The Foreign Service Journal, December 2003

Western governments sup- porting them were no longer advocating structural reform by introducing the quality bank concept, but promoting the major pipeline investment projects instead. An opportunity for mutually beneficial structural reform was thereby lost. Those particular Western oil companies were no longer affected by the absence of quality banking in Transneft. But Russian oil exploration and production continued to suffer under the system that rewards low-value heavy crude oil production and penalizes high- value light crude oil production. Distorted price signals led to wrong investment decisions in upstream petrole- um. Rail transportation of crude oil became prevalent though it costs three times more than pipeline trans- portation. Buried in a long list of policy recommendations from industry participants in the St. Petersburg sum- mit, endorsed by the four cabinet ministers and sec- retaries in a report to their two governments, is a small mention of the need for quality banking in the Russian oil pipeline system. Nothing has been done in a dozen years on a simple reform step that every- one, including Transneft today, agrees must be imple- mented. The list of policy recommendations sets nei- ther priorities nor a timetable. Politics and Power It appears to be more appealing to government leaders to discuss projects like Murmansk or Russian natural gas exports to the U.S., even though megapro- jects like these take many years to come to fruition. Nor is it yet clear that they advance the reform agen- da. Already the Russian government has rejected publicly the concept of privately owned and con- trolled trunk oil pipelines and the idea of breaking up the Gazprom monopoly in natural gas anytime soon. Whether these positions will become more flexible after elections in a second Putin presidential term is difficult to know. This takes us back to the richest man in Russia, sit- ting in the Moscow prison, at the start of winter 2003. As long as a country’s economy is based on the exploitation of oil and gas resources, it will favor a highly centralized political sys- tem where a few men hold the power to reward state-owned concessions and to guarantee investment conditions. Left to its own devices, the petroleum industry, which by its very nature routinely takes multi-billion dollar investment risks, would support central authority overruling local authority or civil society in Santa Barbara County, Calif., or Jefferson Parish, La., as well as in the delta of Nigeria, Lake Maracaibo in Venezuela, or Western Siberia and Sakhalin. Mr. Khodorkovsky was the ben- eficiary of such central power in a few hands at the beginning of privatization in Russia. He is now a vic- tim of the same kind of power. A bonanza of oil income allows governments to pay social benefits, reward friends, punish enemies, buy elections and maintain power without seeking the sort of political legitimacy a broad tax base demands in a diversified economy. This has been the unfortunate universal experience around the world in natural resource-exporting countries. It may be too early in Russia’s still young and potentially promising reform process to know whether this is the path it is now on. What we do know is that Russia is endowed with many human and cultural advantages not enjoyed by other resource- rich countries and, therefore, has better policy choic- es. What happens in the coming months with the Yukos crisis will go a long way in telling us the vision Mr. Putin and the people around him have for Russia’s future. The U.S. and other industrialized countries can consider what it really means to have Russia in the G-8, beyond an additional spot in the photo opportu- nity, if it is to be truly integrated into the industrial- ized world economy. But Russians, who are at a piv- otal moment in their history, will first have to make their choice. ■ F O C U S D E C E M B E R 2 0 0 3 / F O R E I G N S E R V I C E J O U R N A L 39 Sharing our own evolving regulatory experience with Russian colleagues is far better than preaching to them on what laws to pass in order to attract American investment.