Russia, Iran, and Qatar control the largest natural gas resources in the world — enough to dominate the future business of shipping liquefied natural gas (LNG) to consumers around the world. But of the three, Russia and Iran don’t even show up as LNG exporters in the trade statistics. According to the latest BP Statistical Review, the three biggest exporters of LNG are Qatar, Indonesia, and Malaysia.

Russia and Iran have legacies of Marxist policies and generally have trouble getting along with their neighbors, so they haven’t exactly been fostering the type of environments that attract international investment. And investment is what they both desperately need.

Iran is a basket case, and as long as the clinically insane are running the show, the country is unlikely to attract the investments in technology and capital assets it needs to transform its natural gas reserves into a tradable commodity. But Russia is apparently open to foreign investment, as long as that foreign ownership is limited to small, non-controlling stakes.

Despite all the headlines of Russia confiscating big projects started by international oil companies, the country doesn’t want them out entirely. On July 9, BBC News reported that state-controlled gas giant Gazprom, after discovering how difficult and costly it would be, is sheepishly reapproaching the companies it had kicked out of the Shtokman gas project:

"Russian gas monopoly Gazprom has said it is close to pairing with foreign firms to start developing the world’s largest offshore gas field.

"The comments made by one of the firm’s top executives, Alexander Medvedev, mark a dramatic U-turn from its tough stance last year.

"Last October, Gazprom said it alone would exploit the untapped Shtokman gas reserves in the Barents Sea.

"Signing a deal would be a major boost for any of the overseas firms involved.

"Norway’s Statoil and Hydro, ConocoPhillips and Chevron in the U.S., and France’s Total had all been shortlisted as potential members of a consortium to start pumping gas from the strategically crucial Shtokman field on the ice-free Kola Peninsula.

"But Gazprom dealt them all a huge blow last October when its chief executive Alexey Miller said Gazprom would take control of 100% of the resources.

"The 1,400-square-kilometer field has the potential to become the world’s largest offshore gas field with 3.2 trillion cubic meters of gas contained in reservoirs 2 kilometers below the seabed — itself at a depth of 350 meters.

"The cost of the operation has been estimated at between $20-30 billion, which Gazprom would have to foot if it decided to go it alone.

"Mr. Medvedev [said] Gazprom was in talks with foreign companies to allow them to ’share in the economic benefits of the project, share the management, and take on a share of the industrial, commercial, and financial risks.’

"This would be through overseas companies taking a stake in the company created to operate Shtokman, while Gazprom will retain control of the license to the field."

To place it into context, Shtokman’s estimated reserves of 3.2 trillion cubic meters translate to about 113 trillion cubic feet, or the amount of gas the entire U.S. economy consumed over the past five years.

This is a smart move on Gazprom’s part because the estimated development cost of $20-30 billion is probably a fraction of what it will ultimately turn out to be. Many projects that resemble Shtokman in scope and complexity are struggling with major cost overruns.

This plays right into the hands of companies like Chicago Bridge & Iron, Foster Wheeler, and the infamous Iraq contractor Kellogg Brown and Root (KBR — recently spun out of Halliburton). The stocks of these companies are expensive for good reason: They’re all big players in the engineering and construction of LNG liquefaction terminals, so their businesses will benefit as this market grows and continues to experience cost inflation.

Despite the fact that it’s proceeding at a slow and expensive pace, the continued growth in liquefaction capacity raises the possibility of the LNG market eventually looking like the oil market does today — with a few players dictating the terms under which they’ll export gas. Rumors of a planned OPEC-like natural gas cartel have even popped up in recent months.

But they are way ahead of their time.

In order for a gas cartel to develop, its members must control huge shares of low-cost global gas production and cooperate to suppress supply. Not to mention the fact that the majority of gas consumption would have to be shipped via LNG — rather than pipeline — so it can be sold to the highest bidder (like the oil industry). The LNG market may not develop to this degree for another 20 years, if ever.

Petroleum Review Sees Cost Pressure in LNG "Megaprojects"

Chris Skrebowski, editor of Petroleum Review, follows the progress of major LNG projects as closely as he follows major oil projects. Drawing from his observations of the Energy Institute’s IP Week conference, Skrebowski explains that the marginal cost of LNG is increasing rapidly:

"Considerable uncertainty remains for projects due to startup in 2010 and later. In the course of a presentation during IP Week, Andy Flower, an LNG consultant, produced a listing of projects that had been expected to get final investment decisions (FIDs) in 2006. This is because no FIDS have been signed off in the last 18 months."

Apparently, a lot of engineering and design work is under way, but companies remain hesitant to fully commit capital to liquefaction projects. Rapid increases in Greenfield construction costs have "reversed all unit costs reductions in the last 20 years. This means new liquefaction trains will have markedly higher unit costs than recently built ones."

