Technology & innovation | Materials, extraction

Marchmont Advisory Board Review

31 Jan '11

The rising price of oil: Russia’s fat purse or doomsday curse?



The global price of oil is once again probing $100/bbl resistance. By 2020, the Russian Academy of Sciences forecasts a rise in the price of Urals to $185/bbl, with prospects of skyrocketing to as much as $233/bbl by 2030. Russian economic pundits can’t see “any serious alternative” to this country`s oil export focus.

With Russia’s notorious addiction to ‘the Pipe’ for fueling its economic growth, the future of an innovation-based domestic economy is once again at stake. For some, higher oil revenue means there is little or no incentive to further revamp the economy. For others, ‘petrodollars’ are the perfect way to generate the capital needed to create an innovation economy.

Marchmont approached a panel of experts in various fields, its long-standing business partners, for their scenarios of where Russia’s economy should focus.

Philip H. de Leon, president of DC-based Trade Connections International, LLC, thinks the country’s over-reliance on oil stifles innovation and Russia’s vastly underutilized intellectual potential. The real culprit, however, is pervasive corruption and the lack of political will:

“I feel that a price of $185/bbl is exaggerated, at least in the immediate future—despite the anticipated sharp increase of consumption from other BRIC countries such as China and India.

Russia’s addiction to oil is similar to the addiction to vodka: you keep coming back to it despite all your good intentions. Oil, as well as natural gas, is such a guaranteed cash machine for so many years to come that it’s hard to blame Russia for continuing to exploit its most valuable resource. Two years ago a chief economist at Merrill Lynch figured out that every time the price of a barrel of oil goes up by $1, the Russian government budget earns an extra $1.7bn. Although this raises Russia’s GDP, the problem is that high oil prices stifle any desire to diversify the economy. What we end up with is the Dutch Syndrome.

There are visible efforts of change, however, to take advantage of Russia’s underutilized intellectual potential. The most notable example is the creation of Rusnano and the heavily promoted Skolkovo project. But we still need to see more progress in protecting intellectual property rights and we need some concrete results stemming from the commercialization of projects funded by Rusnano. If Skolkovo ends up being just a big real estate coup by local cronies, it will be a real blow.

Russia isn’t adverse to innovation. At the Farnborough Air Show last July, for example, the Russian pavilions showcased some remarkable and quite inspiring aeronautics. Although Russia has tried to give a boost to its aviation industry for years, it’s countries such as Brazil with Embraer, Canada with Bombardier and even China that have been more agile in positioning themselves as real players in the collective mind of potential buyers.

President Medvedev is certainly talking the talk but is definitely not walking the walk. Allegations of corruption at the highest levels and description of Russia as a virtual “Mafia State” in cables leaked by Wikileaks make it difficult to position Russia on the international stage as an innovation center. “One cannot differentiate between the activities of the government and organized crime groups,” says one cable. That assessment is not conducive to business.

Should we lose hope about the development of innovation in Russia? The answer is definitely no as the potential is there. The question is: will Russian brains stay in Russia and if they do, will they ever get the financial and regulatory support they need to thrive? That remains to be seen…”

Mikhail Treyvish, president of Moscow-Vienna based rating agency OmniGrade, feels that an upsurge in the global oil markets is possible but doubts a flood of ‘petrodollars’ will change the way Russia does business:

“A lot depends on what $185 will really be worth in 2020. By that time the dollar might weaken, and such a price won’t look too high. However, assuming the prices of oil and other energy sources soar in real terms, it will have catastrophic implications for Russia. There will simply be nothing powerful enough to stop the degradation of other sectors of the national economy.

It’s utterly naïve to believe ‘petrodollars’ would fuel the development of Russia’s innovative sectors. It’s not investments that innovations primarily need, but rather a stable tax system, efficient and uncorrupt law enforcement, independent justice and other effective mechanisms of a law-abiding state. In my personal opinion, innovations also need government “propaganda” —a notion that may cause aversion from a historical viewpoint, but is in fact crucial to help instill respect for innovative entrepreneurship in the minds of the general public.

I have no doubt, though, that the global economy’s reliance on oil won’t last forever. An end to it might be put later than 2020, but our grandchildren, if not children, will surely see that happening.

As rumor has it, the Polynesian island nation of Tuvalu may disappear underwater in 50 or so years. And so may Russia under oil (figuratively, of course), if the current situation prevails.

But I think there are ways of steering clear of this kamikaze course irrespective of future oil prices. An idea has even been floated by an RF Ministry of Finance spokesman to start gradually withdrawing from the decades-old practice of building the national budget based on oil tax projections. This, however, will take much courage and resolve.”

Anatoly Korkin, president of the U.S.-based Nano&Giga Solutions and associate research professor at University of Arizona, agreed that government policy, not oil prices, will determine the future of innovation, and believes that until Russia has the spine to stop corruption nothing will change:

“Government policy is the key determinant here—not the price of oil. Just look at what happened to the huge financial reserves that Russia accumulated during the previous boom and bust cycle. Unlike China, Russia wasted its opportunity to modernize its economy because the government didn’t act.

