Russia,
a promising and exciting
business environment
ABN AMRO Group Public Affairs:
Economics Department:
Sector Research:
Marijke Zewuster, [email protected]
Jan van den Berg, [email protected]
Thijs Pons, [email protected]
Commissioned by:
Sector Advisory NL: Willem Rol
Commercial Client Segment / IDCC: Nico Overwijn
Finalised: September 2007
Russia
Introduction
When evaluating Russia, from whatever perspective, there are usually two
extremes: from very sceptical or even unfavourable to nearly euphoric. From the
perspective of a foreigner who has spent some three and a half very bright and
intense years in the country, I can confirm the saying by the Russian poet Tutchev
that there is no intellectual understanding of Russia, nor can it be measured with a
standard arshin (old Russian measure that equals 0.711 metre). It can indeed be
anything, but never dull. Russia is unique, diverse, challenging, exciting and
promising. I could extend this list of epithets further, but the incontestable facts
about Russia’s current economic situation and its potential, analysed in detail in
this report, speak for themselves.
The fundamentals are very strong. Russia’s GDP growth rate for the last five years
has substantially exceeded that of most industrially developed countries. Growth is
driven by high commodity prices and booming domestic consumer demand.
Favourable prices for commodities, such as oil, gas, gold, nickel and many others
that Russia has in abundance, have created excess cash in both the public and
private sectors and a positive current account balance. Russian currency and gold
reserves – the world’s third-largest – reached historical highs of over USD 420 bn
in mid-September 2007. Inflation is coming down, the rouble is quickly becoming a
currency to be reckoned with and the sovereign rating has increased to well
beyond investment grade level. In summary, the Russian economy has
transformed to become one of the largest (ranking ninth) and most important
economies in the world. And I am convinced that this is only the beginning, given
all the potential (size of the market, availability of high-quality labour, growth
potential, etc.) that is yet to be tapped.
The Russian Government is putting a lot of effort into attracting more investment
into the country and improving the investment climate in general. It has created
investment institutions such as the Investment Fund and the Development Bank to
ensure investments in all sectors of the economy as well as infrastructure projects.
“I want to note that 300 billion rubles [currently about USD12 bn] have been
allocated to these institutions this year alone. Moreover, we have put in place a
mechanism that ensures that these funds will increase each year, but only so long
as they are used effectively”, - stated President Putin during his opening remarks
at the International Investment Forum in Sochi (September 24, 2007). There is a
clear willingness on the part of the government and the business community to
develop a relationship, as long as it is based on mutual interests and benefits.
International business and foreign investors are striving to increase their market
share, strengthen their financial position, broaden their product range, ensure
stability and find the best talent. Russia provides a solid basis for this. It may not
happen overnight, but surely in the somewhat longer term.
The coming year will be an exciting one for the country in general and the
business community in particular, with parliamentary elections scheduled in
December 2007 and presidential elections in early 2008. However, we all
witnessed the local market’s rather limited reaction to the recent and sudden
changes in the Russian Government. The market overall is very focused on
2
Economics Department/Sector Research, September 2007
Russia
business and trusts that the new government will continue the on-going projects,
policies and reforms.
The liquidity crisis in the international financial markets is having a much greater
impact on the Russian business environment. Until now the country has been
enjoying a boom in the capital markets across all sectors, with one of the fastest
growing equity markets in the world (up over 1000% during the “Putin era”), and
stable growth in the fixed income market. Further developments in that area will
greatly depend on overall international market conditions. But of course this by no
means stops many foreign companies from coming to Russia as they see much
greater opportunities here than elsewhere in the world. And bear in mind that of all
the BRIC countries, Russia enjoys the highest percentage of satisfied foreign
investors. Over 80% of foreign businesses indicate that they are generating very
attractive returns on their investments in Russia, a statistic that cannot be matched
by other countries.
Russia should be more and better promoted. I trust this report will give you
valuable insight into the country from which it is sometimes argued that doing
business is, despite its challenges, the best kept secret in the world.
Henk Paardekooper, Country Executive Russia
3
Economics Department/Sector Research, September 2007
Russia
Contents
Introduction......................................................................................2
Chapter 1: Economic Overview .......................................................6
Economic structure and trade....................................................................................... 6
Economic developments .............................................................................................. 9
SWOT analysis ........................................................................................................... 13
Chapter 2: Russia’s Minerals & Mining Industry............................18
The importance of the sector to the Russian economy .............................................. 18
Exploration spending in the global mining sector ....................................................... 19
Growing demand for mining equipment...................................................................... 20
Medium-term outlook.................................................................................................. 20
Opportunities in mining equipment, services and systems......................................... 21
Chapter 3: The Russian Oil Industry .............................................22
Oil reserves ................................................................................................................ 22
Oil production ............................................................................................................. 22
Oil exports .................................................................................................................. 22
Oil production and export outlook ............................................................................... 23
Chapter 4: The Russian Natural Gas Sector .................................25
Natural gas reserves .................................................................................................. 25
Natural gas production ............................................................................................... 25
Natural gas exports .................................................................................................... 26
Natural gas production and export outlook................................................................. 27
The China option ........................................................................................................ 29
Chapter 5: Opportunities in Russian Oil and Gas..........................31
Investment climate...................................................................................................... 31
Resource nationalism increasing................................................................................ 31
High investments needed ........................................................................................... 32
The E&P momentum .................................................................................................. 33
Chapter 6: Agrifood .......................................................................35
Exports from the Netherlands to Russia..................................................................... 35
Dutch companies are investing in Russia................................................................... 37
Chapter 7: “Doing Business is People’s Business” .......................39
1. Campina in Russia: ‘Ask for support from the local authorities’ ‘Establish a good
relationship with the local authorities’ ......................................................................... 39
2. Jørgen de Ree, Managing Director of De Ree Holland BV ‘The Russians are loyal,
reliable customers’...................................................................................................... 41
3. Mammoet in Russia A good business contact is based on friendship................... 43
4. Ottevanger Milling Engineers is successful on the Russian market ....................... 45
5. Gebroeders Van den Berk B.V. ‘With patience and respect, you can do good
business in Russia’..................................................................................................... 47
6. For Econosto, Russia is a top market in the making .............................................. 49
4
Economics Department/Sector Research, September 2007
Russia
5
Economics Department/Sector Research, September 2007
Russia
Chapter 1: Economic Overview
Strong growth and…
After the roaring nineties, which began with the collapse of the Soviet Union in 1991
% GDP
and ended with the rouble crisis in 1998, the start of this century was characterised by
12
a much more stable and prosperous development. The year 1999 was one of
8
adjustment, and since president Putin took power in 2000 the Russian economy has
4
shown an outstanding performance. The period of uninterrupted decline over the first
0
eight years of the transition period were followed by a period of prolonged strong
growth following the rouble crisis. And in fact, the end of this sustained growth is not yet
-4
-8
1995
in sight. The year 2006 was a milestone as it was the first year in which Russia was
1997
1999
2001
2003
2005
able to make up for the large decline in the real value of GDP during the years of
2007
transition prior to the rouble crisis. 1
Source: Thomson Financial
With a population of over 140 million people, a nominal GDP of almost one trillion USD
and rising wealth levels, Russia is not only attractive because of its rich natural
resource base and related industrial investments and services, but has also become an
interesting consumer market with a rising middle class.
…a strong rouble
Although the positive economic developments since 1999 are mostly attributable to
high energy prices and the much improved competitive position due to the sharp fall in
40
the rouble at the end of 1998, sound macroeconomic management also played an
36
important role. Fiscal surpluses became the rule and debt levels were reduced to the
point that the government became a net creditor. The currency started to strengthen
32
and inflation was brought under control. The much improved macroeconomic stability
28
also enhanced the inflow of foreign investment, which rose considerably over recent
24
Jan-05
years. There is, however, a flipside to these strong growth levels and the inflow of
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
foreign capital. The central bank is having a hard time balancing the need to keep
inflation in check and the risk of a strong loss in competitiveness due to the resulting
—— RUB per EUR
RUB per USD
strong currency. A loosening of fiscal policy in the run-up to the parliamentary elections
at the end of 2007 and the presidential elections in March 2008 makes this balancing
Source: Thomson Financial
act even more difficult.
Economic structure and trade
Service sector has become more important
Russia
2006 2007 2008
% changes
GDP
6.7
7.3
6.5
Inflation (average)
9.7
8.2
8.0
The transition from a centrally planned economy towards a more market-oriented
economy has led to far-reaching changes in the country’s economic structure. During
the Soviet era, the focus was on heavy industry which was where most people were
employed, while the service sector was underdeveloped. Already in the first years after
the collapse of the Soviet Union, the economic structure changed dramatically. The
levels
Current account (% GDP)
9.6
5.9
4.9
share of agriculture in GDP fell from 17% in 1990 to 7% in 1995 and continued its
Budget balance (% GDP)
7.4
6.0
2.5
gradual decline in the years thereafter to a current share of 5%. At the same time, the
Government debt (% GDP)
9.0
5.0
5.0
agricultural sector’s productivity declined strongly, as is evident by the fact that while its
Foreign debt (% GDP)
29
28
24
share in GDP has declined, the share in total employment has hardly changed and now
year-end
stands at around 12%, against 13% in 1990. Furthermore, much of the activity in the
Short interest rate (3m)
11.0
10.0
9.0
informal economy likely takes place in the agricultural sector, which implies that even
RUB per USD
26.3
25.3
25.5
RUB per EUR
more people are making a living of farming as the statistics indicate. Estimates for the
34.6
36.7
34.4
informal economy vary between 25% and 40% of GDP.
Forecasts ABN AMRO Economics Department
1 The cumulative decline in GDP in the period from 1991 to 1998 was 52%, while the cumulative growth
in the period 1999 up to 2006 was 54%.
6
Economics Department/Sector Research, September 2007
Russia
The share of industry also showed a declining trend, with the share of industry to GDP
Economic Structure
falling from 48% in 1990 to 38% in 1995, where it still stands. Sixty percent of this
Share of GDP
continues to be heavy industry, the sector is dominated by large industrial enterprises.
Agriculture
These statistics are not completely reliable, however. During the Soviet era, output
figures were more likely overestimated while now, given the fact that tax evasion is
considerable, output figures are likely to be underestimated. Services, on the other
hand, increased its share from 35% of GDP in 1990 to 55% in 1995, and has remained
Industry
Services
around this level ever since. If we look at the other sectors, employment has developed
more in line with the contribution of these sectors to total production. Industry’s share in
employment fell from 42% in 1990 to 30% currently, while services increased its share
Source: EIU
in that period from 42% to 55%.
The oil and gas sector contributes over 50% of industrial output and represents around
25% of GDP, including other oil and gas-related activities. It also generates 65% of
total exports and 35% of state revenues.
Due to the concentration of economic activity in the capital intensive energy sector, the
…real growth agriculture and industry
current government has dedicated various measures to stimulating investments outside
20
the resources-based industries. These measures include special zones, tax incentives,
and export promotion. Meanwhile, the government is concentrating its own influence on
10
what are called the strategic sectors of the economy, of which the oil and gas sector is
0
obviously the most important component.
-10
-20
1996
Strategic sectors
1998
2000
2002
2004
2006
2008
At the start of 2007 the Russian government finally published the long-awaited draft law
—— Industry
Agricutture
on the limitation of foreign investment in the country. The law designates 40 industries
as "strategic" for Russian development. Predictably, the list includes the production of
Source EIU
military equipment, aircraft, spacecraft, ciphering tools, treatment and trade of
radioactive and nuclear materials. This "strategic" status will also be assigned to fields
highly endowed with natural resources, with thresholds of some 70 million tonnes for
oil, 50 billion cubic metres for gas, 50 tonnes for gold and 500,000 tonnes for copper.
The list of strategic industries also includes natural monopolies and arms-related
Savings and investment rate
% GDP
metallurgy. Moreover, the regulation stipulates eight criteria for evaluating any
particular company, which effectively enables any type of production to be classified as
40
"strategic". The regulation sets up a special inter-departmental commission uniting
35
economic and security officials to approve deals involving "strategic" companies. Its
30
permission will be necessary for purchases and other deals related to the controlling
25
shares of strategic companies, even if they do not belong to the state. Foreign states,
20
their subsidiaries or international organisations will have to seek approval for deals
15
10
1993 1995 1997 1999 2001 2003 2005 2007
—— Investment rate
Savings rate
Source: Thomson Financial
above the 25% share threshold, and will be completely prohibited from acquiring
control over "strategic"' companies.
The long list of strategic industries and the provisos for potentially classifying
companies beyond them as strategic, reflects the government’s increasing control over
economic issues. On the other hand, the fact that there is now a policy for considering
foreign involvement could lead to less uncertainty and is hence an improvement over
the earlier non-transparent ad-hoc decisions.
7
Economics Department/Sector Research, September 2007
Russia
EU most important trading partner
Main export markets (2006)
USD bln
% of total
177.2
61
Since the collapse of the Soviet Union, Russia’s imports from non-CIS countries have
35.9
12
grown rapidly, with especially strong growth in trade with the EU. The EU is by far
24.5
8
Russia's main trading partner, accounting for around 50% of its overall trade. Total
USA
8.9
3
exports from Russia to the EU amounted to USD 177 billion in 2006. Of this total,
China
15.7
5
Ukraine
15.0
5
EU-25
o.w Netherlands
Germany
Total
291.3
around 65% involved energy and fuels, making Russia the EU’s single most important
energy supplier. Imports from the EU amount to USD 61 billion. They include
machinery (36%), chemicals (14%), manufactured goods (11%), transport equipment
Source Datastream/IMF direction of trade statistics
(10%), food and live animals (7%). Although the EU is clearly the most important
trading partner, trade with China is quickly increasing in importance. China is now
Russia’s fourth export market and the second most important source of imports. And
Major exports (ITS)
Russia is China’s 10th leading trading partner. For the EU, however, trade with Russia
Agricultural products
6.1%
is less important, given that most trade is of an intra-regional trade. Exports to Russia
Fuels and mining products
67.7%
account for less than 5% of total EU exports, comparable to the share of exports from
Manufactures
23.2%
the EU to China.
Source WTO
Exports to the Netherlands have also grown strongly. In 2006, exports to the
Netherlands accounted for 12.3% of total exports, while this was only 4% in the period
Main import markets (2006)
% of total
61.3
46
we look at the import side, Germany is still number one, with a share of 14% of total
2.7
2
imports. However, China is catching up quickly and has become the second largest
18.4
14
supplier of imported goods, with a share of almost 10%, while the Netherlands doesn’t
6.4
5
even appear in the top 10. However, if we take a closer look at the figures regarding
12.9
10
9.2
7
EU-25
o.w Netherlands
Germany
US
China
Ukraine
Total
from 1995 to 2000. This makes the Netherlands Russia’s largest export destination. If
USD bln
132.5
trade between Russia and the Netherlands, there is a huge gap between the figures
the IMF provides for Russia and those provided by the IMF for the Netherlands.
According to IMF statistics for Russia, the value of imports from the Netherlands is just
Source Datastream/IMFdirection of trade statistics
USD 2.7 billion, representing a share of 2% of total imports. However, if we take the
same statistics for the Netherlands, the value of Dutch exports to Russia amounted to
USD 7 billion. This would mean the Netherlands takes fifth position as a source of
Major imports (ITS)
Agricultural products
Fuels and mining products
Manufactures
imports for Russia. The same discrepancy can be seen if we compare Dutch imports
15.4%
from Russia (USD 21 billion) with exports from Russia to the Netherlands (USD 36
3.9%
billion). According to the IMF, the principal reason for this is related to differences in 1)
80.2%
classification concepts and detail, 2) time of recording, 3) valuation, 4) coverage, and
5) processing errors.
Source WTO
Value of import and export
USD bln
Relations with both EU and US remain difficult
Given the growing importance of trade relations and because they have become
400
neighbours, both the EU and Russia have a shared interest in a stable and prosperous
300
Europe. So far, however, the EU and Russia have not found a way of working together
constructively. In fact, collaboration between Russia, the EU and the US seems to have
200
become even more problematic.
100
EU policy towards the east currently consists of three types of strategy; the
0
1993 1995 1997 1999 2001 2003 2005 2007
—— Import
Source: EIU
Export
enlargement process, the European Neighbourhood policy (ENP) and the Four
Common Spaces with Russia.
Plans to build the four 'common spaces' [in economics, education and research and
internal and external security have made little headway. The EU-Russia summit in
8
Economics Department/Sector Research, September 2007
Russia
Samara on 18 May on a new EU-Russia treaty failed to achieve a breakthrough. The
summit underlined that further delays should be expected to the start of talks on
replacing the partnership and co-operation agreement (PCA) that is due to expire at the
end of 2007.
The failure to reach an agreement has a great deal to do with political tensions and
differing values. Where Russia insists on strategic partnerships among peers, the EU
aims at making the country more responsive to EU standards and values with respect
to issues like democracy and human rights. The EU is also concerned about Russia's
autocratic tendencies, its use of energy resources for political purposes and its bullying
of smaller neighbours, but has so far not been able to formulate a common policy.
Moscow, on the other hand, sees this as unacceptable interference in its domestic
affairs and prefers to work directly with the big member-states like Germany.
The ENP, the vehicle for stronger engagement of the EU with the CIS member
countries, is also a source of tension between the EU and Russia. This is especially
true for the relations with Georgia, Ukraine, Azerbaijan and Moldova – the so-called
GUAM countries – which seek a closer connection with the EU but are seen by Russia
as the “near abroad”. Furthermore, although many former CIS countries would like to
be absolutely independent from Russia, they are not prepared to lose the economic
benefits, such as cheap gas, which they continue to enjoy. This has resulted in the “gas
wars” with Ukraine, Georgia and Belarus, for example. On the one hand, the EU
supports the more independent position of these countries while on the other, it is
concerned about the security of its own oil and gas supplies. Energy is hence one of
the most pressing topics for discussion between the EU and Russia.
Strong economic differences also play a role in explaining the difficulties in achieving
economic and political cooperation. Despite Russia’s current strong economic
performance, the EU is still far larger than Russia in terms of economic size, population
and wealth.
In fact for Russia, even trade with the EU is much more important as a share of total
trade than it is for the EU. Nevertheless, now that its economic situation has improved
on the back of high oil prices, Russia's international political interest has become
increasingly geared towards renewing its status as a world power, which doesn’t make
cooperation any easier.
