Russia has been hit with a triple-whammy since the beginning of the global financial crisis: Falling oil prices, a lack of demand for exports, and a pandemic of capital flight.

Even before the crisis reached its zenith, rattled investors were pulling their money out of Russia. Capital outflows totaled $21 billion in the two weeks ended Aug. 22 – the two weeks following Russia’s Aug. 8 invasion of Georgia – according to Goldman Sachs Group Inc. (GS).

Of course, even more money found legs out of the country late last year as the financial crisis intensified. Deputy Prime Minister and Finance Minister Alexei Kudrin told a meeting at the Federal Tax Service that net capital flight stood at around $130 billion in 2008.  Addressing the service earlier Kudrin said that some $200 billion had been taken out of Russia from October 2008 through to late January 2009.

An additional $80 billion in capital could flee the country this year, said Russia’s Economy Minister Elvira Nabiullina. The external debt of Russian companies widened drastically from $175 billion to $500 billion in 2008, and interest would have to be paid this year, according to Nabiullina.

Meanwhile, a drastic decline in oil prices has put a kink in the country’s most vital economic lifeline. After hitting a record high of more than $147 a barrel last year, Russia watched the value of its lifeblood dip below $40 a barrel. At one point, crude had lost an astonishing 80% of its value, forcing the government to rethink last year’s budget outlays.

The new 2009 budget estimates that oil will average $41 a barrel, versus $95 a barrel in the original. Government revenue will tumble 39% to $195 billion (6.7 trillion rubles), while spending will rise 7% to $282 billion (9.7 trillion rubles).

However, Minister Kudrin estimates that Russia’s budget deficit may exceed 8% in 2009.

“This may happen if we do not distribute budget spending differently or change the structure,” he said.

Kudrin indicated that the government would be forced to “make a number of tough decisions regarding budget spending,” as the revenue of the federal budget for 2010-2011 would be 33% lower than in 2009, according to his estimation.

And even if the price of oil holds on to the gains it has made in recent weeks, Russia’s gross domestic product is set for a significant contraction.

“GDP will fall, even if oil prices climb not to $41 per barrel, but $44, $50, or $55,” Kudrin said.

In light of the challenges facing the economy, even the 6.6% GDP growth forecast for 2020 is “too optimistic,” he added.

Russia’s economy shrank 7.3% year-over-year in February, a slight improvement from January’s 8.8% decline.

Russia’s MICEX stock index and the ruble have taken their lumps as a result of the economy’s downward trend. But while both the Russia’s currency and stocks have shown some signs of life, unemployment continues to soar and shows no sign of abating.

Russia’s total number of unemployed jumped 20.6% year-over-year in February to over 6.4 million people, or 8.5% of the economically active population, according to the Federal State Statistics Service. That represents a 4.9% increase from January 2009.

The rising level unemployment and bleak outlook for Russia’s economy have stirred rumors of social unrest that have grown increasingly audible, even in the nation’s repressed mainstream media. And some analysts and officials believe the former president and current prime minister Putin could be the scapegoat for Russian oligarchs eager to maintain their influence, as well as Putin’s handpicked successor Dmitry Medvedev

The Growing Putin-Medvedev Rift

Gleb Pavlovsky, a pro-Kremlin political scientist and adviser, said earlier this month that the economic crisis poses a growing threat to both Putin and Medvedev, whom he suggested could also be swept away in an uprising financed by Russia’s oligarchs. Pavlovsky warned of a “remake” of the 1991 street protests that helped bring down the Soviet Union, and the 2004 Orange Revolution in Ukraine.

“The transition of the [economic] crisis into the political arena has already begun happening,” Pavlovsky wrote in Russia’s Moskovski Komsomolets. “The sources of social protest should be sought in the corridors of power.”

With so much at stake, tensions at the Kremlin are beginning to rise and even the 20-year relationship between Putin and Medvedev, his 43-year-old protégé might crumble.

Over the past few months, Medvedev has struck a far less aggressive, less nationalistic tone than the ex-KGB agent. Medvedev has scaled back a bill to expand the definition of treason and resurrected a dormant human rights council. He’s also taken a more lenient stance towards protests and free speech.