Even today, a large share of what is called innovation in the economy is just smoke and mirrors. Graft and high technology are hardly compatible. If the price of oil rises, the money will just go to fatten the bureaucracy and fuel kickbacks. If oil hovers where it is, social tension is likely and the government will have an even tougher time recalling what innovation is.

The truth test is whether or not a country’s socio-economic system either supports or weakens the investment climate. Either it nourishes or kills innovation. With little or no investment from industrial captains and no support from innovators and SMEs, a corrupt state can only beget loss-making ministries or Skolkovo-like Potemkin villages. It’s important for the state to back innovation, but unless trust is established between the state and businesses, the backing is not effective.

So, the price at which oil trades is irrelevant. It’s the resolve to drastically shake up the entire government that will make a difference, starting with fighting corruption. The latter now resembles clan struggles in a criminal war for power rather than an actual campaign against graft.

In Russia’s current situation, oil-related divinations will do nothing to alter the economic structure; they might only help preserve social stability to a certain extent. The collapse of the present corrupt system is inevitable, as was the demise of the USSR. Higher oil can only postpone the debacle—it won’t fix the economy or improve its prospects.”

Denis Pryanichnikov, head of the Issuer Relations Department at the MICEX Stock Exchange, Moscow, admitted the prospects of Russia’s innovation economy are still bleak, but sees some light at the end of the tunnel:

“As long as oil rises, cementing the RF’s dependence on oil and gas revenue as the foundation for a national budget, innovations will remain a tough sell. Low levels of competition across domestic economic sectors prove an even thicker wall for innovations to penetrate.

With all this a reality innovation infrastructure is nonetheless on a roll. At the MICEX, for example, the Innovation and Investment Market (IIM) project is being pushed as a venue for innovative companies to raise investment.

In 2010, the program welcomed innovative issuers from such segments as pharma (DIOD and Pharmsintez), navigation technology (Russian Navigation Technologies) and electronics (Don Radio Parts). We also listed stocks of four regional venture funds led by management company Sberinvest, engaged in investing in small businesses in the Kaluga, Voronezh and Chelyabinsk regions and the Republic of Bashkortostan.

Investors are interested in the new issuers; Pharmsintez’s IPO, for one, drew 583 bids. In derivative trading, the securities of all IIM issuers are fairly liquid. These stocks had an average monthly turnover ratio of 18% last year—much higher than 1-2% for large entities that did IPOs in 2010.

Good liquidity and investors’ interest give me hope for further advancement of the IIM endeavor that I expect to be a key element in Russia’s innovation economy.”

Martti Vallila, founder of Fuzzy Chip LLC., Heywus, USA, and managing director of Buddha Biopharma OY Ltd., San Francisco, feels that with or without higher oil prices, Russia must embrace the fact that it is part of the global village—a village that already speaks the language of innovation:

“It is impossible to predict the future price of oil. The fact that prices will fluctuate, like the weather, is the only long-term certainty.

It is far easier to observe trends that are irreversible and frame the opportunities and challenges they present. Even for a country as “unpredictable” as Russia.

Globalization is changing the world, propelled by connecting technologies, many of which have been (and continue to be) invented in Silicon Valley, and are being manufactured in Asia, for worldwide distribution by transnational entities.

The value of technology in the increasingly “flat world”, a phrase popularized by Tom Friedman, is actualized through collaboration with complimentary elements, whether they are technical or organizational. The world of alternate competing universes (think Cold War) is today replaced by a shifting playing field of interconnected cross-border commercial alliances.

These trends are irreversible. And they are good for Russia, the largest country on earth, with research centers located in some of the globe’s most remote locations, containing science and discoveries that have not yet been connected to the global village.

Russians with skills and technologies of value to this village no longer need to escape to participate. They need only to connect.

Real (trusted) protection for new ideas is the proven foundation for mining and developing their value. Such protection is available through international conventions to which Russia is a signatory. An understanding of the practical application of these protections is growing in Russia, but is, understandably, incomplete, in a country where the notion of private ownership of land is recent.

Trust in real protection is what any inventor must feel before he allows his idea to escape his mind and enter the public realm. Trust in a business partner who brings complimentary skills and resources to the needed collaboration is essential. The building of such trust requires time and positive examples.

The emerging Russian entrepreneurial ecosystem is a fundamental element of wealth creation in this modern world. A focus on science in an environment of hardship that drives creativity has given Russia potentially strong cards. Self-policed isolation has preserved and cultivated unique perspectives. Some of these unique perspectives are unpolished jewels, needing collaboration with external partners to achieve value.

I believe that Russia has transformational potential in the global market. An example of such technologies is a cure and prevention of Alzheimer’s disease, the #1 unsolved medical problem in the Western world! The solution is coming from Russia, via Finland, where the discoveries of Dr. Igor Pomytkin in clinical trials being conducted in Kazakhstan are now being validated.

It’s one thing for a small banana republic, lacking a well-educated, creative citizenry, to rely on fruit for its economic stability. But for Russia to rely on its oil when it has so much more to contribute to the world’s progress than its “liquid“ bananas, whatever their price, is counter-productive.

With such enormous intellectual and financial resources, the only question is not if Russia will actualize its innovative potential, but when.”
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