In addition, the forthcoming Duma elections (December 2007) and presidential
elections (March 2008) cast further uncertainty on future relations, as is evidenced by
the increased rhetoric from Moscow concerning both the EU and the US. Examples are
the strong negative statements from Moscow regarding the US ambition to implement a
military missile defence shield in Poland and the Czech Republic, and its reaction to
Different in size
US
the request by the UK to extradite the main suspect sought by the UK in the Litvinenko
EU-25
Russia
murder case. Given all this, we therefore expect that relations between Russia, the EU
and the US will remain wobbly in the coming years.
Nominal GDP
(USD bln)
Population (mln)
GDP per capita (PPP)
13247
14550
985
299
490
142
44244
28420
12162
Economic developments
Domestic demand will remain the sole driver behind economic growth, while the
Source EIU
contribution of the external sector will become increasingly negative. A looser fiscal
stance in the run-up to the presidential elections in March 2008 will further add to
9
Economics Department/Sector Research, September 2007
Russia
growth. Higher import demand will only partly offset the increase in domestic demand.
GDP per capita at PPP
We therefore predict that although the high growth level of 7.8% seen in the first half of
14000
2007 might not be sustained, growth for the full year will remain robust at 7.3%, up from
12000
6.7% in 2006. In 2008 we expect growth to remain strong, albeit slightly lower, at
10000
around 6.5%.
8000
6000
2000-2006, years of rising prosperity
4000
1991
1995
1999
2003
2007
The strong growth performance over the last eight years has resulted in an even
stronger increase in per-capita GDP. Measured at purchasing power parity, per-capita
Source: EIU
GDP fell from USD 8,400 in 1991 to a low of 5,800 in 1998 and has since risen to over
12,000.
Driven by domestic demand, the economy grew by an average of 6.7% per year
between 2000 and 2006. Consumer demand is fuelled by a strong increase in
disposable income. Real wages have increased by more than 10% a year since
president Putin came to power. This has given rise to a consumption boom and a rapid
growth in the retail sector. Private consumption grew by 9.5% annually between 2000
and 2006. Investments accelerated by no less than 12.6% per year. The growth in
domestic spending drove up import demand by over 20% a year, while export demand
Growth of real disposable income
jumped by an average of just 9% per year. Despite the strong growth in the value of
%
imports, the current account remained in surplus thanks to the high oil prices.
15
10
Windfall oil revenues were channelled into a stabilisation fund, which was used in 2005
5
to repay the IMF obligations and the former Soviet debt to the Paris Club (the club of
0
debtor nations). Despite the debt repayments, the fund now has a balance of over USD
-5
100 billion. The Stabilisation Fund was also an important tool of macroeconomic policy,
-10
-15
1996
as it helped prevent an even stronger appreciation of the rouble and kept the economy
1998
2000
2002
2004
2006
2008
Source: EIU
from overheating.
Recent developments 2006-2007
Gross investments, which dipped below 10% growth in 2005, bounced back strongly in
2006. In the first quarter of this year, gross fixed capital formation was up 19.8% yoy,
compared to 17.4% in the last quarter of 2006 and just 5.7% in the first quarter of last
year. Including inventories, the rise was even more impressive, amounting to 34.2% in
the first quarter, against 19.7% in the last quarter of 2006 and 4% in the first quarter of
2006. Foreign direct investment increased by USD 16 bn to a total of USD 81 bn. This
Government debt
contradicts fears that investment would suffer from the government’s renationalisation
% GDP
140
120
100
80
60
40
20
0
1995
efforts and a worsening political climate. The bulk of investments, both domestic and
foreign, is directed to the energy sector, construction, transportation and services.
Foreign direct investment is also increasingly directed towards the financial sector.
Private consumer demand also remained robust, growing 10.9% in 2006. Private
consumption growth accelerated during the second half of last year to 12.6% in the
final quarter of 2006, slowing slightly in the first quarter of 2007 to 11.9%. Domestic
1998
2001
Source: EIU/Economics Department
2004
2007
demand is not only stimulated by the continuing increase in real disposable income but
also by increased access to consumer credit. Overall credit rose 46% in 2006. Loans to
individuals were up 75% during that year, while credit to the corporate sector increased
by 39%.
10
Economics Department/Sector Research, September 2007
Russia
Industrial production growth
Booming consumption market
% yoy
Table: Top 20 of private consumption expenditure, at current market prices in billion US dollar
ranked by 2008
15
10
5
0
-5
-10
1996
1998
2000
2002
2004
2006
2008
Source: EIU
Real import and export growth
% yoy
Country
2000
2001
2002
2003
2004
2005
2006
2007
2008
UNITED STATES
6739
7055
7351
7704
8211
8742
9271
9640
10087
JAPAN
2624
2340
2259
2431
2629
2600
2495
2814
3102
GERMANY
1924
1122
1127
1194
1451
1621
1644
1684
1878
UNITED KINGDOM
944
946
1035
1183
1394
1439
1520
1689
1731
FRANCE
743
751
819
1019
1166
1213
1279
1439
1483
CHINA
554
595
635
687
771
865
988
1146
1294
ITALY
656
657
715
888
1007
1032
1075
1193
1226
SPAIN
347
360
402
510
605
652
713
815
847
CANADA
401
401
418
490
553
627
709
719
758
RUSSIAN FEDERATION
120
151
177
218
289
367
476
594
688
1
2
3
4
5
6
7
8
9
10
11
12
INDIA
296
308
318
371
419
474
536
601
666
MEXICO
389
433
448
439
465
525
570
596
613
KOREA, REP. OF
276
266
305
327
351
415
474
530
592
13
BRAZIL
366
309
267
287
333
442
533
563
585
14
15
16
17
18
19
20
AUSTRALIA
228
218
244
308
374
407
421
428
418
NETHERLANDS
185
201
220
270
300
308
321
362
371
TURKEY
143
105
122
160
200
245
265
281
295
INDONESIA
102
101
132
160
171
184
229
253
276
TAIWAN
195
181
181
183
198
215
220
236
259
SWITZERLAND
148
151
166
195
216
221
224
250
258
Total top 20
16579
16656
17408
19280
21274
22617
24002
26028
27471
Total World
19279
19374
20145
22437
24903
26652
28448
31056
32824
86
86
86
86
85
85
84
84
84
as % of total world
40
place
source EIU
20
Not only has private consumption shown remarkable increases in recent years
0
compared to the pre-Putin era, but is also impressive when compared to other
-20
countries. This is illustrated in the table above, showing the nominal amount of national
-40
1991
income spent on private consumption from 2000 to 2008. These countries rank as the
1995
1999
—— Export
Source: EIU
2003
Import
2007
top 20 in 2008 and, over the years, have represented around 85% of total global
private consumption expenditure. Given current growth prospects, Russia is expected
to move from 19th place in 2000 to 10th in 2008, outranking countries like India,
Mexico, South Korea and Brazil. This will make Russia an increasingly attractive
market for both retail and other consumer-related activities.
Construction and manufacturing show strongest growth
Looking at the supply side, it is the construction and retail sectors that showed the
strongest growth. In the second quarter of this year, growth in the construction sector
was 22% yoy. Overall GDP grew by 7.8% yoy in the second quarter, just below the
7.9% growth level recorded in the first quarter. Other sectors registering growth above
the GDP average are trade, financial activities, real estate and transport and
communication. The state administration sub-sector also showed remarkable Q2
growth at 8.1%. This merely reflects sharp increases in public sector salaries in the
run-up to the elections. Growth in the manufacturing sector was below average at 6.2%
following a very strong performance of 11.8% in the first quarter. Resource extraction
remains sluggish due to a lack of investment in new fields and infrastructure. The
sector grew by just 1.4% in the second quarter, after recording a lacklustre 2.4%
growth in the first quarter. Another sector which continues to underperform is the
agriculture sector, which grew 2.6% in the second quarter and 2.9% in the first quarter.
11
Economics Department/Sector Research, September 2007
Russia
The construction and retail sectors are expected to continue to outperform due to
Current account
further increases in overall wealth levels. The manufacturing sector might slow down
% GDP
furhter over the coming period, as the sector will eventually be negatively impacted by
25
the loss in competitiveness caused by the continuous strengthening of the rouble. This
20
will particularly affect those areas of manufacturing that are oriented to the export
15
market or compete on the domestic market with imported goods.
10
5
Current account surplus will diminish
0
1993
1997
2001
Trade balance
2005
Current account
Despite strong import growth and a slight decline in oil prices in the second half of last
year, the current account surplus rose further in 2006 to USD 94.5 billion, compared
with USD 83.3 billion in 2005. For 2007 we expect a small decline in the nominal value
Source: EIU/Economics Department
of the surplus as imports continue to swell. This trend will continue in the coming years,
but we do not foresee a current account deficit, at least up until 2010.
Strong inflows of foreign capital will more than compensate for the lower current
account surplus and foreign reserves will hence continue to swell. Figures for the first
half of 2007 indicate that foreign capital continues to pour into the country. To a large
extent, this is related to foreign borrowing by Russian corporates, but foreign direct
Real effective exchange rate against USD
1997=100
2007 compared to the year-earlier period. FDI inflows amounted to USD 16 billion2,
bringing the total amount of FDI to USD 81 billion. The Netherlands is the most
120
important source of direct foreign investment with over USD 30 billion invested in
100
Russia. Most of this is invested in the extraction industries. Cyprus, which is the major
offshore banking centre for Russian corporates, is the second largest source of FDI.
80
60
40
1995
investments are also surging. Total FDI inflows more than doubled in the first half of
Rouble remains strong and inflation subdued
1998
2001
2004
2007
The net capital inflow has led to a continuous strengthening of the rouble, which had a
dampening effect on inflation, despite strong consumer demand. In March 2006,
Source: EIU
inflation fell below 10% for the first time since the start of the rouble crisis in August
1998. Inflation ended 2006 at 9%, precisely at the upper end of the central bank’s
target. It fell to a low of 7.4% in March, but has since risen above 8%. We expect
inflation to end 2007 around 8.5%, above the official inflation target, which is set
Inflation
between 6.5-8.0%. Interest rates were lowered by 50 basis points in mid-June to 10%,
% yoy
but there is little room for further cuts.
150
125
In July 2006, the rouble became fully convertible, meaning that the remaining
100
restrictions on capital account transactions were removed. As the balance of payments
75
(current account plus capital balance) will remain in surplus, there will be continuous
50
upward pressure on the exchange rate. Therefore, the central bank needs to continue
25
0
1995
Source: EIU
maintaining a balance between efforts to reach its inflation target and heeding political
1998
2001
2004
2007
pressure to keep appreciation of the currency in check. Clearly this is a difficult
balancing act. Raising interest rates to stem inflation will only lead to more capital
inflow and hence probably to even stronger upward pressure on the currency. The
appreciation of the currency itself also attracts additional capital inflows and could thus
lead to further appreciation. Another option is to further increase its reserve
requirements as a loosening of fiscal policy in the run-up to elections makes it even
more difficult for the central bank to achieve its inflationary targets. The one thing that
2 According to figures from RosStat
12
Economics Department/Sector Research, September 2007
Russia
could exert downward pressure on the currency could be political uncertainty in the
period surrounding the coming elections. However, the chances that this will lead to
strong and prolonged currency volatility are small given the country’s huge international
Short term interest rate
reserves and substantial current account surplus.
year-end
70
60
50
40
30
20
10
0
1996
Source: EIU
Elections could pose some risks to our positive outlook
Uncertainty about Russia’s political outlook after President Putin steps down at the end
of his second term in 2008 represents a major threat to our forecast for the coming two
years. Infighting among rival factions in the Kremlin that are competing for influence
could give rise to political turbulence, and might even trigger some capital flight.
1999
2002
2005
2008
However, the most probable scenario, given Putin’s formidable power base and his
tremendous popularity, is that whoever he appoints will win the elections and carry on
his policies. Although it is unclear whether this new president will be able to maintain
the same powerbase as Putin, the very favourable current economic developments –
particularly the extremely favourable external liquidity position – strongly mitigate the
political risks. Therefore, as long as the oil price continues to prop up the economy and
create growing prosperity among broader sections of the population, the current power
base in the Kremlin is unlikely to be seriously threatened.
The more relevant vulnerability, in our view, is therefore the fact that the government is
using its oil wealth to avoid painful reforms and to expand its presence in the economy.
Given the inefficiency of state-owned firms, this could constitute a long-term structural
constraint on growth. Further, because both the institutions and the legal framework are
very weak, many approved reforms are not being implemented. This, together with high
and increasing levels of corruption, could become a serious constraint to further
investments.
SWOT analysis
Though Russia is an extremely attractive market for investors, it is also fraught with
pitfalls. The most common problems concern the complexity of the tax system,
corruption, regulatory volatility, the lack of regulatory transparency, government
bureaucracy, weak contract legislation, the absence of a commercial market and
business ethos as well as the absence of a commercial law system. This means that
deals must often be made on the basis of trust. Investors also frequently encounter
financing difficulties and have problems obtaining payment from Russian companies3.
Despite these problems, businesses and investors are increasingly finding their way to
Russia. Western exports to and investments in Russia are steadily rising. Every day,
new products and services are launched in the Russian market. The most important
reason for this is the tremendous scope for entrepreneurship in this country.
In the table below we have summarised the most important strengths and weaknesses
as well as the respective opportunities and threats these may give rise to. As the
economic strengths have already been addressed in our outline on the current
economic situation and prospects, we will only very briefly summarise the strengths
and emphasise the risks to our overall very benign picture of the Russian economy.
3 The Institute of Direct Investments Foundation has been set up by the Russian government to assist
investors in Russia.
13
Economics Department/Sector Research, September 2007
Russia
Table : SWOT analyses of Russia
Strength:
Weakness:
rich resource base
fragile political situation
growing wealth
state interventionism
large domestic market
weak institutions and corruption
sound economic policy
demographics, infrastructure,
Low sovereign debt levels
Sound external liquidity situation
education, and health
low degree of diversification
Opportunity:
Threat:
deepening of financial markets
losing competitiveness
diversification of the economic base
Lower oil prices
development of SME sector
shrinking population
to improve transparency and corporate
governance
Source: ABN AMRO
Strengths
Russia’s current strength is related to the fact that its rich resource base and
favourable commodity prices – in combination with sound economic policies – have
enabled the country to lower its sovereign debt to less than 10% of GDP and
dramatically improve the external liquidity situation. This makes the country much less
vulnerable to adverse internal or external developments. Although we expect that both
the fiscal and the current account surplus will diminish rapidly in the coming years, the
low levels of government debt and huge international reserves will cushion the
economy for a long time from a possible change in investor sentiment. The oil boom
has also led to a strong increase in wealth, which, given the size of the population, also
makes Russia very attractive as a retail market.
Weaknesses
Fragile political situation
The country’s present political stability has, in part, been achieved at the expense of
progress in democratic development, which could in turn set the stage for longer-term
instability. The biggest short-term threat to the benign risk environment is related to the
question of what will happen after president Putin's second term ends in 2008. The
concentration and centralisation of power in the hands of the president could result in
instability in the longer run, regardless of who wins the elections. This is even more
likely if the relationship between politicians and the private corporate sector further
deteriorates as this could hamper future investment growth. This scenario could also
have a strong negative impact on the allocation of scarce resources, impeding healthy
economic development and leading to strong inefficiencies. But as we stated
previously, as long as oil prices stay high and the economy continues to grow, the
political risks are strongly mitigated. Another risk related to the concentration of power
among only a few individuals is that the sudden death of the president could have a
strong negative impact, especially if it leads to political infighting among different
factions in the Duma and the country’s different regions, which now are firmly under
state control. These risks range from increased fiscal instability in the regions to a rise
in terrorist activities.
14
Economics Department/Sector Research, September 2007
Russia
State interventionism
In the long run, the increasing discretionary role of the state in society and the economy
has several distortionary impacts. Inefficiencies in state-controlled sectors are likely to
grow and corruption will rise. In addition, private business that is no longer supported
by the government could suffer strongly.
Weak political, legal, and economic institutions
There has been rapid legislative reform since the election of President Putin, but
enforcement is still a major problem due to weak institutions and a weak legal
framework. This is also true for the intellectual property legislation that was passed in
2002 as Russia makes its bid to join the WTO. The lack of enforcement severely
hinders the investment climate, which is also negatively impacted by the high and rising
corruption levels. Russia currently ranks 121 out of 158 countries in the Transparency
International Corruption index 2006.
Demographics, education, health, housing and infrastructure
Years of underinvestment have resulted in a dilapidated infrastructure and inadequate
education and health system. Decent, affordable housing remains an important issue
as well, as it hampers the movement of labour from the agricultural sector to more
productive sectors of the economy. Government investments are still clearly
insufficient, and increased spending in these areas is urgently needed in order to
maintain a strong human capital base. This should diminish the risks related to the
negative demographic trend of a rapidly declining, and rapidly aging, population.
Now that the foreign sovereign debt levels have declined to the extent that Russia has
become a net creditor, it could be argued that part of the stabilisation fund could be
used for such government investments. This would help further bolster political stability.
Russia’s poor infrastructure is a major impediment to trade. Several major projects are
being carried out to improve its infrastructure with financial support from the World
Bank and the European Bank for Reconstruction and Development (EBRD). The aim is
to upgrade the road network as well as modernise the ports and airports.
Only 9 per cent of the total freight volume is transported by road, as most of the
reasonably good roads are located in the European part of Russia and only in the
proximity of its larger cities. In the rest of the country, the road network is less
developed. Nearly 40 per cent of the villages have no access via paved roads. The rail
network is also in very poor technical condition, while the numerous ports and
waterways are often poorly located or lack facilities for the transshipment of large
volumes of goods4.
Opportunities
Deepening of financial markets
The financial sector is developing rapidly. The market for consumer credit and
mortgages as well as the rise of the corporate bond market are particularly
encouraging. The reduction in borrowing costs was very helpful in enhancing credit
growth as were improvements in the regulation of the banking sector in recent years
and the introduction of deposit insurance. Nevertheless, the sector is still far from
4 For example a large portion of agri-food products destined for West Russia is transported via ports in
Western Europe or the Baltic states because the ports in Russia lack the required facilities.
