2015 09 wj all by Russia Beyond

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This supplement is produced and published by Rossiyskaya Gazeta (Russia) and did not involve the news or editorial departments of The Wall Street Journal RTSI

‘The only thing Moscow might use Mistrals for would be to land a force in Syria to help President Bashar el-Assad’s regime.’

‘ The China-led slowdown and

GEORGY BOVT, POLITICAL SCIENTIST

IRINA MIRONOVA, SENIOR LECTURER AT ENERPO PROGRAM

Dollar/Ruble

decline in manufacturing are the biggest factors behind the drop in oil prices.’

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Distributed with The Wall Street Journal

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Saturday, September 12, 2015

Economy Russia, beneficiary of China’s rise, may see collateral damage from a Chinese slowdown

China’s Economic Woes Threaten Russian Exports

IN THIS ISSUE BUSINESS & POLITICS

Sanctions & Agriculture Farmers get a boost from the trade embargo PAGE 2

EPA/VOSTOCK-PHOTO

SPECIAL REPORT

E-commerce Boom Online sales grow despite the recession PAGES 4-5

MONEY & MARKETS

Gazprom: Profit & Woe The gas giant’s challenges PAGE 6

China’s economy has downshifted to the slowest growth rate seen in a quarter century, as tumult in the country’s stock market raises fresh concerns.

China’s skyrocketing growth reoriented corporate and geopolitical strategies around the world, prompting Russian policymakers to pursue costly new pipeline megaprojects linking Russian energy supplies to Chinese markets. In June, Russia overtook Saudi Arabia to become China’s biggest supplier of crude oil for the first time in almost a decade, and the two countries reached mammoth agreements on future natural gas sales last year — deals that also require the construction of long and expensive new gas pipelines across Siberia. Now, China’s economic growth has decelerated to its slowest rate in a quarter century. Fears over the state of China’s economy deepened further still in late August when

Trouble in the Chinese economy poses a dilemma to commodity exporters, including the country’s biggest supplier of oil — Russia.

DAVID MILLER SPECIAL TO RBTH

Russia’s attempt to “pivot to Asia” is facing a fresh challenge amid concerns about a slowdown in China’s economy, as a major buyer of Russian raw materials faces the prospect of weaker demand. China has maintained the world’s fastest-growing large economy for decades, with annual growth rates often exceeding 10%. The effect has been to support global commodity markets with seemingly insatiable demand for products like oil, natural gas, coal, iron ore and steel.

the Chinese stock market tumbled, dragging down global equity markets in an Aug. 24 rout dubbed “Black Monday.” The tumult prompted economists to wonder whether China’s growth trajectory — and its seemingly limitless thirst for raw materials from Russia and other exporters — may be less stable than previously assumed. “The focus on the combination of China growth concerns and weaker commodity prices has become intense over the past few weeks,”analysts at U.S. investment bank Goldman Sachs, including Peter Oppenheimer and Christian Mueller-Glissmann, wrote in a research note to investors in late August.“The risks in China itself, and those directly tied to China, have

no doubt risen.” To be sure, recent economic statistics show China’s economy continuing to grow, and imports continuing to rise. But the question is: for how much longer? Chinese economic growth slowed to 7.4% last year, and is expected to decline further to 6.8% this year, according to the International Monetary Fund. “People are not sure if Chinese demand is going to be there,” Damien Ma, a fellow at Chicago’s Paulson Institute, told the Los Angeles Times. In August, the Bloomberg Commodities Index of 22 raw materials, including oil and metals, fell to its lowest level in 16 years amid concerns about global oversupply and high oil output rates.

ALEXANDR RYUMIN / TASS

New Fields for Old Friends China eyes a 10% stake in a large LNG project PAGE 6

FEATURE

FireChat: Beyond Text and Instant Message

E-commerce Russians are buying more online even as overall retail sales slump in the recession

Online Sales Grow, Defying Economic Gloom Internet sales are booming in Russia despite an overall economic downturn and falling retail spending. Analysts predict the sector will continue to grow. ALEXEY LOSSAN

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Russians are going online in record numbers to seek out deals for consumer items from clothing to electronics, in spite of an overall downturn in one of Europe’s most important retail markets. Amid a barrage of bad news, from falling oil prices to a plummeting national currency, e-commerce is still a bright spot in Russia’s economic gloom. Online sales in Russia ballooned

Russian shoppers head online as web connectivity expands.

by 35% last year to $14.5 billion for physical sales alone, according to research firm Data Insight. While growth this year is expected to slow, the Russian e-commerce market should reach $50 billion in five years and could reach $100 billion in 10 years, analysts at East-West Digital News predicted this summer. Orders from vendors outside Russia are growing even more quickly, and China’s AliExpress became Russia’s No. 1 online retailer last year as orders from beyond Russia’s borders increased by 75%. Russia’s online market is growing in part due to its relatively late start compared with Europe and the U.S. The first payment systems, CyberPlat and Webmoney, appeared

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in Russia in 1997, but the industry didn’t begin expanding rapidly until the mid-2000s. “E-commerce is growing due to the increased penetration of telecommunications into people’s daily lives,” says Georgy Vashchenko, Freedom Finance Investment Company’s Head of Operations. Investment into the sector was fueled in 2010 and 2011 by the successful stock listings of Russian Internet giants, including the owner of the country’s largest e-mail service, Mail.ru Group, and the country’s top search engine, Yandex. According to data published by the company Synovate Comcon, the average Russian online shopper spent 23% more in the first half of 2015 than in the same period last year. Yet overall spending remains low compared with European or U.S. figures. The average Russian consumers paid about 691 rubles ($10.61) in the first three months of 2015 for games, movies, software.

The new messaging app with Russian roots works without a cell network or Internet connection

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How Moscow’s top chefs cope with the food embargo

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Agriculture A ban on U.S. and European foodstuffs has created shelf space for Russian produce

• Food prices in Russia have risen by 10.6% in the first seven months of the year compared to the same period last year, state statistics service Rosstat said in a statement. Statistics show that all food groups have risen in price since the beginning of the year. Fruit had the highest growth, with prices going up by 25.4% from January to July compared with the same period a year earler. Fruit is followed by fish and seafood with 17.8% growth. Prices for sugar, jam, honey, chocolate and other sweets climbed by 16.3% from January to July. Prices for bread and cereals have grown by 11.6%. • Airbus signed an agreement at the MAKS air show with satellite manufacturer Russian Space Systems (RKS) to launch a production line for satellite hardware, Russian daily newspaper Izvestia reported, citing RKS chief Andrei Tyulin. Though sanctions discouraged many Western firms from participating in the MAKS air show — the largest business event for the Russian aviation industry — companies such as Airbus and the U.S. aerospace giant Boeing, which make civilian air and space products, took part in the forum.

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• The most expensive Moscow mansion currently on the rental market can be had for 2 million rubles ($30,000) per month, news website Gazeta.ru reported earlier this month, citing a press release from the Inkom-Nedvizhimost real estate company. The property owners are considering selling the estate, however, according to the report. The 1040-square-meter mansion is located on Bolshaya Tatarskaya Ulitsa. It features amenities such as central air conditioning, a sauna, gym, an underground parking garage and a grand fireplace. • Consumer safety watchdog Rospotrebnadzor has ordered retailers to withdraw batches of detergents produced by several foreign consumer

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groups. The state regulator said some products made by manufacturers Henkel, Procter & Gamble, Colgate-Palmolive, and Clorox had to be removed from the marketplace because they did not meet Russia’s toxicological safety criteria. Last year Russia banned many food imports from the EU and United States.

Farmers Get A Boost From Sanctions

Production rose in all major livestock products in the first quarter, including a 6% increase in overall meat output.

Agricultural production is weathering the recession in Russia better than other sectors thanks to a ban on U.S. and European cheeses, meats and poultry.