On March 15, Russian protestors held a sanctioned, peaceful march in Vladivostok, the very same city where just months earlier they had been beaten and arrested for similar actions. And in his monthly television addresses, Medvedev has also acknowledged that unemployment in Russia is actually closer to 6 million than the 2 million officially reported.

Medevedev is also building his own political powerbase, which consists of mainly of economic liberals – the archrivals of the siloviki, the military security officials grouped around Putin.

The Kremlin announced in February that it was establishing an advisory group to address the current financial crisis. The group, called the “Golden 100″ will eventually grow to 1,000 and ultimately supplant many holdovers from Putin’s administration.

“Medvedev is building his own power base, up to a certain point,” Alexander Khramchikhin, a senior researcher at the Institute for Political and Military Analysis told TIME.

What’s more is that both Medvedev and his team of liberal economists have both in recent weeks ramped up their rhetoric against Putin and his old guard.

Igor Yurgens, director of the Institute of Contemporary Development, a new thinktank created by Medvedev, has criticized Putin for restricting freedom of the press and stressed that “the most honest and independent opinions on Russia’s problems are coming from the liberal wing, rather than from the so-called statist patriots.”

Even Medvedev himself has taken some thinly veiled shots at Putin, saying at a recent meeting with economic officials that criticized Putin’s response to the financial crisis as “unacceptably slow” and said that instead of action on promised reforms there had been only “talking and talking.”

“Medvedev has got the whiff of power in his nose and he likes it,” Mikhail Delyagin, an analyst and former government adviser on economic policy, told the The Guardian. “He’s given tacit approval for his administration to engage in an information war with Putin’s apparatus.”

Critics continue to allege that Medvedev still has nowhere near enough political muscle to take on Russia’s iron politician, but there is also evidence that Medvedev’s popularity is growing and that Putin is past his political peak.

According to a February 2009 national survey, 73% of those polled said they trust Medvedev, a substantial increase from 56% in 2006. Putin continues to enjoy popularity among the public as well, but his political capital seems to be deteriorating along with the economy.

“Putin used to act as an arbiter standing above the two main clans – the siloviki and the rational economists,” Dmitry Oreshkin, a leading political analyst, told the The Guardian. “Now he’s been dragged down into the fight and he’s under fire from both sides. The siloviki say he’s a weakling incapable of imposing his will and showing the economists their place, while the economists in turn are consolidating around Medvedev.”

Putin is also falling out of favor with Russia’s powerful aristocracy. Russia’s top 10 billionaires alone lost an estimated $150 billion last year, according to the The Guardian.

“It is very conspiratorial,” Vladimir Milov, former deputy energy minister and a leader of the Russia’s Solidarnost political group, told the Financial Times.  “But, for the first time, they are putting the question that perhaps Putin should go, to prevent him from pulling everyone else to the bottom.”

How Might Medvedev Pull the Trigger?

If Putin does go, many believe Medvedev will be the one to show him to the door. One of the many policy changes arranged by Medvedev in recent months has been an orchestrated crackdown on political corruption that dates back to May 2008.

Medvedev’s new anti-corruption measures prohibit conflicts of interest, require government officials to report income and property, and further mandate coworkers to report any noncompliance.

Now, analysts are beginning to wonder whether some of these new laws, shepherded through parliament last December by Medvedev himself, will be his weapon of choice in ousting Putin.

According to Foreign Policy, Stanislav Belkovsky, a Russian political analyst and insider, gave sensational interviews in November 2007 to Die Welt and The Guardian, stating that Putin was worth approximately $40 billion. Belkovsky said Putin was the beneficial owner of 37% of Surgutneftegaz OAO ($18 billion), 4.5% of Gazprom OAO (OTC: OGZPY) ($13 billion), and half of a Swiss-based oil-trading company Gunvor ($10 billion), run by a former St. Petersburg KGB agent. If true, Putin would not only be one of the richest people in the world, but one of the most corrupt.

