Streetwise Professor

December 1, 2008

So, Which Is It

Filed under: Economics,Energy,Politics,Russia — The Professor @ 9:29 pm

Last week I linked to a Reuters story (one of many from a variety of news sources) that stated that Russia was backing away from liberalization of the power market.   (That’s the market for electricity, not the market for political power, which will remain illiberal for the foreseeable future;-)

Not so fast, says Vladimir Putin:

Prime Minister Vladimir Putin pledged Friday not to slow the development of the power industry, responding to concerns from Germany’s E.On, Russian news agencies reported Friday.

“All the plans that we set out for this sector, we will fulfill. We will not cut them back,” Putin said, RIA-Novosti reported.

On Friday, Putin received E.On’s chief executive, Wulf Bernotat, at the presidential residence in Novo-Ogaryovo. Bernotat was reported as saying the planned liberalization of the power market was a key factor in E.On’s $6 billion acquisition of power producer OGK-4 this year.

Since the acquisition, the global financial crisis has knocked Russian share price indexes down by some 70 percent, and many industries have begun to lobby against the full liberalization of electricity prices by 2011, which power firms like OGK-4 are counting on to make a profit.

“As far as we are being assured, nothing has changed,” Bernotat said, Interfax reported. “It is important to us to know that all obligations will be fulfilled. … It is important for us to have political support,” he was quoted as saying.

“We are conducting fruitful negotiations with [Deputy Prime Minster] Igor Sechin and [Energy Minister] Sergei Shmatko on this issue, but it is important for us to have political support,” Bernotat said.

This echoes Shmatko’s statement from last week:

The pace of the move toward market rates for electricity will not be slowed, Energy Minister Sergei Shmatko said Friday, dispelling fears that the liberalization might be delayed.

The Market Council, a state-controlled watchdog for the electricity sector, said Wednesday that the idea of slowing deregulation of power prices was being discussed.

“We have been getting a great number of requests from various sectors asking to freeze the tariff,” Shmatko said on the sidelines of a meeting with power industry executives devoted to preparations for the winter heating season. “But we suggest sticking to the decisions that have already been made.”

Under the liberalization plan, half of Russia’s electricity production is to be traded at market rates from July 1, 2009, while prices for the other half are to be set by the Federal Tariffs Service. Only 25 percent of the electricity trade is currently deregulated.

A delay “would affect the investment climate and investors’ activity in the sector,” Shmatko said, calling it “a very bad signal to the market.”

He also said for the first time that Russian power consumption had slowed and that there was a special team at the ministry to “react swiftly” to problems in the power sector.

“We know there will be problems between the wholesale and retail companies, between Gazprom and the generators … problems with payment delays,” Shmatko said. He added that companies shouldn’t bother asking the ministry for the help, including the financial support.

So what’s going on?   Who knows?   And that’s exactly the problem.   The fact that E.On felt compelled to genuflect to Putin personally tells you all you need to know about Russia’s politico-economic system.   Namely, that it is a personalized system of rule in which crucial decisions are the result of negotiations (and who knows what else) centering on Putin, the Godfather.

Investment and growth are crucially dependent on the existence of credible policy commitments.     Investors who have no confidence that the returns to their capital are secure from expropriation or radical policy shifts will not sink their wealth into immobile, specific assets–like power plants.   A stable political system that has mechanisms to make policy commitments credible is essential to providing investors with such assurances.   It is virtually impossible to make credible commitments in a highly personalized political system like Russia’s.   Especially since that system is extremely corrupt, lacking in a rule of law, and suffused with violence and the potential for violence.

So, perhaps Putin made the right decision–today.   And regardless of the correctness of the decision, the process is far more problematic.   With such a process, in which CEOs of major companies must seek personal assurances from the nation’s prime minister, there is no assurance that today’s decision will survive until tomorrow.   And given the uncertainty which is inherent in a personalized system lacking the institutional mechanisms to make policy commitments credible, investors will be very wary about investing in Russia.

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1 Comment »

  1. Russia is now between the rock and a hard place here as well. If it raises the cost of electricity and lets the market set prices, this will push many inefficient industries under and will force those on fixed incomes to see their electric bills skyrocket. This will lead to a great deal of popular discontent. To do nothing, however, will leave large chunks of the population potentially without electricity.

    Comment by Michel — December 1, 2008 @ 10:45 pm

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