Since Asian and European markets will experience growing demand for reliable supplies of seaborne LNG, the regasification terminals slated for construction on the Gulf Coast (primarily by publicly traded Cheniere Energy) may face the prospect of having to pay unprofitably high prices to import LNG to the U.S. "The problem is that the lack of new [liquefaction] projects is now certain to produce a supply shortfall around 2012 [emphasis added]. The time from [final investment decision] to first gas is normally around four years," writes Skrebowski.

U.S. Gas Supply Will Rely More Upon LNG and Drilling Activity

What does a potential shortage of LNG by 2012 mean for U.S. gas consumers? First and foremost, it means that the U.S. must keep drilling intensely on its own land to maintain the domestic gas production its home heating, electricity, and petrochemical industries rely heavily upon.

The big white space in this chart is the portion of U.S. gas demand that’s fulfilled by homegrown drilling. About 80% of gas demand is produced locally, while 17-20% is piped in from Canada (shown in blue) and 3-5% is imported as LNG (shown in red) — mostly from Trinidad and Tobago:

Zooming in to a smaller scale shows the trends since January 2001. Pipeline imports from Canada decline each year during the "spring breakup." When the ground thaws each spring in Canada, it becomes too soft to move around heavy drilling equipment, so production and exports to the U.S. temporarily decline:

But beyond the seasonal swings in gas imports from Canada, an important trend is emerging. I make note of it in the chart above. A growing share of Canadian gas production will be consumed by tar sands projects as production is projected to grow by a few million barrels per day over the next decade; this mined substance consumes a great deal of natural gas as it’s upgraded into useable fuel.

Furthermore, in its quest to cut down on carbon emissions, the Canadian government is pushing for the replacement of its coal-fired power plants with gas-fired plants. So what remains of Canadian gas resources may eventually be piped to domestic power plants, rather than exported to the U.S.

A final blow to U.S. pipeline imports: Gas supplies will continue to be limited as long as the Canadian rig count remains near the bottom of its five-year range. Last Halloween’s decision by the Canadian government to phase out the tax-favored status of energy trusts not only upset scores of income investors; it also dramatically curtailed drilling projects that are vital to sustain oil and gas production — and exports to the U.S.

So despite the fact that LNG imports have grown to satisfy about 3-5% of U.S. demand, this is no reason to expect gas prices to collapse. In fact, this 3-5% figure will have to double and triple in the coming years to compensate for lower Canadian imports.

Lastly, a look at domestic gas production (the maroon section of this chart) shows a flat trend since 2001. This has occurred even as the rig count has soared. So the U.S. will need a healthy, growing domestic drilling rig fleet to avoid shortages in the future:

Rising Drilling Intensity Reveals Need for Rig Fleet Overhaul

As many industry and government sources point out, the U.S. sits on plenty of untapped natural gas resources — especially "unconventional" gas. This is gas that’s "nonassociated," meaning it’s not a byproduct of oil production, and it requires more significant investment in fracturing and pressure-pumping services to start and maintain production. On the bright side, the best operators in unconventional plays experience drilling success rates north of 95%; so it’s more of a manufacturing operation than it is "wildcatting."

But the key aspect to remember about growing unconventional gas drilling activity is that it will require a large rig count and a growing oil field service industry.

In a Feb. 27 Strategic Investment weekly update entitled "Opportunity in Unconventional Natural Gas," I wrote:

"I constructed the following two charts to illustrate this rising trend in drilling intensity. This information is publicly available on the Web sites of the Energy Information Administration (EIA) and oil field equipment and service company Baker Hughes.

"The blue line is the Baker Hughes Natural Gas Rig count in the ‘lower 48′ United States, including offshore basins. By ‘gas’ rigs, Baker Hughes refers to rigs drilling for natural gas in U.S. territory. Out of the total U.S. rig count, gas rigs now comprise about 84% of active rigs, with oil rigs comprising the other 16%:

"As you can see, 10 years of monthly data refute the oft-repeated line, ‘Newly built drilling rigs coming online will lead to a glut of natural gas and cause prices to crash.’ This is cited as a reason why so many drilling and E&P stocks remain cheap.

"The second chart combines the two data sets from the first chart — it’s monthly U.S. gas production divided by the monthly rig count. A simple regression line shows a clear trend running from 3 bcf per month per rig 10 years ago to 1 bcf per month per rig in 2006:

"What conclusions can we draw from this chart? Well, it lends heavy support to the view that drilling demand will more than absorb any increase in the rig population. Most E&P companies are earning huge returns on invested capital at current gas prices. So they will bid aggressively to put newly built rigs to work on their drilling projects.

"Another conclusion? Just maintaining current natural gas production will require a steady uptrend in rig activity (the blue line in the first chart). This can be achieved by building more rigs and refurbishing the huge population of rusted-out rigs left over from the early 1980s drilling boom…

"So disregard headlines about the impending wave of new rigs destroying the drillers’ profit margins. Many will be put to work on unconventional gas projects where break-even gas prices are in the $2-4 per mcf range. Unconventional gas production is very drilling intensive because operators are seeing 60-70% production decline rates after the first year of production from a new well."

So what investment conclusions can we draw from the trends transforming the natural gas industry?