15
Economics Department/Sector Research, September 2007
Russia
offering the full range of modern instruments needed to support a dynamic corporate
sector. The Russian banking sector also remains relatively small, weak, and
segmented. Given continued scarcity of skilled bank personnel and substantial nontransparency with respect to the operation and ownership of domestic corporations,
there is inadequate means to assess the creditworthiness of clients. This increases the
share of bad loans. There is no legislation to protect the banks against delinquent
customers. Meanwhile, the public—the potential customers—still distrust banks, but
instead prefer to keep their savings in cash. This hampers the proper working of
financial intermediation in the economy.
Development of the sector would clearly further enhance the economy’s growth
prospects. The development could be facilitated by eliminating inconsistencies among
different laws and codes, and clarifying responsibilities among the various agencies
charged with overseeing the sector.
Diversify the economic base
To further broaden the base of economic development it is important to stimulate
investments in other sectors as well as development of the SME sector. The latter is
especially important, as a well-developed SME sector increases competition and is an
important source of jobs and a generator of innovations. This would also be a better
stimulus for achieving the government’s aim of stimulating innovation than the current
trend towards more centralisation.
Improve transparency and corporate governance
More and more Russian companies are listed abroad. Although there are no
guarantees, this will very likely expose Russia more to "international" standards
(including increasing transparency and corporate governance) and will create a certain
integration between Russian and Western(-European) Financial Markets.
Threats
Sharp fall in world oil prices
A sharp drop in world market oil prices would severely slow the pace of the Russian
economy’s expansion and increase all other risks. But as long as oil prices remain high
and above USD 40 a barrel, most short and medium-term risks remain limited.
Dutch disease development
A sharp fall in the oil price is not the only risk; high oil prices also pose a threat to
sound future economic development. Oil dependence makes the country vulnerable
and creates uneven development. During the Soviet era the economy was relatively
well diversified. But since the fall of the centrally planned communist system, import
demand has started to rise at the expense of domestic production. This process
accelerated when the oil boom began. Russia’s strong currency has worsened its
competitive position, which was greatly enhanced by the mega rouble devaluation in
1998. As a consequence, diversification has diminished at the expense of the energy
sector. So far, the shift in concentration of economic activity out of the labour-intensive
manufacturing sector into the capital-intensive oil and gas sector has largely been
compensated by strong employment growth in the services sector and construction, but
this could come to an end when the country’s development reaches a more mature
stage.
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Economics Department/Sector Research, September 2007
Russia
Demographics
The Russian population is dwindling and – due to low birth rates in the late Soviet and
transition eras – is rapidly aging as well. This could lead to labour shortages and
pension problems. In addition to this negative demographic trend, the technological
basis of higher education has been depleted since the fall of the Soviet Union, resulting
in a lack of good technically skilled employees.
17
Economics Department/Sector Research, September 2007
Russia
Chapter 2: Russia’s Minerals & Mining Industry
This chapter describes Russia’s non-fuel mining industry, i.e. excluding coal, oil,
natural gas and uranium mining. Oil and natural gas will be discussed in the next
chapters.
The importance of the sector to the Russian economy
The non-fuel mining industry (including the further processing of ores) is of vital
importance to Russia’s economy. Russia has a long mining tradition and is currently
one of the world’s leading producers and exporters of minerals and mineral-based
products. Blessed with vast resources, the country is a major producer of aluminium,
cobalt, copper, diamonds, gold, iron ore, mica, nickel, platinum, potash, tin, titanium
and zinc. In addition, many other metals and various industrial minerals are mined. The
country’s most important regions for metals mining are East Siberia, the Kola
Peninsula, the North Caucasus, the Russian Far East and the Urals. Mining conditions
in some of these regions are harsh.
Following the collapse of the Soviet Union in 1991, it became clear that the Russian
mining industry – which is almost exclusively state-owned – was in a poor state due to
years of underinvestment and lack of maintenance. Low labour productivity, high
energy use and, at times, low product quality resulted in decreasing competitiveness in
the world market. The transition from a centrally planned economy to a free market
system in the early 1990s affected domestic demand for many basic metals and
industrial minerals. By 1998, Russia’s industrial production had fallen to 45% of its level
in 1990. One positive effect of the slump in domestic demand was that substantial
volumes became available for export, resulting in a rapid increase in the export of
minerals and metals.
The sector’s poor performance and the free market economy caused the collapse of
several large state mining companies, while private mining companies began to
emerge. Meanwhile, small mining and metals companies closed down or merged,
thereby creating larger and financially stronger companies. This reconstruction was
necessary in order to survive against a backdrop of lower global commodity prices at
the end of the 1990s and the 60% depreciation of the Rouble in 1998. However, the
resulting capacity rationalisation was a major positive effect of the turmoil hitting the
industry. The transition of the Russian mining industry also brought about major job
losses and many miners left their regions to find work elsewhere.
Privatisation was used to bring in Western know-how, technology and the muchneeded foreign capital to upgrade the industry. However, many Western companies
were still reluctant to invest in the Russian mining sector as a result of its negative
image due to the unreliable legal system, problems with subsoil licensing, doubtful
reserve classification and high federal and local taxes. Although some of the problems
were overstated by the media, the Russian Government has recognised the need to
improve foreign investment conditions and bring legislation up to world standards.
18
Economics Department/Sector Research, September 2007
Russia
Worldwide nonferrous exploration spending
Exploration spending in the global mining sector
USD bln, 1994-2006
Exploration is the key element in unlocking new reserves and increasing a mining
8
company’s reserve base. Data from the Metals Economics Group (MEG)5 show that,
after the peak in 1997, global exploration spending in the non-ferrous mining sector
6
started to decline. The reasons for this decline were the low price environment and
falling investor confidence in the mining sector. As a result, less capital was available
4
for the mining sector while the more promising dot.com sector attracted huge capital
2
flows. At the turn of the century, the combined market value of quoted mining and
metals companies (representing real ‘bricks and mortar’) is said to have fallen to only
0
about half the value of Microsoft.
1995
2000
2005
After bottoming out in 2002, global exploration spending began to boom once again
Source: Metals Economics Group
from 2004. This type of boom-to-bust cycle is typical for the mining sector. Key drivers
for the sector are global economic growth and, in particular, demand growth in the
manufacturing, construction and infrastructure sectors. The current boom is based on a
combination of:
•
years of underinvestment since the Asian crisis in 1998;
•
lagging reserve replacement, a key issue for the mining industry;
•
surging demand, particularly from the emerging economies of India and China.
Metals and minerals consumption per capita in India, China and other developing
countries is still low compared to consumption levels in developed countries. This
implies that there is considerable scope for sustained high demand growth over the
medium term as long as economic growth in these countries remains relatively high.
Total global exploration spending was estimated at USD 7.13 billion in 2006, up by
Distribution of worldwide exploration budgets
in 2006, USD 7.13 billion
USD 2.2 billion (45%) from 2005. Although gold and diamond exploration spending still
represents a major part of total spending, most of the increase can be attributed to
base metals exploration spending. Canada, Australia and the US traditionally head the
Others
Canada
Since 2004, Russia has quickly moved up the top ten list, jumping from seventh place
Australia
China
Mongolia
Brazil
South
Peru
Africa
Source: Metals Economics Group
list of top ten countries, together accounting for 38% of total global exploration budgets.
United
States
Mexico
Russia
in 2005 to its current fourth place spot. In 2006, Russia accounted for 5% of global
exploration spending.
Expansions are usually the preferred method of reserve replacement over grassroots
discoveries. A major reason for this is that grassroots projects take an average of 7-10
years from initial discovery to production. According to MEG’s survey, there is currently
a clear trend towards late-stage/feasibility exploration budgets, which outpace the
increases in grassroots projects. In the present price environment, with most metals at
15 to 20-year highs, several dormant, abandoned or technically difficult projects are
now being re-assessed for near-term development.
5 The 2006 data collected by MEG are based on an analysis of 1,624 international nonferrous mining
companies with exploration budgets of at least USD 100,000.
MEG is a world leader in mining industry intelligence and a provider of information and analysis on global
nonferrous metals exploration, development and production. MEG’s data are widely used by the mining
industry and by governments to analyse trends and formulate policies.
19
Economics Department/Sector Research, September 2007
Russia
The data collected by MEG show that over the past few years the so called ‘junior
exploration companies’6 have significantly outpaced larger mining companies in
exploration spending growth. Although this can partially be explained by the focus of
junior exploration companies on gold mining, they are also looking for opportunities in
other commodities. In 2006, the junior exploration companies accounted for about 50%
of total global exploration spending.
It is becoming increasingly difficult to find economically viable metal ore and mineral
deposits as most of the ‘low-hanging fruit’ has already been discovered and developed.
Therefore, it will take considerably more capex to discover, explore and develop new
grassroots deposits than in the past, particularly when local infrastructure is lacking. As
a result, the expansion of supply will continue to struggle to keep pace with the
expected continuing growth in demand.
Growing demand for mining equipment
Acute shortages constrain the equipment
supply side
Item
MEG’s survey of exploration budgets indicates a sustainable revival of the global
mining industry. However, one should realize that a substantial part of the increase in
Normal delivery
Current delivery
exploration spending over the past few years can be attributed to cost inflation. Since
time (months)
time (months)
the trough in 2002, there have been significant cost increases in wages, services and
Grinding mills
20
44
mining equipment. Therefore, the amount of real capital invested in 2006 may be much
Draglines
18
36
smaller than the survey indicates.
Barges
24
32
Locomotives
12
26
Power generation
12
24
Wagons
12
24
The Freedonia Group, global demand for specialised mining machinery and equipment
9
24
is forecast to increase 9.3% per year through 2009 to USD 27.5 billion. Freedonia
Reclaimers
18
24
expects Eastern Europe to offer the best regional prospects due to the long period of
Tyres
0-6
24
underinvestment and the region’s extensive mineral resources.
Large haul trucks
0-6
24
Crushers
15
24
8
22
Rope shovels
Ship Loaders
The revival of the exploration market and the development of new deposits will be key
drivers for mining and processing equipment market. According to a recent study7 by
Despite the recent turnaround in the fortunes of the global mining industry, the sector
still faces many challenges. Considerable equipment cost inflation and the lack of
Source: Rio Tinto, Outlook for Metals and Minerals
human resources are not the only problems hindering production and capacity growth.
Some projects are encountering environmental oppositions, technical problems or cost
overruns. In addition, the availability of equipment is currently causing stress in the
mining sector, leading to project delays.
Medium-term outlook
The medium-term outlook for Russia’s minerals and mining industry looks rather
promising, considering the global supply/demand trends. The industry has profited from
increasing global demand and rising prices since 2002, which has stimulated increased
production.
6 Junior exploration/mining companies are small to medium-sized companies involved in early-stage
mining projects. Their exploration expenditures vary from USD 50,000 to 1,000,000. Because they have
no cash flow (i.e. no income from an operating mine) and their assets consist of exploration properties,
their capital needs cannot be satisfied through normal financing channels. The capital for mineral
properties, exploration, plant and equipment is raised through the issuing of shares. Investors consider
junior mining companies ‘high-risk/high-reward plays’. Many are listed on the Canadian TSX Venture
(TSX-V) Exchange or London’s Alternative Investment Market (AIM).
7 World Mining Equipment, World Industry Study with Forecasts to 2009 & 2014. The Freedonia Group,
Inc., April 2006.
20
Economics Department/Sector Research, September 2007
Russia
Like many of their competitors elsewhere, Russian companies are also being
confronted with the depletion of their high-grade ore deposits. They will have to
develop new deposits in order to meet both increasing indigenous demand from the
manufacturing sector and from exports.
The potential for mineral exploration in Russia has been recognised by several large
Western companies, such as Anglo American, AngloGold Ashanti, BHP Billiton and Rio
Tinto. In recent years, several alliances and joint ventures have been announced with
Russian companies to explore and develop attractive mineral deposits. Most of these
joint ventures will develop greenfield mineral deposits in certain areas, such as western
Siberia and the north-western part of Russia. Junior exploration companies are also
likely to play a role in the development of these deposits. The successful development
of a deposit could make these junior mining companies more attractive for acquisition
by larger (‘senior’) mining companies, as this increases their reserves and production
base.
Opportunities in mining equipment, services and systems
Despite its production potential, the Russian minerals and mining sector still faces
major problems, such as ageing equipment. In 2000, about 80% of Russia’s mining
machinery was near the end of its operable life and in need of urgent replacement.
Although there have been some improvements since, many mining companies are still
using outdated technologies from the Soviet era. According to estimates, 30-70% of
Russia’s minerals reserves are not economically exploitable. Major investments will be
needed to reach Western standards of product quality, pollution control, energy use per
unit of output and labour productivity. Moreover, new mineral deposits will have to be
developed to meet the ever-increasing demand and compensate for the depletion of
existing deposits.
Vast investments will therefore be required in the coming decade, offering significant
opportunities for Western companies involved in exploration and development, and for
suppliers of control systems, logistics, mining technology or mining equipment.
Medium-sized companies will be particularly interested in optimising mining and plant
operations through advanced process control systems, and minimising the idle time of
mining equipment through better coordination with the transport system. Even large
mining companies tend to contract specialised companies for services that require
certain expertise.
Automation of mining equipment is also an important issue in modern mining
operations, particularly in underground mining. Automation considerably improves both
productivity and safety. Some Russian mining companies have poor safety and
environmental records, and automation could surely help them improve safety, health
and environmental (SHE) conditions. A consistently good SHE performance is
increasingly becoming a prerequisite to sell to Western customers.
21
Economics Department/Sector Research, September 2007
Russia
Regional distribution of proved oil reserves
at year-end 2006, 1,208 bln bbl
North
America Iran
Chapter 3: The Russian Oil Industry
Saudi
Arabia
Oil reserves
Other
Europe
Russia’s proved oil reserves amounted to about 79.5 billion barrels as at year-end
Russia
2006, accounting for 6.6% of the world’s total proved reserves (BP estimate). Most of
Africa
Asia
Pacific
these oil reserves are located in four oil provinces: Western Siberia, Volga-Ural, Timan-
Other
Middle
East
S&C
America
Pechora and Northern Caucasus. In addition, the country has roughly the same level of
probable and possible oil reserves, putting this non-OPEC country in the top league of
oil-producing nations that includes OPEC members like Saudi Arabia, Iran, the UAE
Source: BP Statistical Review of World Energy June 2007
Regional distribution of oil production in 2006
and Venezuela. According to BP, Russia’s R/P ratio was 22.3 at year-end 2006, i.e. its
proved reserves can sustain its 2006 production level of 9.77 million bpd for 22.3 years.
81.66 mln bpd
S&C
America
Asia
Pacific
Saudi
Arabia
Oil production
Iran
In the 1980s, the Soviet Union became a major world oil producer due to the
Other
Middle
East
Africa
Other
Europe
development of the Western Siberia region (also known as the ‘Russian Core’). Peak
production reached 11.4 million bpd (barrels per day) in 1987. Following the
disintegration of the Soviet Union in 1991, Russian oil production fell over the
North
America
Russia
subsequent years to bottom out at 6.1 million bpd in 1996. Oil production then
stabilised at this level for several years. The production decline can be attributed to
Source: BP Statistical Review of World Energy June 2007
several factors: the collapse of the central planning system, the depletion of major
fields due to excessive production targets and insufficient attention to matters such as
Russia’s major oil producers
(production x mln tons)*
infrastructural development, enhanced oil recovery techniques, maintenance and
energy-saving measures.
Company
2005
2006
Lukoil
87.81
90.42
Rosneft
74.42
81.71
TNK-BP
75.35
72.42
year. This turnaround can be attributed to the introduction of Western technologies and
Surgutneftegas
63.86
65.55
the re-engineering of oil fields in Western Siberia. Another driver was the sector’s
Gazprom Neft
33.04
32.72
privatisation, leading to better management and new field developments. Yukos and
Tatneft
25.33
25.41
Sibneft played an important role in the production increase by using Western-style
Slavneft
24.16
23.30
Yukos
24.52
21.53
Russneft
12.18
14.76
Gazprom
12.79
13.40
Russia’s oil production (crude oil plus condensates) amounted to 9.77 million bpd in
The turnaround for Russia’s oil production came in 1999. In 2000, Russian oil
production showed an increase of almost 360,000 bpd, a rise of 5.8% over the previous
production methods.
Others
36.44
39.31
2006, with the ‘big four’ Lukoil, Rosneft, TNK-BP and Surgutneftegaz accounting for
Total
469.90
480.53
64.5% of total production. Oil production in 2006 showed an increase of 2.2% over
* incl. gas condensates
2005, the lowest growth rate seen since 1999 when oil was still at USD 10 per bbl
Source: Gazprom Neft
(barrel). This represents a marked slowdown from the 8-10% annual growth rate seen
Oil production and consumption in the Russian
Federation (mln bpd)
in the 2001-2004 period. In fact, Russia was the motor for global oil supply growth in
2001-2004, accounting for 50-75% of non-OPEC supply growth during those years.
12
Oil exports
9
6
Russia has a vast integrated oil transportation system, which handles both crude oil
(mostly Urals blend) and refined products. The pipelines, which were in urgent need of
3
0
1985
repair in the 1990s, have since been substantially upgraded. The pipeline network
consists of more than 60,000 km of long-distance pipelines, local oil pipeline networks
1990
—— Production
1995
2000
Consumption
2005
and several export pipelines, the most important of which are ‘Druzhba-1’ and
‘Druzhba-2’.
Source: BP Statistical Review of World Energy
22
Economics Department/Sector Research, September 2007
Russia
Over 70% of Russia’s crude oil production is directly exported, while the remaining
Sources of crude oil exports in 2006
30% is refined locally. Most of Russia’s oil exports are transported via pipelines
38.81 mln bpd
(overland to other countries or to export terminals at ports). About 35% of Russia’s
Rest of
world
crude oil exports are still shipped via higher-cost railroad tankers and river barges due
Africa
to pipeline bottlenecks. Some of the crude oil export capacity deficit is handled by
exporting refined petroleum products to Europe, mostly fuel oil and diesel fuel.
