Glimmers of an Investor-Friendly Russia
New York Times
February 15, 2003
By Sabrina Tavernise

MOSCOW, Feb. 14 — With a pen stroke at 9:45 Tuesday morning, BP agreed to make the single largest foreign direct investment in Russia's post-Soviet history. BP's $6.75 billion commitment to create a giant new oil company here left businesspeople asking whether Russia, after a decade of zigzagging economic policies, had finally become safe, fertile ground for foreign investors.

That it was BP taking the plunge was seen as an especially encouraging sign, since the company's earlier ventures here were so fraught with problems and frustrations that they scared off some other foreigners.

But many investors said that despite BP's move, the jury was still out on Russia. "It's gotten better, but in terms of red tape and bureaucracy, it hasn't changed much," said Gary Wilson, chief executive of SladKo, a Russian confectionary holding company, and the former head of Coca-Cola’s operations in St. Petersburg. "BP was a landmark deal," he said. But, he added, "the honeymoon will subside and reality will set in; there's still a long way to go."

Few question that the country has made substantial progress since the early 1990's, when it was not unusual for companies' assets to mysteriously disappear, shareholdings to be diluted, debts piled up and left unpaid, and regulators and the courts manipulated or ignored. The murky free-for-all culminated in a financial collapse in 1998.

The effects on investor sentiment were clear enough: from 1994 to 2001, Russia attracted just $165 in foreign direct investment per capita, while Poland got $889 and the Czech Republic $2,200, according to Renaissance Capital, a Moscow-based investment bank.

Beyond the figures, there was a widespread feeling that Russia was a world apart, disconnected from the Western industrial and financial economy, with no culture of playing by the rules in either business or politics.

Now, a decade of painfully wrought change appears to be paying off for Russia. Inflation has been brought under control, the federal budget has been in surplus for three years running, the economy has been growing robustly for nearly five years and the ruble has been fairly stable. President Vladimir V. Putin has affirmed legal protection for property rights, giving many Russians the assurance they needed to invest at home.

Perhaps more important was a gradual but important change in incentives. Put simply, it has become profitable for Russian executives to start treating their shareholders well. In the land-rush phase of Russian capitalism, "oligarchs" emerged and amassed riches by grabbing them any way they could. Now the oligarchs are settling down to the business of making their empires work, and finding they have more to gain from courting the international capital markets than from engaging in more skulduggery.

BP's chief executive, Lord Browne, cited this evolution when he said on Tuesday that the company had agreed to buy a half-interest in a new oil company that would absorb its oil assets in Russia as well as those of Tyumen Oil. BP's commitment to the deal is equal to one-fourth of all foreign direct investment in Russia since 1992.

BP's Russian partners in the deal also spoke of an improved landscape for investment. Mikhail M. Fridman, chairman of the Alfa Group, a conglomerate of oil, retail and telecommunications businesses, said the deal would encourge other investments in Russia and tie the country to the West more concretely than any political talk could.

The deal "marks a fundamental breakthrough in foreign investors' belief in Russian companies," Mr. Fridman said.

"Now Russia is part of the international business community," he added. "Russia has stopped being associated with instability and opaqueness."

Other major international oil companies may now feel pressure to get into the game in Russia, as well, by buying reserves in the country's vast hinterland. But little is up for sale. The few new oil fields that have been found recently have gone, almost as a rule, to Russian companies. In the rare exceptional cases, like Exxon Mobil’s investment in Sakhalin Island in the Far East, the foreign companies have sought guarantees from the government about future tax treatment for the projects before committing themselves to invest, a practice now publicly opposed by some in the domestic oil industry.

Russia's oil producers, having climbed back out of their deep post-Soviet decline, strongly prefer that foreigners participate by buying stakes in Russian companies, as BP will do, and not by buying oil fields to operate without Russian partners.

"A few years ago, you had poor oil companies with declining production," said Stephen O'Sullivan, head of research at United Financial Group, an investment bank in Moscow. "Now they have money and are investing. They want to limit the competition. They would rather do it themselves, because they feel it's their country and they've got the money."

The main risks for foreign investors now lie in weak Russian protection of property rights. The legal system remains too frail and too easily influenced by powerful business figures to win the trust of Westerners.

BP itself was victimized in the courts in 1999, when an oil-producing subsidiary of Sidanco, a Russian company in which BP held a large stake, was snatched from BP's control in a bankruptcy hearing. BP's Russian partner at the time, a tycoon named Vladimir Potanin, had taken Sidanco deep into debt, and a rival company closed in for the kill, leaving BP sputtering with frustration.

In a typically Russian twist, the owners of that rival company are BP's new partners in the deal announced this week. BP was finally able to resolve the Sidanco problems by joining the company it could not beat.

For all the country's evolution toward stability and open dealing, local partners remain vital to help foreign investors navigate Russian reality. Powerful businessmen like Mr. Fridman handle everything from relations with unruly regional governors to problems with the tax police.

Though there is little sign in the statistics — investment from abroad totaled just $2.6 billion in 2002, barely up from $2.5 billion in 2001 — there are signs that more companies are now willing to set up shop in Russia. Ford Motor and General Motors each began producing cars here in 2002; Caterpillar is building a factory, and the Swedish retailer Ikea is building its fourth large home-furnishings store in three years.

And though the risks are high, so are the potential profits. Ikea has rapidly become a familiar name in Moscow, and the two stores already in operation here are among its 15 most profitable worldwide. The company expects its $400 million investment to be profitable by February 2004.

"The market in Russia is huge," said Lennart Dahlgren, Ikea's country manager in Russia. "It's much bigger than you believe. There is more money in the normal family than anyone ever expected. Just don't look at the statistics."

Still, Ikea has had its share of difficulties with the local authorities. Twice, the police have come to the parking lot of one of Ikea's Moscow stores and stopped every customer driving away, saying they were looking for stolen vehicles. For a while, senior Ikea managers who had traveled to Sweden for the 2002 holidays were denied visas to return to Russia.

"Officially speaking, foreigners are very welcome," Mr. Dahlgren said. "But you also find others who are not very interested in having foreigners. You can even hear people on very high levels saying, `We don't need foreigners.' "

Business conditions are improving, though, and government bureaucrats are beginning to ease up, according to a recent survey of 2,000 small businesses across Russia conducted by the Center for Economic and Financial Research in Moscow. The survey found that new laws limiting government interference had begun to reduce paperwork for many respondents.

BP said its investment enjoyed support at the highest levels of the Russian government. But just in case, the deal includes a safeguard for BP, requiring that disputes with its partners be settled through international arbitration in Sweden, not in the Russian courts.

The hope here, investors said, is that before long, deals like BP's, which binds the partners at least through 2007, will soon stop being the stuff of banner headlines and become, in a word, normal.

"Two years in Russia is a very, very long time," said Robert Dudley, the BP vice president who negotiated the deal.

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