As Foreign Policy points out, it was Putin who, after being transferred temporary presidential responsibilities a decade ago, sealed his fate as a modern-day tsar by granting former-President Boris Yeltsin and his family lifelong immunity from criminal prosecution, administrative sanction, arrest, detention, and interrogation.

Should the economy continue to falter, it’s possible that Medvedev could end up offering Putin the same deal.

Source: With Russia’s Economy in a Deep Freeze, Is Medvedev Gearing Up to Give Putin Das Boot?

Well, I did some digging and found a couple articles that might help explain why…

The BBC reported late Thursday that Russia’s new president, Dmitry Medvedev, is headed to Kazakhstan. It’s his first stop on his first trip as the new president. And what’s first on the agenda? Oil.

K-stan exports most of its oil through Russian pipelines. That means a great deal of revenue for Medvedev and friends. We’ll see if K-stan signs a long-term deal with Russia or not, but you certainly can’t ignore Russia’s influence in the region.

Kazakhstan isn’t the only place Russia’s looking to boost revenue – and influence.

The Russian News and Information Agency, Novosti, announced, “Russian oil and gas companies are interested in developing the Mediterranean region.”

In fact, one Russian company has already bought a 50% stake in the El-Arish offshore concession agreement in Egypt.

Russia wants to consolidate its power over energy resources in Asia, and extend its influence in Western markets, too. I think these announcements are just the beginning, and you’ll start to hear more about investing in the Russian oil and gas industry.

Sara Nunnally

Source: Russia Up in a Sea of Red

Judging by the performance of outgoing President Vladimir Putin, Europe should beware: The so-called “links” he’s seeking may resemble those used to chain together prisoners in the Gulag.

On the other hand – though it’s admittedly unpleasant to say so – there’s a point at which the effects of high oil prices are so great that in the short run they far outweigh one’s distaste for the thuggish Russian regime. And at $123 a barrel, we may be at that point.

Politically, Russia has pretty much reverted to the pre-1991 Soviet system.

Today, just like then, there’s only one real party: The United Russia party, which controls 315 of the 450 seats in the Duma (essentially the lower house of parliament) and whose leader is one Vladimir Vladimirovich Putin. There is considerable censorship of the media, and dissident reporters and editors have a habit of disappearing – not that there are many left now. There is huge emphasis on military power, and on throwing Russia’s weight around in foreign policy.

What’s New About the “New” Russia

However, there are a couple of significant economic differences between today’s Russia and the pre-1991 Soviet Union. One key difference is economic: While the state still controls most of the property today, it doesn’t control all of it, as it did before 1991. Even so, foreign investment in strategic sectors of the Russian economy was effectively banned by a decree of May 5. For this purpose “strategic” covers not only the military sector and energy, but also more than half of Russia’s output.

So, if the afore-mentioned difference is one of substance, this next one is all about style. Prior to 1991, Politburo members were relatively impoverished and notorious for their baggy Soviet suits and lack of fashion sense; these days, the top brass – and especially Putin – are snappy dressers with a nice Italian wardrobe, and bank accounts to match.

Putin’s even viewed as a sex symbol: In a recent No. 1 single in Russia, a female pop star cooed that she needed a new boyfriend and that “Takogo kak Putin” (he must be like Putin), and not a useless wimp like her last beau!

If you analyze the economic impact of Putin’s regime since 2000, you’ll find the result has been huge economic growth – an annual average of nearly 10% since that time with growth of 8.1% in 2007. Now a certain percentage of that was due to the proverbial “dead-cat bounce” as the economy recovered from the debilitated state it had reached by 1998-99. An additional portion reflected the benefit of a Ronald Reaganesque tax reform passed in 2001, which produced a “flat tax” income-tax system with a rate of 13%.

That caused many conservative U.S. commentators to favor the Putin regime in its early years, despite the signs of human rights abuses. However, since the arrest and imprisonment of oil company tycoon Mikhail Khodorkovsky and the looting of his company Yukos, it has become obvious that the nominal rate of income tax doesn’t matter much when the state can – and does – seize anything it wants.

