Saturday, November 18

Russian Consolidation

The Great Russian Consolidation - The Mr.Putin Plan

The rise of mega companies is part of a concerted Kremlin effort to lend a competitive edge to Russian industry and extend its reach into global markets.

ON NOVEMBER 2, the Russian Government approved the merger of the country's main aircraft design and production assets, including MiG, Sukhoi, Ilyushin, Tupolev and Yakovlev, in a state-controlled United Aircraft Corporation (UAC). On the same day, the Government sent a bill to Parliament to clear the way for rebuilding the vertically integrated Soviet-era nuclear industry complex from what is today a fragmented assortment of commercial and state-owned enterprises.

The moves reflected Russia's new strategy of forming giant national champions capable of becoming global players.

A month ago two private Russian companies and a Swiss commodity trader announced a merger that would form the world's largest maker of aluminium. Russia's natural gas monopoly Gazprom earlier this year emerged as the world's third biggest company in terms of capitalisation after buying some oil assets.

Unfolding consolidation stands in sharp contrast with the policy of breaking up, bankrupting, and selling off giant state companies the government of President Boris Yeltsin pursued in the 1990s. The policy aggravated the economic crisis triggered by the collapse of the Soviet Union.

After taking over as President from Mr. Yeltsin in 2000, Vladimir Putin sought to reverse asset fragmentation. He began by consolidating the natural resources industry, the most viable sector of the Russian economy at the time. Gazprom led the way. The company, which claims to control a third of the world's natural gas resources, has diversified into oil production aiming to become the world's biggest energy company in a few years.

Back in the 1990s, way before he became Russia's leader, Mr. Putin wrote a paper for his Candidate of Science degree where he argued that globalisation "demands all possible state support for creating strong financial-industrial corporations with an inter-sector profile on the basis of resource extraction enterprises." These entities should be "capable of competing on equal terms with Western multinational corporations." It is this programme that Mr. Putin is implementing today. He has consistently pushed for consolidation in "strategic sectors" under state control.

"Resource extraction" was the first target of Mr. Putin's policy. Last year the Russian government raised the state's stake in Gazprom to a controlling 51 per cent. The Kremlin also promoted a medium-sized state-owned company Rosneft to become Russia's biggest oil company. Rosneft snapped up the main production assets of the private Yukos company crushed with back-tax claims last year and is planning more acquisitions. Thanks to Gazprom and Rosneft, the share of the Russian state in oil production rose from 10 to 30 per cent over the past three years, and may go up to 50 per cent next year.

The idea is to create 30 to 40 large holding companies in a range of fields in which the state will control at least 50 per cent of the shares. Following the pooling of aircraft-building assets, plans have been drawn up to consolidate nuclear energy, aircraft engine building, tank building, electrical machine engineering, and some other industries.

Mr. Putin's plan also provides for consolidated Russian companies to aggressively expand globally through mergers and acquisitions. This will help Russia to get access to Western markets and advanced technologies, which the West is still reluctant to share with Russia, even though the Cold War is long over and the COCOM lists of Western technologies banned for export to the Soviet Union have been abolished.

"We are still meeting rigid curbs on transfers of high technologies to Russia," Mr. Putin said.

Mr. Putin is encouraging Russian corporations to buy their way into European industry on a grand scale to form a giant highly competitive market encompassing the Russian and European Union economies.

Kremlin has a powerful instrument to help advance Russian corporate interests abroad — the country's vast energy resources. Mr. Putin made it clear Western companies would not get access to Russian oil and gas unless Russian industry — both commodity and manufacturing — was allowed to expand into Europe. A month ago Gazprom reversed its earlier plans to invite foreign partners for the development of the world's biggest gas field, Shtokman. Explaining the surprise decision, which dealt a blow to Western multinationals, such as ConocoPhilips and Chevron, Mr. Putin said Western companies had failed to offer comparable assets in exchange for a stake in Shtokman.

Moscow has demonstrated readiness to play it rough if its commercial interests are not taken into account by other nations. When the former Soviet state of Lithuania unwisely decided to sell its only refinery, which runs on Russian oil, to a Polish company rather than a Russian bidder, the Russian state oil transport monopoly, Transneft, just cut oil shipments to the disputed refinery citing pipe safety fears.

Russia's hard-nosed strategy is paying off. Earlier this year, Gazprom won a 50 per cent minus one share in Germany's BASF gas distribution network in exchange for a stake in the vast Yuzhno-Russkoye gas field in Siberia.

Internationalisation of the Russian corporate sector deserves closer attention from the Indian business community if it does not want to miss new opportunities on the Russian market. Aircraft building is one example. At the Airshow China-2006 earlier this month, Russia invited China to join forces with Russia's UAC to create an aircraft building centre on a par with Airbus and Boeing. Meanwhile, India is in a far better position to form such an alliance with Russia given their long successful record of cooperation in combat aviation. In fact, the head of Russia's Irkut aircraft corporation, Alexei Fyodorov, who has been appointed to lead the UAC, has consistently favoured India over China for strategic partnership in the aircraft industry.

Extracts from an article by Vladimir Radyuhin