First, growth in LNG trade is important to satisfy demand. Most of the world’s largest gas resources are located far away from major population centers, as you can see by looking at the map of the Shtokman field. There’s no shortage of LNG shipping or regasification capacity at the moment, but there’s a growing shortage of liquefaction capacity. Once the billions are ultimately spent to build out this capacity, U.S. importers may very well have to outbid Asian and European customers for LNG. This makes U.S. gas drilling activity all the more important.

Second, since the existing land drilling industry was largely constructed during the early 1980s oil boom, most of its equipment is nearing the end of its useful life. Lots of new rigs are being constructed, but they’ll be necessary to replace those that are retiring. This trend is long lasting and will favor forward-looking rig operators and equipment companies.

Despite its week-to-week ups and downs, there’s a sustainable boom under way in manufacturing, refurbishing, and operating the equipment necessary to meet the demanding drilling environment of the 21st century.

Good investing,
Dan Amoss, CFA

July 11, 2007

Costs Spiral for LNG Projects was originally featured on Whiskey and Gunpowder

The geographic connection between high-ranking Russian government officials and Gazprom executives is not a coincidence. A very high proportion of those in the halls of power happen to be from St. Petersburg, a port city on the Baltic Sea — the city called Leningrad prior to 1991.

In “Gazprom May Thwart Putin Drive for Russian Energy Dominance,” Bloomberg writer Lucian Kim takes us back to the formative years of Putin’s St. Petersburg crew:

“The president [has] personal connections to the men who run Gazprom. Putin worked in the office of then St. Petersburg Mayor Anatoly Sobchak from the collapse of the Soviet Union in 1991-1996. When Putin served as head of Sobchak’s foreign investment committee, Gazprom CEO [Alexey] Miller, 45, was his aide. Valery Golubev, 54, a Gazprom deputy CEO appointed last year, was, like Putin, born in St. Petersburg, served in the KGB intelligence service and worked in Sobchak’s office starting in 1991.

“Dmitry Medvedev, Russia’s first deputy prime minister and Gazprom’s chairman, was Putin’s legal adviser in Sobchak’s office. In a poll released by the All-Russian Center for Public Opinion on April 17, those surveyed picked Medvedev, 42, along with Sergei Ivanov, also a first deputy prime minister, as most likely to succeed Putin. The president must leave office next year after completing his second four-year term.

“‘It’s not a state company; it’s the president’s personal company,’ says Vladimir Milov, a former deputy energy minister who runs the Institute of Energy Policy in Moscow. ‘It’s a bunch of people from the St. Petersburg administration enjoying the windfall.’”

In the wake of the Soviet Union’s collapse, a mad rush to acquire former state-owned assets convinced many that if you wanted a piece of Russia’s economic future, you’d better have the right connections. While most oligarchs pursued profit by snapping up inefficient companies for pennies on the dollar, Putin craved power and influence more than riches. His doctoral thesis centers on the importance of using natural resource wealth to enhance Russian power, so he believes that the government should have control over this vital sector, rather than privately owned companies.

Russian Gas Needs an Investment Boom

In his quest to reestablish Russia’s position as great power — and gain enormous public popularity in the process — Putin seems to ignore why private ownership and free markets do a better job of efficiently extracting the maximum value out of resources. Left without a real profit motive, government-controlled companies like Gazprom are more like burning matches than they are going concerns.

Gazprom uses its stranglehold on the Russian pipeline grid and connections with environmental regulators to bully its way into growth. Like a gangster, it threatens corporate death in exchange for majority ownership in any project it covets. Companies like Shell just say, “Thank you, sir, may I have another?”, happy to salvage some of their sunk costs from projects like Sakhalin 2. They have no leverage over government-backed Gazprom.

But while it was busy stealing others’ properties, Gazprom seems to have ignored the basic necessity to replenish its ever-depleting production base. It must now accelerate big projects to make up for lost time. Kim’s Bloomberg article continues:

“[Gazprom’s] options for expanding [natural gas] output are challenging. One is to open the 700-kilometer-long Yamal Peninsula that juts into the Arctic Ocean to gas production. While Gazprom said in October it would begin developing the project, the remoteness of Yamal, which holds an estimated 10.4 trillion cubic meters of gas, demands a huge investment…

“The other option is Shtokman, a field holding as much as 3.7 trillion cubic meters of gas and located 500 kilometers offshore in the icy Barents Sea. A year ago, Gazprom’s plan was to develop the site with the help of two or three foreign equity partners. The bidders were Norway’s Norsk Hydro ASA and Statoil ASA, Chevron Corp. and ConocoPhillips of the U.S. and France’s Total SA.

“After months of delaying a decision on choosing its partners, [Gazprom CEO Alexey] Miller last October went on Russia Today, the Kremlin’s English-language satellite news channel, to tell the world that Gazprom would develop the project without foreign investors. ‘On the technical side, Gazprom needs foreign expertise,’ says Roland Nash, chief strategist at Renaissance Capital in Moscow. ‘But Gazprom can afford to wait because there’s fierce competition for its reserves.’

