Several years ago, it was uncertain what the Russian economy was dominated by: private businesses or public companies; but we believe that today the situation is unambiguous. Public companies are currently shaping the economic agenda, at least, in terms of real investments.
The Rosstat has recently announced good news: according to the 2011 results, investments in equity in Russia grew by 8.3% against the previous year. This impressive result against the background of any of the last couple of years (an investment decline by more than 15% was recorded in 2009; 2010 witnessed just a 6% growth) should make us, true patriots, happy and so we are. The only sad thing about such success is that this growth is recorded against the backcloth of the declining investment activity of private business.
Firstly, the nominal value of investments in private business projects that are started, implemented, and launched (see Figure 1) is gradually declining. By the way, over the period from November 2011 to January 2012, we recorded 26 projects with the amount of investments of USD 4.27 billion, while 33 projects worth USD 7.2 billion were recorded in the previous year. A year on year decline amounted to 22% in terms of the number of projects and almost 40% in terms of the amount of investments.
Secondly, we noticed that the number of potential investors announcing in the media their plans to build new plants, factories, pig complexes, etc. fell as compared to the first half of 2011 (see Figure 2).
Hopefully, many of them are just keeping quiet in the pre-election and election periods and will re-emerge next spring and propose new ideas and projects. This hope is supported by the fact that development of the number of projects actually launched in 2011was the same as in 2010 (see Figure 3), i.e. no decline was recorded in this case. Private capital differs from public one by fear susceptibility and inertia or, to be more exact, accurate calculation and consideration of all possible risks, while the latter is fearless. This fearlessness permits public companies to force their way despite any possible obstacles. In our case, it means that they may invest funds without taking into account the payback period and other investment troubles, which a private investor can’t afford to omit a priori. In our opinion, this characteristic of public investments may be used for the benefit of the whole country, and not for the benefit of specific individuals close to the Government.
Planning, accounting, and control
According to our data, investments made by public companies currently total approximately 60% of all investments in the real economy (see Figure 4) and, relying on the latest data made available by the Rosstat, we can understand to what industries this money goes (see Table 1). Two industries alone: transport and communications and mineral extraction, accounted for nearly half of all the investments and three quarters of their growth rate in 2011. The show in both of them is run by public companies: Gazprom, Transneft, RZD, and Rosneft. For the last few years, the largest public companies have annually invested approximately RUB 3.5 – 4 trillion in their equity (this represents over one third of all investments in the country, including small and medium-sized businesses and informal economy accounting, according to the Rosstat data, for 28.5% of total investments).
These huge funds represent an immense resource for developing our economy! They should serve as an economic driver while private businesses are sleeping. To be honest, they are the driving force in fact, but, unfortunately, not at the desired quality level. For this reason, perhaps, Russia needs an institution similar to the almighty State Planning Committee of the Council of Ministers that existed in the USSR, which could be in charge, in particular, of planning and controlling investment activities of public companies. In fact, it is not about introducing any innovation in public government, but using old forgotten methods, which are working more than successfully, as experience of the USSR, South Korea, and China shows. Therefore, it is likely that we cannot do without a counterpart of the State Planning Committee, if we are to carry out new industrialization of the country.
At present, Gazprom, Rosneft, RZD, Transneft, Rushydro, Rosatom, FSK, and MRSK do have huge investment programs for which private businesses are no match. Well, the Government has to keep the funds of these companies inside the country, i.e. public companies should purchase machines and equipment in Russia to the maximum extent so as to directly contribute to construction and renewal of the Russian manufacturing industry, in particular, engineering, by placing their orders. The newly created State Planning Committee could coordinate the needs of public companies (their investment programs) and construction of new plants, perhaps, by often attracting foreign capital, putting out products in demand. And the most important thing is that the new State Planning Committee could perform economic control of expenses to be incurred by public companies, primarily when it comes to investment matters, which specialists and civil society have complained about many times.