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Sanctions against European and American agricultural imports are providing a boost for Russian farmers as the country moves to replace foreign products with home-grown foods. Meanwhile, an increase in small government grants of $20,000 is helping to boost the number of new farmers in the country. In the first quarter of 2015, the number of farming entrepreneurs grew by 4,670, compared with an increase of 3,000 for the full year of 2014, according to Russia’s Federal Tax Service. “The food embargo made room for Russian entrepreneurs on the shelves of major supermarkets,” says Mikhail Nikolayev, managing partner of the company Nikolayev and Sons and the winery Lefkadia. “Demand for Russian products has grown dramatically since the introduction of sanctions in the summer of last year,” Nikolayev says. The U.S. and Europe have slapped sanctions on Russian en-

million tons is the total grain harvest in Russia.

billion is the combined profit of all Russian agricultural companies.

is the amount by which Russian grain exports rose to Jordan.

ergy, financial and military-industrial firms over Russia’s involvement in the unrest in neighboring Ukraine. In response, Russia banned a host of food products, from European cheese and pork to American beef and poultry.

state statistics service RosStat. Production rose in all major livestock products in the first quarter, including an uptick in meat of 6%. Domestic Russian cheese has doubled its local market share to 40% this year, according to Mr. Nikolayev.

“The introduction of embargo on the supply of products gives impetus to import substitution,” said Elmira Krylatykh.

Import Subsitution

In the first quarter of 2015, total profits reported by Russian agricultural companies nearly tripled compared to a year earlier, rising to 91.3 billion rubles ($1.38 billion), compared to 32.3 billion rubles ($488 million) during the same quarter of 2014, according to the

“The introduction of embargo on the supply of products from several countries in August 2014 gave an impetus to import substitution,” says Elmira Krylatykh, head of the Department for Firm Management of the Russian Presidential Academy of National Economy and Public Administration (RANEPA). According to Ms. Krylatykh, over the past nine months, the total value of food imports into Russia fell by 27%; imports of meat and milk fell by 33%.

The boost to Russian farmers comes as the country suffers through a deep recession, amid a plunge in the value of the country’s energy exports and its currency, the ruble. The cheaper ruble has had a mixed impact on Russian farmers. On the one hand, it has raised their costs by making imported supplies more expensive. But it has also given Russian producers a newfound competitive advantage against foreign producers, since all imported items have also become pricier for shoppers in ruble terms, providing a boost to sales. “In the first months of 2015, due to the combined effect of the devaluation of the ruble and food sanctions, agriculture remained the only economic activity to demonstrate significant growth,”says the director of RANEPA’s Center for Agricultural and Food Policy, Natalya Shagaida. Yet the fact that imported goods cost more has also allowed Russian producers to raise prices while still undercutting the cost of imported foodstuffs. “These [Russian] products are now seeing increased demand, and the accompanying rise in prices allows manufacturers to increase margins in their production,” says Timur Nigmatullin, an analyst at the Moscow investment firm Finam. The cheaper ruble has also helped Russia boost food exports. In the agricultural year ending June 30, 2015, Russia exported a record 32 million tons of grain, the news agency TASS reports, citing data from the Federal Customs Service. “The devaluation of the ruble has made Russian grain more competitive on the world market, and demand is very high,” Mr. Nigmatullin says. In particular, exports of Russian grain to Jordan increased by 90%, to Saudi Arabia by 78%, Nigeria by 70% and Turkey by 34.5%. Moreover, Turkey has become the largest export market for Russian grain producers. The country has taken almost 6 million tons of Russian grain so far this year. The total grain harvest in Russia in 2015 amounted to 95-98 million tons, including 54-55 million tons of wheat, said Alexei Kozlov of Moscow brokerage UFS IC. “The most favorable trends in import substitution were the production of meat products, cereal crops, traditional Russian vegetables, fruits and berries,” says Mr. Koslov. The preliminary results of the sowing campaign show that the sown area for potatoes and vegetables has increased by 1.5 times. According to the Ministry of Agriculture, the growth of potato acreage in agricultural organizations and peasant farms amounted on June 25, 2015 to 56-59% compared to the previous year.

Budget Economic ministry says state income is set to decline sharply due to lower oil prices

Read, Watch and Listen to RBTH’s weekly analytical program, featuring three of the most high-profile recent developments in international affairs.

Russia Faces Falling Revenues lion rubles ($9 billion) of state funds, or nearly double the ministry’s figure. “In reality, without new growth stimuli and without structural reforms, the fall of the economy may become lengthier and more intense, especially if measures will be taken that have a negative effect on attracting investment to the Russian economy, such as the Central Bank’s increase of the key rate in order to support the value of the ruble,”said Petr Dashkevich, an analyst at Moscow brokerage UFS IC.

A downward revision of Russia’s official forecast for the price of oil is causing concern among economists worried about the decline in state budget revenues. ALEXEY LOSSAN RBTH

ENGAGING THE WEST GLOBALLY SPEAKING GOING EASTWARD

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Russia’s economy will contract by 3.3% this year, the country’s Ministry of Economic Development said, revising downwards an earlier estimate for a 2.8% decline as the price of oil continues to flag. The ministry also predicted that falling oil prices will have a significant negative impact on government revenues, which are largely funded by taxes on energy production and sales. Ministry analysts predict that the economy will return to growth in 2016, expanding by 1% to 2%, Minister of Economic Development Alexei Ulyukaev said, according to Russian business newspaper RBC Daily. The ministry previously said that it expected 2.3% growth in 2016. The new growth estimates stem partly from a reduction of the ministry’s official forecast for the 2016 price of crude oil, Russia’s key export, to $55 per barrel from $60 per barrel. The price of Brent crude languished around $40 per barrel as of late August. As a result of lower oil prices and slower growth expectations, projected revenues for the Russian state budget were slashed by a total of 1.5 trillion rubles ($22.6 billion). Roughly half of Russia’s state budget comes from mineral extraction taxes and export customs du-

A stressful scenario

GETTY IMAGES

The Moscow City financial district has been hard hit by the economic crisis.

ties levied on oil and natural gas.

Falling revenues The Ministry of Economic Development’s new estimates indicate that the shortfall in state revenue versus previous expectations will grow wider every year: in 2016 the loss will be 310 billion rubles ($4.67 billion), in 2017, 426 billion rubles ($6.42 billion) and in 2018, 781 billion rubles ($11.76 billion). Independent Russian economists called even these forecasts overly optimistic. The analytic center at one of Russia’s largest banks, Alfa-Bank, has determined that a $1 change to the per-barrel oil price takes 120 billion rubles ($1.81 billion) out of the government budget. In 2016 alone, therefore, a $5 decline in the average price per barrel, if accurate, will result in a loss of 600 bil-

Authorities Pin Hopes on Reserve To compensate for falling state revenues, the Russian government will be forced to either reduce expenditures or start spending its Reserve Fund, a rainy day account collected from oil and gas revenues in order to prepare for an eventual fall in energy prices. As of Aug. 1, 2015 the volume of this fund was approximately 4.3 trillion rubles ($64.8 billion). In an extreme case, the Ministry of Economic Develepment said it does not exclude the possibility of spending the entire Reserve Fund in 20162017. Russia’s international reserves are highly liquid foreign assets managed by the Central Bank of Russia.

The Ministry of Economic Development’s forecast also outlined an alternative, more conservative scenario, in which the oil price averages $40 per barrel over the next three years. Should this happen, Russia’s recession will last until 2017. In turn, inflation may run at 8.8% in 2016 and 7% in 2017. “The oil price cannot be predicted with sufficient accuracy,” says GeorgyVaschenko, Director of Operations on the Russian Capital Market at Freedom Finance. “If the price stays at $40 per barrel throughout the year, the recession will end only in one to two years due to the high debt burden.” If the price returns to $70 per barrel, GDP will begin to grow after one or two quarters, Mr. Vaschenko said. “The fact alone that the ministry is testing the economy at a price of $40 per barrel says that it expects prices to fall to this level,” says Alexander Krasnov, an analyst at Moscow’s Verum Option.

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NEWS IN BRIEF

Crimea Tourism, the mainstay of the peninsula’s economy, has declined since the Russian takeover

Moscow Scrambles to Save Crimean Tourism

• Uralkali approved a $1.3 billion share buyback which could lead to its delisting from the London Stock Exchange due to a decline in liquidity. The world’s largest potash producer previously spent $1.1 billion on a buyback this year to cut its free float to 23%, and the company held a review about the benefits of keeping its Global Depositary Receipts listed on the LSE. The new buyback program is for up to 14% of Uralkali’s shares at $16 per GDR and may be extended to the end of 2015. • U.S. film corporation Warner Bros. became the first foreign rights-holder to stop illegal distribution of its movies on the Internet using Russia’s anti-privacy legislation. The company applied directly to the Moscow City Court in order to stop the illegal distribution by Russian torrent websites of its film “Entourage,” which was released in Rus-

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sia on July 30. As a result, 16 websites have already restricted access to the film. Another four have been ordered to remove illegal content before Aug. 24. If the companies refuse to comply, the Internet pages of these resources will be blocked.