“Gazprom has pushed back the earliest production date for Shtokman to 2013. Chevron puts the price tag of the project at as much as $20 billion.

“Gazprom executives insist they won’t have any trouble meeting future demand. ‘We’re investing as much as necessary,’ Deputy CEO Medvedev says. In January, Gazprom’s board approved total 2007 investments of more than $20 billion, including $1 billion for Yamal and $600 million for Shtokman. The company says it plans to spend $24 billion on capital projects in 2008 and $27 billion in 2009.

“Economy Minister German Gref, who sits on the Gazprom board, is skeptical. At a government meeting in March, he complained the company still hadn’t submitted production plans through 2020. Miller replied that Gazprom wouldn’t produce new gas until there were concrete buyers for it.”

By “concrete” buyers, Miller refers to reliably profitable buyers. A highly regulated Russian natural gas market leaves Gazprom in a difficult position. The state subsidizes consumers by capping the price at which gas can be sold. This has led to a situation in which Gazprom is losing money on the gas it sells domestically, so the company has made up for it by jacking up prices on its European customers.

Gazprom Is Running on a Fast Treadmill

Ending gas price subsidies to former Soviet Union states like Ukraine and Belarus enabled Gazprom to receive full market prices for the gas it sells to European customers. The Kremlin rightly received criticism for the way in which it abruptly cut off customers in the middle of winter, but the fact remains that Gazprom needs to charge fair market prices in order to fund its massive investment program. Putin’s government (and that of his handpicked successor) plans to gradually raise the cap on domestic gas prices as well. This clearly won’t bolster his popularity.

Why would Putin risk his legacy by lifting the cap on domestic natural gas prices? Because he realizes that the situation is dire for his old St. Petersburg friends. Intelligence service Stratfor recently wrote that if the current status quo is maintained, Gazprom will literally run out of natural gas within a decade.

“Gazprom’s problem is simple. Its investment into bringing new fields on line is absolutely abysmal. As of 2000, only three major fields in western Siberia — Urengoy, Yamburg and Medvezhye, with reserves of 16 trillion cubic meters of natural gas among them — accounted for about 70% of Gazprom’s total natural gas production. All are past maturity, and efforts to replace them are middling and lagging. The first major field brought on line since the end of the Cold War — the 3.3-trillion-cubic-meter Zapolyarnoye superfield — only began commercial production in 2001, and its output peaked in 2004.

“All the low-hanging fruit already has been picked, and Gazprom has not shown the managerial foresight, interest in foreign investment, or technical capacity to replace output at a pace that will forestall production declines. The chart below indicates the International Energy Agency estimation of Russia/Gazprom’s output decline without a substantial and immediate increase in investment dollars. Most of the increase — the blue region — is likely to come from Kazakhstan and Turkmenistan, and since those increases depend on an improvement of the infrastructure linking Russia to Central Asia, the real picture might even be bleaker.”

Gazprom desperately needs to invest massive amounts of capital into mitigating production declines at its existing properties. Companies that provide drilling services, drilling equipment, and enhanced recovery technology stand to benefit. At first glance, many would say that this projection going out to the year 2020 is too pessimistic since it doesn’t include much of a bump from potential future discoveries.

This may be true, but in order to bring potential discoveries into production, Russian operators will require more drilling and more rig equipment. It’s not a stretch to assume that the Russian rig fleet is old, overtaxed, and must be refurbished in order to accomplish a very busy future.

The North American natural gas industry appears to be in a similar situation. It will need to gradually increase drilling activity just to maintain current production rates. This chart, maintained by EOG Resources, shows the production from gas wells drilled in each year since 1990 and how much the wells contribute to total U.S. gas supply:

It appears that production from wells drilled prior to 1990 makes up less than 20% of total gas supply. Decline rates are accelerating because higher and higher proportions of U.S. gas production comes from “unconventional” sources. This helps explain why the number of land rigs actively drilling in the U.S. has gone up and up, yet gas production remains flat.

Russian Oil Needs an Investment Boom

Natural gas is not the only industry that needs massive investment. The Russian oil industry requires an investment boom as well.

For the May issue of Petroleum Review magazine, editor Chris Skrebowski wrote a piece entitled “Dancing with the Bear.” Skrebowski wrote it after attending the Energy Institute’s International Petroleum Week 2007 in February. Held in London, IP Week’s “Russia Day” attracted a standing-room-only crowd eager to hear key leaders of Russia’s oil and gas industry. I was intrigued by Skrebowski’s views on the evolving role of private oil companies in Russia, drawn from Vladimir Milov’s presentation:

“Vladimir Milov of the Institute of Energy Policy, Russia, then spoke to the title ‘The Rise of State Energy Companies and Its Effect on Oil and Gas Sectors in Russia.’ He started by showing that up to 2004, private oil companies had accounted for 83.5% of production, with state-owned companies providing just 16.5%. By the end of 2006, the state section had grown to 32%, the private sector had fallen to 42%, and there was a ‘gray zone’ accounting for 26% of production. The gray zone comprises Surgutneftgaz, the remainder of Yukos, and the Russian-owned 50% of TNK-BP. He anticipated that these were likely to move into the state sector over time, giving the state dominance in oil production.

