One PSA was offered to the French company Total as an inducement for it to undertake the development of the Kharyaga field in Timan-Pechora. According to the geologist John Grace, no Russian company seemed to be able to work with the poor quality oil in the field. The other two PSAs were offered in an effort to attract developers to the island of Sakhalin. The first PSA was signed in June 1994 with a consortium led by Royal Dutch Shell, which agreed in exchange to work the Sakhalin II offshore oil and gas fields. Because of the extreme weather, it is impossible to work there in the winter months. Shell agreed to put up 55 percent of the equity with two Japanese partners, Mitsui, which took 25 percent, and Mitsubishi, which took the remaining 20 percent. Notice that there were no Russian partners in the Sakhalin II project. By contrast, in the Sakhalin I consortium signed a year later, Sakhalinmorneftegaz was included with a 11.5 percent equity and Rosneft with 8.5 percent. But because they too lacked the technology and experience of working in Arctic offshore conditions, it was agreed that Exxon-Mobil would serve as the lead partner with a 30 percent share. The other partners were SODECO, a Japanese company with 30 percent, and an Indian company, ONGC Videsh, with the remaining 20 percent.19
The Russian government agreed to these PSAs with great reluctance and only because the authorities were so eager to halt the slump in petroleum and natural gas production. Russian oil companies, including Yukos and its owner, Mikhail Khodorkovsky, led the opposition to PSA concessions.20 He and some others viewed the offer of a PSA for a foreign company as a form of unfair competition. But with petroleum prices barely rising above $10 a barrel in 1999 and output 40 percent below its 1987 peak, the prospects for a recovery in petroleum and gas production were not very good. Thus as in times past, Russia was forced to make concessions to obtain the help it needed. However, in a repeat of history, as soon as it felt confident enough to operate on its own, it moved to invalidate those same concessions.
4
Post-1998 Recovery:
The Petroleum Export Bonanza
THE 1998 FINANCIAL MELTDOWN
The 1998 financial crisis hit Russia hard. There were obvious signs that the Russian fiscal system was in desperate shape, but at the time, few saw that a collapse was eminent.1 Indeed, the almost universal conventional wisdom was that Russia had successfully managed its transition from Communist central planning to market capitalism and that the future was bright. Many had come to believe that Russia had become the next Klondike. They urged investors to put in their money before share prices rose even higher! Only fools and anti-Sovietchiks could think otherwise. Typical were studies such as Anders Aslund’s How Russia Became a Market Economy, published in 1995, and Richard Layard and John Parker’s The Coming Russian Boom, published in 1996. Both appeared just in time for investors to buy in before the financial crash that followed shortly thereafter in August 1998.2 While the economy and its stock market have recovered significantly since then, there were many as we shall see who took their advice at the time and lost considerable sums as a result—in several cases, hundreds of millions of dollars.
It was easy to be misled. Bullish signs were everywhere. By October 6, 1997, the RTS index, the Dow Jones Index of the Russian Exchange, hit 571, an all-time high. That represented an almost fivefold increase over just a half dozen years. Investors who bought shares on October 31, 1996, in the Lexington Troika Dialog Russian Fund, which invested only in Russian companies, had a threefold increase in one year, a higher one-year return on their investment than stock market investors anywhere else in the world. Bankers in London, Frankfurt, and even New York trampled over each other to buy Russian stocks and lend money to Russian companies and government borrowers. Few could resist the frenzy.
What such analysts and investors chose to discount or ignore, however, was the deplorable state of the Russian economy. As of 1998, the officially reported GDP, as well as crude oil output, had fallen by 40 percent or more from its 1991 level. At the same time, there was also inflation. In 1992 alone, prices rose twenty-six-fold, and then more than doubled each year for a several years thereafter. By 1997, price increases had moderated to 11 percent a year, an improvement, but by most standards, still high. Overall, by December 1999, it took 1.6 million rubles to buy what 100 rubles could have purchased in December, 1990. Of course there wasn’t much on the shelves to buy in 1990, but be that as it may, this hyperinflation wiped out whatever savings most Russians had built up.
Nor did it look like inflation would be less of a problem in the future. How could it be, when the government was generating an immense deficit and growing debt each year? Few Russians were paying their taxes and those that made a payment rarely paid as much as they actually owed. Combined with inflation, the underpayment of taxes meant that each year the budget deficit grew larger, which in turn meant that the government had to borrow even more money.
By mid-August 1998, government authorities concluded they could not continue what, in effect, was “kiting their checks.” This involved writing a check to pay a bill from a bank account with not enough money in it at the time but with the expectation that there would be a check from another bank a few days later, which would cover the first check before it was presented for payment at the first bank. This is done in the hope that neither bank would realize that initially there had not been enough actual money to pay the bill. The Russian Central Bank and the Treasury had simply run out of money to pay the bill. When a government bond matured, the only way Russia could compensate the bondholder was to roll over the loan and issue another bond in the hope that the original bondholder would accept the new bond as a replacement for the old one and not ask for cash. Alternatively, the government could hope that someone new would be foolish enough to buy a new government bond so the funds could be used to pay the first bondholder for the same amount he had paid for the bond, plus interest. But because the revenue the government collected was so little and slow in coming in and the interest rate it had to pay to attract lenders willing to buy those reissued government securities was so high, after a time the government was forced to borrow larger and larger sums of money just to pay the ever-increasing amount of interest. It was a marathon race without a finish line.
Since this fiscal slight of hand was unsustainable, the government eventually was forced to default on its debt. Simultaneously, it found it no longer had enough dollars to meet the demand of those who wanted to exchange rubles for dollars at the official rate of exchange. In other words, it had also run out of dollars. Unless it acquired enough new dollars, it would eventually have to devalue the ruble and require that those who wanted to buy dollars pay more rubles for them. As of mid-August 1998, because it could not find enough lenders willing to buy new or reissued government securities, combined with the fact that it had run out of dollars and convertible foreign currencies and could not pay its bills, the Russian government, in effect, had become bankrupt.