Middle
East
Other
Europe
Traditionally, exports are primarily transported overland via the Druzhba trunk pipelines
into Central Europe and by sea via the Black Sea ports of Novorossiysk, Tuapse and
FSU
Odessa, and via the Baltic port of Ventspils and several other ports in the Gulf of
S&C
North
America
America
Finland. The Baltic Pipeline System (BPS), which came on stream in December 2001,
transports oil from the West Siberian and Timan-Pechora oil fields westward to a new
Source: BP Statistical Review of World Energy June 2007
terminal at the Russian Baltic port of Primorsk, diverting the flow from the Latvian port
of Ventspils. The final stage of the BPS was completed in 2006.
FSU net exports* of crude oil and petroleum
products (million bpd)
In 2006, about 85% of Russian crude oil exports went to non-CIS countries. Major
destinations were Germany, Italy, France and the Netherlands. The remaining 15%
2004
2005
2006
Crude oil seaborne
3.96
4.05
4.07
Druzhba pipelines
1.10
1.15
1.20
Other pipelines
0.23
0.25
0.38
The Russian oil pipeline system is very inefficient due to inept management, and is
Total crude exports
5.29
5.45
5.64
often troubled by reliability and environmental problems. Over 90% of the system is
- of which Transneft
3.76
4.04
4.09
owned and managed by Russia’s state-owned monopoly Transneft. The tariffs charged
Exports petroleum products
2.19
2.38
2.51
Total exports
7.48
7.83
8.16
by Transneft for use of its pipelines are based on distance. In order to maintain control
mainly went to CIS countries.
over oil exports, Transneft has so far opposed deregulation of the pipelines.
Source: IEA Monthly Oil Market Report
In October 2005, a new export tax system was introduced to stimulate crude oil
production growth by capping the export tariff rate. The unintended side-effect was a
Differential Crude oil Urals Med. vs dated Brent
USD per bbl
shift toward exports of refined products at the expense of crude oil exports. This was
mainly due to the fact that under the new tax system, the tax on refined products has
2
declined relative to the crude oil tax. For Urals at USD 40/bbl the difference for light
0
products is about USD 2.8/bbl, but for Urals at USD 60/bbl, the difference is about USD
-2
7/bbl. The differences in taxation have more than offset the higher transportation and
-4
other costs involved in the export of refined products.
-6
Oil production and export outlook
-8
00
01
02
Source: Thomson Financial
03
04
05
06
07
Russia’s oil production is forecast to continue its upward trend. The International
Energy Agency (IEA) expects Russia’s oil production to rise by 2.4% in 2007, slightly
higher than the production growth of 2.2% seen in 2006. For the medium term (20072012), the IEA expects Russian oil production to continue to grow, albeit at a slower
pace compared to the period 2001-2006. This lower growth rate reflects the fact that
several major oil fields are showing signs of maturity as well as the difficulties
encountered in compensating for the decline by developing new fields.
As domestic demand is expected to increase less rapidly than production, this leaves
room for increasing exports of crude oil and refined products. According to the IEA,
Russia’s exports will start to gradually decline soon after 2010 when domestic demand
outstrips the increase in production. IEA’s overall conclusion is that these production
and export trends will remain highly sensitive to politics and taxes and may, therefore,
differ substantially from the current scenario.
23
Economics Department/Sector Research, September 2007
Russia
Pre-peak Russian oil fields (1,000 bpd), 2004
Field
Owner
Priobskoye
Rosneft
Production Depletion*
The medium-term outlook for Russia’s oil production growth is highly uncertain, mainly
due to the fact that seismic data are neither transparent nor made externally available.
Oil analysts have also pointed out the lack of exploration in potential production areas
437.5
8%
Tevlin-Russinkoye Lukoil
241.0
45%
over the last decade. The key factor determining Russia’s future level of oil production
Tyanskoye
Surgutneftegaz
191.1
20%
essentially depends on how long Western Siberia’s current production can be
Sugmutskoye
Gazprom
191.5
44%
maintained while new reserves are meanwhile put into production to offset the decline
Sporyshefskoye
Gazprom
107.5
44%
in maturing or post-peak fields.
Total
1,168.6
* cumulative depletion
Source: EIA, Country Analysis Briefs, Russia April 2007, based
on John Grace’s study Russian Oil Supply
According to a study by John Grace ‘Russian Oil Supply’ (Oxford Institute of Energy
Studies) about 20% (1.8 million bpd) of Russia’s oil production in 2004 came from
fields that had cumulatively produced 80% of their total recoverable reserves.
Attention is therefore likely to shift to less mature basins such as Timan-Pechora, and
Post-peak Russian oil fields (1,000 bpd), 2004
Production Depletion*
to frontier areas such as Eastern Siberia and Sakhalin. However, the development and
production costs for such ‘greenfield projects’ are expected to be much higher than for
Field
Owner
Samotlor
TNK-BP
974.1
71%
existing ‘brownfield projects’ in Western Siberia. Government taxation and the lack of
Romashkino
Tatneft
295.5
84%
clarity regarding subsoil resources ownership will continue to create uncertainties. In
Momontovskoye
Rosneft
251.5
82%
this type of environment, it will be quite difficult to achieve sustained production growth.
Federovskoye
Surgutneftegaz
456.3
67%
Lyantorskoye
Surgutneftegaz
168.2
81%
Pravdinsko-
Khantymnasiysk-
119.4
27%
Salymskoye
neftegaz
Povkhovskoye
Lukoil
Arlan
Bashneft
The key to Russia’s future oil production growth will be the availability of viable export
routes via pipelines. Alternative methods of exporting oil (by rail or barge) are far more
112.1
95%
costly than shipment via pipelines. Both Transneft and the Russian government have
75.0
91%
acknowledged the future capacity problem and have introduced incentives to develop
Total
2,452.0
* cumulative depletion
Source: EIA, Country Analysis Briefs, Russia April 2007, based
on John Grace’s study Russian Oil Supply
new export infrastructure. This export infrastructure will also take into account the
growing demand for oil in the North East Asian market, which has so far been a limited
target for Russian oil exports.
A major project aimed at increasing oil exports to the North East Asian market will be
the 4,200-km Eastern Siberia-Pacific Ocean (ESPO) pipeline, which was approved in
December 2004.
Many problems had to be solved before construction could start, such as the possible
connection with China, the sourcing of the oil and the financing of the pipeline with an
estimated cost of USD 7.0 billion for the first section and USD 6.0 billion for the second
section. There were also environmental concerns related to Lake Baikal (a UNESCOprotected site) and Perevoznaya Bay (a sensitive area for whales). In the meantime,
environmental and safety problems have been solved, but total construction costs may
be double the initial estimate when both sections are completed.
The first 2,800-km section of the ESPO pipeline, owned by Transneft, is expected to be
completed by December 2008, with the second section to be finished in 2010. The
route has been amended and the pipeline now passes 200 km from Lake Baikal. The
pipeline is designed to deliver 80 million tons/year (1.6 million bpd) of Siberian oil to
China and Asia-Pacific countries.
24
Economics Department/Sector Research, September 2007
Russia
Regional distribution of proved gas reserves
Chapter 4: The Russian Natural Gas Sector
at year-end 2006, 181.5 tcm
S&C
America Qatar
North
America
Other
Europe
Natural gas reserves
Russia has the world’s largest proved natural gas reserves, totalling 47.65 trillion cubic
Russia
Asia
Pacific
Iran
metres (tcm) at year-end 2006 or 26.3% of the world’s total proved reserves (BP
Other
Middle
East
estimate). Russia‘s R/P ratio was 77.8 at year-end 2006, i.e. its proved gas reserves
can sustain its 2006 gas production level of 612 billion cubic metres (bcm) for 77.8
years. Gazprom’s reserve estimate for Russia at year-end 2006 was 47.85 tcm. These
Africa
reserves are in the Russian A+B+C1 ‘proved’ or ‘commercial grade’ category of reserve
Source: BP Statistical Review of World Energy June 2007
classification, comparable to the international ‘proved plus probable’ or 2P category.
Iran, which has the world’s next largest reserves, has about 28.1 tcm.
Gas reserve structure in Russia at end 2006
Volume (tcm)
Share (%)
Gazprom (controlled reserves)
29.85
62.4
Independent producers
10.20
21.3
Undistributed fund
7.80
Total
In addition to these proved reserves, Russia has more than 30 tcm of undiscovered
gas resources (U.S. Geological Survey estimate, 2000). Some 20 giant fields have
been discovered, each with more than 500 bcm in gas reserves; so far, only seven of
these fields have been brought into production.
16.3
47.85
100
Around 80% of Russia’s gas reserves are located in Western Siberia, mainly in the
Nadym-Pur-Taz (NPT) region where several giant fields were discovered in the 1960s.
Source: Gazprom
Three major fields Urengoye, Yamburg and Medvezhye (the ‘Big Three’) still account
for the majority of the country’s gas production, although these mature fields are now in
decline. Significant natural gas reserves are also found offshore on the shelf of the
Barents Sea and Pechora Sea, in Eastern Siberia and in the Timan-Pechora region.
Regional distribution of gas production
in 2006, 2,865 bcm
Algeria
In 2006, Russia accounted for 21.3% of global natural gas production. Russia’s gas
Indonesia
Russia
Others
NL
Norway
production is largely controlled by state-owned Gazprom, the world’s largest gas
Iran
company. Gazprom owns and operates the 156,900-km network of high-pressure gas
Saudi
Arabia
trunk pipelines. The company also owns 25 underground gas storage facilities in
Russia, with a total of 63 bcm of gas stored in 2006/07. These storage facilities are
important in matching supply with seasonal demand fluctuations. Via its ownership of
USA
UK
Natural gas production
Gazprom, the Russian government controls about 85% of the domestic gas production.
Canada
However, the Russian gas sector has largely retained its centralised Soviet structure
Source: BP Statistical Review of World Energy 2007
dating back to the 1980s. Although the restructuring of the gas sector has been high on
the government’s agenda for some time, the move was blocked by President Putin.
Russia’s gas production by oil majors, bcm
After the collapse of the USSR, domestic gas production fell sharply in response to
Company
2005
2006
lower domestic demand. Russian gas production peaked in 1991 at 600 bcm and
Surgutneftegas
14.36
14.62
bottomed out to 533 bcm in 1997. Production was flat for several years, but the
5.80
14.11
13.05
13.56
turnaround came in 2002.
TNK-BP
6.45
8.65
Gazprom Neft
1.99
2.05
Lukoil
Rosneft
In 2006, Gazprom accounted for about 85 % of total gas production in Russia, while oil
Yukos
1.97
1.89
companies and independent gas producers accounted for the remainder. The recent
Others
4.37
2.01
increase in production can be largely attributed to the independent gas producers, the
47.99
56.89
largest of which is currently Novatek (with gas production of 28.6 bcm in 2006). These
Independents, Gazprom
545.04
599.34
‘independents’ are mostly private companies that – unlike Gazprom – have managed to
Total Russia
641.02
656.23
Total oil majors
Source: Surgutneftegas
increase their gas production, filling the gap between domestic gas supply and
demand.
25
Economics Department/Sector Research, September 2007
Russia
Gas production and consumption in the Russian
Federation (bcm)
Nearly a quarter of the gas production by independents is still being flared. This is
largely attributed to the unprofitable gas processing and sales conditions for these
producers compared to Gazprom. In most cases, these other producers have to sell
750
gas to Gazprom, or Gazprom has to provide access to its Unified Gas Supply System
600
(UGSS) to enable them to deliver gas to non-Gazprom buyers. Gazprom’s control over
450
the Russian gas market is likely to change due to the long-expected policy shift towards
gas market deregulation, necessitated by growing market imbalances.
300
150
In November 2006, the Russian government approved proposals for the liberalisation
1985
1990
1995
—— Production
2000
2005
and price deregulation of the domestic gas market. The proposed system should result
in a better supply/demand balance for the domestic gas market due to the introduction
Consumption
Source: BP Statistical Review of World Energy June 2007
of a new pricing system and the introduction of long-term pay-or-take contracts.
The regulated market segments (households and utilities) will see quota-based
deliveries with inflation-adjusted prices. Gas prices for industrial consumers and power
Increase in Russian domestic gas prices in
2007-2011, USD per 1,000 cu m
generators (about 70% of the domestic market) will be determined by export netback
parity, which is scheduled to be reached by 2011. These price hikes will create an
140
economic incentive to improve energy efficiency, offer opportunities for independent
120
gas producers and the monetisation of associated gas that is often still being flared.
100
In addition, the new gas policy encourages non-regulated gas trading. Mezhregiongaz
80
(a wholly-owned subsidiary of Gazprom) has set up an electronic trade board, which
60
enables Gazprom and independent suppliers to sell gas at free market prices. Trading
40
has been conducted on a monthly and ten-day-period basis since February 2007. Spot
20
prices have often exceeded the regulated gas prices by 30-40%, reflecting the
0
increasing dynamics of the Russian domestic gas market.
H1 2007 H1 2008 H1 2009 H1 2010 H1 2011
Natural gas exports
Source: Institute of Energy Policy, Moscow
Gazprom has a monopoly on all gas exports outside the Commonwealth of
Independent States (CIS). Via its subsidiary Gazexport, the company is the leading
supplier of natural gas in the European gas market. Russian gas supplied to Europe is
mainly sold on the basis of long-term contracts. In addition, Russia exports significant
volumes of natural gas to customers in the CIS.
CIS republics, such as Belarus, Georgia, Moldova and Ukraine have been offtakers of
Russian gas for many years. These supplies were paid for at the expense of Russian
citizens, who sometimes experienced supply disruptions due to these exports.
Gazprom’s natural gas sales to CIS and Baltic
countries, 2005 and 2006 (bcm)
Moreover, the CIS republics were charged only a fraction of what European offtakers
paid for Russian gas despite the serious non-payment problems with the CIS republics.
Country
2005
Ukraine
37.6
59.0
The Western CIS states (especially Belarus and Ukraine) are still important to
Belarus
19.8
20.5
Gazprom as transit countries to Central and Western Europe, its main markets. In
Kazakhstan
4.0
6.5
2006, Western Europe imported about 25% of its gas needs from Russia. Other major
Azerbaijan
3.8
4.0
Lithuania
2.8
2.8
Moldova
2.8
2.5
Georgia
1.4
1.9
represented only 28% of its gas sales volumes. This was due to the continuing marked
Armenia
1.7
1.7
difference between the gas prices realised in the European export market compared to
Other
2.7
2.1
Gazprom’s other markets.
Total
76.6
101.0
Source: Gazprom Annual Reports
2006
non-EU suppliers are Statoil/Petoro (Norway) and Sonatrach (Algeria).
Gas exports to Europe provided 60% of Gazprom’s gas revenues in 2006, but
The European gas price in 2006 was RUR 5,238.5 per 1,000 cubic metre (excluding
excise tax and customs duties), compared to only RUR 1,125.4 per 1,000 cubic metre
(excluding VAT and excise tax) in the Russian market.
26
Economics Department/Sector Research, September 2007
Russia
Gazprom’s natural gas sales to European
countries, 2005 and 2006 (bcm)
In 2006, Gazprom’s gas sales revenues in the CIS and Baltic states increased by
93.5% compared to 2005, mostly due to the 46.7% increase in the average sales price
Country
2005
2006
Germany
36.0
34.4
Italy
22.0
22.1
Turkey
18.0
19.9
France
13.2
10.0
for a gradual transition to more market-related prices in these countries, Gazprom has
to RUR 2,077.4 per 1,000 cubic metre (excluding excise tax and customs duties). This
price increase forms part of Gazprom’s strategy to adjust the contractual terms and
conditions to levels similar to those for exports to the European countries. In exchange
Hungary
9.0
8.8
stated its goal of gaining access to ultimate consumers through participation in gas
United Kingdom
3.8
8.7
assets.
Poland
7.0
7.7
Gazprom has ambitious plans to expand its activities in Europe as well, via joint
Czech Republic
7.4
7.4
Slovakia
7.5
7.0
Austria
6.8
6.6
Romania
5.0
5.5
European gas transport and distribution companies, but this strategy has sometimes
Finland
4.5
4.9
met with strong opposition. One example was Gazprom’s bid for Centrica, the UK’s
The Netherlands
4.1
4.7
biggest gas supplier. When several European countries expressed concern about
Belgium
2.0
3.2
Gazprom’s take-over plan, the company warned that it could redirect supplies to other
Greece
2.4
2.7
Bulgaria
2.6
2.7
Other
Total Europe
4.8
5.2
156.1
161.5
ventures (for instance in gas transport companies) and the acquisition of distribution
companies. Over the past few years, Gazprom has acquired shares in over 40
markets, such as North America and China.
Natural gas production and export outlook
Source: Gazprom Annual Reports
Over the next few years, Gazprom and independent producers will need to bring
several new fields on stream to compensate for declining production from the ‘Big
Three’. Gazprom expects production from these fields to decline by 7-8% a year over
Average gas prices FSU and Europe
(RUR per 1,000 cu m)
the next few years. The company has indicated that it prefers to develop new fields
rather than trying to sustain the production levels of the ‘Big Three’.
The cost of developing new gas fields, all of which are located within the harsh Artic
6000
5000
zone, is estimated at USD 30-40 billion excluding the necessary infrastructure. This is
4000
the major reason that Gazprom will give priority to the development of a number of
3000
smaller fields in the NPT region. As these fields are in the vicinity of the super-giants,
2000
the existing pipeline infrastructure can be used.
1000
0
2002
This allows Gazprom to take advantage of the spare capacity in the existing pipeline
2003
2004
—— FSU
2005
2006
Europe
system running from the NPT region. Recent exploration in the region has indicated
that there is still a large number of smaller fields with substantial potential. Although
some of the gas reserves are in the ‘yet-to-find’ category, the gas reserves with
Source: Gazprom
economic potential in the NPT region could add another 100 bcm to the annual supply
in the near future.
Gazprom’s production is forecast to show only modest growth (1.0-1.5% per annum)
Gazprom's production outlook (bcm)
over the next few years. This reflects the change in the company’s medium-term
strategy. Gazprom is shifting its focus away from increasing its overall upstream
700
production toward investments in midstream and downstream, both at home and
uncertainty range
600
abroad, moving closer to its European customers. Most of Russia’s gas production
500
growth will therefore have to come from other companies (oil companies and
400
300
independent gas producers), giving them a substantial window of opportunity as
200
Russian domestic demand is also expected to increase. Supply from these
100
independents is forecast to increase from 105 bcm in 2006 to over 200 bcm in 2015.
