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Silk Purses from Sows’ Ears: Russian Railways and the Pig Market Silk Road Stimulus

 
 

Russian author Viktor Pelevin once pointed out that while the West has bear and bull markets, Russia’s is a pig market: pay the pigs or pay the price. In the wake of this year’s Belt and Road summit, the glow surrounding concepts like win-win cooperation neglects the messier reality of the Belt and Road’s impact on the ground in Russia. Not everyone wins equally and oligarchs will position themselves to benefit. Despite a public front of unity, the Kremlin is growing uneasy with the fact that Eurasian integration is increasingly dictated by Beijing. But growing rail freight volumes between Europe and China create new opportunities for Russia’s railroad barons to enrich themselves, a complicating factor when one considers the Kremlin’s attempts to fashion a coherent policy response to a China rising in its historical sphere of influence.

The Object of Oligarchs’ Affection

Russian Railways (RZD) is a completely state-owned behemoth knitting together Russia’s far-flung regions, Central Asia, Europe, and China. RZD alone contributed 1.2 percent of Russia’s GDP in 2016, more than 3 percent of Russia’s investments in fixed assets, provides 1 percent of all Federal tax revenues, and employs over a million people directly or through subsidiaries to whom it pays inflation-indexed salaries per a collective bargaining agreement 28 percent higher than the national average.

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RZD is a prime target for oligarchs looking to increase their sway with the Kremlin. Access to railway contracts is worth billions of dollars. Reuters found in 2014 that firms competing for bids on tenders are often formed by the same owners but separated through shell companies, often don’t even have physical offices, and rarely put in bids more than 1 percent below the initial price put forward by RZD for a tender. That situation hasn’t changed. Competition is therefore often an illusion, one that can be managed best when markets grow for all players. The growth of Europe-China transit trade is buoying returns on rail freight, heightening the need for further investment in rail, and increasing demand for rolling stock. Smaller firms may benefit but oligarchs want their hands on the spigot.  

Clash of Clans

Arkady and Boris Rotenberg — members of Russia’s second-wealthiest family — lobbied hard to replace Putin’s man Vladimir Yakunin, head of RZD for 10 years, with Oleg Belozyorov in 2015. There was even a fake press release from the Russian government’s news service announcing Yakunin’s firing that had to be beat back before Yakunin himself resigned in August. Belozyorov’s appointment was Prime Minister Medvedev’s loss, as he had backed the First Vice President of RZD, Alexander Misharin. Misharin also leads RZD’s high-speed rail subsidiary Skorostniye Magistrali, its principal point of contact with Chinese firms for the proposed high-speed rail line between Moscow and Kazan and the initiative to link Moscow to Beijing by high-speed rail. The Rotenbergs hoped that any reform such as the partial privatization of RZD could benefit them, a blow to those with even the most tepid hopes of liberalization.

Belozyorov’s appointment also fit into a broader strategy Putin and those closest to him have developed in recent years: replace certain old guard barons and governors with younger technocrats, political lightweights with managerial capacity who can insulate oligarchs and powerbrokers from political responsibility. Belozyorov was a First Deputy Minister of Transport before becoming president of RZD, not a political threat. Ideally, he could initiate reforms at the margins to improve the company’s competitiveness without demanding hundreds of billions of rubles in extra support from the state like his predecessor. Oligarchs could keep pilfering RZD for contracts but steps would be taken to return the company to profitability. Though sanctions, counter-sanctions, depressed oil prices, and economic crisis left RZD in a tough position at the close of 2015, there’s cause for cautious optimism. China’s rail ambitions are driving the railway’s evolution and its value for oligarchs in search of cash flow.

(Contained)erization

The stabilization of Russia’s economy in response to capital flight, declining imports, and declining exports due to import substitution policies have settled much of Russia’s freight market. Improvements in RZD’s profitability are largely driven by rising tariffs that remain problematic for Russia’s domestic container trade, yet don’t seem to hinder transit trade. Containers are essential for Europe-China rail freight because they allow for the standardization of border procedures, accounting, shipment sizes, and so on. Russian and Chinese state policies reveal a game being played by oligarchs.

Container traffic for RZD’s logistics subsidiary increased 20 percent in 2016 alone, reaching 95,000 TEUs. But of that 95,000, only 12,000 were for domestic traffic in Russia. The other 73,000 were Europe-China transit traffic. Tracking overall statistics with private players is difficult but overall container flow was up 30 percent. The container market grew 10.2 percent year-on-year to 3.26 million TEUs in Russia in 2016, but only made up 4 percent of RZD’s revenues. RZD may be modernizing electronic data sharing, lobbying the Kremlin for price deregulation of tariffs, and expanding its partnerships in the Baltics and elsewhere, but the domestic container market is not a moneymaker due to the nature of the Russian economy and Russia’s economic geography. In fact, the growth in RZD’s container turnover domestically is driven by the distorted nature of the Russian market.