“He then went on to show how production from companies that had been nationalized had fallen over the last two years. He also noted that if the Yukos companies had just maintained production at end-2004 levels, Russia would already be producing over 10 million b/d [emphasis added].”

For perspective, here’s an updated version of the Russian/Saudi oil production figures as reported by the Energy Information Administration:

Russia is producing about 9.5 million barrels per day and is widening its lead over Saudi Arabia as top oil-producing country in the world.

Skrebowski continued:

“Milov then went on to show the way that Western technology was leading to the greatest expansion in Russian production. Rosneft’s re-establishment of links with Schlumberger had allowed Yuganskneftegaz production to expand by 4.5 million tonnes in 2006. Foreign-owned projects — Salym, Sakhalin 1, Kharyaga — had contributed another 3 million tonnes in 2006. Schlumberger was performing 30 hydrofracs a month for Yuganskneftegaz and 100% of the wells in the Priobskoye field had been treated.

“His estimate was that Russian production in 2006 would only have expanded by 1.6% rather than the actual 2.2% without foreign investment. Yet, ironically, the campaign against foreign investors escalated in 2005-2006. This has already led to laws defining ‘strategic’ oil and gas fields where foreign investment is limited to a minority holding. President Putin at two recent meetings had floated the idea of not expanding Russian oil production any further [emphasis added].

“Milov went on to show that a similar pattern was seen in the gas sector, with production from the independent sector growing fast while Gazprom’s output was little changed. In his view, a gas supply gap was already emerging as Gazprom’s investment in gas production was too low to meet the requirement.”

President Putin is floating the idea of not expanding Russian oil production any further? Even the possibility of this occurring should grab large media headlines. Yet few in the Western world are thinking about the possibility that a) Russia may not be able to expand production much beyond current levels without massive assistance from private international companies like Schlumberger, or b) whether Russian leaders would want to expand production in exchange for foreign currency.

As I noted to Strategic Investment readers in recent weeks, the long-term value of the U.S. dollar (and other paper currencies) will become more and more of an issue for those in Asia and the Middle East who find themselves overwhelmed with too much cash and too little energy and resources for themselves.

It remains to be seen whether Putin and his cronies at Gazprom will come crawling back to big Western oil companies once they discover just how difficult big future projects will be. But this much should be expected: International oil service companies have an opportunity to satisfy huge demand for cutting-edge oilfield technologies in places like Russia and the Middle East.

Meanwhile, those who feel they’re entitled to buy all the cheap hydrocarbons they want with U.S. dollars need to realize that Russia has re-emerged as a great power. President Putin and whichever crony he’s lining up to be the next president have a firm grip on the future of Russian energy, and it doesn’t look like they’re going to loosen it anytime soon.

Good investing,
Dan Amoss, CFA

June 7, 2007

From Russia With Love was originally featured on Whiskey and Gunpowder

I am in Long Beach, California this week, attending the annual convention of the American Association of Petroleum Geologists (AAPG). Why not? I have been a dues-paying member of AAPG for 30 years (even during my Navy days) and have learned quite a bit about the world of oil and gas by participating in the organization and reading its many excellent publications.

As for the annual convention, a lot of the premier oil finders in the world are here in Long Beach, as well as people from many of the critical vendors who sell articles and services to the oil industry. Everyone is gathered together to talk shop and compare notes about what is going on in the energy industry, from remote sensing to seismic, from exploration prospects to drilling decks, from total depth to the pipelines.

So this convention is exactly where I ought to be, considering that my beat is oil and other natural resources. And yes, it means that I must travel to sunny Southern California. It’s a tough job and somebody has to do it. But I do it all for you, dear readers. As the week wears on, I will be writing about the AAPG convention, and you can be certain that the best of the information that I pick up here will find its way into future articles in Whiskey & Gunpowder, as well as into the other Agora Financial publication for which I write, Outstanding Investments.

The Man of Steel

I mentioned above that last week the LA Times published an article about a television series currently being broadcast on Russian television concerning Joseph Stalin. This prompts some thoughts about the late comrade and generalissimo, and what the revival, if not the rehabilitation, of Stalin’s legacy may tell us about what is happening in Russia.

The man’s real name was Iosif Vissarionovich Dzhugashvili, born 1878 in Georgia, and died 1953 in Moscow. Early in his adult life, Dzhugashvili studied for the Russian Orthodox seminary. But not long into his godly pursuits, he gave up notions of sacrificing material things on Earth for the prospect of gaining them in heaven. Instead, young Dzhugashvili pursued material things on Earth, adopting and embodying a hard line of Marxism and communism in the process. Through his own brand of that ideology, the man pursued these material things with a vengeance. “The death of one person is a tragedy,” he once commented. “The death of a million is a statistic.” You have to be a hard, cold person to think like that. And the Georgian adopted a name that suited his character. He called himself Stalin, which in Russian means “man of steel.”