Creation of the new State Planning Committee must not be delayed. In the foreseeable future, tariffs of services to be rendered by monopolies and large public companies are anticipated to increase faster than inflation grows. This means that more and more funds will be actually withdrawn from private businesses for the benefit of the largest public companies. And the latter’s investment activities are likely to bring benefits for other private companies owned by a restricted number of “particularly close individuals”. Therefore, prevalence of public activities in the area of real investments will result in and already leads to total redistribution of capital: from normal private businesses for the benefit of new tycoons whose activities are practically not controlled by public now.
And there are plenty of examples on hand.
As soon as we come, in the course of our research, across any pipeline that is being built or has already been built, the transport industry immediately becomes a leader among all the economic sectors in terms of the amount of investments because infrastructural projects are too capital intensive. So, the Baltic Pipeline System-2 (BPS) oil pipeline put into operation accounted for USD 3.3 billion (about 20%) out of USD 16.38 billion of the total nominal amount of investments.
The first phase of the BPS-2 has been built so far. It is a thousand kilometer oil pipeline connecting the town of Unecha in Briansk Region and the port of Ust-Luga in Leningrad Region with the capacity of 30 million tons of oil. The BPS-2 is a large capital intensive project financed by the Government. It was built for the geopolitical and universally declared purpose: the need for diversifying the Russian oil export channels. Launch of the BPS-2 first phase significantly reduces any possibility of pressurizing Russian companies and Government by the Governments of Belarus and Ukraine the territory of which is crossed by two branches of the Druzhba oil pipeline. And upon launching the BPS-2 second phase in 2013, Russia will be able to transport practically the entire volume of oil to western consumers by sea bypassing transit countries. This project is irreproachable from the geopolitical perspective.
From the macroeconomic perspective, the BPS-2 has also positive consequences. The Government represented by Transneft invested huge funds in construction of the oil pipeline, which contributed to the Russian economic development: construction and installation works and purchase of pipes, which increased the amount of products made by our pipe manufacturers and metallurgists. In addition, in the near future, the main payment for oil transportation may go to Russian companies instead of the budgets of Belarus and Ukraine, which can be viewed as a positive consequence of the BPS-2 construction.
And even from the business perspective, the BPS-2 project seems to be well built. Oil transportation via this pipeline will be more expensive for oil companies than via the Druzhba pipeline. Increased tariffs are necessary to recover funds invested in the BPS-2 construction.
Substantial complaints about the project consist in development of market relations in the country. Firstly, this means higher influence of Transneft and additional monopoly pressure on oil producers, which are likely to lose a lot once the BPS-2 is put into operation. Secondly, the pipeline construction led to sudden growing influence of a group of companies controlled by businessman Gennadiy Timchenko, which occurred beyond the market framework. In particular, the BPS-2 was built in an emergency mode and at a high level of shortages (15% according to Transneft data), which resulted in high construction costs. The oil pipeline was built by Stroytransgaz that was purchased by Mr. Timchenko in late 2007, when the BPS-2 pre-design works were carried out. Moreover, the oil pipeline goes to the Ust-Luga port or, to be more exact, the oil-loading complex of Nevskaya Truboprovodnaya Kompania, which is owned by Timchenko’s businesses as well. Finally, oil will be transported by sea from the Ust-Luga port to European ports by Gunvor, which is controlled by Mr. Timchenko as well. There is no evidence that businessman Timchenko was given access to all the aforesaid orders and assets through market procedures; obviously, this is the result of its particular closeness to the higher echelons of the Civil Service in Russia.
Electric power industry
The investment boom we described in our previous overviews continues to be recorded in this industry. This time, we counted 11 investment projects totaling USD 2.7 billion, all of which are financed by public companies or even directly from the state budget. Having seen such a picture, a question arises against one’s will: perhaps Government-controlled YeES Rossii RSJC that fell into oblivion could cope with all of these investments on its own given today’s tariffs? It is clear that the question is rather rhetoric, but we could state that there would be fewer problems with market relations that fail to be built in the electric power industry.