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Attracting Russian tourists to Crimea’s sun-dappled coast is key to Moscow’s efforts to sustain the region against European and American sanctions.

Last year Russia absorbed the Ukrainian region of Crimea. Now, officials in Moscow are fighting desperately to support its troubled economy. SAM SKOVE SPECIAL TO RBTH

Over a year after Russia annexed Ukraine’s Black Sea region of Crimea, residents of the peninsula are counting up the costs and benefits of joining a new country. Under Russia, Crimeans receive higher pensions, more federal spending, and — despite the current recession in Russia — association with a more stable national economy than they enjoyed as part of Ukraine. The downsides, however, have also been significant. Tourism, the mainstay of the region, declined sharply in 2014 after the Russian takeover. The odds for a recovery in 2015 look slim thanks to the continued standoff between Kiev and Moscow over the region, in which Ukraine has kept land access to the peninsula closed. Rampant inflation has pushed prices up dramatically, while both foreign and major Russian businesses have steered clear thanks to punishing Western financial sanctions imposed on Russia.

The Kremlin shows no signs of backing off the region, and Russian PresidentVladimir Putin himself visited this August. But among the residents here, the initial euphoria on leaving Ukraine has settled into the routine problems of daily life, while many take stock of what the future might hold. The local government, meanwhile, is battling reputational damage from a spate of forced nationalizations. Corruption has become so rampant that even Mr. Putin called it out on a visit to Crimean lawmakers during his August visit. “The level of corruption and economic crimes is not falling … I ask that you seriously intensify your work in removing corrupt [officials] from power,” Mr. Putin said.

Tourism takes a hit Crimea, a Russian-speaking peninsula welded to Ukraine by Soviet fiat in 1952, was annexed by Moscow in March last year following street protests in Kiev that swept away the pro-Kremlin government. The move, while hailed by many in both Russia and Crimea, struck a harsh blow to the tourism industry here. The mountain-rimmed peninsula saw tourist numbers

drop from around 6 million visitors — primarily Ukrainians — in 2013 to around 4 million mostlyRussian tourists last year, former Crimea tourism minister Yelena Yurchenko told reporters in December of 2014. A lack of easy transport options to the peninsula has kept Russians from completely filling the void left by Ukrainians. With the land route through Ukraine closed, Russians can only reach Crimea via a lone civilian airport, or by taking the over-burdened ferry from southern Russia. Russia’s government, however, has struck back in a bid to boost tourism. In the spring, Moscow announced it would spend 612 million rubles ($9.4 million) to subsidize flights to Crimea from June through October. Russia is also planning to build a multi-billion dollar bridge from southern Russian to Crimea by 2018, along with other major investments in the region’s infrastructure.

Budget tightening These plans, however, have proved little help in the short term. Inflation on the peninsula hit 21% in July compared to December of last year, according to the region’s fed-

eral statistics agency, racing ahead of Russia’s 9% inflation rate for the same period. Crimea’s business sphere — from tourism to retail — has become an international no-go zone. U.S. and EU sanctions against the region prevent foreign credit card companies from working there, creating a cash-based economy. Even major Russian businesses have steered clear for fear of sanctions. German Gref, head of major state lender Sberbank, told reporters in May that expansion into Crimea would be “inexcusable in the context of sanctions. For now we will not operate in this area.” Despite the tough economic conditions, few Crimeans are publicly complaining. As the conflict between the Ukrainian government and pro-Russian rebels drags on, Crimeans still lean towards Moscow. How long Russia can hold their faith remains an open question. Speaking in August in Sevastopol, the home of Russia’s Black Sea Fleet, Mr. Putin urged local officials to address citizens’ concerns. Otherwise, he warned, “outside powers”could manipulate“the government’s ineffective actions to channel justifiably concerned citizens onto a destructive course.”

• Deputy Transport Minister Oleg Belozerov has replaced Vladimir Yakunin, a long-time ally of President Vladimir Putin, as head of Russian Railways, TASS news agency reported, citing Prime Minister Dmitry Medvedev. “I have decided to appoint you head of Russian Railways while simultaneously releasing you from the post of deputy minister of transport,” TASS quoted Medvedev as telling Belozerov. Mr. Yakunin had headed the state rail monopoly for 10 years. • McDonald’s will significantly expand its chain in Russia’s remote Siberian regions after the company signed the first big franchising deal in its 25year history in the country. Up to 20 McDonald’s franchises will be opened in Siberia’s Kemerovo, Novosibirsk, Tomsk and Altai regions. The first restaurant is scheduled to opening this month. • Food retailer Dixy lowered its 2015 growth forecast at the end of August saying it has been slow to react to the drop in consumer purchasing power. The company also reported a 27% fall in second-quarter net profits.

CO N V E RT I N G M O N O LO G U E S I N TO D I A LO G U E

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Recession A new analysis argues Western sanctions aren’t driving the economic downturn

Experts Say Oil, Not Sanctions, Caused Decline ALEXEY SERGEEV RBTH

According to a new report by Central Bank analysts, sanctions against Russia have not played a significant role in starting the country’s current recession. Rather, the decline in economic activity is mainly due to falling oil prices. Western sanctions against Russia are responsible for only a 0.50.6% decline in the country’s annual Gross Domestic Product, the broadest measure of economic output, the analysts said, according to Russian business daily Kommersant, citing an economic study carried out by Central Bank analysts. Russia is one of the world’s top suppliers of oil and gas, and energy accounts for some two-thirds of the country’s export revenues. The report, completed by Andrei Sinyakov and Sergei Seleznev, who work with the Russian regulator, and Agustin Roitman, an economist from the International Monetary Fund, models the country’s economic dynamics following the introduction of Western sanctions in the third quarter of 2014, and

looks at the impact of the decline in oil prices from $110 to roughly $50-$55 per barrel. The model used by the authors is based on work carried out by Arnold Harberger, one of the founders of the Chicago school of economics, and Carlos Vegh from Johns Hopkins University. Looking forward, the authors factored in the extreme assumption that Russia will not have any access to capital from foreign markets over the next five years. If true, the country’s foreign debt would be eliminated entirely by the year 2019, analysts from the the Central Bank concluded. Vladimir Bessonov, director of the Laboratory of Inflation Problems and Economic Growth Study at the Higher School of Economics in Moscow, said he supported the Central Bank’s conclusion. “The precision of such evaluations is inevitably relative,” Mr. Bessonov said. “However, in general, I concur that Russia’s GDP has fallen in relation to the change in energy prices, not because of the sanctions.” According to official information, Russia’s GDP in the JanuaryJune 2015 period fell by 3.4% compared to the same period in 2014. The U.S. and other Western nations imposed a series of economic sanc-

RUSSIA-DIRECT.ORG August Monthly Report

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A new report by analysts from the Russian Central Bank argues that U.S. and EU sanctions have not dealt significant damage to the Russian economy.

• The net profit of Polyus Gold, Russia’s largest producer of the yellow metal, more than doubled in the first half of this year on the back of higher sales and revaluation gains on derivative financial instruments. Polyus, controlled by billionaire Suleiman Kerimov and his partners, has been supported by its gold price hedging program which helped offset lower bullion prices. Net profit rose to $583 million, beating analysts’ average forecast of $342 million, while adjusted net profit jumped 89% from the year before, to $432 million.

Energy accounts for about two-thirds of Russia’s export revenues.

tions against Russia starting in March 2014 to punish Moscow for its seizure of Crimea and its subsequent backing of militants in Ukraine’s eastern Donbass region. The sanctions target a wide range of Russian companies and individuals seen as close to PresidentVladimir Putin, and among other things, block state companies and banks from acquiring foreign credit.