One would truly have to be a child who was, as the modern expression goes, “left behind” in school not to have heard about and to know at least something of Stalin. Stalin was one of the key players in the Bolshevik Revolution of Russia in 1917. He worked with Vladimir Lenin to found the USSR out of the remains of the Russian monarchical government. After Lenin’s death in 1924, a death in which some scholars believe that Stalin played a role, Stalin rose rapidly to power in the USSR and ruled that nation with a grip of…well, with a grip of steel, until his own demise due to complications from a stroke. Yes, a stroke. At least that is what the Soviets said about how Stalin died, back in 1953. Not long afterward, they blamed a conspiracy of Jewish doctors.

Stamp out Religion in Russia

After seizing power in the 1920s, Stalin, the former seminarian, moved to stamp out religion in Russia, a place where Orthodox Christianity had traditionally been thought of as part of the very soil. Thousands of churches were destroyed, and the clergy sent away, which in Russia is very far away (to Siberia). As the 1920s and 1930s wore on, Stalin presided over the collectivization of property in Russia, to include establishing state ownership of essentially all resources both natural and man-made. Stalin collectivized Russian agriculture and drove off or killed any who opposed him, and many who did not. Similarly, Stalin forced a pattern of massive heavy industrialization on Russia, at something approaching a breakneck speed. And he broke many necks in the process. Stalin’s secret police arrested and imprisoned anyone who was considered an enemy of the state, and of those there were many. Stalin was responsible for the deaths of well over 20 million of his fellow Soviet citizens, “a statistic” in his words, but a statistic that staggers the mind.

Brethren

In the late 1930s, Stalin purged his army of tens of thousands of its most senior and experienced officers. And then, in 1939 through his foreign minister Molotov, Stalin signed a nonaggression pact with Germany and its leader, Adolph Hitler. When Hitler’s German armies attacked Russia in June 1941, they sliced through the ineptly led Russian formations and battered their way to the gates of Moscow. When, in July 1941, Stalin initially addressed his Soviet people to urge resistance to the Germans, the first word out of his mouth called his millions of listeners “brethren,” a devout reference back to his seminarian days, and to the ancient Orthodox religion that he had done so much to destroy. When all else was failing, Stalin attempted to enlist God into the Red Army.

A Common Soviet Soldier

During the war with the Germans, Stalin’s son Yakov was captured by the invading troops. At one point, the Germans sent a message offering to bargain with the Soviets over the return of Yakov. Stalin replied with words along the lines that the leader of the Soviet Union does not concern himself with the fate of a single “common Soviet soldier.” Yakov eventually died in German captivity. The Man of Steel had settled the issue.

The fate of this “common Soviet soldier” concerns us in this article because a rather idealized and sentimental, even maudlin, version of Stalin’s relationship with his son forms part of the background to a 40-part series currently running on Russian television, called “Stalin Live.” The theme of the show is a rather flattering portrayal of an elderly Stalin, a few weeks before his death, recalling and flashing back to events from the past. The show is presented as a history of the Stalinist period in the USSR, as recalled by the “Best Friend of Soldiers” himself.

The Legend of Stalin

To admirers of Stalin, of whom there are many in Russia today, the show is an educational and informative vehicle by which to bring the legend of Stalin to a younger generation of Russians. To many critics, however, the show is a long campaign of historical distortion and outright propaganda that glosses over and whitewashes the inexpiable crimes of a horrific dictator.

Georgian actor David Giorgobiani, who plays Stalin in the series, states that “Many more years have to pass before we can make an unbiased judgment on that great man [sic]…One hundred years from now, no one will pay attention to the fact that so many people perished and the costs were so terribly high.” In reference to the war against the Germans, Giorgobiani states that “Everyone will remember that such a great country was saved” by Stalin.

However, Danill Dondurey, editor of a film-themed Russian newspaper, states that “In the show, Stalin is portrayed as the savior of the people, the country, and all of civilization, the leader who destroyed fascism…Not for a split second do we see Stalin soaked in blood up to his elbows, as he really was.” And because the TV series is focused on Stalin just before his death, there is no plot device through which to offer the perspectives of Stalin’s contemporary critics. There were, of course, those who knew Stalin well, such as Nikita Khrushchev who as Soviet premier later gave the famous “anti-Stalin” speech that denounced much of Stalin’s legacy and sowed the seeds of the illegitimacy of the founding myths of the USSR.

“The message is clear,” states Dondurey. “Russia needs a wise leader…The main goal of this show is to preserve and nurture in the people the desire to obey a supreme leader, to take pride in having a supreme leader, to see no alternative to this model in the development of society.”

Apparently, this message is getting through, if not touching nerves. The LA Times article quotes one satisfied Russian who has a fond recollection of the good old days. States one fan of the series, a viewer named Viktor Kurenkov, “Under Stalin, we had the best weapons, the best planes, the best tanks. He built the country that was first to send a man into space. As for the repressions attributed to him, their scale was always exaggerated.”

