State oil funds have proved to be an invaluable source of emergency funding for resource-rich emerging markets during the global financial crisis, but with these cash reserves soon to be depleted, it is foreign investors who could end up footing the bill.
Sovereign wealth funds (SWF) are normally created during boom times, when the budget is enjoying surpluses and the government faces little international debt, as a way of managing excess liquidity.
Just like any savings account, the basic premise of these funds is to accumulate sufficient financial reserves for the state to draw on in times of financial or political need. This form of fiscal management is particularly popular with governments which generate their principal revenues from natural resources because the volatile nature of commodity prices tends to be cyclical – as was demonstrated in 2008 when record high oil prices proved to be unsustainable and were swiftly followed by a market crash and global recession.
Kazakhstan and Russia are almost textbook examples of SWF use in emerging markets as both states have relied heavily on their oil-subsidised “rainy day” savings to fund government spending and bail-outs.
In January, the combined value of the Kremlin’s two national oil funds was estimated to be just over $221billion, but this figure has steadily declined over the past 10 months as the government continues to spend its way out of recession and draw on this money to cover the growing budget deficit.
Subsequently, Russian finance minister Alexei Kudrin has announced that the fund will be completely exhausted in 2010 and that it is unlikely that reserves will be replenished until 2013, at the earliest.
The political and economic ramifications of this will undoubtedly have a direct impact on the business environment, particularly for oil&gas majors, which will play a vital role in getting the government’s savings back in the red.
Energy firms operating in Russia – and, indeed, all the countries of the Former Soviet Union – will be acquainted with the state’s resource-nationalist approach to foreign investment whereby the government retains control over strategic reserves and the most lucrative up and downstream activities to guarantee maximal financial gain and ensure that these operations remain in domestic hands.
This climate, while often inhospitable and sometimes overtly hostile, has not significantly deterred investment in Russia. This is because the past decade has been extremely profitable for all parties, and commercial disputes have been forgiven and forgotten.
Without the stability of years of excess cash to rely on, there is now an increased likelihood that the state could once again revert to protectionist measures.
However, this issue is not likely to receive serious consideration from many oil majors at present as Russia’s business environment appears to be experiencing a second wave of liberalisation in a bid to attract more foreign investment.
The government plans to hand out a further 40 exploration licences in November/December, and there are even whispers of long-term ambitions to privatise the state monopolies.
This air of optimism among investors is, in part, driven by the tacit acknowledgment that Russia and Kazakhstan, not to mention Turkmenistan with its vast gas reserves, still need foreign cash and expertise to help them exploit their natural resources, particularly as older deposits mature and demand for hydrocarbons looks set to rise. Domestic infrastructure also suffers from chronic under-investment and many refineries are in need of upgrade and modernisation with the help of external financing.
Nonetheless, investors should not be lulled into a false sense of security and assume that this will preclude unpopular, or even discriminatory, policies being introduced.
When the government is looking to raise cash in a hurry, additional or increased taxes, as well as financial penalties for pricing and environmental violations, are always reliable methods.
The main Russian players in oil&gas have close business and personal links to those in government and are therefore often successful in lobbying against unfavourable duties. It subsequently falls to foreign investors to make up for this shortfall and, perhaps somewhat surprisingly, investors face an increased risk of hostile behaviour in times of prosperity, especially if the government feels it is being short-changed while others take profits out of the country.
Western firms should also be aware that the recent raft of deals between Moscow and Beijing could constitute an indirect threat to their position as the long-term energy-supply contracts come with the added sweetener of bilateral loans from the world’s biggest holder of foreign exchange at favourable rates.
Despite ongoing rivalry between the neighbouring superpowers, China is a dream investment partner for Russia, being cash-rich and not constrained by diplomatic issues such as human rights or Moscow’s policy towards Iran.
Given the current economic climate and renewed ties with China, in the effort to rebuild Russia’s sovereign wealth fund, it is likely to be foreign firms paying the economic and political price.
Samantha Wolreich is the Russia and Former Soviet Union specialist from international security and risk mitigation firm AKE Group
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