Since at least 2004, Russia’s economic growth has been driven almost entirely by high oil prices. At first, oil production increased along with prices, producing real economic progress. Since Putin’s partial seizure of Royal Dutch Shell PLC (RDS.A, RDS.B) concessions in 2006 and BP PLC (BP) earlier this year, it has become obvious that the Russian state will control all economic activity in the energy sector. As a result, output has now stopped increasing and in this year’s first quarter it actually declined slightly.

I wouldn’t want to be a wealthy entrepreneur in today’s Russia, no matter how many bodyguards I surrounded myself with. At the same time, however, there’s also no question that some of the benefits of economic growth have gone to the Russian people – something that was rarely, if ever, true under the old Soviet system.

Consumer spending rose 12% in 2006 and matched GDP growth of 8% in 2007. With a current account surplus of $74 billion in 2007, foreign exchange reserves of $470 billion and ever-escalating oil prices, Russia’s ruble has been strong, making imports super cheap. Given the lack of high quality goods in Russian stores before 1991, and the impoverishment of the country in the 1990s, this consumer boom is not surprising. But it does mean that there are finally investment opportunities in Russia outside the energy sector, in places where the Russian government’s heavy hand is less evident.

As long as global oil prices remain high, or continue increasing as they have in the past five years, Russian energy companies will make record profits and Russian consumers will enjoy a bonanza, producing profits in consumer sectors also. Once energy prices turn around, Russia is in trouble. However, there is no sign of that yet, and at least in the short term, there’s money to be made from the continued advance in energy prices.

Politically, it’s unclear how much of a difference Medvedev will make, since, after all, Putin will now serve as prime minister (one news report described Medvedev as the “puppet president” of Putin’s).

To be sure, as the former CEO of Gazprom OAO (OTC: OGZPY), Medvedev has at least a basic knowledge of how business works. And it’s likely that he’ll continue to follow Russia’s current “mixed economy” policy, meaning that “strategic” sectors will remain government playthings, while non-strategic sectors such as consumer goods are pretty much left to operate freely – and unharmed. Russia even intends to use its version of a “sovereign wealth fund” to go on a bit of a global buying spree, although it remains to be seen just how aggressive it will be.

Presumably, if Putin had wanted to restore full Soviet Communism he would have chosen someone else; that at least is a consolation.

Cashing in on Russian Capitalism

Does this leave any real plays for U.S. investors? It does, but you must keep in mind that this is a highly speculative market, and that you should be ready to sell if U.S. interest rates are increased. The reason: An upward increase in U.S. interest rates could cause a reversal in energy and commodity prices, which would have a major impact on the Russian economic advance. Here are a few Russian profit plays to consider:

• OAO Gazprom (OTC: OGZPY): This is one of the obvious Russian plays, the state-owned natural gas monopoly with ambitions to control Western Europe’s gas supplies. Since its ambitions don’t yet extend to the U.S. market, it is quoted only on the Pink Sheets. It has a Price/Earnings ratio of 12, based on trailing earnings, but gas prices and Gazprom’s dominance are both rising.
• Lukoil (OTC: LUKOY): The other obvious Russian heavyweight, Lukoil is the largest state-controlled oil company; again, the firm doesn’t care if you buy the stock, meaning it also is only available through the Pink Sheets. This one has a trailing P/E ratio of only 8, and that was based on 2007 earnings when oil prices for the year averaged $80. A good speculative play on a further run-up in oil prices.

Moving outside the oil sector, there are two mobile telephone companies you might look at:

• Vimpel-Communications (VIP): This company has 55 million subscribers and mobile operations in Russia, Kazakhstan, Ukraine, Uzbekistan, Tajikistan, Georgia and Armenia. Right now, it trades at 22 times trailing earnings, but only 13 times forward earnings. It does pay a dividend, but the yield is only 0.9%. I slightly prefer its collection of non-Russian operations to those of MBT (the Russian operator we’ll get to in a moment) – you especially want Kazakhstan, which is oil-rich.
• Mobile TeleSystems OJSC (MBT): This mobile operator has 73 million subscribers and operations in Russia, Ukraine, Uzbekistan and Turkmenistan. It is cheaper than Vimpelcom, trading at only 14 times trailing earnings and 12 times forward earnings, and it has a dividend yield of 2.5%.
• Finally, for a flyer on Russia’s consumer-oriented agribusiness, albeit an expensive one, you might look at Wimm-Bill-Dann Foods OJSC (WBD), which manufactures and sells branded dairy, juice, water and baby-foods products in the Russian market. The shares trade at a pricey 37 times trailing earnings, and the forward P/E of 21 isn’t much of an improvement. The dividend yield is tiny at 0.1%. However, earnings are racing forward as the Russian consumer market opens up to quality branded goods.

Don’t put your retirement savings in the Russian market – Vladimir Putin might get tempted! However, for a modest oil-related flutter, Russia is well worth a look.

Last month, 78 Federal Security Service (FSB) officers raided the Moscow offices of BP and TNK-BP. The raid resulted in the arrest of one TNK-BP employee and his brother, who will both face charges of industrial espionage. Soon after the raid, the Natural Resources ministry said it would check TNK-BP’s largest oil field for environmental violations and the Interior Ministry accused the company of breaking visa rules.

Sources close to the situation, including TNK-BP Chief Executive Robert Dudley, said the raids and subsequent arrest were a “one-off” incident. But many analysts see a more sinister motive behind the crackdown.

Tax claims, corporate malfeasance and government investigations could be just the kind of pressure the Kremlin needs to exert for one of its state-owned oil monopolies – some of which are the most heavily indebted companies in Russia – to acquire a stake in the venture for a relatively cheap price.

TNK-BP is currently co-owned by BP and a group of Russian billionaires. The Russian investors agreed not to sell their combined 50% stake in the company until 2008. But as the agreement nears its end, Gazprom is reportedly encouraging BP’s Russian partners to sell out.

Gazprom, whose chairman, Dmitry Medvedev, will be sworn in as Russian president on May 7, has frequently found itself the beneficiary of government interference in the energy sector.

Two years ago, OAO Yukos Oil Co., formerly one of the world’s largest private oil companies, went out of business after Russia’s Federal Tax Service demanded the payment of $30 billion in back taxes.

Soon after, Royal Dutch Shell PLC (RDS.A) was forced to relinquish control of its Sakhalin-2 oil and gas project to Gazprom for $7.45 billion when the Russian government threatened to block investment plans by canceling building permits on environmental grounds.

And just last year, TNK-BP was talked into selling its 62.8% stake in one of the world’s largest gas fields, the Kovytkta field, to Gazprom, after Russian authorities threatened to revoke the company’s license to develop it.

So it’s perfectly reasonable to believe that TNK-BP, which produces close to a quarter of BP’s total oil and natural gas production, could be Gazprom’s next takeover target. It’s also reasonable to expect that Gazprom may want more than to simply replace the Russian oligarchs as junior partners in the venture.

“We think there is a possibility that BP ends up as a minority shareholder in TNK-BP,” analysts at JP Morgan Chase & Co. (JPM) wrote in a research note.

Just two weeks after the Moscow raid, BP chief Tony Hayward began making a suspicious set of rounds. He met with Gazprom CEO Alexei Miller last Thursday. That meeting was followed by a meeting with Rosneft chairman Igor Sechin, and then another meeting with shareholder Viktor Vekselberg. Vekselberg, along with Mikhail Fridman and Len Blavatnik, is one of TNK-BP’s largest shareholders.

RBK Daily reported earlier this week that Gazprom is seeking a 1% stake in the joint venture from BP, while at the same time buying out TNK-BP’s three Russian shareholders, thereby giving the state monopoly a controlling stake in TNK-BP.

Sources cited by the paper, also said any deal would likely take place after President-elect Medvedev’s inauguration.

“We are all worried there is going to be some political maneuvering in order to relieve BP of the stake,” Colin Morton, a fund manager at Rensburg Fund Management who owns BP shares, recently told Reuters.

Source: http://www.moneymorning.com/2008/04/08/bp-caving-to-kremlin-pressure-over-joint-venture/