Mr. Kurenkov’s sentiments are not exactly a minority view in Russia. In fact, no less an authority and scholar of the USSR than Russian President Vladimir Putin has called the demise of the USSR “the greatest geopolitical disaster of the 20th century.”

A Word From the Sponsor

Interestingly, the Russian network NTV, which broadcasts the Stalin series, is owned by the state-controlled entity Gazprom, the massive energy company that has effective monopoly control over the vast natural gas resources of Russia. According to editor and critic Dondurey, by sponsoring and broadcasting such a program that glorifies the Stalinist past, the Russian state is essentially promoting and encouraging the trend toward authoritarianism in contemporary Russian political life. So the broadcast of the “Stalin Live” show is not exactly the equivalent of, say, Texaco sponsoring the New York Metropolitan Opera over the past many decades.

The show’s producer, Grigory Lyubormirov, states that his goal is to portray both the historical Stalin and the myth of Stalin. “Our Stalin is not only Joseph Dzhugashvili. It is Comrade Stalin, (whose) myth is still alive in the minds of Russian citizens.” No doubt it is.

Lyubormirov goes on, “I categorically refuse to show Stalin as a paranoid, bloodthirsty wolf, because everything Stalin did had ironclad logic to it…Stalin was doing all that for logical reasons. Stalin was responsible for everything that happened in the Soviet Union after 1924, everything good and everything bad.”

The Medium and the Message

So we see in Russia a popular television program, sponsored by energy giant Gazprom, which tends to glorify Stalin and the days of his dictatorial reign over the USSR. The show depicts Stalin in the context of using communism and political repression to build a strong nation, defend Russia against foreign invasion, and save the Soviet state, if not the world, from German fascism. The series glosses over the almost bottomless, decades-long brutality of the Stalinist period. The series also elevates Soviet Communist cultural myth over historical reality, and recalls how a supreme leader was able to offer some semblance of what the producer depicts as domestic stability and security from external threat to the Russian people.

All of this may well be emblematic of the current political evolution within Russia. There is no question that Stalin was a critical player on the history of the 20th century, and understanding Stalin is helpful to understanding how our world came to be in its present state. But the message of the Russian series “Stalin Live” is ominous, particularly because it fits with so much else of what we are currently seeing in Russia, particularly in the area of Russian resource nationalism.

That is, the Russians are going out of their way to rewrite and reform, if not simply to renege and abrogate, agreements from the 1990s. Their goal is to recover Russian state sovereignty and control over natural resources from any semblance of foreign control, particularly foreign control over energy resources. The recent well-publicized troubles that Exxon and Shell have had with their projects on the Russian island of Sakhalin, or BP and the Sakhalin gas project in northern Russia, fit neatly into this new political paradigm. To the extent that any foreign business interests are permitted to operate in Russia, especially energy interests, it is only so long as they play the game, suffer along with whatever indignities are hurled their way, and look the other way when the Russian state displays its iron fist.

As more than one nation has learned to its eventual sorrow, the Russians will go their own way in this world. And it is not as if we in the West could (let alone, should) ever muster, let alone apply, sufficient resources to change the fundamental trajectories of Russian history. But we should at least understand the risks inherent in where the world’s largest country is headed. And wherever that trajectory is headed, it is not reassuring to learn that a show distorting history and glorifying Joseph Stalin is among the most popular items on Russian television.

Until we meet again…
Byron W. King

April 2, 2007

Stalin Lives! was originally featured on Whiskey and Gunpowder

Perhaps there is no better quote to illustrate the unique place of Russia in the investment world than this simple comment from the Financial Times: “Gazprom [the giant Russian oil and gas company] does not comprehend why its thinly veiled threats and bullying are not, as at home, seen as a normal negotiating tactic.”

What do we make of Russia? Assassinations, broken promises, corruption, frequent roughhouse tactics…these things loom large in the investor’s mind, reinforcing the idea of Russia as some sort of recurring nightmare. Then there are those flashbacks to 2004 and the whole Yukos fiasco. The government basically seized the company for back taxes in a move widely considered politically motivated (i.e., Putin didn’t like its ambitious billionaire CEO, Khodorkovsky, who was arrested and sent to rot in Siberia).

Investors lost everything — billions of dollars.

Russia seems to realize it has an image problem. I thought it was funny that various Russian news organizations/agencies published a lengthy advertising supplement recently in The Washington Post, called “Trendline Russia.” The six-page pullout section was like a mini-paper within the paper. The main point of which appears to be massaging the bruised reputation of Russia.

One headline grabbed my eye: “An Image of Future Russia: 80 Ireland-Like Regions.” And the cutaway quote: “Every Russian region, depending on its specific characteristics, can copy the breakthrough experience of Ireland or Dubai.” Heady stuff. These guys should be writing my marketing copy.