“Russia’s GDP has fallen in relation to the change in energy prices, not because of sanctions,” said Vladimir Bessonov. According to Mr. Bessonov, evidence that oil, rather than sanctions, is the primary driver behind Russia’s recession can be seen by examining the chronology of events — the country’s GDP began to decline not when Western sanctions against Russia were introduced, but at the beginning of 2015, after the drastic fall in oil prices.

“The influence of sanctions on various sectors of Russian industry was mixed,” he said. “Some sectors were able to establish the process of import substitution,”Mr. Bessonov continued, noting that the Central Bank was forced to raise the key interest rate, which determines the cost of all credit in the country, to 17% at the end of 2014 as the ruble went into freefall. The rate has since been reduced, step-by-step, to 10.5%. “It is the key rate and the consequence of the cost of credit within the country that has had the main influence on the economy. The manufacturing industry is suffering especially from high borrowing costs,” he said. Georgy Vashchenko, director of operations on Russia’s Capital Market at Freedom Finance, agrees with Mr. Bessonov.“The main reason for the recession is the inflation brought about by the ruble’s fall, which in turn is related to the drop in oil prices and the Central Bank’s refusal to support the currency,” Vashchenko said.

FROZEN CONFLICTS IN THE POST-SOVIET SPACE The latest Russia Direct report explores the ongoing conflict in Ukraine, Russia’s tense relations with Georgia, and Russia’s ability to ensure stability on its borders. Can the Kremlin efficiently address potential security risks while avoiding the outbreak of new crises?

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QUOTES

E-COMMERCE IN FOCUS

Jack Ma

SHOPPERS GO ONLINE IN RECORD NUMBERS AMID ECONOMIC DOWNTURN

Our goal is not to sell Chinese goods in Russia. I dream of a service via which small businesses in Russia will be selling their goods all over the world. Things in the Russian economy are not great, so why not sell to China? We have 2.5 million people belonging to the middle class. I think, in 15 years’ time there will be 500 million of them. And they have an appetite for good-quality products. We are also thinking of improving our payment system. We already have AliPay and in future we may have RussiaPay. If we start to invest — working with the Russian Post and financial organizations — in 10 years’ time Russia will have a very advanced online retail sector and the infrastructure for it, much faster than world trade overall.”

Alexei Ulyukayev IN COMMENTS FOLLOWING TALKS WITH CHINA’S MINISTER OF COMMERCE GAO HUCHENG, AUGUST 2015

China is a most important trading partner for Russia. Having said that, the situation in bilateral trade is not straightforward. In late 2014, there was a slowdown in trade, which continued into the first six months of 2015. It is obvious that this is a temporary trend, caused by certain difficulties that our countries’ economies are going through. In order to overcome this slump in bilateral trade and return to the pre-crisis growth rate, I believe it is necessary to diversify the trade structure with an emphasis on high-tech products and to develop new areas and mechanisms of cooperation.”

Alisher Usmanov ALIBABA INVESTOR, IN AN INTERVIEW WITH CBS, NOVEMBER 2014:

RUSSIAN E-COMMERCE DEFIES RECESSION CONTINUED FROM PAGE 1

Speaking at the St. Petersburg Economic Forum this summer, Jack Ma, founder of the Chinese online goliath Alibaba, said the current moment is favorable for expansion into Russia. Firms with brick-and-mortar stores that haven’t previously relied on the Web for sales are expanding online in Russia as well. Sweden’s IKEA plans to launch online ordering options in Russia in 2016. The retailer has already launched a trial online store in the Siberian city of Omsk, and the company intends to make similar moves in six more central Russian cities: Surgut, Tyumen, Ishim, Nizhnevartovsk, Khanty-Mansiysk and Novy Urengoy. Looking beyond the consumer sector, business-to-business sales are also primed for growth, analysts said. In October 2015, the Chinese company Rufavor plans to launch a platform for wholesale e-commerce sales between Russia and China, with a focus on servicing Russian online retailers. Rufavor aims to sell products to small online retailers in major cities of Russia, and has plans in the future to establish local service centers granting purchasers the ability to return goods to the seller.

What Russians buy

We have had a very good entry to the Chinese Internet market. Together with Yury Milner, we hold positions in Alibaba, Xiaomi and JD.com. We have very good results in those companies today — a manifold increase in value. The Chinese mobile phone manufacturer Xiaomi will become a future technological giant. Its smartphones have already overtaken other Chinese equivalents and even Samsung in terms of sales, thanks to a horizontal expansion and the acquisition of similar service companies. We have sold our stakes in U.S. assets with a very good result; we are very happy with that investment.”

In addition to physical sales, about 46% of Russians spend money on games according to Synovate Comcon. Meanwhile, 42% spend on applications for smartphones or tablets and 30% buy software online. In turn, according to a ranking compiled by Russian publishing house Kommersant — called the Runet’s 100 Largest Sellers — the single most popular online purchase item for Russians is air and train tickets. That has made the top two domestic retailers online national rai-

ries,Verum Option analyst Alexander Krasnov said. “Interest in online shopping is growing because of the lower prices,” Mr. Krasnov said.

Future prospects Mr. Pivovarov said analysts broadly expect growth of around around 20-25% for the e-commerce market in Russia in 2015. If correct, such double-digit expansion would create an oasis of economic growth in the midst of Russia’s overall downturn. But the sector itself may become segmented as Russian’s disposable income gets squeezed, industry analysts said. “Demand will rise far less quickly for expensive products,” Mr. Krasnov said. More costly items like computers and home appliances may have a harder time sustaining growth among Russian shoppers. The falling ruble is also having a big impact on the sector, pushing Russians to buy local and to look for cheaper Chinese products as opposed to European items.

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FOUNDER OF ALIBABA, IN AN INTERVIEW WITH RUSSIAN NEWS SERVICE RBC, JUNE 2015:

Foreign sales, higher prices E-commerce is growing after a late start as connectivity expands in Russia.

“Top categories are electronics, computers, clothing, shoes, mobile phones and gadgets,” said Oleg Pivovarov.

“There is a growing interest in online shopping because of the lower prices,” said Alexander Krasnov.

lway operator Russian Railways and airline Aeroflot. “The majority of e-commerce in Russia is retail business,”said Oleg Pivovarov, Head of Online Marketing at ABBYY Language Services. “The top categories are electronics and computers, clothing and shoes,

mobile phones and gadgets, and automotive. Around 40% of all online orders come from Moscow,”Mr. Pivovarov said. Online stores have been able to offer shoppers discounts by saving money on rent, wages and utilities relative to brick-and-mortar sto-

Although cross-border e-commerce orders are expanding quickly in Russia, the country’s integration with online vendors from abroad is being hindered by rising prices for foreign items as the ruble slumps, Mr. Krasnov said. Prices for imported equipment have practically doubled as the currency has slumped, Mr. Krasnov said. According to Russian online retailer Yandex.Market, the average price for popular models of refrigerators in online shops grew by 7% from early June to August 23. The price of washing machines went up by 9%, while the price of vacuum cleaners rose by 10%, the firm said. In comparison, the dollar and the

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Data center construction is helping to drive Russia’s information technology sector in the wake of a new law requiring firms to store the personal data of Russian citizens on databases located inside the country. On Sept. 1, 2015, the Law on Personal Data, which forbids many companies with significant online operations in Russia storing the data of Russian citizens abroad, entered into force. The Russian market for services based on commercial data centers was estimated at 11.35 billion rubles ($174 million) at the end of 2014, and with growth of about 2025%, the consulting company Direct INFO said in a report. Experts predict the segment will continue to grow over the next three years due to the development of cloud computing and data-intensive web-based businesses in Russia, as well as the new law. “The law will be another growth driver,” said Oleg Zhukov, CEO of construction company RD Construction, which specializes in the construction of data centers.“Certainly, we’re seeing growth in this market in Russia.” Mikhail Anopin, co-owner of Smart Unit, the only commercial data center in the remote Republic of Sakha (Yakutia), said, commenting on the situation,“We have not yet received orders from international players, but the new law has brought to us state institutions,

which actively began to transfer corporate e-mail and websites from external hosting to us.”