RZD functionally controls access to most ports, primary nodes for container transit. That position was strengthened when the Kremlin introduced the Platon toll system for trucks on Federal roads, a budgetary measure that happens to be administered by an operator half-owned by Arkady Rotenberg’s son Igor. Trucking is often cheaper on a price-point basis. However, rising taxes and fees mean that many operators violate the law to stay competitive. Any port official realizing a violation would swiftly either reject the goods or force them to pay out more, raising costs. Tariffs on domestic containers rose 8-9 percent year-on-year in 2016 to make up for lost money from bulk cargoes like coal. But the railways can soak consumers and users without losing market share due to the inconsistencies of the shipping market imposed by the irregular rule of law. Containers in transit tell another story of pig markets, but with different issues at stake.

Containerized trade between Russia and China reached 190,000 TEUs by 2015 and has grown since, an important precursor to deepening cooperation on Europe-China transit at the business level. From January to April of 2017, RZD announced it had carried 90,989 TEUs of containers for Europe-China transit, up 81.3 percent from the same time last year. That increase is all the more remarkable as Chinese New Year, normally a slow time for shippers, did little to impact growth. Transit volumes will continue rising, raising questions about their significance for the oligarchs trying to use RZD to advance their own interests.

The viability of transit routes remains an open question. Local governments in China concoct schemes to subsidize rail freight to Europe to show Beijing growth indicators for good performance, China considered subsidizing up to half the costs of shipping Chinese goods to Russia’s Ural regions with possible expansions in the future, and Russia has subsidized container imports from China shaving off 10-15 percent of associated costs. It’s China’s money saving shippers as much as half of what it should cost to use rail between Europe and China.

Last October, RZD admitted that Russia’s rail capacity was 20 percent short of current demand at a time when it was moving to raise tariffs on container traffic another 4 percent for 2017. Container tariffs are propping up the company’s capital investments, a means of essentially sucking money out of China through foreign subsidies while hurting domestic consumers with no other shipping options. High-margin commodities like consumer goods are taking a hit in Russia because of increased costs while the same goods from China are paid for by Beijing or transit Kazakhstan first, reducing the negative impact of higher prices. RZD is becoming more profitable at the expense of Russian consumers and China’s regions and central government.

More is More

Growing Europe-China transit through Russia is contributing to a narrative of greater connectivity, which piques the interest of investors. China is interested in numerous rail projects in Russia: a high-speed line between Moscow and Kazan, an express line between Samara and Kazan, bridges across the Amur river, a mining railway in Tuva, the Belkomur railway connecting the White Sea to the Urals through the Komi republic, and many others. For the most part, these projects are in preliminary stages or otherwise going nowhere fast due to Chinese fears of angering Western partners too much, Russian intransigence at the negotiating table, and the considerable risks on the Russian market. The line connecting Moscow and Kazan alone is worth upwards of $22.4 billion assuming valuations from early March hold. Belkomur is estimated at 2.67 billion Euros, the Kuragino line in Tuva is estimated at around $2.7 billion, the Amur River bridge stands at around $275 million, and billions more add up with other projects. Chinese firms will likely provide critical financing and RZD and its partners will control the tendering process.

If the oil and gas sector is any indicator, RZD will do whatever it can to domestically source the firms that win bids on tenders for these projects. That doesn’t fit China’s model of seeking foreign projects to generate demand for its construction sector and rail expertise. If China wants to maintain these routes without subsidies, Russia has the gift of geography on its side. Billions in contracts will be doled out under the aegis of the Silk Road Economic Belt if China’s recommitment at the Belt and Road summit to invest a further $100 billion into infrastructure bears on its interests in Russia.

The Usual Suspects

China has already attempted to curry favor with the Kremlin by providing financing for projects like Yamal LNG or buying into petrochemical ventures with Sibur in support of oligarchs like Leonid Mikhelson and Gennady Timchenko. Arkady Rotenberg’s firm Stroygazmontazh won the contract for the Kerch Strait Bridge and has been working more closely with the Russian Ministry of Transport for rail contracts of late. Chechen oligarch Ruslan Baisarov owns a controlling stake of the firm contracted to build the Amur River Bridge as well as the Tuva Investment Corporation slated to build the Kuragino line in Tuva. Oleg Deripaska and his firm Rusal will likely supply aluminum for rolling stock. Alexei Mordashov — Russia’s richest man — and his firm Severstal will likely supply steel for construction. Smaller figures like Anatoly Ledovskikh, head of the Federal Agency of Mineral Resources and chairman of the board of rolling stock supplier Transmashholding will also inevitably benefit, already the recipients of state support due to import substitution policies and tedious legislation.

Russia’s shameless conflicts of interest among its political and economic gentry hinder its ability to set rational policies into motion. National interests rarely cohere when competing feudal barons in control of different economic sectors vie for policy influence without real oversight or checks and balances. China’s infrastructure push has the potential to ensnare many of these elites into partnerships worth hundreds of millions in contracts, purchases, and sales. Russia’s ambivalence towards China’s political aims and interest in China’s money will cost it strategic room for maneuver. China, intentionally or not, gains lobby power through these deals. Win-win cooperation will net these men billions, but the average Russian very little.

Nicholas Trickett currently works at a think tank in Washington D.C. He is finishing an M.A. in Eurasian studies through the European University at St. Petersburg with a focus on energy security and Russian foreign policy.

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