that to a large extent influence the pricing policy on the world market build their new facilities virtually in the sea - on the peninsula in order to do without overland cargo transportation. Russian business people do not have any other option but transfer their facilities closer to ports or acquire ready-to operate facilities in other countries. It is obvious that factories that were built in hinterland regions within the vast Russian territory during the Soviet period will be able to survive on the market only at very low tariffs for energy and cargo transportation. This is exactly what nobody can promise.

Konstantin Simonov, General Director of the National Energy Security Fund, says that in 2009 production costs per ton of oil increased by 25%. They will keep on going up in future, as the Russian fuel and energy sector has been trapped in a tight situation. Easy-to-reach oil is approaching its limit, and Russian oil and gas companies cannot and do not want to develop hydrocarbon production in Eastern Siberia and shelf sea.

Having privatized Soviet black gold, Yeltsin-time business entrepreneurs embarked on milking the industry. Without having exploration and drilling technologies that could be applied to shelf conditions, without state-of-the-art refineries, oil and gas company owners spent their huge profits on payment of dividends, lining their own pockets, rather than on know-how. Development of Eastern Siberia (and the Yamal peninsula) is impossible without cutting-edge technology and extremely costly control systems. This will require technological reforms in the entire industry and in research financing. At the same time, Russia has not even considered the problem of liquefied gas transportation from Yamal, which requires special ice-class tankers. Things came to the point that today Russian oil-field experts are not able to perform properly fracturing operations, opting to invite professionals from the Schlumberger Company to do the job.

However, the worst problem is that having put aside sizeable capital, oil and gas companies started to export it, choosing territories with better climate and easier production rather than Eastern Siberia. TNK-BP decided to invest millions of dollars in fields located in Vietnam, LUKOIL opted for Iraq. State-owned companies follow the private sector's lead: Rosneft refused to participate in the Sakhalin-4 and Sakhalin-5 projects due to their economic inefficiency and announced its development of a gas field in the United Arab Emirates. In 2010 alone, the company is investing more than 60 million dollars in this project.

The government turns a blind eye to the capital flight. Konstantin Simonov even suspects that it encourages acquisition of foreign assets by oil and gas companies, being sure that supposedly it bolsters Russian influence in the world. The expert is confident that this position is erroneous because it is production of hard-to-reach oil in Eastern Siberia and the Barents Sea that is able to drive Russian technological progress from the deadlock. Furthermore, shrinking the industry that is the basis of all the Russian production and that underlies the national budget can play a low-down trick with the government.

In the meantime, the situation is getting worse. K.Simonov expects that Russia is going to face a dramatic drop in oil production, which will be followed by a collapse of the domestic fuel and energy complex. Under such circumstances, all talks about low tariffs for metallurgical companies are useless. However, cheap gas and electricity made it possible to do profitable business during the USSR times. If today's trend of increasing price for energy is retained, any manufacturing business will soon be futile in the large cold country. It is fraught not only with outrageous unemployment rates, but also with dissolution of Russia.

Experts believe that the only alternative to this process is nationalization of major properties, price control, free secondary and higher education, and task-specific public investment in innovative industries. Can these tasks be accomplished in today's situation? Most unlikely. The two-year-long talks of the Kremlin about industry modernization have shown that the economic and political system of the country is geared to primitive guzzling up of resources. Therefore, it may happen that Russia soon will have to import fossil fuels; however, there is the question that has been factored out - where will it take money from to purchase them.

Vladimir Terletsky