Russia? Think Again

By Vitaliy Katsenelson, CFA

As you look at the high-flying Russian stock market, you may feel like you want some of it. But before you dive into Russia consider this: as it is, Russia is a dysfunctional play on high oil prices as well as commodities. It is no less bureaucratic than it was some fifteen years ago. When you buy a Russian company, with the exception of Gazprom (OGZPY), you run the risk that the Russian government will decide it “wants it,” the same way it “wanted” the Yukos and Sakhalin project from Shell (RDA).

Gazprom is a unique case since it seems the whole country’s foreign policy is written in the Gazprom HQ for the benefit of Gazprom and Gazprom alone. When one of the former republics has a dispute with the company about its pipelines or prices, the Russian foreign ministry gets involved. I guess the fact that Gazprom is owned in part by Russian government and remains one of the largest sources of tax revenue in the country certainly makes it Mother-Russia’s business.

Gazprom’s play is limited to several factors: it’s a cheap stock (if you trust the reserve numbers); it has been raising natural gas prices in former Soviet republics to market rates; in some cases it is receiving shares of local gas distribution companies in lieu of payment. But in the long-run, I wouldn’t bet on higher production from Gazprom because its capital expenditures are allocated from the Kremlin, whose objectives are more short-term oriented.

Current Russian prosperity is completely driven by high commodity prices. Take the $60 oil away and what you get is a very backwards economy, poor infrastructure (especially outside Moscow and St. Petersburg – two cities that are swimming in oil money), very high pension liabilities that the country accrued to its seniors during the Soviet days, corrupt local governments and a fairly unstable political system.

If you are interested in playing on high commodity prices you might consider (non-Russian) oil services stocks (e.g. GSF, HAL, SLB, BJS etc.) – it’s the same reward or better and lower risk.

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