Russia's oil pricing power worries Washington (page 1 of 2)

By controlling both oil production and exports, Russia can strongly influence international oil prices. Maintaining high international oil prices is critically important to economic restructuring in Russia and long-term political and social stability. Ongoing political centralization in Russia will prevent any significant decline of international oil prices 2004, underpinning Russian asset values.

President Putin's centralization project has tamed the country's oligarchs and extended the government's power over Russia's media, law enforcement agencies, electoral commissions and the judicial system. Moscow's increasingly autocratic tilt has not gone unnoticed in Washington.

Secretary of State Colin Powell, who visited Russia last week, voiced the Bush administration's concerns in an article published in Izvestia in which he lamented that "certain developments in Russian politics and foreign policy in recent months have given us pause." The political developments are undoubtedly the centralization that has weakened Russia's oligarchs.

The foreign policy developments are Putin's efforts to increase Russia's influence in Central Asia. In the Izvestia article, Powell further surmised that civil society in Russia was underdeveloped and political power was not "fully tethered to the law."

As learned in the years prior to Putin's presidency, the restructuring of civil society and the legal system cannot occur in an unstable political environment. Political stability, or heightened autocracy in Russia, must precede the development of these institutions. Washington is well aware of this.

The real concern of the Bush administration is not civil and legal weaknesses, it is the role of centralization in reasserting government control over Russia's enormous natural resources, particularly oil.

In the past several years, the Kremlin's grip over oil production and export has slowly tightened. Foreign direct investment in oil production through production sharing agreements (PSAs) has been shunned by the Putin government. Oil export via pipeline is controlled by the state-owned pipeline monopoly, Transneft. The government has considerable direct and indirect influence over Russia's second largest oil producer, Lukoil, and natural gas giant, Gazprom.

The arrest, last October, of Yukos Chairman Mikhail Khodorkovsky, which raised strong rebuke from Washington, further elevated the government's indirect role in oil production. Yukos is Russia's largest oil producer and one of the largest oil producers in the world.

Khodorkovsky's arrest has quashed efforts by Yukos management to sell a stake in the company to a major foreign oil company. Investors have become increasingly alarmed by Moscow's growing resistance to foreign influence over oil production and export. But why would the Putin government resist foreign investment in the most lucrative sector of the economy?

Russia is the world's second largest oil exporter. With global oil demand and supply tightly balanced and spare production capacity severely limited, Russia can control international oil prices. In order to do this, Moscow must contain domestic production and exports, hence efforts to strengthen its influence over the oil sector.

Russia has more to gain from restraining oil production and exports, thus supporting high international oil prices, than from foreign investment, which would lead to increased production, exports and lower oil prices. Moscow's motivation for ensuring international oil prices remain high is the vast restructuring that must occur in Russia's non-commodity industrial sector.