The South-Western HPP in Saint Petersburg proved to be the largest investment project this time. The planned investments total here about USD 1 billion. What is remarkable, this HPP construction is not financed by a private investor, but directly by the city of Saint Petersburg! Construction is carried out by Stroytransgaz mentioned above that was hired in 2007 as a contractor by Sintez Group controlled by Chuvashia Senator Leonid Lebedev. However, in 2008, Sintez Group refused to implement the project and offered (!) all of 100% shares in the plant to the city, which is now financing construction works. The initial cost estimate for construction of the plant amounted to RUB 21 billion; but now this sum rose to RUB 30 billion and, according to certain media, reached the level of RUB 35 billion. There is rumor that the city intends to replace the failing contractor, which is unable to meet the deadlines for putting the plant into operation, but this is unbelievable given influence of Gennadiy Timchenko controlling Stroytransgaz.
Network companies such as FSK and MRSK are developing huge investment activities. We identified here eight projects worth USD 1.2 billion. The companies build new and fundamentally modernize old electrical substations all over Russia, pointing narrow places. Three out of eight projects are implemented in Sverdlovsk Region, which has suffered from such problems since long ago.
Oil refining and chemical industry
The leader of our previous overview has receded from its positions to hold the third line in the table of ratings of the sectorial investment activity in November, December 2011 and January 2012. However, the industry indicators are not bad at all: five investment projects worth USD 2.63 billion.
Just as in the transport and electric power industries, the largest investment project is financed from public funds: Rosneft performs fundamental modernization of Tuapse Oil Refinery by increasing its oil refining capacity from the current 5 million tons to 12 million tons. We have waited since long ago to see when the Russian largest oil company would finally translate words into deeds and build or reconstruct at least one oil refinery. And now it has happened: a new full-fledged oil refinery is put into operation on the territory of the operating oil refinery complex, which is, to be honest, more like an oil depot than a plant.
Primary oil refinery plant ELOU-AVT-12 with a section of naphtha hydrofining is scheduled to be put into operation at stage one to be completed this year. Including construction of offsites, this project is worth USD 2.3 billion. At stage two to be completed in 2014, it is planned to build a vacuum gasoil hydro cracker and diesel fuel hydrofining unit, catalytic reforming units, and other similar facilities. As a result, the oil refinery will be able to produce high quality diesel fuel Euro-4 and Euro-5. According to the estimates of Valeriy Yezhov, former general director of RN-Tuapsinskiy NPZ LLC, Rosneft will have to invest about USD 3 billion more to build all of these plants and units. Tuapse Oil Refinery is distinguished by a unique geographic location: it is built on the Black Sea coast and has its own oil loading terminal. Once the new oil refinery is built, its products are likely to be exported to the Mediterranean countries.
Another oil refinery, although with smaller capacities, was built in Volkhov District of Leningrad Region by Volkhovneftekhim owned by former Lukoil employee Konstantin Tikhomirov. The first stage of the mini oil refinery with a production capacity of 0.5 million tons of ship fuel, straight-run petrol, and diesel fuel was launched. The company’s owner invested USD 200 million in the first stage. In the near future, the second stage of the plant is planned to be built, in which USD 400 million more will be invested. The plant’s capacity will grow twofold to reach 1 million tons; it is also planned to build a diesel hydrofining plant.
While oil refineries oriented to exports their products are built in the sea areas, inside the country, in Tatarstan, local businesses are focused on import substitution. Thus, local company Danaflex, one of Russia’s largest flexible package producers, in cooperation with Rosnano, launched the first stage of its second plant worth USD 100 million. Danaflex is currently purchasing equipment for the second stage the total production capacity of which will reach 46 thousand tons in 2014; USD 157 million will be invested in total. This project is an example of how logically medium-sized businesses are fit in the existing business processes of other companies. Tatarstan is the Russian largest mayonnaise producing area; in the near future, its production volumes will grow considerably thanks to Nefis Group (See “They went into the bottle” No. 42 of Expert, 2011). In addition, Nefis Group produces large quantities of washing powders and detergents and practically tries to compete with global players such as Procter & Gamble and Henkel in the Russian market on its own. Both mayonnaise and washing powders need flexible packages: this is why Danaflex decided to build this new plant to produce lacking packaging.
Agriculture and food processing industry
The agricultural sector and the food processing industry make us happy with their investment activities as usual, giving nine projects worth USD 1.47 billion. Higher investment activity in the agricultural sector can be explained quite simply: this is the only Russian economic sector that has access to cheap borrowings. The interest rate on such borrowings is subsidized from the budget; investors can obtain credits at an interest rate of 4% – 6% per annum, which is even lower than the inflation rate recorded in 2011 (6.1%).
