NEW YORK, Aug. 20 (UPI) -- Back in April, well ahead of most market analysis, "Bottom Line" warned of the unfolding assault on the Russian oil giant Yukos, a threat to both Russia's equity markets and to international energy markets. (See "Russian Rule-ette," April 28, UPI.)
The situation is made all the more acute by the logic, albeit devious, of Putin's assault on the company. In one stroke, Putin punished a political enemy, the former CEO of Yukos; drove down the value of the company, which the country can now take over for pennies on the dollar and re-sell; distributed much of the pain for this to outside investors; and helped ratchet up the price of a commodity that accounts for most of Russia's exports, much of its GDP, and a large share of government revenues: oil.
By becoming the tsar of world oil supply on the margin -- the new OPEC -- Putin has vastly improved his position on the international power curve as well. China is begging to sign long-term supply contracts, buy a stake in Yukos, and even pay the transportation costs for Russian shipments. Bush Administration officials, and the President himself, have called Putin to politely encourage him to keep pumping oil, and ask hat in hand if he would please consider not wrecking the interests of their investors. Russia now plans a 40 percent increase in defense spending for next years, and has been weighing in again on geopolitical issues in the Middle East and Asia, after a decade as a non-player.
All this is fine as far as it goes. As we've noted, however, a key to the enterprise was for Putin to limit this model of indirect seizure-through-tax-regulation to Yukos itself. A number of other Russian companies, "Bottom Line" observed back in April, would seem to be vulnerable to similar assault. If the model was extended -- likely to be a severe temptation, given how "well" the first effort has gone, at least for Mr. Putin -- then one could witness a rush to the exits by international capital.
Hence the following item from the Moscow Times must be viewed with concern by those who remain invested in Russia:
"A Rodina deputy is urging law enforcement agencies to investigate Gazprom shares owned by United Financial Group, a Russian investment bank partly owned by Deutsche Bank, saying it and other brokerages allow foreigners to buy domestically traded shares in the gas giant illegally."
The irony is that such trading is apparently going on -- and at a fast pace -- as international investors have sought to protect themselves from a collapse of the Russian stock market in the wake of Yukos.
The whisper on the streets, which can't be confirmed but has risen to the level of heavy market chatter, that some of the largest Wall Street firms invested in Russia are purchasing significant hedges -- synthetic puts -- on the country's equities.
These investors, some of whom have 9-figure and even 10-figure stakes in Russia, are loathe to dump their shares on the domestic exchange, which would be a sign that they are, indeed, beginning to panic. This would only hasten the decline of the massive stake they have in Russian firms. So the traders have tried to cover their downside by working outside the Russian market per se, through the ADR market and through the offices of Goldman Sachs, Deutsche Bank, and other firms willing to write artificial options for the funds.
A reliable source at the Russian Finance Ministry confirms that a sudden exit of capital appears to be underway. At the worst, MinFin calculates, this could amount to the removal of $10 billion from the Russian stock market over the next year.
This is not the type of figure that one saw during the 1998 run on the ruble, particularly given the much larger base of foreign investment and the growth in the Russian stock market, which has more than quadrupled since Putin took office. But it also assumes nothing worse than an orderly march to the exits. International capital seldom behaves so calmly -- look at the oil markets, for instance. Once the move to the exits begins, it may quickly become a stampede.
The bottom line is, Russia was a good short in April and May, a position we suggested flipping to a long trade in July, as the spike in oil prices began to lift Russian shares despite of the ominous potential for the virus to spread to other firms. Now it's seems prudent to sell off any Russian long positions and monitor developments at Gazprom -- not to mention such firms as Vimpel, Tatneft, and Mobile Telecom, all of which have been the object of the same kind of extra-Russian hedging in recent months.
Indeed, given that Putin appears to have found "the next Yukos," Russia's a short again. All the more so, given that his deputies appear to have selected for a crackdown the very device, of overseas hedging, that global investors were forced to in response to the threat of a Yukos domino effect.
Throw in the possibility of at least a mild correction in oil prices, and a negative synergism as investors grow fearful, Putin punishes their fearful behavior, and the fear in turn grows larger -- and there's a good chance of a nice, brisk downturn in Russian stock prices.
The time to cover will be if Putin makes a decisive move to deal fairly with Yukos -- but at present, the movement seems one of extending the model to other Russian firms. We're out.
Gregory Fossedal manages international investment research for Emerging Markets Group. His clients may (and usually do) hold long and short positions in many of the investment securities and opportunities mentioned in his reports. "The Bottom Line" is compiled from sources we believe to be reliable, but no representation is made that they are necessarily accurate or complete. Investors should perform their own due diligence and consult their own professional advisor before buying or selling any securities. Mr. Fossedal's opinions are entirely his own, and are not necessarily those of UPI or EMG. Furthermore, they are subject to change without notice.