European gas demand is forecast to continue rising by about 3% (12-15 bcm) per
0
96
Source: Gazprom
1
2
3
4
5
6
10F 20F
annum. As European domestic gas production is soon likely to enter a phase of
decline, the EU’s dependency on gas imports will rise from 57% in 2005 to 83% by
2030. This provides considerable scope for increasing Russian gas exports, which will
27
Economics Department/Sector Research, September 2007
Russia
Forecast of gas demand and supply by sources
necessitate the construction of new Russian export pipelines. In addition, growing gas
demand in Asia (driven mainly by the power sector) will present opportunities for
1000
Russia to export gas from Eastern Siberia to several Asian countries. This will not only
800
necessitate the development of new gas fields, but the export pipeline infrastructure
and underground storage facilities as well.
600
400
In 2006, the State Dume adopted the Federal Law ‘On gas export’ which grants
200
exclusive rights to Gazprom to export gas. This allows Gazprom to pursue a
coordinated production and export strategy (‘the unified export channel’), forming an
0
2005
Russia demand
Europe demand
FSU demand
Source: IEA,TNK-BP
2010
2015
Gazprom supply
Imports Central Asia
Independents
additional guarantee for the reliability of Russian gas exports.
Europe will remain dependent on Russian gas for the foreseeable future. European
offtakers will therefore be forced to work with Gazprom on the security of the gas flows.
There are currently no signs that Gazprom is unwilling to cooperate. This is clear from
the agreement on the 1,200-km Nord Stream pipeline (formerly referred to as the North
European Gas Pipeline, NEGP) through the Baltic Sea, which was signed in
September 2005 by Putin and Schröder.
Nord Stream consists of two parallel pipelines with a total capacity of 55 bcm per
annum. The first part of Nord Stream is expected to come on stream in 2010 and
transport up to 27.5 bcm of gas a year. Initially Nord Stream will supply Germany, but
further expansion is possible to the UK, Belgium, France and the Netherlands.
The Nord Stream pipeline is a new channel for Russian natural gas exports and is seen
as a major infrastructure project, which sets a new benchmark in the co-operation
between Russia and the EU. Nord Steam is regarded as a clear sign of Gazprom’s
willingness to cooperate and find solutions to the transit risk problem. As a result,
Gazprom can avoid negotiating transfer fees, in this case by bypassing Belarus,
Poland and Ukraine.
The International Energy Agency expects Russian gas production to rise from 598 bcm
in 2005 to about 900 bcm in 2030. Despite this impressive production growth, there is
limited scope to increase exports as domestic demand is also expected to rise
substantially. However, imports from the Central Asian republics will enable Gazprom
to increase its exports to Europe. In addition, improving domestic energy efficiency can
redirect gas from the domestic market to the more lucrative export markets. Energy
inefficiencies across Russia currently account for about 100 bcm of wasted gas.
Gazprom has control over more than 60% of Russia’s natural gas reserves. This
reserve base gives the company ample opportunity – albeit currently mostly from
relatively smaller fields – to increase its future production. Gazprom can also purchase
additional gas from independent producers. So far, Gazprom has used its transport
monopoly to prevent these producers from getting direct access to the European
market.
Recent meetings between President Putin and Central Asian leaders may help shift the
tense geopolitical relations and Gazprom’s policy. Given its problems with increasing
its gas production, Central Asian gas is very important in filling Gazprom’s looming
supply gap.
Gazprom has already concluded future gas supply contracts with the Central Asian
republics Turkmenistan, Kazakhstan and Uzbekistan. The additional volumes would
have to come on top of the volumes already allocated by Gazprom to Ukraine. The
supply contract with Turkmenistan (80 bcm/year by 2010) appears to be particularly
challenging. Turkmenistan has substantial reserves of natural gas, said to be over 20
28
Economics Department/Sector Research, September 2007
Russia
tcm of recoverable reserves. However, there is lack of reserve transparency and so far
Development of satellite and new fields
Field
Launch Year of peak Peak production
Pestsovoye
all their production targets have failed.
date
production
(per annum)
These three Central Asian countries have significant gas reserves, but up to now the
2004
2006
27.5 bcm
(current) inadequate throughput capacity of the pipeline linking Central Asian gas
reserves with Gazprom’s network have limited their supply. Gazprom’s recently
Kharvutinskoye
1996
2008
25.0 bcm
Ety-Purovskoye
2004
2006
15.0 bcm
Aneryakhinskoye
2004
2006
10.0 bcm
Yen-Yahinskoye
2003
2008
5.0 bcm
Yuzho-Russkoye
2007
2009
25.0 bcm
Shtokmanovskoye
2010+
after 2012
67.5 bcm
developed satellite fields will soon – or have already – reached their peak production. If
Gazprom wants to meet its targets, the company will have to improve pipeline access
for these Central Asian producers and the gas sales conditions for Russian
independent gas producers and oil companies.
In addition to cooperation with Central Asian producers, Gazprom will need to develop
Source: Gazprom
Major uncommitted FSU natural gas reserves
as of 31 December 2005 (tcm)
more resources, which are presently inaccessible, posing immense challenges for the
company. Considerable investments will be needed in greenfield projects to
compensate the declining production from existing fields and prevent a future gas
700
600
500
400
300
200
100
0
deficit. This will make the timing of new projects essential.
Gazprom has indicated that after 2010, new strategic gas fields will be developed on
the Yamal Peninsula, the shelf in the Barents Sea, the shelf in the Kara Sea (including
the Obskaya and Tazovskaya bays), Eastern Siberia and the Russian Far East. This
will be a challenging task, given the severe climate conditions in these regions and the
environmental sensitivities.
Nadym Pur
Taz
Yamal*
Barents
Sea
Kara Sea
Central
Asia
Eastern
Russia
The U.S. Geological Survey (USGS) is very optimistic about the potential of the Arctic
Undiscovered resources
Uncommitted resources
* Yamal Peninsula undeveloped resources combined with
Nadym Pur Taz
Source: Jensen Associates
offshore as well as the opportunities in the Central Asian republics and Eastern Russia.
A large part of the undiscovered resources are located in the Arctic, where Russian
explorers planted a flag on the seabed just below the North Pole in August 2007. The
flag is a symbol of Russia’s claim to the vast Artic territory, where an estimated 25% of
the world’s undiscovered oil and gas resources lie.
Russia’s ‘gold rush’ for the North Pole
Russian explorers have planted their country’s national flag on
the seabed 4,200 m below the North Pole to confirm Moscow’s
claim to the Arctic.
Canada, which also claims territory in the Arctic, has criticised
the mission. “This isn’t the fifteenth century. You can’t go
around the world and just plant flags and say ‘We’re claiming
this territory’ ”, Canadian Foreign Minister MacKay told a TV
channel.
Melting polar ice, said to be the result of global warming, has
opened the possibility of new shipping routes in the region (the
Northwest Passage). As exploration of offshore oil and gas
also becomes easier, this has led to competing claims over
Arctic resources.
Shtokman field (or Shtokmanovskoye) in the Barents Sea, a ‘world-class gas project’
with reserves of 3,700 bcm and additional volumes of gas condensate. Shtokman will
be developed by a consortium consisting of Gazprom, French oil company Total and
other foreign companies. Starting in 2013, Shtokman should deliver 22 bcm of gas to
European consumers and later – in the form of liquefied natural gas (LNG) – to US
consumers as well. The investment required to develop Shtokman are estimated at
USD 20-30 billion. This huge amount reflects the difficulties that will be encountered in
developing this gas condensate field, situated 600 km offshore in 350 metres of
dangerous Artic waters.
Source: BBC News, Financial Times, 2 August 2007.
Russia’s gas production and looming gas
deficit (bcm)
2004
2010
Gas production by Gazprom (a)
545
550
Gazprom’s exports to Europe/CIS
191
312
Deliveries to domestic customers
354
238
Russia’s domestic demand (b)
402
469
48
231 / 202
Supply gap (b / c)
One of the gas fields that is very likely to be developed in the near term is the giant
Deliveries from Central Asia
-
105
Total supply gap (b / c)
-
126 / 97
Shtokman is just one example of the huge investments needed. The IEA expects that
Gazprom will have to invest USD 330 billion over the period 2005-2030 (the amount
was not further specified) to meet both future domestic and European gas demand.
Ruhrgas has indicated capex needs for the Russian gas sector of USD 227 billion to
2020. This total includes USD 85 billion for upstream, USD 55 billion for new Russian
pipelines, USD 67 billion to upgrade existing pipelines and USD 20 billion for new
pipelines to Europe.
The China option
(a) Optimistic estimate without output from Yamal
(b) Probable scenario, annual demand growth of 4.3%
(c) Reduced scenario, annual demand growth of 2%
Source: CEPS Policy Brief, October 2006
For many years, natural gas in China was mainly used as feedstock for nitrogen
fertilizer production. Natural gas for other uses was limited to those areas near gas
producing fields. However, given the environmental benefits of using natural gas in
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Economics Department/Sector Research, September 2007
Russia
power generation, China is currently undertaking a major expansion of its gas
infrastructure. China’s gas pipeline system, which is currently still rather fragmented,
needs more interconnections between networks. Only Sichuan province in the
southwest can boast a sophisticated natural gas distribution network.
Natural gas consumption (58 bcm in 2006) accounted for only 3% of China’s total
energy consumption that year, but gas consumption is expected to increase to 100 bcm
per year by 2010. Although China has its own substantial gas reserves, its future
supply will increasingly depend on imports via pipeline and in the form of LNG.
Given the fast-growing gas market in China, a widely discussed option for Russian gas
companies is to export gas to China. The giant Kovykta gas condensate field (2,000
bcm of natural gas) in Eastern Siberia was discovered in 1987. Kovykta, operated by
RUSIA Petroleum (until recently,8 63%-owned by TNK-BP), could provide China with
natural gas in the next decade. However, this is a medium-term option as the project
will initially supply 2 bcm/year of natural gas from 2007 to households and industrial
consumers (power stations and chemical plants) in Russia’s Irkutsk Region.
In March 2006, Gazprom and China National Petroleum Corporation (CNPC) signed an
outline agreement to deliver 60-80 bcm/year of Russian gas to China. This involves the
construction of two pipelines, to be completed by 2011 at a total cost of at least USD 10
billion. One of the pipelines is to carry West Siberian and the other East Siberian gas. It
is still unclear which fields will supply the gas, although Kovykta and Sakhalin-1 are the
most likely choices.
When successfully completed, the ‘China option’ will be a crucial step in Gazprom’s
strategy of becoming a global energy player and – as a consequence – will increase its
bargaining power as Europe’s major gas supplier. However, Gazprom recently asked
the Russian Government to annul the agreement of ExxonMobil to supply China with
gas from Sakhalin-1, arguing that it needs the gas to supply its domestic customers.
Although Russia seems to be the most logical supplier of gas to China, there are other
options from neighbouring countries. Kazakhstan’s KazMunai Gas (KMG), for instance,
has conducted a feasibility study in cooperation with CNPC for the construction of a
pipeline to supply gas to China. In the longer term, this pipeline could also transport
gas from Turkmenistan and Uzbekistan to China.
Given the many uncertainties surrounding Gazprom’s agreement with China, the
potential competition from Central Asian producers, the routing of pipelines and the
sourcing of gas, it is crucial that the Russian government develop a master plan for the
eastern Russian gas sector. This plan should cover the financial issues, which fields
should be developed first, supplying the domestic market versus export markets (given
that gas demand in Eastern Siberia is also increasing), and the potential role of foreign
investors.
8 In June 2007, TNK-BP was forced to sell its stake in RUSIA Petroleum to Gazprom. BP announced
that, in connection with the deal, a strategic alliance with Gazprom will be formed to invest ’jointly in major
long-term energy projects or swap assets around the world’. Given the Russian regulators’ threat to
withdraw the licence for Kovykta, BP had in fact no real choice and would be well-advised to accept
reality.
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Russia
Chapter 5: Opportunities in Russian Oil and Gas
Investment climate
The current political, fiscal and regulatory climate negatively impacts the development
of marginal fields, particularly relatively high-cost fields. The fiscal reforms process is
unlikely to be resolved before the 2007/08 national elections. In the meantime, ad hoc
changes to the tax system are likely to continue. The uncertainties in the investment
climate complicate the task of long-term project planning for all investors in the Russian
oil and gas industry. The lack of tax holidays for new fields and reduced taxes for
maturing fields (i.e. more tax differentiation) is seen as counterproductive.
The Russian government has acknowledged the need to reform the current tax system.
Incentives will be introduced to stimulate oil production growth in Russia’s ‘periphery’.
However, Russian companies are likely to remain reluctant to invest their money in
Siberian greenfield projects, as they would have to redirect their scarce financial
resources from fields that are already producing.
The regulatory framework governing the licensing of subsoil use is still under revision.
The government submitted a draft of a new law on Mineral Resources to the State
Duma in June 2005. The draft bill included several reforms recommended by the
Ministry of Natural Resources (MNR), such as the creation of full-cycle licenses
(combining exploration and production rights) and the replacement of the current
administrative legal regime with subsoil licenses with a civil law framework.
However, the draft bill contained some controversial proposals. In particular, the new
rules for direct foreign participation in bidding for ‘strategic fields’ would put restrictions
on potential foreign investors. Strategic fields are legally defined as oilfields with more
than 1.0 billion barrels of oil, or gas fields with more than 1.0 trillion cubic metres of
gas, or any fields located near military installations.
Although several amendments have been made since the draft bill was introduced, the
formal adoption of the new bill on Mineral Resources has not yet taken place. It
therefore remains unclear how attractive the outcome will be to foreign investors and
how it will impact their appetite.
Resource nationalism increasing
Several international oil and gas companies have recently been faced with increasing
‘resource nationalism’. Resource nationalism basically consists of changes in fiscal or
operating regimes by oil and gas producing countries. These changes are used to
maximise their returns or change ownership in upstream assets, often in reaction to
domestic social unrest. The re-emergence of state control can have unwanted sideeffects as history has shown: increasing inefficiencies, resulting in deterred upstream
investments that are essential for sustained output in the long term.
Bolivia, Ecuador and Venezuela are prime examples of how terms and contracts have
recently been renegotiated to use their energy resources to press for their political
interests. Bolivia nationalised its oil and gas fields, state-owned Petroecuador took over
the former production assets of Occidental Petroleum and Venezuela doubled the
taxes levied on oil production by the foreign operators in the country.
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Russia
Some fear that Russia is moving in a similar direction, putting foreign participation in
the oil and gas industry at risk. “Greater state-ownership of oil-producing assets is likely
to distort the incentives facing the remaining private oil companies, because they fear
unfair treatment when competing with large state-owned producers” (The World Bank).
After the privatisation and restructuring of Russia’s oil industry in the 1990s, the sector
became the most rapidly developing part of the Russian economy, contributing
significantly to the country’s growth. However, since 2004 the Kremlin has taken steps
to restore the government’s control over the oil and gas sectors, revising some of the
deals made in the 1990s. Moreover, Russia has used its energy supplies as a political
weapon, bullying its former Soviet neighbouring states.
The gas dispute between Russia and Ukraine in early 2006 caused considerable
upheaval in Western and Central & Eastern Europe. While Russia’s actions were
based on a combination of political and economic motives, the result was that the
security of energy supply was once again put high on the EU agenda.
Russia’s political agenda for its oil and gas industry seems to be driven by increasing
Putin’s views on Russia’s energy policy:
nothing new under the sun
Putin’s views on state planning and the importance of energy
policy for Russia’s foreign relations date back to the time when
he was still a senior official. His views can be found in his
dissertation for St. Peterburg’s State Mining Institute, which he
defended in June 1997.
In an abstract, which appeared in 1999, he laid the foundation
for Russia’s current energy policy. Putin outlined that Russia’s
oil, gas and mining base should be used to secure the
country’s international position. In order to use the energy
factor in international politics, state control over the country’s
energy resources must be ensured.
When Putin met Gerhard Schröder in October 2003, he told
him: “The gas pipeline system is the creation of the Soviet
Union. We intend to retain state control over the gas
transportation system and over Gazprom. We will not divide
Gazprom. And the European Commission should not have any
illusions. In the gas sector, they will have to deal with the
[Russian] state”.
Source: Gazprom in Crisis; Conflict Studies Research Centre
state influence, particularly when ‘key strategic energy assets’ are involved. The
developments involving Shell’s Sakhalin-2 project – and more recently TNK-BP’s
forced sale of its Kovykta gas field to Gazprom – are clear signs that the Kremlin wants
to retain control of access to its natural resources.
Tighter control on its energy resources has become the Russian government’s
unwritten policy, which is said to be sustained by President Putin. This reversal of the
Kremlin’s earlier policy of privatisation is evident: in 2003, state-dominated companies
controlled only 16.5% of Russia’s oil production, while in 2006 this had increased to
32%. Lukoil is currently the only major Russian oil company that is not under state
control.
This new policy will clearly benefit state-owned companies (in the form of favourable
licensing and regulation) or those companies that are politically well-connected. The
clear winners of the Kremlin’s policy to secure greater control over the country’s oil and
gas industry will be the state players Rosneft and Gazprom. Their desire to expand
their operations will also trigger further consolidation in Russia‘s energy sector.
High investments needed
An OPEC-like Gas-PEC?
Russia, with its vast proved reserves of oil and gas, will remain one of the world’s
A major source of uncertainty among gas-importing countries
is the possibility that major gas-exporting countries will
coordinate their investment and production plans in order to
avoid surplus capacity and keep gas prices up.
The Algerian national oil and gas company Sonatrach and
Russia’s Gazprom signed a memorandum of understanding
(MoU) on cooperation in upstream activities in August 2006.
This move has raised concerns among European gas
importers about its implications for competition and prices.
Such a coordinated action will put Europe at the mercy of two
of its three largest gas suppliers.
largest producers and exporters of oil and gas for several decades to come. In August
Source: IEA, World Energy Outlook 2006
Russia’s ability to meet its future production targets. Several new fields, some located
2003, the Russian government confirmed ‘Russia’s Energy Strategy to 2020’ (ES2020), sketching the key trends and parameters for Russia’s energy sector. The
starting point is that the energy sector forms a fundamental element in Russia’s foreign
policy. A major objective of ES-2020 is to align the energy strategies of Russia with the
EU and other major energy players, such as OPEC, to make a contribution to global
energy security.