Profitable location Sixteen of Russia’s 20 largest data centers of the country operate in Moscow. Each contains more than 1,000 computer storage racks and has a total capacity of 12 megawatts. Large-scale construction is also planned in the Skolkovo Technopark in the Moscow Region, the “technological Mecca”for Russian startups. At the beginning of 2015, Russia’s largest bank, Sberbank, announced plans to build its own data center at Skolkovo, with 5,000 square meters of server room space and 2,000 racks. “In 2009, Russia had 110 data centers; by the end of 2014, about 180, with 60% located in Moscow,” said Mr. Zhukov of RD Construction. Telecommunication operators have been the main clients of data center construction in Russia in recent years, Mr. Zhukov said. In 2014, Moscow-based RD Construction built a data center for Russian telecommunications giant Beeline in the central Russian region of Yaroslavl. In recent years, large-scale infrastructure projects in Russia have been built mostly by foreign companies, mainly Turkish ones, he Mr. Zhukov said.

Cold means cheap The cold Russian climate is an added bonus for data storage, saving companies on money needed for year-round cooling systems. The chilly weather gives Russia a natural advantage over locations

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Kremlin Boosts Best travel Data Center apps to enrich your Construction Data center construction is expanding both in Moscow and Siberia.

Data Center Spending Expands

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like India, China, Malaysia and the United Arab Emirates, analysts said. In 2015, a tech firm called Siberia managed to attract $250 million (16.5 billion rubles) from local investors to build the first commercial data center in Omsk. According to the plans of the founders, the construction of the center, with a total area of 10,000 square meters and a capacity of 2,000 racks, is to be completed in 2018 with an expected payback period of five years. “We want to enter the international market after receiving a Tier III certificate,”says Dmitry Butsik, co-founder of the data center and

president of Siberia, referring to a status that indicates the facility requires no shutdowns for equipment replacement or maintenance. The Omsk data center will be competitive due to the low cost of service, Mr. Butsik said. “Cooling is required only three months a year”thanks to the local temperature, he said. According to Pyotr Gabyshev, deputy director of the Yakutia Technopark, Russia’s biggest mobile operators, Megafon, Beeline and MTS, are all interested in working with a new data center planned for the Russian Far East. The data center there “will be 30% cheaper than in Moscow,” Smart Unit’s Mr. Anopin said.

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Why Russians Are Shopping More Online VLADIMIR MALYUGIN SPECIAL TO RBTH

ALENA REPKINA

But, “even with significant reductions in exchange rates, goods become cheaper very slowly,”Mr. Aleshin said. Tatyana Komissarova, dean of the Higher School of Marketing and Business Development at the National Research University Higher School of Economics, said Russian shoppers have proved their willingness to shop online.

euro each gained roughly 20% against the ruble during those months. The head ofYandex.Market, Pavel Aleshin, said that higher prices for foreign items were likely to prove “sticky,” even if the ruble regains territory. “Trends of the previous periods show that prices will inevitably rise with the fall of the ruble,” he said.

“Russian users today are willing to pay for content, and this is a very promising niche for investors,” said Ms. Komissarova. “The Internet is evolving,” she continued. “It is coming to small, far-flung towns, where young people are finally getting an opportunity to find the content that they want on their own, rather than waiting for the next new movie to come

to their town or village.” Timur Nigmatullin, an analyst at Finam, agreed that online in Russia would continue double-digit growth despite the recession. “As the popularity of smart phones grows in Russia, we should see relatively high growth rates in such market segments as streaming services and mobile games,” Mr. Nigmatullin said.

China Wins Online Sales in Russia Following the success of China’s largest retailer, AliExpress, on the Russian market, China’s secondlargest online player JD.com is moving into the country. KIRA EGOROVA

REUTERS

RBTH

Chinese online vendors have won the lion’s share of Russia’s crossborder e-commerce business over competitors from Europe and the U.S., spurred on by the ruble’s continued decline and a recession that has prompted Russians to shop for less expensive items. Chinese firms took 65% of Russian online orders made abroad in 2014, according to a report by the East-West Digital News (EWDN). “In 2014, Russians placed about 50 million orders from Chinese online stores, up 40% from the previous year,” said Evgeniya Arnautova, press officer for Russian payment platform Yandex.Money. Chinese vendors’ success in Russia comes amid double-digit growth in e-commerce sales in Russia. The cross-border segment of the Russian e-commerce sector expanded by 70% last year to reach total sales of $5 billion. According to Ms. Arnautova, users spent almost eight times more on orders from China during summer 2015 than a year ago, using Yandex.Money as well as Yandex. Kassa, a full-fledged payment option that includes not only electronic wallets but also bank cards, Internet banking, mobile phone account payments, and payments through terminals. Russians’ interest in Chinese online shopping has increased with the entry of new players into the Russian market. Over the last year,Yandex.Money connected nearly 40 new large and medium Chinese online shops to the payment system. “The second reason for the popularity of Chinese platforms is a wide range of products and low prices, competitive even with an unstable exchange rate,” Ms. Arn-

Richard Liu, CEO and founder of Chinese e-commerce company JD.com

Selling Russian Goods in China Chinese online merchant Alibaba Group has reached an agreement with Russian retail chain ABK on the sale of foods, cosmetics and convenience goods in China. JD.com expects to start selling Russian food, jewelry, furs and other goods in China by the end of 2015, Victor Xu, president of JD.com’s international business group, announced at a press conference in June. According to Mr. Xu, JD.com’s managers also met with Russian government officials. Chinese authorities plan to expand the presence of Chinese firms in the logistics chain by shipping Chinese goods to Western markets. “We hope to implement projects such as building an e-commerce logistics center in Yekaterinburg to expand trade between the two regions,” said the mayor of Harbin, Song Xibin, in an interview with RBTH in June. Proposals for the construction of such centers in Vladivostok and Ulyanovsk have already been made by Chinese officials.

autova said. Adrien Henni, lead author of the EWDN research study on crossborder sales to Russia, noted that a range of Chinese players who now sell via such platforms as AliExpress, eBay or Amazon are interested in the Russian market and will attempt to sell directly to Russian consumers as soon as they have decided they understand the market and set up the necessary procedures. A subsidiary of Alibaba Group, the online retailer AliExpress, which appeared in Russia in 2012, has become the most popular online retailer in Russia. In 2015, the Chinese platform became the leader on the Russian ecommerce market in terms of the total number of customers. According to TNS, the monthly customer base of the online retailer in Russia amounted to almost 19.6 million people in April 2015, showing a 50% increase compared to the year before. Russia ranks second in AliExpress’s global audience, providing almost 10% of the retailer’s traffic, according to the website Similar Web, and is second only to the U.S., with 11% of traffic. Gross merchandise sold through Alibaba’s marketplaces in Russia

in 2014 totaled 110 billion rubles ($1.69 billion). Meanwhile, the dynamics of the U.S. online businesses, which appeared in Russia in 2010, are stagnating. U.S. giants eBay and Amazon earned no additional market share in Russia in 2015. Their customer bases amount to 4 million people and 1.5 million people respectively. At the same time, according to East-West Digital News analysts, forecasts for the Russian online retail market remain very favorable, even taking into account the changed geopolitical realities and the effect of the falling ruble. In June 2015, JD.com, the second-largest Chinese retailer entered the Russian market; 11% of the company’s shares are owned by Russian oligarchs Alisher Usmanov and Yury Milner. The retailer aims to take 20% of Russia’s e-commerce market in the next five years, selling Asian electronics and appliances at discounted prices. “JD.com, which localized its site in Russian just two months ago, can be regarded as a serious competitor with its alliances with such powerful players as the Russian Post and SPSR (for logistics) and Ulmart.ru (for distribution),” said Mr. Henni. In his opinion, AliExpress leadership in the China-to-Russia ecommerce segment is largely due to its first-mover advantage. These new entrants could have a big impact on the Russian market, which is far from being mature. “Millions of Russian people will start buying online over the next decade, and they will certainly be interested in their offers,” says Mr. Henni. Both AliExpress and JD.com also plan to sell Russian goods in China. “In China, some categories of Russian products are now very popular, such as eco-products,”Ms. Arnautova said.