Russia’s bad reputation hasn’t yet soured investors. Even though they’ve gotten pie thrown in their faces before, investors keep coming. Foreign direct investment in Russia hit a record $27 billion through the first nine months of 2006. That’s a 43% increase from a year ago.

An Insider’s View From Moscow

Recently, I’ve been reading the comments and analysis of Eric Kraus, head of the Moscow-based Nikitsky Fund. On his fund’s site is an excellent free monthly newsletter, called Truth and Beauty (…and Russian Finance). I feel it is an insider’s on-the-ground account of what’s happening in Russia. As I love to get as close to the source as possible, Truth and Beauty has become a regular part of my reading. In his latest letter, Kraus takes to task what he calls “deeply biased Western pundits”:

“In 1997, you would have been warned of the impending collapse in oil prices, in 1998 of the catastrophic breakup of the Russian Federation — while every subsequent issue of The Economist has warned of a veritable potpourri of impending catastrophes…In the meantime, of course, oil prices quintupled, the Russian equity market has soared 30-fold, while Russian GDP has exploded to almost $1 trillion.”

Kraus points out that Russia’s growth rates over the last eight consecutive years make it the fastest growing economy in the Western Hemisphere.

Much of Russia’s success is tied to commodities, of which it is a veritable storehouse. Russia is the largest producer, or among the largest producers, of palladium, platinum, diamonds, nickel, and gold. Russia is also rich in oil and gas.

Russian oil giant Gazprom has a market capitalization of $250 billion, putting it in the weight class of international heavyweights such as Exxon and General Electric. The Russian stable also boasts other heavies such as Rosneft at $100 billion and Lukoil at $80 billion. These are just a few examples.

Russian multinationals are large and ambitious. They’ve raised billions on the London Stock Exchange. They’ve also spent billions buying up assets in emerging markets around the world — in Belarus, Ukraine, Kazakhstan, Uzbekistan, and Africa. But they are also active in more developed markets. In the U.S., for example, it was a Russian company that bought and turned around Rouge Industries, the fifth largest American steel producer and Ford supplier. It was a Russian company that paid $2.3 billion for Oregon
Steel Mills this past November.

So we see how the Russian bear is awake and has become quite the global competitor.

Russia and China — Getting Chummy

Russia’s economic wagon is lashed more and more to China and Asia. “Russia and China appear to be cozying up as never before,” The Wall Street Journal reports. In 2004, they resolved a long-standing border dispute, with Russia ceding some territory. In 2005, they carried out joint military exercises for the first time. China buys more than $1 billion worth of Russian weapons every year, making it Russia’s biggest customer. Trade between the two grew 37% in 2005.

And as China continues to scour the globe for resources, Russia figures prominently in those plans. Rosneft pledges to double its exports of oil to China and it will partner with CNOOC, the big Chinese oil company, to build an oil refinery and run gas stations in China.

Sparsely populated Russian territories bordering China are taking on waves of Chinese immigrants. By some estimates, there are over 250,000 Chinese living in Russia. This has also become something of a source of tension between the two, as small Russian towns fear becoming more and more Chinese and less and less Russian.

It’s fascinating to see all of this happen. An economically vibrant Russia certainly becomes something an investor must consider. I believe it is part of my role to analyze and report on events extraordinary and important, even though these insights may not lead to an immediate investment recommendation. I feel this is the case with Russia.

The Real Gems in Russia Are Hard to Get

As well as Russia has done, I don’t regret missing the explosive rally in Russian stocks. Surely, it is a tired and easy cliche, but investing in Russia still has the feel of playing Russian roulette. How do you account for the possibility of complete nationalization, as with Yukos? How do you account for the possibility of assets and contracts disappearing overnight?

I recently heard Bruce Berkowitz, the manager of the top-notch Fairholme Fund, speak at an investment conference. Though he may have been quoting someone else (I can’t remember), I scribbled on my notepad a quote that sticks in my mind when I think of Russia: “Anyone who accepts a small risk of losing everything will lose everything eventually.”

And then there is Douglas Adams, the great humorist. He had a great quote apropos of Vladimir Putin, Russia’s head of state: “When he heard the words ‘integrity’ and ‘moral rectitude,’ he reached for the dictionary, and when he heard the chink of ready money in large quantities, he reached for the rule book and threw it away.”

Kraus, though, is bullish on Russia. To his credit, he’s been right. But he invests in things that are hard for us to get at. “At Nikitsky,” Kraus writes, “we believe that the greatest value is to be found in privatized post-Soviet industrial assets — generally unpronounceable (e.g., Sevzapelektrosetskroy), hugely undervalued, and unknown outside a small circle of small-cap specialists.”

Short of investing in Kraus’ fund, there is no way for us to play in that sandbox. There are, however, a few backdoor plays. These are ideas that do not require an investment in a Russian company, but that benefit from some trend in Russia.

So in a world in which there seems to be many other possibilities, I see no reason to buy the popular big caps of Russia. I’ll keep watching.

Sincerely,
Chris Mayer

January 31, 2007

The Russian Bear Is Back was originally featured on Whiskey and Gunpowder