Aside from the recent changes in the Kremlin’s energy policy, there are doubts about
in harsh environments, will have to be brought on stream to compensate for the decline
of maturing fields, while at the same time production must increase. This will
necessitate considerable capex in upstream production, the upgrading of existing
systems and new pipelines to markets in Europe and Asia.
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Economics Department/Sector Research, September 2007
Russia
In its World Energy Outlook 2006 the International Energy Agency forecast that Russia
needs to invest USD 478 billion in its oil sector and USD 440 billion in its gas sector
over the period 2005-2030. Although the Russian government would prefer to raise the
necessary capital domestically, external sourcing will be inevitable.
In order to be able to attract foreign capital, financial investors have indicated that
several critical issues must be resolved, such as the definition of ‘strategic fields’.
Another major issue is the current Russian reserve classification system A+B+C1 (for
proved + probable reserves). This system will have to be brought into conformity with
international reserve classification standards such as US/SEC and SPE9, and
sustained by a reserves audit by external renowned consultants.
However, despite these issues, Russia’s potential is so great that the major
international oil and gas companies cannot afford to stand aside and wait for a more
favourable investment climate.
The E&P momentum
The Oil Field Services (OFS) industry supplies products and services to all kinds of
companies involved in the Exploration and Production (E&P) of oil and gas in onshore
and offshore areas. Drilling is the industry’s most important activity. In its broadest
sense, the OFS industry involves many other activities: seismic survey, installation, well
testing and completion, maintenance, pipelay, heavy lift and construction. In offshore
areas, in addition to several types of drilling rigs and ships, a host of other types of
vessels service the oil and gas industry.
The key challenge for oil and gas companies is meeting their production growth
targets. As the development of new resources have long lead times, oil and gas
companies therefore have to take a long-term view on their supply base and depletion
rate, allocating their E&P (or upstream) spending accordingly. During the oil price
plunge of 1998/1999, E&P spending was cut drastically due to the reduced level of free
cash flow.
World E&P investment 2004-2007
USD bln
400
Driven by the continuing strong global economic growth, oil and gas demand has
increased considerably over the past few years. Limited E&P spending in the period
1999-2002 has narrowed the gap between global oil and gas demand and production
capacity. High energy prices combined with poor reserve replacement ratios at several
uncertainty range
350
oil and gas majors have created a strong impetus to increase E&P spending. Leading
300
indicators in the oil field services industry, such as day rates, rig counts and seismic
250
crew counts, have shown a positive development since 2003.
200
150
According to a study by IFP (Institut Français du Pétrole), world E&P spending in 2006
100
was estimated at USD 267 billion, up 25% from the amount spent in 2005. As the
50
search for new oil and gas fields continues, IFP expects E&P spending in 2007 to grow
0
by 20-25% to USD 320-335 billion. Although part of the increase can be attributed to
2004
2005
North America
North Sea
Russia & China
2006F
2007E
Latin America
Other
Total 2007
cost inflation, there is surely growth in volume as well. It is believed that the Middle
East, West Africa, Southeast Asia and Russia will show strong growth in E&P spending
in 2007 and beyond.
Source: IFP
9 The current most widely used standards for the classification of oil and gas reserves are those
developed by the US Securities and Exchange Commission (SEC) and by the Society of Petroleum
Engineers (SPE).
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Economics Department/Sector Research, September 2007
Russia
The structure of the Russian OFS market,
USD 11.4 billion in 2006
Baker
Hughes
Organic production growth and reserve replacement have become important issues for
Russian oil and gas companies. Vast investments will be made over the coming
decade, which will make the oil field services sector very important to Russia. The size
WF Integra
SSK
Small /
mid
indep.
of the Russian oil field services market was estimated at USD 10 billion in 2005, with
an expected growth of 20-25% from 2006 to 2007.
The Russian oil field services industry currently consists of several hundred local
Oil
company
in-house
BK
Eurasia
HB
companies, offering a wide range of services. These local companies vary considerably
in size, from one-product SMEs to the internal services departments of the large
SB
Russian oil and gas companies. In the past few years, some oil and gas companies
have outsourced their oil service activities.
WF = Weatherford, HB = Halliburton, SB = Schlumberger
There are also many international companies active in the Russian OFS sector. These
Source: Douglas-Westwood/Integra
can provide the quality, reliability, sophistication and know-how that most of the local
companies are not able to deliver. Foreign companies accounted for about 15% (USD
1.5 billion) of the total Russian OFS market in 2005. US-based oil service companies
are currently the major foreign suppliers to the Russian market, and are mainly active in
Russian OFS market
the high-end part of the market. But they are facing increasing competition from
USD million
suppliers from Canada, Japan, France, Germany, Italy, Norway and the UK.
25,000
20,000
The ageing production base and the potential growth of Russia’s oil and gas sectors
15,000
offer significant momentum for upstream development and rehabilitation equipment
10,000
and services. According to consultant Douglas-Westwood10, the Russian OFS market
is set to double in value over the next five years: from USD 11.4 billion in 2006 tot 22.5
5,000
billion by 2011. “The sector will be driven by increasing use of outsourced services and
0
2005 2006 2007 2008 2009 2010 2011
a move to western business models”, the consultant concluded.
Western companies can profit from the Russian oil field services boom, as modern
Logging and Seismic
Drilling, workover, technology services, etc.
technology is often lacking. A major problem is the lack of unified norms and standards
in the Russian oil field services sector, such as the internationally used ISO, API and
Source: Douglas-Westwood/Integra
CEN certifications. Russian companies are therefore actively seeking collaboration with
foreign partners to import expertise, technologies and technical advanced equipment.
Russia - Expenditure on facilities by component
Foreign participation will be particularly needed as Russian projects are likely to
become more complex and challenging, and will move to frontier areas. A prime
40
example is the Shtokman field in the Barents Sea that will need operational partners
30
with expertise in LNG transport and deep water gas production, the kind of expertise
20
Gazprom does not currently have.
10
Contracts for oil services in Russia are usually awarded through tenders, with
0
2004
2005
2006
Oil & Gas Production
Pipelines
LNG Terminals
2007
2008
2009
2010
price/quality the major competitive aspect. Working with local companies via
partnerships or joint ventures is often the best strategy to gain access to the market.
Refining & Gas Processing
Maintenance & Modifications
Source: INTSOK Annual Onshore Market Report 2006
10 Douglas-Westwood, The Russian Oilfield Services Market Report 2007-2011, “the first publicly
available report detailing the multi-billion dollar opportunity in this high-growth sector.”
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Economics Department/Sector Research, September 2007
Russia
Chapter 6: Agrifood
The Russian market for food and beverages was worth about EUR 160 billion in 2005.
It is Europe’s third-largest market in terms of size after Germany and France. Russia is
one of the fastest-growing markets for food and beverages in the world, expanding by
20 to 25% in 2004/05. Russian consumers spend about 40% of their income on food
and beverages. Favourable economic developments, higher disposable income,
improving market access, new players in the market and a more stable political climate
have expanded the consumer market and triggered a change in consumer patterns in
Russia. In the coming years the market for food and beverages will grow further as real
incomes continue to increase.
Top-10 Dutch exports of Agrifood products 2005
x USD 1 mln
The rise of food retail
Germany
13,461
Though food is still largely sold in Russia through traditional distribution channels such
United Kingdom
6,242
France
5,686
as weekly and daily markets (known as the ‘rynok’), Russian food retail is rapidly
Belgium
5,114
Italy
4,096
United States
2,297
the large cities. Foreign retail chains are buying local chains and existing stores. Small
Spain
2,035
independent retailers are increasingly making way for multiple chains and large
Sweden
1,111
shopping centres while hypermarkets are springing up around the country. This trend is
Russian Federation
1,019
set to continue in the coming years. The rise of the supermarkets is particularly crucial
Denmark
945
One important factor in the growing food market is the rise of food retail in Russia.
coming to the fore. The first supermarket in Russia dates back to the late 1980s.
Hundreds of supermarkets are now being opened each year in Russia, particularly in
for manufacturers of branded articles. Supermarkets carry a larger product assortment,
which mainly draws people with higher disposable incomes. However, the growth of the
Source: UN/Comtrade
retail sector is mainly confined to the major cities such as Moscow and St Petersburg,
where supermarkets virtually account for all food sales. In the more remote areas, food
is still largely sold via markets and roadside stands.
Exports from the Netherlands to Russia
Alongside the consumer markets, the local food industry has also grown rapidly in
Russia over the past years, with annual growth running at about five per cent per year.
This growth in local food production was made possible by the expansion of production
capacity and the Russian government’s policy of stimulating home-grown produce.
Nevertheless, local food production is not growing fast enough to keep pace with
accelerating demand. A sizeable share of the products (over 40% in 2006) is therefore
sourced from abroad. The most important exporting countries are Brazil, Ukraine,
Germany and the United States. The Netherlands is among the top-10 suppliers to
Dutch exports of flowers and plants to Russia
x EUR 1 mln
2000
46.4
2001
73.8
2002
86.9
2003
103.6
2004
93.4
2005
101.0
2006
128.4
Russia. Total agricultural imports from the Netherlands amount to about EUR 1.0
billion. The most important product groups are flowers and plants, fruit and vegetables,
meat and dairy.
Flowers and plants
Russian consumers love flowers, especially roses. The Netherlands is the most
important supplier to the Russian market. Dutch exports of nursery flowers and plants
to Russia increased by 27% to EUR 128 million in 2006. Russia has thus climbed to
become the ninth largest purchaser of flowers and plants from the Netherlands.
Source: HBAG
Phytosanitary requirements sometimes impede nursery exports.
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Economics Department/Sector Research, September 2007
Russia
Fruit and vegetables
Dutch fruit and vegetable exports to Russia grew by over 50% in 2006. However, this
percentage does not accurately reflect the greater demand for Dutch products. In the
first two months of 2005, exports were at a standstill due to an import ban on vegetable
products from the Netherlands.
Per capita fruit and vegetable consumption is small. Russians do not have a great
culture of eating fresh vegetables and consumption is largely limited to the rougher
(and cheaper) types of vegetables such as onions, various kinds of cabbage and
carrots. However, interest in a more varied diet is increasing and, as a result, demand
for fruit and vegetables such as tomatoes and peppers is growing strongly.
Meat
Per capita meat consumption showed a steady decline in Russia until 2004, then
received a strong impulse in 2005. The consumption of mainly pork and poultry
continued to grow thereafter, while beef consumption decreased.
Domestic production in Russia is not sufficient to meet demand. Additional imports are
therefore necessary. Russia imports about three million tons of meat annually, and the
EU is an important trading partner. The Russian market for meat is a particularly
interesting one because the Russians tend to purchase parts of pigs and cattle that are
less in demand in the EU. This often concerns meat with a higher fat content. Russia is
constantly threatening to impose an import ban on European meat.
Dairy
The Russian market for dairy produce is rapidly expanding. Russians traditionally
consume lots of dairy products. Russia is the most important export destination for
butter from the EU.
After a dip in 2004 and 2005, butter exports to Russia rebounded in 2006. In the first
ten months of 2006, 38,600 tons of butter were exported, an increase of one third
relative to the entire previous year. The main beneficiaries of this increase were
Poland, Lithuania and the Netherlands. One of the reasons behind the increased
exports to Russia is that butter exports from Ukraine have largely ground to a halt due
to the Russian import ban on dairy products from that country.
Netherlands AgriBusiness Support Office
In 2004, the Netherlands Agribusiness Support Office (NABSO) was set up in Moscow.
This is an initiative of the Dutch Ministry of Agriculture, Nature and Food Quality and is
supported by several industry and marketing organisations from the Dutch horticultural
sector. This support office is entrusted with the task of improving and expanding
exports of flowers, bulbs and trees from the Netherlands to Russia. In addition, the
office provides information to Russian entrepreneurs and establishes contacts between
Russian and Dutch entrepreneurs who are active in horticulture.
Import tariffs
Certain products are subject to import tariffs. Meat imports that fall within the set import
quota attract an import duty of 15%. Imports of products in excess of the quota are
subject to duties varying between 60% and 80%. Some products, such as sugar, are
taxed at extremely high rates.
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Economics Department/Sector Research, September 2007
Russia
Certificates
Food and beverages that are exported to Russia must be accompanied by a certificate
confirming that the products have been tested and meet Russian food safety
standards. Institutions that issue such certificates must be recognised by the Russian
Federal Agency for Technical Regulation and Metrology (FATR).
Some products are subject to further requirements in addition to the aforementioned
mandatory certification. The ‘Federal Service for Veterinary and Phytosanitary
Supervision of the Ministry of Agriculture’ is the body responsible for food products.
Dutch companies are investing in Russia
Opportunities for foreign investors
Russian demand for agricultural and food
machinery and equipment increasing
Due to the reform and modernisation in the food industry, there
is a large demand for machinery and equipment. In the
agricultural sector the demand for modern machinery is also
significant, but supply is lagging. By 2006, Russia had 572,500
tractors (shortfall of 36%), 156,600 harvesters (shortfall of
48%), 40,300 forage harvesters (shortfall of 37%), 199,100
cultivators (shortfall of 47%) and 248,200 seeders (shortfall of
32%). Annual demand for new agricultural machinery and
equipment is estimated at USD 3.0-3.5 billion. As financing in
the agricultural sector remains a major problem, commercial
leasing has become an important alternative financing tool.
Two trends are visible in the Russian food industry. Firstly, a consolidation process is
taking place, and smaller companies are being bought by the larger players. Secondly,
the sector is undergoing vertical integration, with processing companies acquiring
interests in their suppliers.
Due to the rapid growth in the food market, the Russian food industry is in great need
of investment, both on a small and large scale. Many production processes are
obsolete and are incapable of meeting the rapidly rising demands in terms of both
quantity and quality. About half the production facilities in the food industry are ripe for
replacement and only an estimated 20% of all facilities meet international norms. The
Russian government has made an effort to improve the investment climate, but
The increase in disposable income has resulted in higher
demand for more variety in food products. The domestic
poultry sector, for example, has seen explosive growth of 1517% per annum due to stimulation by the Russian government
in the form of soft loans. The domestic industry is incapable of
meeting the huge demand for equipment and machinery from
the poultry sector and is unable to compete with foreign
suppliers, which can offer a full range of higher quality
products. This offers opportunities for Dutch companies to
supply the Russian market with high-quality machinery and
equipment.
investments are mainly being made in the energy sector and raw material sectors,
while investments in the Agrifood sector are lagging.
Opportunities abound for foreign companies interested in investing in Russia. It is
therefore not surprising that foreign investments in Russia have risen sharply since
1999. The best prospects for investments within the food sector are offered by the dairy
sector, the poultry sector, the beverages sector and the confectionery sector.
Source: U.S. Commercial Service, Agrarisch Dagblad
Dairy sector
The dairy industry is the least developed branch of the Russian food industry.
Productivity is very low and the sector is inefficiently organised. Dairy production fell
particularly sharply after the collapse of the Soviet Union. Milk production has not
increased in recent years and is unlikely to show growth in the near future. As
previously noted, the Russian market for dairy products is growing fast. Russians
traditionally consume a lot of dairy products and the expanding range of choices gives
the market great growth potential.
The most important Russian dairy player is Wimm-Bill-Dann. Foreign companies that
have invested in local dairy factories are Danone, Ehrmann, Arla and Campina.
Poultry sector
The poultry sector constitutes the most important sub-sector in the Russian Agrifood
industry. Demand for poultry products is set to increase further in the coming years.
Russia imposes quotas on meat imported from abroad and strict veterinary
requirements are in force. An increase in domestic production is therefore necessary to
meet demand. There are plentiful opportunities for Dutch companies to invest in
Russian poultry processing companies.
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Beverages industry
Within the beverages sector, the beer market holds the greatest potential for the
coming years. The beer market currently accounts for about 40% of the total alcoholic
drinks market in Russia. Beer consumption is increasing at the expense of vodka,
which is set to experience a decrease in demand in the coming years.
The most important beer brewers and their beer brands are: Baltika with Baltika 3
Klassicheskoye, Sun Interbrew with Klinskoye and Ochakova Moscow Beer, and
Softdrinks Enterprise with Ochakova. Heineken is the third-largest brewer in Russia
with a market share of 15%.
In the soft drinks category the consumption of fruit juice is rising rapidly. The Russian
company Wimm-Bill-Dann (with a subsidiary in the Netherlands) is the largest producer
of fruit juices followed by Lebedyansky and Multon. Jointly, these companies hold
about 75% of the total fruit juice market. Growth in this market is being achieved thanks
to a modernised and increased production capacity, but the marketing of fruit juices
has also improved compared to the past. Russians’ growing health consciousness is
another factor boosting demand for fruit juices.
Confectionery
The confectionery sub-sector is experiencing rapid growth. Russians traditionally have
a sweet tooth. Russia is Europe’s fourth-largest market for confectionery in terms of
size and has already attracted many western investors. More than half the market is
dominated by foreign companies. Nestlé and Mars are examples of western producers
that have established a presence in the Russian market.
Advisory organisations
There are also opportunities for advisory organisations in the field of technical advice
and project development in the agricultural sector. There is a lack of experience in this
field and the demand for knowledge of new-build projects is strong. Advisory
organisations that open locations in Russia can respond quickly and efficiently to this
demand.
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Economics Department/Sector Research, September 2007
Russia
Chapter 7: “Doing Business is People’s
Business”
In this chapter we have included interviews with a number of Dutch companies active in
the Russian market to place the findings of the report in the perspective of the day to
day reality of doing business with Russia.
We thank the representatives of these companies for their time and willingness to
participate in these interviews. We are convinced that their expressed views constitute
a valuable contribution to this report.
In this context we would also like to thank the interviewers, Mrs. Mar Oomen and Mr.
Joep Auwerda, who made these interviews possible.
1. Campina in Russia:
‘Ask for support from the local authorities’
‘Establish a good relationship with the local authorities’
If you want to set up a business in Russia, first you have to establish a good
relationship with the local authorities. This is the advice of Bob Steetskamp, who for
two years has been Campina International’s managing director for Russia and the
former Soviet states. And, he adds, it’s best to do business the Russian way. There are
a lot of restrictions initially, but ultimately anything’s possible.