nline shopping continues to gain popularity with Russian consumers. An annual study conducted by PayPal and Data Insight showed significant growth both in consumers who have made purchases in foreign online stores (31% this year versus 18% last year) and comsumers who have purchased from domestic ecommerce outlets (55% this year versus 44% last year). The study results also suggest that online shopping is gaining popularity outside of major cities, including towns with populations of less than 400,000 people. Approximately 41% of active Internet users from smaller cities said they are planning to start buying goods online within the next 12 months, or are planning to do so more often. Our Russian study reveals that the most popular items purchased by Russian consumers online include clothes and footwear, electronics, travel-related items (tickets, accomodations) automotive parts and digital products (games, music, books). One of the important trends revealed in another study conducted by PayPal and Ipsos in 22 countries is that Internet shopping on mobile phones and tablets is almost as popular in Russia as it is in the countries of Western Europe. On average, Russian tablet owners make 2.38 purchases per month (compared to 2.4 purchases made by consumers in Western Europe), while owners of smartphones make 2.6 purchases per month (versus 3 purchases in Western Europe). In terms of mobile online shopping, the global study shows that 49% of Russian smartphone or tablet owners/users name the convenience of using apps as a benefit when paying online or in stores. Meanwhile, 37% say it is a rapid way to pay, and 27% think that apps simplify the payment process. The most important barrier to shopping from a smartphone is the small size of the screen (35% of online shoppers who own a smartphone but don’t use it to shop online say that this is what prevents them from using it to shop online). Still, the key driver that makes consumers go online is the convenience offered by Internet shopping (this was confirmed by 39% of the respondents). The Russian study shows that people choose the Internet as a tool for making purchases not only because of their desire to save money or find goods which are not generally available in retail stores, but because searching for information and making purchases online has become extremely convenient and familiar. However, this is more common for people living in large cities. For those who live in small towns and villages, far away from regional centers, online stores often become a necessity. Russian consumers want more than the limited choice or prices offered by just one store — so they are increasingly taking to the Internet for their shopping. Vladimir Malyugin is head of PayPal Russia

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VIEWPOINT

Energy The gas giant’s earnings rose in the first quarter, but market watchers see difficulties ahead

E-commerce Part of Import Substitution Plan

Gazprom Posts Profit Hike, Faces Challenges

Alexey Lossan is executive editor of Russia Beyond the Headlines for Business

owned firm posted a tidy profit in the first quarter of 382 billion rubles ($5.9 billion). Prices for natural gas are tied to prices for crude oil and lag behind by several months. As a result, Moscow-based Gazprom got a boost in the first quarter as gas prices reflected the higher crude oil prices from late 2014.

Gazprom surprised observers with higher-than-expected profits for the first quarter of 2015. But key questions remain about the company’s future. DAVID MILLER SPECIAL TO RBTH

Russian natural gas firm Gazprom posted a 71% increase in net profit for the first quarter, beating analysts’ expectations as a decline in the exchange rate of Russia’s national currency boosted earnings and offset lower export volumes. Yet market watchers say that despite the earnings surge, Russia’s most important company faces considerable challenges ahead, ranging from rising competition at home and abroad, to sanctions and antitrust charges in Europe. Meanwhile, its quest to unlock new markets in Asia will require enormous and costly new pipelines. Gazprom’s exports to Europe fell 8% year-on-year in the first half of 2015 to 76 billion cubic meters (BCM), due in part to a relatively mild winter and to European customers taking less gas during the first quarter in anticipation of lower prices ahead. Russia’s main gas market competitor, Norway, edged ahead to become the top exporter of natural gas to Europe in the first quarter. Meanwhile, Gazprom’s domestic sales fell 5% in the first six months of 2015 amid rising sales from Russian firms Novatek and Rosneft. Gazprom still sits on some of the world’s biggest reserves of natural gas. But production is falling. Russia’s Ministry of Economic Development predicted in July that the firm would produce an all-time low of 414 billion cubic meters of gas in 2015, down from 444 BCM last year due to flagging demand and lower investments in production. “Gazprom is confronted with the greatest challenge in its history,” Chris Weafer, a partner at the Macro Advisory consultancy firm, recently told French news agency AFP. “What remains to be seen is whether Gazprom becomes an appendage of the foreign ministry or evolves into a global energy company.” Despite these problems, the state-

Profit spike Gazprom earns most of its profits in Europe, where the firm supplies about a third of total gas imports, and where gas prices are higher than in Russia. In April, however, the European Commission began the process of filing formal antitrust charges against Gazprom — a slow-motion drama that may take years to resolve, but which could result in large fines for the company. The European Commission said in a statement in April that its“preliminary view is that Gazprom is breaking EU antitrust rules by pursuing an overall strategy to partition Central and Eastern European gas markets, for example by reducing its customers’ ability to resell the gas across borders. This may have enabled Gazprom to charge unfair prices in certain [European] member states.” Gazprom denied the claims, saying in a statement that it “considers the claims brought by the Euro p e a n C o m m i s s i o n t o b e unsubstantiated,” and that it “strictly adheres to all the rules of international law.” Meanwhile, Gazprom has been targeted by sanctions from the United States and European Union — stemming from Russia’s role in the conflict in Ukraine — that hurt its ability to access foreign capital markets. In the midst of a new policy known as the “pivot to Asia,” Russian officials reached agreements with China on exporting large quantities of gas by pipeline to China for the first time. Gazprom signed a deal with the China National Petroleum Corporation to sell 38 billion cubic meters of gas per year for 30 years. But the catch is that Gazprom will be required to build expensive pipelines over enormous swathes

REUTERS

s Moscow’s relations with Western capitals spiral into a deep freeze, Russia responded with an ambitious attempt to restructure its entire economic system. The import substitution course declared by the government is, in reality, a bid to reduce the share of energy resources and oil in the overall volume of Russian exports. In search of a silver lining to the crisis, officials are hoping to shore up economic growth in a way that alleviates Russia’s reliance on energy exports. However, in order to spur foreign sales of Russian goods, significant changes are necessary. Online trading platforms are one way Russian producers can sell their goods directly to foreign consumers. There are already successful examples: Russia exports not only oil and iron ore to China, but also juice and toothpaste. The U.S. buys software developed by Russian programmers.Yet the new players still do not have the necessary trade instruments to fully take advantage of the available opportunities. The Russian government is trying to create a universal instrument or platform for the growth of non-oil exports. To be sure, the idea predates the fall in oil prices and the political cooling with the West. In 2011, Moscow established the Russian Agency for Insuring Export Credit and Investment, Eksar. From 2011 to 2015, this agency insured export supplies worth more than $6.5 billion. Officials within the agency are trying to turn it into a universal platform for the development of Russian exports. To make this work, the agency has to have enough political clout, and it does. It is headed by Petr Fradkov, son of the head of Russia’s foreign intelligence service, Mikhail Fradkov. Nevertheless, the agency still has not become a driving force for the development of Russia’s non-oil exports. Indeed, statistics confirm that the share of oil in Russian exports is decreasing. According to official data, in the first six months of 2015 the share of fuel energy products in exports to faraway countries fell from 75% to 68%. But the cost volume of these goods declined by 35%, while the physical volume increased by 10%. The volume of exported crude oil grew by 12%, electric energy by 25% and oil products by 20%. Non-oil-related exports are also growing. The overall share of chemical industry products grew from 5% to 6.6%, cars and equipment from 3% to 5% and food products from 2.7% to 3.2%.

Gazprom is facing competition at home and abroad as production falls.

Gazprom Quarterly Net Proﬁt

ALENA REPKINA

RBTH

of virgin territory. And talks aimed at finalizing the deals have become bogged down. Nevertheless, observers say Gazprom is here to stay, though its mettle will be tested by its current difficulties. While European officials are seeking to diversify imports, they have little choice but to import gas from Russia. Gazprom“will remain a vital gas supplier to Europe over the medium term,”the Fitch ratings agency said on August 24.

Market cap decline Gazprom, the world’s largest publicly-listed utility by production and reserves, occupies a special place in Russia’s corporate landscape, supplying the government with billions of dollars of revenues while powering Russian industry and heating homes with

discounted domestic sales. The company was even tapped to help underwrite new infrastructure for the 2014 Olympics in Sochi. Just a few short years ago, the firm’s power and financial success appeared destined to keep growing. In 2008, the company became the world’s third-largest by market capitalization, with a total valuation of roughly $360 billion. In those salad days, Gazprom’s deputy chief executive Alexander Medvedev predicted Gazprom would achieve a $1 trillion market valuation by 2014. Instead, since then, the company’s market cap has plummeted to a little more than $50 billion. No company among the world’s top 5,000 firms has suffered a bigger decline in market capitalization during that period, Bloomberg News has calculated.