In Rostov Region, ISK Aristocrat International GmbH plans to start construction of a large greenhouse with the surface area of 60 ha and worth USD 167 million in autumn of 2012. For comparison purposes: the largest operating greenhouse in Russia and one of the largest ones in Europe with the surface area of 144 ha is located in Karachayevo-Cherkessia. It was built in the 1970s. Only 50 ha of new greenhouses have been put into operation for the last 20 years in the country.
Greenhouse construction, just as the entire agricultural sector, is financially supported at the federal level. However, there are cases when an investor may be supported by regional and even municipal authorities, and not financially. Here below is one example of it. Following a three year idle period, a juice plant in Novosibirsk Region started to be built by PepsiCo. Its construction was started in 2007 by Levedianskiy, which was taken over by the transnational giant in spring of 2008. In summer of 2009, PepsiCo froze construction due to the crisis until the better times. Seeing the TNC inertia and the incomplete industrial facility, deputies of the legislative assembly of Novosibirsk Region decided to push the company into completing construction. By a special decision, they expanded the limits of the town of Berdsk so that the territory of the juice plant built by PepsiCo could fit in it. AND WHAT FOR??? “According to the plans of development and technical requirements for the location, the plant is built on a rectangular land plot with the total surface area of 12.6 ha. According to the historically formed configuration, the border between the town of Berdsk and Iskitim District goes directly across the site, on which the main facility of the plant is planned to be erected. A site with the surface area of 3.3 ha belongs to Iskitim District, while the main part of the site and all the utilities are located on the territory of Berdsk. Therefore, with the purpose of optimizing resource management and creating a single territory to complete construction of the plant, it is necessary to change the borders of these municipal entities, - explained Roman Shilokhvostov, Head of the Regional Department of Land and Property Relations”.
Southern Republics are rarely included in the investment overview. It is comforting to know that activity is reaching these regions that have never been abundant in investments.
Moscow-based Prodkontrakt Group, in cooperation with its partners, started construction of a meat processing plant worth USD 167 million in Kalmykia. Frozen beef will be the plant’s end products. Tatyana Bitko, Prodkontrakt Group owner, explained to us why a large meat trader decided to start production:
-- During the last few years, Russia has become a less interesting market for the largest South American meat producers such as Argentina, Brazil, and Uruguay. In the past, we used to have low prices and large amounts and they were interested in trading with us. At present, beef consumption has grown to a considerable extent in these countries; moreover, China became a net importer, so our volumes seem not so interesting for them as before. In other words, as a large importer we feel physical deficit of beef and have to find new partners in Australia, Nicaragua, and Mexico. In the long run, we understand that meat has to be produced here in Russia. Kalmykia is attractive as it has the largest beef breed cattle stock in Russia. So we decided to build our meat processing plant here. We have recently obtained a credit from Rosselkhozbank at the interest rate of 13% per annum. Upon receiving subsidies for the paid interest rate from the Ministry of Agriculture, the real interest rate on this credit will be at the level of 5% per annum.
We identified seven projects worth USD 1.28 billion in this sector. However, four out of them are still at stage zero of the declarations of intent. It seems that foresters, just as before the crisis, are becoming fond of investments in one of the most potentially competitive Russian industries and want to reconnoiter the ground. And the ground is unsteady here as the last few years show.
This unsteadiness is due to the Government-led ambiguous policies regulating the sector. In February 2007, the Russian Government made a decision to gradually increase export duties on unprocessed wood pursuing a strategic objective to develop deep wood processing in the country. This is a worthy and noble objective. Seeing the Government’s determination in this matter, some large wood exporters believed it and started to invest in construction of wood processing plants so as to process all round timbers and export finished products: converted timber, plywood, peeled veneer, pallets, etc. The export customs duty imposed on business round timbers in Russia was gradually increased from 6.5% in 2006 to 25% of the supply price, but no less than EUR 15 per cubic meter, in the middle of 2008. In 2009, customs duties were planned to rise to 80% of the supply price, but no less than EUR 50 per cubic meter, which would actually lead to ban on exporting round timbers. Wood exporters got afraid of these duties and started to invest in wood processing. However, pressurized by the EU, the Russian Government froze this increase three times (in 2009, 2010, and 2011). Moreover, plans to reduce the export duty rates are now debated due to Russia’s joining the WTO.