Over seven years ago, in 2000, Campina built a dairy plant 80 km south of Moscow in
the city of Stupino. It was a ‘slimmed-down’ operation, as Steetskamp describes it,
speaking from Moscow. With 80 employees and one yoghurt line to ‘limit the risks’.
Now the company has 400 staff and there are three yoghurt lines, two ‘dairy drinks
lines’ and a ‘coffee cup line’. Steetskamp: ‘We’ve designated Russia as Campina’s
fourth home country. The other three are the Netherlands, Belgium and Germany,
where 70 percent of our turnover is generated.’
In 1992, Campina began exporting yoghurt from Germany to Russia. That developed
very favourably: every year more trucks full of yoghurt travelled east. Until the rouble
crisis hit in 1998. From then on Campina sold nothing at all to the former East Block
country. Steetskamp: ‘Exports fell to zero. Then we decided to launch our own
production operation. Given the financial crisis, this was an extremely courageous
decision. But everyone realised there were also significant opportunities for Campina.
The home markets were saturated, so in order to grow, we had to go abroad. It was a
logical step to expand our activities in Russia given that our success with exports had
proven there was a market for Campina products there. Moreover, Russia is relatively
close, it is a big country with a huge potential for growth.’
Enormous sales market
It quickly became clear that we had to build the plant near Moscow. With 16 million
inhabitants, the region is an enormous sales market. And there is enough good quality
milk in the area. There were various large cattle farms, Steetskamp explains; former
kolkhozes with 1,000 to 1,600 cows. The choice was made for the city of Stupino, a
former military and industrial city where unemployment was high due to the collapse of
industrial activities. ‘When we started, the only entertainment was a petrol station
where you could buy a beer. Now it’s a thriving city with shops and restaurants, and
39
Economics Department/Sector Research, September 2007
Russia
unemployment has fallen to zero. The local authorities have done their best to attract
foreign investors. The governor of the region made a personal effort. Without the
support of the local authorities, we wouldn’t have made it. We would never have been
able to comply with all the bureaucratic rules that are so typical of Russia.’
The region’s farmers were also pleased with Campina’s plans. When the Soviet
economy ground to a halt, so did the agrarian sector to a large extent. The farmers
were happy to supply milk to the Dutch plant. However, things didn’t always run
smoothly. Steetskamp: ‘The Russians were and are very adept at breeding cows but
the quality of their milk was poor. The milk wasn’t refrigerated, for instance, and there
were problems with hygiene. This prompted us to set up a development programme
and train people locally. We gave the farmers favourable loans so they could install
cooling tanks. Now there are around 16 farms in all, which supply us with a total of 200
tonnes of milk a day.’
Campina in Russia is not a cooperative, as is the case in the Netherlands and the rest
of Europe. Instead, the milk is purchased from the suppliers. The company in Russia is
an LLC and a wholly-owned subsidiary of Campina, which leases the land the plant is
built on from the Russian government for 49 years. The staff are nearly all Russian,
with only three expats among the 400 employees. Initially, there were more Dutch and
Germans on site, primarily to supervise the Russian staff, but they have since left.
‘Business must be conducted with Russians by Russians,’ says Steetskamp. ‘And it
should be conducted the Russian way. In other words: nothing is a given, but anything
is possible. You have to be flexible. Including when it comes to credit terms. We can’t
require a client in Vladivostok to pay within the same timeframe as one in Moscow –
our products take a lot longer to get there. And in fact the payment morals in Russia
are an important point of attention. We need to be careful with credit limits, so if an
invoice remains unsettled for too long, we need to get right on it. And we won’t make
another delivery until the last invoice has been paid.’
Red tape is the biggest headache
Some tips...
The biggest problem in Russia continues to be bureaucracy and regulations. Every
product has to be inspected and certified. Every new investment must be reviewed by
1. If you want to set up a business in Russia, first you have to
establish a good relationship with the local authorities.
the local authorities. If a new machine has been purchased, it can only be used if the
2. Business must be conducted with Russians by Russians,’
and it should be conducted the Russian way.
machine produces is required to undergo extensive certification before it is sold.
3. Be careful with credit limits.
comes to this, the law is very complex. But there are plenty of people in Russia who
authorities have checked it for safety, hygiene and so on. And every new product the
Steetskamp: ‘If you don’t comply with the rules, production can be shut down. When it
can advise you on such matters.’
... and some comments.
Campina would greatly benefit if Russia joined the WTO. Ninety percent of Campina’s
sales are generated locally and 10 percent are imported. Imports are subject to an
• The biggest problem in Russia continues to be bureaucracy
and regulations.
even more complicated procedure. ‘For instance, they want to know the origins of the
• Campina would greatly benefit if Russia joined the WTO.’
regulations are harmonised, we can supply products to Russia that are accepted under
• Russia will be the largest food market in Europe in 2010.
European regulations.’
raw materials in every product, which is sometimes unfeasible for us. If the laws and
Despite the quirks involved in doing business in Russia, the plant in Stupino was an
excellent investment. It is showing profitable growth. And the market for Campina
Website
www.campina.com
products – ‘products with added value’ – is expanding. Russia will be the largest food
market in Europe in 2010, Steetskamp predicts. Russian consumption patterns are
very similar to those in Europe, particularly in comparison to Asia. That makes Russia
very attractive. ‘In Russia, they eat cheese sandwiches too.’
40
Economics Department/Sector Research, September 2007
Russia
2. Jørgen de Ree, Managing Director of De Ree Holland BV
‘The Russians are loyal, reliable customers’
Sometimes he receives a simple letter from a consumer in Siberia, addressed equally
simply to: De Ree, Lisse, Holland. ‘The tulips have come up beautifully; you supply
good bulbs.’ Apart from demonstrating that the Dutch postal services can still find an
address without a postal code or even a street name, Jørgen de Ree, managing
director of De Ree Holland BV in Lisserbroek, likes to recount this anecdote chiefly to
show that his products can cope in temperatures of minus 15° Centigrade. Provided
they’re planted deep enough, that is.
De Ree Holland hasn’t been active in Russia for long – only since 2000 – yet Russia
has already become an important market for the Dutch bulb exporter. Jørgen de Ree:
‘We export to 35 countries and Russia has climbed to fourth place. The United States,
UK and France are in first, second and third place respectively, and they each take
roughly the same volume of goods from us. The other top ten countries are Germany,
Canada, Sweden, Austria, Switzerland and Norway.’
De Ree’s Russian sales account for approximately EUR 5 million. In 2006/7, all the
Dutch bulb exporters together posted a turnover of EUR 18 million in Russia. This
illustrates how important Russia is for De Ree. ‘It may not happen in the first ten years,
but I’m firmly convinced that the Russian market will become just as important for the
bulb sector as the American market.’ On his office desk stands a bottle of vodka. The
label features a photo of Jørgen de Ree together with the words The Best Partner. It
was a gift from a good customer whom he looked up in Moscow just a week before
giving this interview. While he was out there, Jørgen became more convinced than
ever that Russia is becoming a consumer economy like the West. ‘I visited an
enormous supermarket at ten o’clock at night and there were at least 15 people
queuing at each of the 100 checkouts. Just think of that: 1,500 people all ringing up
their purchases, with 5,000 additional customers walking round the aisles. It looked like
someone had announced happy hour.’
‘Initially we thought that Russian consumers would only really be interested in our
cheaper lines. But that’s not the case at all. In fact, our high and medium-priced bulbs
are the first to sell out. Russia takes as much of our most expensive and luxurious
products as the rest of Europe. As an exporter, you’ve got to understand what people
want. Don’t think you can simply fob the Russians off with lower quality goods if they
haven’t asked for them. They know what quality is, and they won’t settle for anything
less. That’s my number one tip: make sure you deliver quality.’
Get yourself a good website
In fact, Jørgen de Ree didn’t have to do much to attract customers in Russia: they
came to him. ‘In 1999 and 2000, we knew that we were supplying to Russia through a
German and a Polish distributor. But we didn’t know exactly who we were supplying.
We found out when they came and looked us up. The Russians always want to go
directly to the source. I would estimate that in the past couple of years we’ve had
around 25 potential Russian clients visit us. Nine eventually placed orders. You can
often identify the serious customers as soon as you meet them. To begin with, they
take the trouble to make an appointment; they don’t just drop in. You very soon notice
that they haven’t got much time and have no problem meeting our payment conditions,
which is settlement in full prior to delivery. I won’t do business with would-be customers
41
Economics Department/Sector Research, September 2007
Russia
who aren’t prepared to meet those terms. Serious potential business partners usually
come well prepared. They’ve done their homework on the Internet and elsewhere. So
that would be my second tip: get yourself a good website: one that’s transparent, up-to
date and in English; it doesn’t have to be in Russian.’
De Ree was incidentally cautious before doing business with his new customers. Just
as his prospective clients conducted research on his company, he also investigated
them. For that, a network in Russia is crucial, and it can often be built up simply by
visiting the right trade fairs in Russia. De Ree: ‘I’ve always been able to talk very openly
with the Russians at these fairs, because I’m very open about my own company.
They’re happy to share their knowledge.’
The Russians, says De Ree, are reliable, loyal business partners who aren’t going to
switch to a competitor just to save one tenth of a per cent. They understand that
everyone in the chain from grower to consumer has to get their fair share. Loyal
customers of De Ree with a proven track record of creditworthiness can often pay only
half the invoice in advance and the rest 14 to 30 days later. ‘Sometimes I’ll be happy
with a fax for a banker’s order, and so far, I’ve never been let down. Once or twice,
though, I’ve had to postpone a delivery until the funds have cleared.’
Russians are just like the Dutch
The Russian way of doing business is very similar to that in the Netherlands. De Ree:
‘In terms of directness, they’re just like us. They may appear a bit more surly at first, but
they can become very relaxed once you get to know them better. They’re also efficient
and keen to learn. For instance, one of our Russian customers had registered 50
complaints about our shipments. That was an awful lot, especially when you consider
that the total number of complaints we’d received from all 35 of the countries we export
to came to just 85. When I visited the customer to look into the matter, we found that
Some tips...
only two complaints involved substantial amounts. He was a bit embarrassed about this
and immediately told his secretary to raise the lower limit of complaints.’
1. Make sure you deliver quality.
2. Get yourself a good website: one that’s transparent, up-todate and in English; it doesn’t have to be in Russian.
3. When you go to Russia, take a mobile phone with you,
because if you don’t you’ll be completely stuck.
‘It’s well known that the Russians can sometimes be rather blunt and like to hammer
their fist on the table for what in our view was no apparent reason,’ says De Ree. One
of his customers once did this, even though De Ree only speaks two words of Russian
(‘yes’ and ‘cheers’) – and he noticed that the female interpreter was leaving many
phrases out of her translation so as not to upset him too much. ‘She knew her boss
… and some comments
didn’t need to take things to that level, and everything worked out fine in the end.
• Russia is becoming a consumer economy like the West.
background, but in fact they often hold very senior positions with lots of responsibility.
• Russian businesswomen really are the top. They seem to
beaver away quietly in the background, but in fact they
often hold very senior positions with lots of responsibility.
What’s more, they’re perfectionists.
What’s more, they’re perfectionists. I’ve got at least three Russian companies as clients
Russian businesswomen really are the top. They seem to beaver away quietly in the
with all-woman management teams – and they’re a joy to do business with.’
De Ree’s third and final tip is this: ‘When you go to Russia, take a mobile phone with
Website
www.deree-holland.nl
you, because if you don’t you’ll be completely stuck. When I’m in a taxi with a driver
who speaks no English, I’ll call the hotel reception and ask them to explain where I
want to go. And don’t forget: the traffic in Moscow is so often gridlocked that you can
usually only manage one or two appointments a day.' That’s the downside of the ‘new,
open, liberal West’.’
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Economics Department/Sector Research, September 2007
Russia
3. Mammoet in Russia
A good business contact is based on friendship
Even if you or one of your employees speaks impeccable Russian, you need to hire a
native if you want to do business in Russia. This is the firm belief of Roderik and
Patrick van Seumeren, president and vice president of the Schiedam-based company
Mammoet, which specialises in solving heavy lifting and transport challenges. Patrick
van Seumeren: ‘Only a Russian knows the language and culture so thoroughly that he
(or she) can help you manoeuvre through all the rules and regulations.’
Mammoet (the Dutch word for mammoth) is a specialist in moving – ‘both vertically and
horizontally’ – any large structure including factories, bridges, refineries, drilling
platforms, reactors and, of course, submerged submarines. In 2000 Mammoet
managed to successfully salvage the Russian submarine Kursk. Roderik van
Seumeren: ‘This gave a tremendous boost to our reputation in Russia. My brothers
were personally decorated by Putin himself. The salvage operation was extremely
important to Putin, who had promised Russia that the drowned marines would be
properly buried.’
Roderik and Patrick are cousins. Over 40 years ago Jan van Seumeren, Roderik’s
father and Patrick’s grandfather, laid the foundation for Mammoet with Van Seumeren
Kraanbedrijf SKB. The company has since grown to become world leader in its sector
and employs around 2,500 people in over 50 countries. In Russia, Mammoet has
operations in Moscow; on the island Sakhalin off the Russian east coast north of Japan
and in Saint Petersburg. ‘Of course we are also present in some former Soviet states
like Kazakhstan, Azerbaijan and Turkmenistan,’ Roderick van Seumeren explains while
sitting in his office in the middle of the office block on the Schiedam port, with a view of
several sky-high red cranes with the mammoth logo.
Two major orders a year
It all started back in the early 1990s with the purchase of a Russian crane. The Van
Seumerens met the Russian Slava Zakharov, who was then a crane sales
representative and is now Mammoet’s managing director in Russia. Shortly thereafter
Mammoet was awarded a contract for the construction of the Olympic stadium.
Mammoet opened a branch office in Moscow and quickly established a joint venture
with Staal Constructia. Roderik van Seumeren: ‘Slowly but surely we developed a
name and gained increasing trust. The Russians saw what we could do, we were given
increasingly large orders and then the Kursk sank. Now we have an average of two
orders a year, primarily in the oil and gas processing industry. For example, we
transported an entire factory for both Shell and Exxon to Sakhalin.’
The Van Seumerens may not say it directly, but without the help of their current
managing director they wouldn’t have got to where they are in Russia. And if the Van
Seumerens hadn’t dedicated as much time to the relationship with the managing
director, he wouldn’t have offered to help them. According to Patrick van Seumeren, it’s
all about gaining trust, which doesn’t happen by itself. Patrick van Seumeren:
‘Russians have been oppressed all their lives. They’ve always had to watch what they
say. They couldn’t speak freely because an eavesdropping colleague might be a KGB
spy. At the same time, they are very emotional people. In order to gain their trust you
have to talk a great deal, explain, tell, communicate and, of course, drink – a lot.
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Economics Department/Sector Research, September 2007
Russia
For traditional Russians – like their managing director – a good business contact is
based on friendship, brotherhood, mutual enjoyment of a successful project. This
means there is one person at Mammoet in the Netherlands – Patrick van Seumeren –
who maintains the contacts with the Russians. While the Mammoet office in America
contacts the appropriate department for each specific problem, the Russians only call
Patrick. And they call him for everything, from a flat tyre to a broken crane, which is
also typically Russian. ‘Every day I get calls about little and big things, the contact is
very intensive. And they always feel their problems should top the list. They don’t much
care that I’m busy signing a multi-million contract. They should come first.’
Russians are unfamiliar with depreciation
Another noteworthy fact about Russians is that they don’t think much ahead. Perhaps
because Russia is a former communist country. In any case, many decisions are taken
ad hoc. And they are unfamiliar with depreciation. ‘How do you buy a new crane,’
Patrick van Seumeren once asked a Russian colleague. ‘That’s your job,’ was the
response. An attitude reminiscent of life under communist rule. Some time ago the Van
Seumerens wanted to sell two used cranes and two old trucks. But this wasn’t allowed
because these items were considered ‘capital under the articles of association’. In
order to carry out the sale, the articles of association would first have to be amended.
Van Seumeren: ‘These types of rules are starting to change. As is tax legislation.
Taxes on profits used to be so high that you ended up in the red. That’s no longer the
case. And they’ve got more realistic about granting permits.’
Some tips...
Patrick van Seumeren explains that, until recently, it took six months to get a permit for
special transport but the delivery date was often just two months away. Van Seumeren:
1. Even if you or one of your employees speaks impeccable
Russian, you need to hire a native if you want to do
business in Russia.
‘That meant you had to be really creative.’
2. It’s all about gaining trust, which doesn’t happen by itself. In
order to gain trust you have to talk a great deal, explain,
tell, communicate and, of course, drink – a lot.
The nouveau riche
3. Only carry out a project after you have the money in hand.
guarantees or LCs. ‘It’s coming though.’ And Russians prefer to pay in dollars. ‘But the
Mammoet only carries out a project after it has the money in hand. ‘Incidentally,’ Patrick
van Seumeren adds, ‘Russians always pay up.’ The company doesn’t work with bank
euro is quickly gaining ground.’ As far as the Van Seumerens are concerned, Russia
... and some comments
doesn’t necessarily have to join the WTO. ‘We already know how everything works in
Russia, which gives us a competitive edge.’
• For traditional Russians, a good business contact is based
on friendship, brotherhood, mutual enjoyment of a
successful project. The nouveau riche on the contrary
aren’t interested in helping you, they’re very impressed with
themselves, they’re only interested in dollars.
• Russia doesn’t necessarily have to join the WTO. ‘We
already know how everything works in Russia, which gives
us a competitive edge.’
• The Russian economy is still growing and for now, the
possibilities seem endless.
Roderik and Patrick feel Russia has changed a lot over the past ten years. Particularly
as a result of the emergence of the ‘nouveau riche’, as they call the 30 and 40somethings who have gotten very rich very quickly. Their mentality is very different from
that of the older generation. Patrick van Seumeren: ‘The nouveau riche aren’t
interested in helping you, they’re very impressed with themselves, they’re only
interested in dollars.’
The differences between urban and rural areas have also increased, particularly
between Moscow and the rest of Russia. Meanwhile, Moscow has become the most
expensive city in the world.
Website
The Van Seumerens don’t yet know what their future plans are in Russia. Roderik van
Seumeren: ‘Our ambitions are undefined. We’re staying in any case. We have some
www.mammoet.com
big Russian clients and the Russian economy is still growing. For now, the possibilities
seem endless.’