Energy Sanctions Russia’s second-biggest gas producer may seek funding from China

Report: China Eyes Stake in Russian LNG Field Russian gas producer Novatek may be close to a deal to sell 9.9% of its Yamal LNG project to a Chinese state investment fund, helping the sanctions-hit company replace Western financing. IVAN BRIZOV SPECIAL TO RBTH

Novatek, Russia’s second-largest natural gas producer, is close to reaching an agreement to sell a 9.9% share in itsYamal LNG project to a Chinese investment fund, Russian media reported, citing unnamed sources. According to Russian business daily Kommersant, the buyer is China’s Silk Road Fund, a $40 billion infrastructure investment vehicle set up last year by the Chinese government with a mission to boost connectivity across Asia. “Being one of the largest importers of oil and gas, China is interested in participating in the production of these resources and investing in this sector,”said Alexander Krasnov, analyst at Verum Optium. Krasnov said Chinese financing will replace Western credit, since Novatek, the owner of the project, has been hit by sanctions from the U.S. and Europe that limit its access to Western financing. According to an estimate by analysts at U.S. brokerage Merrill

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ALEXEY LOSSAN

Russia aims to win a share of the global liquified natural gas trade.

Lynch, the cost of the stake may range from $1.5 to $2 billion.

Conditions of the deal The Yamal LNG project requires the construction of a plant to produce super-cooled Liquefied Natural Gas (LNG) in theYuzhno-Tambeiskoye deposit in the north of Russia. The project also includes the launch of three LNG production lines with a total capacity of 5.5 tons per year, set for 2017. Overall investment in the project is estimated at $28 billion. Prior to the deal described by Kommersant taking place, the project’s current shareholders are No-

vatek with 60%, French oil and gas giant Total with 20%, and China’s CNPC with 20%. Novatek has already reached agreements to sell LNG from the project to the two other shareholders, Total and CNPC, along with Spain’s Gas Natural. By selling the additional 9.9% stake, Novatek would be able to retain a controlling stake in the project, analysts noted. According to Ilya Balakirev, chief analyst at the investment company UFS, the deal would be a coup for Novatek in that it likely allows the company to skirt Western sanctions and access funding for the project. The deal, if it goes through,

bodes well for the success of the Yamal LNG project, he said. Novatek has finally “found a niche” for the remaining stake in Yamal LNG, he said, and the deal is likely to generate new project financing from China, which will be indispensable for the project’s subsequent development. Mr. Krasnov of Verum Optium said the deal helps ensure the future of Russia as a large exporter of LNG, a goal the country’s policymakers have been pushing towards for years. Russia has long been a top global exporter of natural gas. But the fuel must be shipped via pipelines in its natural, gaseous state. Once it is super-cooled into liquid, however, natural gas in the form of LNG can be loaded onto super-tankers and shipped globally to far-flung markets. Russia currently has only one functioning LNG plant, known as LNG Vladivostok, which belongs to market-leader Gazprom.

The threat of sanctions In August the U.S. added Gazprom’s Yuzhno-Kirinskoye condensate deposit in the Pacific Ocean near Russia’s Sakhalin island to its blacklist, barring American companies from supplying equipment for that LNG project. The move threatens Russia’s ability to become a global player in LNG, analysts said. “This could definitely damage the future development of LNG projects,” said Ilya Balakirev. Without access to imported technologies, said Balakirev, Gazprom may face difficulties in developing the deposit.

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THE RUBLE: PARTY LIKE IT’S 1998?

THE BIG BATTLESHIP DEAL THAT SANK

STANISLAV TKACHENKO EXPERT

IORSH

GEORGY BOVT POLITICAL ANALYST

he saga of two French-built Mistral helicopter carriers, which were ordered by Moscow but never delivered because of Western pressure over Ukraine, has finally been resolved. France has fully refunded Russia the $1.3 billion it paid for the two naval vessels. For both strategic and logistical reasons, the purchase of the Mistrals never really made sense to begin with. There is a saying in Russia that fits the occasion: “Anything that happens, happens for the best.” Russian officials first came up with the idea to purchase the ships back in 2008. This was largely a politically motivated deal: RussiaFrance relations were on the rise thanks to French President Nicolas Sarkozy, who not only played a crucial part in resolving Russia’s conflict with Georgia but also helped to minimize the conflict’s impact on relations between Russia and the West in general. While Russia’s then-president Dmitry Medvedev supported the deal,Vladimir Putin, who was prime minister at the time, was never particularly in favor of it. Moreover, Putin revealed two years ago: “We signed these contracts

primarily to support our partners and offer some work to their shipyards. Frankly speaking, it’s of little consequence for us or our defense capability.” Indeed, the French warships were doomed to become“outcasts”amidst the Russian navy from the start. First and foremost, operating those ships would have made Russia reliant on foreign replacement parts. What happens when the country faces sanctions? Second, there were serious doubts as to whether the navy actually had any need for these expensive “toys.” Mistral-class vessels are versatile: they can serve both as flagships as well as command and control centers during naval combat. Incidentally, one of the reasons for the purchase was to try and obtain some insight into modern naval combat techniques used by Western countries. However, the main purpose of the Mistral ships is to land and support ground forces on enemy territory while remaining far from shore. The problem is Russia doesn’t seem to ever stage such operations — they are not even mentioned in the country’s naval doctrine. The only thing Moscow might, perhaps, use these ships for would be to land a force in Syria to help President Bashar el-Assad’s regime. Or, maybe, to fight pirates near the coast of Somalia. But do those missions really justify such an expense? In fact, the Mistral ships did not fit into the

traditional strategy for the deployment of Russian naval infantry troops. To elaborate, unlike Russia’s amphibious warfare ships (which, admittedly, are obsolete and in need of modernization), Mistral ships cannot approach beaches. The technical issues and inconsistencies were numerous, so the ships would probably have needed to be modified further once delivered to Russia — while it was doubtful they would see any use at all. But the really crucial part — that was revealed even before sanctions were imposed on Russia by Europe and the United States — was that France, under intense pressure from its North Atlantic Treaty Organization allies, refused to sell the ships equipped with traditional NATO hardware, namely the SENIT 9 information processing system and the advanced SIC-21 command and control system. Thus, the one strong argument in favor of buying the French “toys” was no longer valid. If the vessels had eventually been sold to Russia, they would have probably seen very limited use, most likely as transport ships capable of carrying out rescue operations in a relatively peaceful environment. It should also be noted that France only built two Mistral-class ships for its navy, and all previous attempts by the French government to sell them to other parties have failed. If it weren’t for Russia, the shipyard in Saint-Nazaire — which constructs the vessels — could have gone out of business. Still, the Russian navy really does need a new generation multipurpose amphibious warfare ship. Such a vessel will most likely be developed by Russia itself, based on the existing Priboi project — which means it will be equipped with Russian-made systems and components that will comply with Russian standards. The first ship of the new class will be launched in 2020. While Priboi-class vessels will be somewhat slower than the Mistral ships and have 20% shorter range, they are in many ways superior. They will have a larger draft and will be able carry more supplies and more helicopters than the French ships. It is still a pity the country wasted seven years on the Mistral deal. But, to recap,“anything that happens, happens for the best.” Or, rather: better late than never.

n August 17, 1998, Russia announced a simultaneous default on sovereign debt and a devaluation of its currency, the ruble. Fast-forward nearly two decades, and there are rising concerns in some circles that the country could be facing a similar scenario. Yet while there are some apparent similarities between today’s economic troubles and the 1998 implosion, there are key differences, too, that put Russia in a stronger position today. These developments suggest that a repeat of the 1998 financial meltdown, with a tumbling exchange rate and sovereign debt default, should be considered out of the question. Nevertheless, we can indeed expect a significant short-term decline in the ruble’s exchange rate. Let’s look at the reasons why. The ruble began falling rapidly in September 2014 before coming to a halt in the period from February-June 2015, and then resuming again in July 2015. The main levers for controlling the exchange rate of the ruble are in the hands of the Russian presidential administration, the government and the Russian Central Bank. So far, these structures have not made any obvious mistakes of the kind that might trigger another landslide devaluation. But neither have they taken any steps to help the Russian economy adapt to the new realities of the global market, which stands on the brink of economic crisis. It should be noted that the situation in the Russian economy today is fundamentally different from 1998. To be sure, in both cases, the trouble has stemmed from low oil prices. However, in 1998, the price decline was more stark: oil dropped below $10 per barrel, less than the base cost of production and transportation. Back then, Russian oil companies operated at a loss. Today, Russia’s oil and gas businesses are operating comfortably. Over the past 17 years Russia’s economy has grown several-fold: it has developed a market orientation with the necessary infrastructure to support it. Yet many regard the Russian Central Bank’s competitive devaluation of the ruble as “Russia’s step” in the global currency wars. Now China has gone down the same path. Through their policy of quantitative easing, the U.S. Federal Reserve and the European Central Bank are suspected of waging a currency war. If the actions of the major players in the global currency market are successful, it will soon be Russia’s turn again to carry through a substantial devaluation of the ruble.

