Streetwise Professor

April 20, 2006

A fool and his money

Filed under: Commodities,Russia — The Professor @ 9:21 am

When I was young and stupid and in New York for the first time (while on leave from the Naval Academy with my classmate Steve Woodmaska), I lost $20 playing three card monte. (Back in the day in NYC–the pre-Guiliani day–there were three card monte dealers on just about every streetcorner downtown, dealing cards on “tables” fashioned from cardboard boxes. When a cop would come, you could see the dealers fold up their tables for blocks.) You may rest assured that I have never lost a dime on this game, or anything like it since. Fool me once . . .

Apparently some people–very wealthy and supposedly financially astute people–never learned this lesson. According to a recent
Wall Street Journal article major investment firms are lining up to participate in an IPO of the Russian state oil company Rosneft, which is the current owner of Yuganskneftegaz, a former Yukos subsidiary sold off as part of the Khodorkovsky scandal. The article lays out with excrutiating specificity the ugly details of Russian oil politics, the lack of safeguards for minority investors, the impenetrable corporate structures, and the arbitrary asset valuation schemes that shift billions from one set of pockets to another.

Rosneft has hired a former Morgan Stanley investment banker to be CFO. Mr. O’Brien pledges to implement world class corporate governance mechanisms. The article also states that investment bankers advising Rosneft on the IPO have put a halt–at least temporarily–to some particularly outrageous asset grabs (e.g., the unilateral 70 percent writedown in the value of a stake in Yugansk still held by Yukos–apparently unbeknownst to Rosneft management until after the acquisition(!)).

I take Mr. O’Brien at his word. I am sure the investment banks will try to put safeguards in place. But at the end of the day, the Russian government will still own 51 percent of Rosneft and Russian law and politics will inevitably be what matters. Moreover, Putin had originally wanted to merge Rosneft into Gazprom, and although US bankruptcy courts threw a spanner in those plans, given Gazprom’s favored status it would be foolhardy to believe that Putin and Gazprom consider this more than a temporary setback. The opportunities for expropriation of minority shareholders are rife–the Kremlin could play the tried and true tax gambit a la Yukos, or discover some illegality at Rosneft and force the sale of the company to Gazprom (or some other favored entity) at a distressed price. Presumably the Kremlin will have learned its lesson, and do this in such a way as to avoid running afoul of US bankruptcy courts. All of Mr. O’Brien’s “international standards of governance and treatment of shareholders” and western banks insistence that “their participation means that the deal will meet their exacting standards” won’t amount to squat if Putin decides to flex his muscle.

This raises the question–what are the incentives to expropriate, and what incentives cut the other way? If Putin were interested in building a reputation for avoiding expropriation in order to attract western capital, he might abstain from aggressive action. However, if anything, Putin seems fixed on–indeed, almost obsessed with–using control of Russian energy assets to exert geopolitical influence. He seems far more interested in control than attracting foreign capital. Moreover, revenues from $70 oil and expensive gas are filling Kremlin and Russian oil company coffers, limiting their need for external capital. Given these circumstances, the lure of increasing Kremlin control over Russian energy production and distribution, likely through its chosen vehicle Gazprom, seems irresistable–especially if it also allows the fleecing of foreigners to the tune of tens of billions of dollars. Even though commodities/energy are hot now and likely to get hotter, all in all, I’d rather take my chances on three card monte.

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