This has been a severe impact on newly emerged wood processing companies that believed the Government and started to build new plants in 2007 and 2008. Thus, Arkaim JV, which used to produce approximately one million cubic meters of wood in the Khabarovsk Territory, risked building several small plants in one site at the same time which would produce plane lumber, chip boards, pallets, furniture veneer, and glued laminated lumber. All of them have been put into operation; equipment is running in the testing mode on the last two plants. In total, the company invested approximately USD 400 million in its wood processing complex.
-- We expected that the Government would do more for us as it has important trump cards to support priority projects such as ours: preferential taxation, customs duties, or preferential credits. Our competitor timber procurers that built no wood processing facilities have now obvious advantages over us following the Government’s decision not to increase export duties as it promised to do. We invested huge borrowed funds in wood processing hoping to recover them in 5 to 6 years; but under today’s circumstances, we will recover these investments in more than 10 years.
We identified three projects worth USD 1.07 billion in this sector, and one of them is quite remarkable.
This is a project of building a rolled product complex at Kamensk-Uralsk Steelworks (KUSW) worth USD 800 million. Aluminiyevye Produkty, owner of the SUAL assets that were not included in UC Rusal, decided to make appropriate investments. A new rolled product complex the first stage of which, namely the cold rolled product shop, is scheduled to be put into operation in 2014, is planned to be built in the next four years at KUSW. This project has already started to be implemented and will enable KUSW to supply new quality of semi-finished products (rolls and sheets) from aluminum and aluminum-lithium alloys in terms of geometry and nomenclature to Boeing, Airbus, and Bombardier. As it reaches its full capacity in 2014 – 2015, the new complex will generate annual revenues of about USD 1.5 billion to KUSW.
This is the first project of building a large aluminum rolled products in the post-Soviet era. UC Rusal, the key aluminum company of Russia, has not risked setting up a similar plant so far, although in the beginning of past year, there were several announcements of En+ (a holding owning UC Rusal) plans to build a similar complex at Krasnoyarsk Steelworks. But the aforesaid plans were delayed due to slightly declining aluminum prices.
Trade shows and retail trade
Last year, we were surprised to include in our overview large shopping malls in Moscow and Saint Petersburg with the amount of investments totaling USD 500 million each, which is quite good even for heavy industries, let alone commerce. This time, we identified an even more magnificent project so that we had to expand our industry classifier by adding the trade show activities section to it.
This is a project implemented by Gazprom (yes, a Gazprom project), which invested USD 1 billion to build a trade show center in Shushary near Saint Petersburg. Alexey Miller, Gazprom Chairman of the Board, explained at the mall foundation ceremony why the company invests such huge funds in a new and completely non-core business. “We are aware that literally in three years Saint Petersburg will reach the level of the world’s congress and exhibition capitals. Gazprom and Saint Petersburg are strategic partners in the broadest meaning of this word”.
Etalon Group is the general contractor of the construction project. A new multifunctional complex will consist of a congress center, exhibition halls, two hotels, two business centers, and other facilities. The total surface area of the complex is more than 200 thousand square meters.
Engineering offered five small investment projects worth USD 318 million from its various sub-sectors.
Sverdlovenergo group built a completely new electro technical equipment plant worth USD 167 million in Yekaterinburg. The plant will produce power transmission pole lines, oil transformers, and complete transformer substations. This plant is another result of the wave of renovating old assets and building new ones in the electric power sector.
The joint project planned to be implemented by Voith Turbo (a large German producer of railway equipment of the second order following global leaders such as Alstom, Siemens, and Bombardier) and Trade House Kambarskiy Mashinostroitelny Zavod may be regarded as the result of another wave: investments in renovating rolling stocks on Russia’s railway. The plant located in the Alabuga special economic zone will produce diesel hydraulic maneuvering locomotives and main line locomotives worth USD 110 million.