Georgy Bovt is a political scientist and a member of the Foreign and Defense Policy Council.

Stanislav Tkachenko is Professor in the International Relations Department of St. Petersburg State University. The article was first published at Russia Direct.

RUSSIA: ‘BIGGEST CASUALTY’ OF FALLING OIL PRICES IRINA MIRONOVA EXPERT

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he China-led slowdown in global economic growth, and a decline in manufacturing appear to be the biggest factors behind the recent decline in oil prices. As news agency Reuters has pointed out, “U.S. oil prices headed for their eighth consecutive week of falls on August 21, the longest losing streak since 1986.” It’s true that oil prices have fallen dramatically on several occasions since the 1970s oil supply shocks: in 1986, 1998 and 2008. But what is new this time is that the current decline is being driven by both rising global output and falling demand simultaneously. Now, the International Energy Agency (IEA) is saying that “prices are likely to stabilize” at levels higher than they are today, “but below the highs of the last three years.” In August 2015, Brent and WTI futures were at $47 and $42, respectively. All of this presents a thorny problem for Russia, which gets 50% of its federal budget from energy export revenues. What’s more, a careful look at the likely future of global energy markets suggests a great urgency for Russian policy planners to make hard choices sooner rather than later. Indeed, Russia appears to be“the biggest casualty of the oil price fall,” the IEA has said. The issue of price is central to the future of Russia’s energy production profile: If oil stays cheap, Russia will be forced to revise development plans for offshore and unconventional projects, which hold the key to future export growth. Thus far, Russia has managed to maintain its global energy market share by signing longterm sales contracts and by pursuing new ex-

port projects, including to Asia. However, in order to hold onto that market share in the future, Russia will have to either aggressively push for developments in the Arctic and East Siberia, or completely change the structure of its oil sector. Both options are immensely problematic in the wake of Western sanctions, which cut access to technology and funding for major Russian energy players like natural gas giant Gazprom, as well as oil leaders Lukoil and Rosneft. The sanctions hit deepwater, Arctic and shale projects. Western majors Total and ExxonMobil have postponed or suspended participation in joint ventures with Russian partners.

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In addition, the ruble fell dramatically at the end of 2014, and the Russian Central Bank increased interest rates. Russian companies have lost the ability to refinance their debt. A lack of funds will inevitably reduce capital expenditures, making it even harder for Russia to develop new areas or change the structure of its energy sector. The result? A decline in Russian energy production can be expected in the future. Irina Mironova is an analyst at the Energy Research Institue of the Russian Academy of Sciences and a senior lecturer at the European University in St. Petersburg. The article was first published at Russia Direct.

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Texting FireChat is a new messaging app that lets users communicate via smartphone without Internet or cell service

FireChat: Off-the-Grid Messaging App

HIS STORY

Stanislav Shalunov PROGRAMMER AND FOUNDER OF OPEN GARDEN, MAKER OF THE FIRECHAT APP

REUTERS

The idea for the FireChat app first came to Stanislav Shalunov, a graduate of the Moscow State University’s Faculty of Mechanics and Mathematics, in 2001. A decade later Mr. Shalunov cofounded the San Francisco tech startup Open Garden, together with Micha Benoliel, the programmer behind Skype monetization; Greg Hazel, who supervised the development of BitTorrent client Utorrent, and systems architect Taylor Ongaro. The seed capital of $100,000 for the firm came from Benoliel himself.

REUTERS

A new messaging app that allows users to communicate by creating local, custom networks without external Internet or cell service has caught on with protesters.

ANDREI RASKIN SPECIAL TO RBTH

When thousands of protesters took to the streets of Hong Kong a year ago to demonstrate against restrictive new election rules, the crowds were so large that cell networks were soon overpowered. The protesters’ solution: FireChat, an off-thegrid smartphone app that links handsets together using the smartphone’s Bluetooth or Wi-Fi connectivity to create a mesh network of users within 60 meters of each other. The more users in a network, the better it works. During the Hong Kong demonstrations, FireChat was downloaded more than 100,000 times, putting it at the top of the list of the former British colony’s Google Play and App Store. The app, barely a year old at the time, rocketed to international fame. FireChat then started catching on in Iraq,

where authorities restricted access to social networks as a way of countering the spread of radical Islam. In Moscow last December, Russian opposition leader Alexey Navalny broke the terms of his house arrest to attend an anti-government rally in the center. But even as Navalny live-tweeted his resulting arrest, Bloomberg News reported at the time that “the real action was on FireChat, where Navalny and his supporters organized protests and exchanged unfiltered communication.”

This year the number of FireChat users exceeded 5 million people. Until recently, the messaging app made it possible to communicate in group chats open to everyone, but the new FireChat will allow users also to exchange private messages. In order to launch an offline message, the developers had to resolve numerous tasks, including coding and operating system compatibility. All private messages in FireChat are coded and only the sender and the recipient can read them.

Beyond text and instant-messaging Russian roots It is fitting, perhaps, that the app has been catching on in Russia, given its Moscow-via-Silicon Valley history. The idea for the FireChat app first came to Stanislav Shalunov, a graduate of Moscow State University’s Faculty of Mechanics and Mathematics in 2001. But the technology only became feasible with the spread of Bluetooth. A decade later and a continent away, Mr. Shalunov co-founded the San Francisco startup Open Garden, the parent company of FireChat, in 2011.

“Forget about SMS and IM; an era of peer-topeer networks is coming,’’ said Micha Benoliel, a co-founder and CEO of Open Garden. “Our invention is a step towards the next phase in the development of the Internet: networks created by the people and for the people.” The firm has announced ambitious plans to extend connectivity to the vast number of people who still live off the grid of the World Wide Web. “Our goal is to provide communication to everyone, to the people of the world. We want to facilitate communication to the 5 billion peo-

T R AV E L 2 M O S C O W. C O M

ple who are not connected to the Internet today because they cannot afford it,”Stanislav Shalunov told RBTH. “And to improve communication for people who can afford to connect to the Internet, but experience disruptions. Most of these disruptions have nothing to do with revolutions. Sometimes they are caused by failure or weaknesses in cell phone infrastructure or by capacity overload in crowded places”. The use of the app peaked during the Hong Kong protests in September 2014. It was then in the Google Play store for Android smartphones that FireChat made it into the “from 500,000 to 1 million” users category. The app’s user base grew further thanks to protests in Moscow and cell phone signal disruption in Paris after the Charlie Hebdo attack. The developers are now trying to shed the image of the app as a revolutionary tool. “Indeed, FireChat became popular thanks to various protests around the world. But I see it as my task to get rid of this revolutionary subtext,” said Anton Merkulov, the Open Garden rep in Moscow. In order to communicate via FireChat, users must be within 60 meters of each other. This allows them to create a peer-to-peer mesh network, in effect, their own communication network. Inside it, messages are sent from user to user. FireChat makes it possible to exchange text messages and pictures. In the future, developers hope it will be able to transmit voice and video too. Open Garden will now focus on boosting daily use of FireChat. For now, the top four countries where FireChat has become most popular are the U.S., Hong Kong, India, and Russia.