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Economics Department/Sector Research, September 2007
Russia
4. Ottevanger Milling Engineers is successful on the Russian
market
In 2009 it will be precisely a century ago that Dirk Ottevanger, a miller’s son, founded a
regional windmill manufacturing company, laying the foundation for Ottevanger Milling
Engineers BV. This globally operating company is located in Moerkapelle, not far from
the windmill that once belonged to Dirk’s father. This company, with over 60
employees, designs and manufactures large machinery for the grain processing and
animal feed industry. It took on its first Russian projects back in the early 1990s.
Ottevanger is currently involved in five projects and has successfully completed 15
ventures, many of them of major size.
Dick Ottevanger is third generation and no longer the company’s chairman, but is still
closely involved. He has been to Russia at least 20 to 25 times on business. ‘It’s not an
easy place to work, but certainly not an unpleasant country either. Culturally, the
Russians aren’t so very different from us. I think the Asians, for example, are much
harder to fathom. You can more easily build up a close – at times even friendly –
relationship with Russians. Anyone wishing to do business there must take their time. I
remember one of my first visits when I was invited for a birthday celebration where
drink was flowing freely. The Dutch wouldn’t have been so quick to include a business
associate.”
A reference makes all the difference
Ottevanger Milling Engineers started its pioneering work in Russia in 1989 and 1990
when opportunities for foreign companies improved. Dick initially focused on winning
contracts via a government agency that had contacts with state-owned companies.
“The agency wanted to promote us, but nothing came of it. We still have a staff
member in Moscow, Nicolaï, who worked for the now defunct agency.”
For the very first project, which was carried out in Lindovskaya in 1994 and 1995,
Ottevanger was approached by Euroconsult in Arnhem. Euroconsult was working on
the Eastern Europe Cooperation Programme for the Agency for International Business
and Cooperation, a branch of the Dutch Ministry of Economic Affairs. Ottevanger: “In
any market completing your first project is good for your reputation. It gives you a
reference. That makes a huge difference.” In 1995 business appeared to be picking up.
Ottevanger: “Stork’s Peja Export BV, which had hundreds of people working in Russia
and did a lot of business with state-owned companies, closed its doors. Ten people
kept the branch office going and approached us. Which brings me to our most
important tip: make sure you have an agent in Russia who is active in the local market
or you won’t get anywhere. Once we had a serious agent, our business in Russia got
off the ground.”
Rouble crisis
Unfortunately, Ottevanger’s success was short-lived as the rouble crisis threw a
spanner in the works in 1998. “Big projects were scheduled but they all fell apart.
Business didn’t pick up again for another five years.” And that highlights Ottevanger’s
second tip: have patience and staying power; both are indispensable.
At times, Dick Ottevanger flew specially to Russia to sign a contract with a business
partner. Upon arrival he occasionally discovered something had gone amiss with the
permits, or the client had key questions about the quote. Sometimes he came home
45
Economics Department/Sector Research, September 2007
Russia
empty-handed. Other times, the issues were resolved. And there were also instances
that the competition managed to steal the contract out from under them.
Tip three: “You’re often well-advised to work with women in Russia, who can be more
serious than the men. They are keen workers, often have a good command of foreign
languages and are well-educated. It’s clear that there has always been a large
proportion of females in the Russian workforce.”
Erik Ottevanger, manager of the Moerkapelle branch (fourth generation and Dick’s
son), doesn’t have to think long before remembering a project in Russia that didn’t
quite go according to plan, to put it mildly. “I remember quite well that the client put a lot
of pressure on us to deliver on time. So we did. Then it emerged that the Russians
hadn’t done anything to prepare the location where the plant was to be built. There was
nothing at all, not even a hangar to store the goods. For two winters our equipment was
buried under a thick layer of snow. That made it difficult to get it up and running again;
the worst part was figuring out which electrical components had broken down. Then
there were endless discussions about the extra costs. We had to prove that the
problems with the equipment were the result of being left outside. The client probably
wasn’t all that interested in this project. It was a gas company that had invested in the
agricultural sector under pressure from the Russian government.” We were, however,
paid without a problem. As has been the case with nearly all Ottevanger’s Russian
clients, this gas company paid the entire purchase price up front.
Some tips...
Trusting
1. Make sure you have an agent in Russia who is active in the
local market or you won’t get anywhere.
2. Have patience and staying power; both are indispensable.
3. Work with women in Russia, who can be more serious than
the men. They are keen workers, often have a good
command of foreign languages and are well-educated.
Erik: “Normally, we don’t design and manufacture the equipment until we’ve been paid.
In a limited number of cases, we allow a 10 percent down payment with the remainder
covered via a letter of credit. In such cases, a large percentage is due upon shipment
and the rest three to four months after delivery. But we only do this if we have a very
solid relationship with the client and we are nearly sure they can pay. We’ve never had
payment problems with the Russians. It is often very difficult for Russians to get a bank
... and some comments
• In any market completing your first project is good for your
reputation. It gives you a reference. That makes a huge
difference.
• In a limited number of cases, we allow a 10 percent down
payment with the remainder covered via a letter of credit. In
such cases, a large percentage is due upon shipment and
the rest three to four months after delivery. But we only do
this if we have a very solid relationship with the client and
we are nearly sure they can pay.
guarantee. Usually they can get an LC, but the amount may be limited. One of our
customers wasn’t able to procure an LC for three million euros. So we allowed them to
arrange three successive LCs for one million euros each. Another noteworthy fact
about Russians is that they are very trusting. Sometimes they pay us 600,000 to
800,000 euros in advance for a project and never ask for a bank guarantee even
though we could easily arrange one. Something could actually go wrong on our end,
but the Russians don’t lose much sleep over it.”
Ottevanger has numerous success stories in Russia. For some three million euros,
entire feed plants were set up for a Russian chicken producer listed on the London
exchange. Erik: “It went very well, despite a slight postponement of the delivery date.
But that’s actually common in Russia. Russians are capable of a great deal, are well-
Website
www.ottevanger.com
educated and have a high opinion of themselves, but their organisational skills are
lacking. They’re frequently overoptimistic in their planning. Getting permits often takes
a great deal of effort. We leave that to the client, who routinely hires a local project
agency.”
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Economics Department/Sector Research, September 2007
Russia
5. Gebroeders Van den Berk B.V.
‘With patience and respect, you can do good business in Russia’
Why does Russia have so much bureaucracy? Why do new, seemingly avoidable,
practical problems arise every day? These are questions you often hear from Dutch
entrepreneurs gaining their first trade experiences in Russia.
Russian-born Svetlana van Son, who has lived in the Dutch province of Noord-Brabant
since 1996, works for Boomkwekerijen Gebroeders Van den Berk in the town of SintOedenrode. She is an advisor and sales manager for the Russian market, on
permanent contract since 2005. Before that she worked as a freelancer, translating
brochures and other documents for Van den Berk.
Commenting on the frustrations experienced by Dutch businesspeople she says: ‘It
works best if you have patience and respect for Russian customs and practices. You
shouldn’t try to understand everything; some things won’t make sense. If a deal with a
Russian client seems to be more or less finalised and the client then goes silent for
weeks on end, don’t get emotional,’ she says. ‘Keep your cool. Consider it from a
rational, business perspective.’
‘It’s not so difficult to do business if you don’t buy into all the talk and stories about
fickle Russians who are incapable of planning and said to be incredibly curt and
stubborn. Just be yourself and draw your own conclusions. Not only do countries differ,
so do people. You might run across Russians who are more Dutch than the Dutch. And
vice versa: Dutch who more than fit the cliché image of the curt Russian.’
130-year-old plane tree
Svetlana speaks fluent Dutch; at most you’ll hear a pleasant Flemish accent as she
learned the language in Belgium. She started out as a German and English teacher, a
legal interpreter and certified translator. Pieter van den Berk, an engineer, is the
general manager of the family-owned business. Its beautiful, vast plantations, where
thousands of trees are cultivated, are reminiscent of a park. Van den Berk is
specialised in street and park trees as well as ornamental shrubs. The nursery can
deliver over 800 varieties of trees and shrubs and excels at somewhat larger and older
trees. Pieter van den Berk: ‘We have a huge plane tree that’s over 130 years old and
even a batch of Taxus bonsai that have been looked after for over 100 years. You can
buy trees from us that cost to EUR 30,000 and are so big you can only fit one in a huge
truck.’
Pieter: ‘During our 2002-2003 financial year we completed our first real sales
transaction with a Russian client we met at the German IPM Essen trade fair. It’s still
an important fair for us, as is Moscow Flowers. Now we have quite a few Russian
clients; it’s an important market for us, which is why we work with Svetlana.’
Svetlana: ‘We are often approached at trade fairs by Russians who are eager to set up
a joint venture, even before they’ve purchased anything from us. In the case of a joint
venture they usually want us to furnish the capital and products, while they provide
knowledge of the local market.’
Pieter: ‘This doesn’t interest us just now. I consider the cultural differences too great for
this type of venture. We recently set up a nursery in Germany. It is a neighbouring
country, but the differences with the Netherlands are significant. Moreover, Russia’s
climate isn’t as suitable for a nursery.’
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Economics Department/Sector Research, September 2007
Russia
Solid market research is key
Svetlana: ‘Our first tip: anyone interested in doing business in Russia should seek
advice from Dutch people with experience in Russia and Russians familiar with Dutch
pitfalls.’
Svetlana: ‘Tip two: do thorough market research at trade fairs, on the internet, and by
following the Russian trade press. Make no mistake: Russians are very familiar with
western products. They’re price conscious and are quite capable of assessing the
quality of merchandise. They have more and more money to spend, they travel a lot,
they know what’s for sale in the world.’
Pieter: ‘We still have our very first client. That’s the delightful thing about doing
business in Russia: the moment someone becomes a client, they’re a true client. They
seriously examine the company they’re getting involved with, and don’t jump to a
competitor for any little thing. It may take a little longer to build trust, but once you have,
it’s unwavering.’
Svetlana: ‘There’s a Russian saying: if you take your time to properly harness a horse,
he’ll ride fast. You need to thoroughly prepare and cultivate good relations.’
Of course this doesn’t mean everything will go perfectly. Pieter: ‘We once met with a
potential Russian client who seemed to have everything in order. We were lavishly
received, given a video presentation of the company, lots of grandstanding. The man
was an incredible show-off but, in practice, not a good trading partner. So we walked
Some tips...
1. Anyone interested in doing business in Russia should seek
advice from Dutch people with experience in Russia and
Russians familiar with Dutch pitfalls.
away.’
‘Another time a group of Russians came to our company who were interested in placing
a sizeable order for birch and fir trees. It was July so I said: these trees are still in full
bloom and it doesn’t make sense to deliver them in August because they might not
2. Do thorough market research at trade fairs, on the internet,
and by following the Russian trade press.
survive. But they were in a hurry. I turned down the deal and they bought their trees
3. Don’t talk about politics. The Dutch applaud perestroika,
but Russians might feel differently.
inform your clients.’
elsewhere. Indeed, the trees died and they came back to us. It’s important to properly
Put clear agreements in writing
... and some comments.
• Not only do countries differ, so do people.
• The moment someone becomes a client, they’re a true
client. They seriously examine the company they’re getting
involved with, and don’t jump to a competitor for any little
thing. It may take a little longer to build trust, but once you
have, it’s unwavering.’
• It works best if you have patience and respect for Russian
customs and practices. You shouldn’t try to understand
everything; some things won’t make sense.
Svetlana: ‘Russians like trees with colourful leaves. They also like large crowns. But big
crowns mean a lot of water evaporation so it’s best to trim back the crown prior to
transport. Sometimes you need to thoroughly explain that to people.’
Pieter: ‘Everything should be crystal clear. For instance, we explain in no uncertain
terms that it can be a problem if the trees are picked up from us later than scheduled,
even if they’ve been paid for in advance as is the case with 90 percent of Russian
clients. (Ten percent – these are longstanding Russian clients – have a credit limit.) If a
lot of trees are picked up late, quality can be lost. You need to thoroughly explain such
things in advance and put it all in writing. If you don’t, your Russian partner might
misinterpret. Communication is a challenge. Such misunderstandings are often
inadvertent and due to inexperience. Svetlana always accompanies me to meetings
Website
www.vdberk.com
with Russian clients. This is an enormous help. It’s not just the language barrier, but
the cultural subtleties, which she understands perfectly.’
The third and final tip comes from Pieter: ‘Don’t talk about politics. The Dutch applaud
perestroika, but Russians might feel differently.’
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Economics Department/Sector Research, September 2007
Russia
6. For Econosto, Russia is a top market in the making
Econosto is still a relatively new player in the Russian market. And yet, this wholesaler
in valves and seals landed a contract in May 2006 to supply all the seals – a total of
18,000 – for the construction of a new oil refinery in Saint Petersburg. The order is
worth a whopping 40 million euros. Project manager Tim Hogervorst and financial
manager Otto de Vries are still amazed at how the negotiations proceeded. ‘It was like
being at an auction. We had to write figures on paper and wait out in the hall.’
It all started a few years earlier. Billionaire Vladimir Bogdanov, the owner of Russia’s
second-largest oil company Surgutneftegaz, wanted to construct a hydrocracker in
Kirishi near Saint Petersburg using the latest techniques. It was to be a plant where
hydrogen would be used to convert heavy distillates into diesel and kerosene, for
example. The international engineering firm ABB Lummus Global BV in The Hague
would provide the necessary technology, design the equipment and draw up a short-list
of western suppliers. Tim Hogervorst: ‘It took AAB years to land that contract.’
In order to realise the project, ABB organised several information sessions for suppliers
like Econosto and launched a tender round. Hogervorst: ‘Of course we listened very
closely to AAB and negotiated with them intensively. We realised that participating in
this project would be a wonderful way to gain access to the Russian market. Moreover,
this project would enable us to learn a lot about that market in a short period of time.’
De Vries: ‘Econosto was already doing business with Russian shipping companies and
we were working with Russian agents, but we didn’t yet have a strong foundation in
Russia.’
Econosto is a supplier of valves and seals. Seals are rings or discs of various shapes
and sizes that prevent leaks. Valves are like faucets or open-and-close-systems; these
can be heating faucets that cost a couple of euros or earthquake-proof sealant systems
that run into hundreds of thousands of euros. In the over 12,000 m² distribution centre
in Capelle aan den IJssel, the company has the largest European stock of DIN, ANSI
and JIS appendages, instrumentation, seals and hoses of its own brand as well as a
wide variety of products from international, renowned manufacturers.
An amazing atmosphere
For its Russian client, ABB was looking for a company that could supply all the valves
needed for the refinery’s equipment. This made Econosto an attractive candidate. It
was a major advantage to Econosto that the technical negotiations regarding the parts
to be supplied were conducted in the Netherlands with ABB. This meant all the risks
could be mapped out in detail. Hogervorst: ‘If we were awarded the contract, we would
officially supply to ABB, which would be the exporting party. They are responsible for
the technical equipment. Still, the big boss in Russia wanted to meet all the parties
involved. ABB was not to be involved in the commercial side.’
During the tender round, there were five major contracts to be assigned and three
similar companies in Russia were invited to bid per contract. Negotiations were
conducted with 15 companies over a three-day period, with each company represented
by four to five senior staff members. De Vries: ‘The atmosphere was amazing. We were
there with 15 companies that all knew one another in their market.’
According to Hogervorst and De Vries, the owner, Bogdanov, wants the refinery to be a
liberal organisation, ‘a professional global player that delivers the best products.’ De
Vries: ‘Bogdanov wants everything to run as cleanly and objectively as possible. Every
potential for corruption must be eliminated. Which is why he prefers to work with
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Economics Department/Sector Research, September 2007
Russia
Western companies. And we think it explains why he organised the auction in the last
phase of negotiations.’
Econosto’s biggest concern was the financial risks. It was determined at the beginning
that Econosto would not be paid until after delivery. As we went along, we managed to
cover all the risks with confirmed L/Cs.’
The red tape involved with the customs certificates continues to be bothersome. ‘You
have to dot all your i’s and cross all your t’s.’ In addition, every product Econosto
supplies to Russia must undergo a thorough technical inspection. Russia works with
different technical standards than the rest of the world. De Vries: ‘Even though we have
ABB as our contact, we still have to meet the Russian requirements. All our products
must be inspected by the authorities in Moscow, which takes six months. It would make
a big difference if Russia joined the WTO; if it harmonised its regulations with those of
other countries. We still consider this a learning experience. We’re getting to know a
great deal about the Russian market in a short period of time.’
A tip...
Physically present
One of the things Econosto has learned is that doing business in Russia is much easier
1. Doing business in Russia is much easier if you are
physically present. Then, it seems, anything is possible.
if you are physically present. Then, it seems, anything is possible. The Econosto group
has Russian-speaking staff and has opened a small office in Moscow. All kinds of
requests for products are now also coming from Russia. Occasionally Econosto is
... and some comments.
• The red tape involved with the customs certificates
continues to be bothersome. ‘You have to dot all your i’s
and cross all your t’s.’
• It would make a big difference if Russia joined the WTO; if
it harmonised its regulations with those of other countries.
• The Russians would rather do business with Western
companies than with Chinese or Indian firms. Sometimes
the motto seems to be “the more expensive the better”.
asked to enter into a joint venture with a Russian company. De Vries: ‘So far we
haven’t further explored any of these requests. They always involve companies that
spread their funds among a number of firms for tax purposes. Then, six months later,
they allow them to go bankrupt. The Russians were very open and honest about this.
They showed us exactly how they did it and let us see their accounts. Of course as a
listed company, we cannot take part in this type of thing, which perhaps limits our
options during this start-up phase.’
Nonetheless, according to Otto de Vries Russia could very well be a top market in the
making for a company like Econosto. ‘It is a very big country with an enormous market
and tremendous reserves. The Russians would rather do business with Western
companies than with Chinese or Indian firms. Products from China and India are taboo.
Sometimes the motto seems to be “the more expensive the better”.
Website
www.econosto.com
We hope we can also profit from all the current investments in infrastructure. In the
Netherlands, our market is limited; everything has already been built, everything is
finished. Here, we only supply replacement parts or upgrades. In Russia it’s about new
projects. Once they’re up and running, things move quickly.’
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Economics Department/Sector Research, September 2007