At the same time, the Russian government has changed its attitude toward the “national champion.” Both the president and his ministers have criticized Gazprom for its ineffectiveness and called for the overhaul of the company’s business model. The finance ministry finally succeeded in raising taxes on natural gas extraction. Fighting back, Gazprom announced a freeze of its key investment projects.

By far the largest threat to Gazprom comes from Putin’s old friends Igor Sechin and Gennadyi Timchenko. The latter owns 25 percent of Novatek, Russia’s second-largest natural gas producer. After Timchenko acquired a stake in Novatek, most of the company’s problems were miraculously resolved: it was allowed to form an alliance with Total and export gas to German consumers. Novatek’s two-digit growth in output has compensated for the decline in Gazprom production, once again demonstrating the advantages of private ownership.

Securing a monopoly no longer creates much value. If Gazprom continues to sell natural gas at premium prices, it risks losing its market share in the European market within several years. In contrast, if the company cuts prices and increases production, it can slow investment in shale gas drilling and liquid gas terminals across Europe. Gazprom still holds a cost advantage over shale gas and can offer a better alternative to the noisy and controversial drilling that is being pursued in densely populated Europe.

The liberalization of the natural resource sector can also help the current ruling clan to stay in power for longer. The survival of the regime depends on the pace of economic growth and the government’s ability to spend money. Considering that Russia has reached full employment, the growth of the natural resource industry remains the easiest way to boost the economy. Softening the investment climate in the oil and gas sectors is a relatively easy task compared with embarking on the painful structural reforms needed to improve overall conditions for business. Major international corporations will be eager to bring their technologies and money to Russia if they are guaranteed unrestricted access to natural resources and reasonable taxation.

More significant economic policy changes could mean not only opening the sector to Russian and foreign private investors and ensuring equal access to the pipeline infrastructure, but also the full-scale restructuring of Gazprom. The company is too big and too powerful for the institutionally weak Russian state. Gazprom’s ineffectiveness and corruption, highlighted by the president and his ministers, are not accidental, but are caused by the intrinsic nature of the monopoly. The company’s size is the reason for high managerial costs and its intolerable level of corruption. The monopoly hampers the development of a competitive environment, triggering consolidation among its clients and suppliers. The recent electric power reforms are a good example of Gazprom leveraging its economic and political dominance to extend its monopoly even further. Gazprom became the largest electric power producer in Russia by acquiring the nation’s most precious electric power assets, including all power plants in Moscow and Saint Petersburg.

Like the magical ring from Tolkien’s trilogy, Gazprom seduces politicians into acting in the company’s best interests. The creation of a more competitive political system is impossible without a significant reduction of Gazprom’s power. Alas, many opposition leaders share the dream of a state-controlled natural resources sector. For example, Alexei Navalny, a popular new-generation politician, proposes corporate governance improvements for state-controlled companies as an alternative to privatization. This is exactly what Putin did ten years ago: he fired Gazprom’s corrupt management team, restored government control over the company, and returned assets that had been stolen from Gazprom in the 1990s. Popular support for state capitalism increases the risk that the current political system will reproduce itself for several more decades even if a new team comes to power.

The restructuring and privatization of the oil industry in the 1990s and of the electric power sector in the 2000s could be used as models for natural gas sector reform. Gazprom should be split into several companies based on their different activities (e.g., natural gas extraction, pipeline construction, distribution, etc.), while the production assets should also be split between different companies. The resulting competition in the sector will ensure its development, provide market-based pricing, and improve the overall structure of the Russian economy. The separate entities would be easier to privatize without running the risk of “hostile” investors taking control of the Russian economy. The sum of the capitalizations of the newly formed companies would most likely be higher than the current market value of Gazprom, which is traded with discounts to its international competitors.

Rosneft Is Likely to Repeat the Story of Gazprom

The ongoing acquisition of TNK-BP by state-controlled Rosneft demonstrates that Putin, though admitting some problems with Gazprom, still believes in the advantages of state capitalism. The case of Gazprom provides good insight into what will happen with Rosneft, a new “national champion” that will control almost half of the oil production in Russia.

By the end of October, 2012, Rosneft confirmed the buyout of another Russian oil company TNK-BP for $61 billion. After the deal is sealed, it will become the largest oil company in the world.

First of all, the Russian government will not receive substantial dividends from Rosneft in the foreseeable future. Rosneft is overloaded with debt and capital-intensive projects, so it won’t find the money to pay its shareholders. Money will go to Russians oligarchs and British investors, not Russian citizens.

Second, an increase in Rosneft’s share price is unlikely. Capitalization growth will be limited not only by the company’s poor corporate governance and Russia’s harsh investment climate, but also by the selling off of BP and Russian government stakes. Most analysts agree that the government pays private shareholders a fair price for their assets. Typically, private investors know better than governments when it is the right moment to cash out. Chances are, the Russian government won’t see the desired return on its investments.

Third, the effective tax rate on the oil industry will continue to fall. Rosneft will probably receive further tax exemptions.

Fourth, the oil industry will continue to stagnate. The largest West Siberian oil fields have surpassed their production peak. Exploration and development of new oil fields requires huge investments and state-of-the-art industry expertise. Competition could have stimulated private companies to invent new ways to extract profit. Rosneft, which will dominate the oil industry in Russia, will most likely concentrate on what it does best—acquiring new assets and lobbying the government for privileges.

Fifth, BP most likely will not become Rosneft’s real strategic partner. Instead, the British company will sell its stake in Rosneft in a couple of years, repeating the pattern of two other ambitious alliances: Amoco with Lukoil and E.ON with Gazprom. Under Russian corporate governance, a 20 percent stake does not guarantee any influence over a company’s strategy. The two BP directors on the Rosneft’s board will likely act only as window-dressing for Rosneft’s controversial business practices.

Sixth, Rosneft, like Gazprom, might become a part of Putin’s geopolitical machine. The economic interests of Rosneft may influence the Russian president’s political decisions. His stance toward the Middle East and other sensitive regions will affect both the world’s oil market and the fortunes of his friends. The peaceful resolution of the Iranian and Syrian crises might drive oil prices down, diminishing the profits of the president’s allies. Hence, Putin’s team is unlikely to be very keen on helping to resolve problems in the Middle East.

Finally, the privatization of Rosneft will become an even more controversial task. Any government would be reluctant to give up control of a company that dominates the country’s most important industry. In this situation, Rosneft’s shares could be sold only with significant discounts, since they would not give investors any influence over the company’s strategy.

In sum, the contribution of the energy sector to the nation’s economic growth seems poised to decline, as does government revenue from the oil industry. The government’s growing presence in the mineral resources sector increases the federal budget risks. Public finances will become even more dependent on oil prices. If oil prices fall, the government will simultaneously lose some of its tax income and face the depreciation of state assets in the oil industry. Even worse, considering Rosneft’s high debt-to-EBITDA ratio, the government might need to bail out the company with public money. If “diversification” and “elimination of oil dependency” were real policy goals, the government would have sold its stakes in Gazprom and Rosneft and used the proceedings to build infrastructure, fix the pension fund deficit, and top up rainy day funds. Those decisions would have fostered economic development and brought macroeconomic stability.

Enthusiasts of state capitalism cite Statoil, a Norwegian state-owned company, as a success story of government control over the mineral resources industry. However, plenty of more relevant examples could be found in Latin America. In most countries of the region, state-controlled companies face similar problems: the inability to develop new oil fields, a high level of debt burden, low efficiency, a lack of transparency, and, as a result, decreasing output. It will not take long to find out whether Rosneft more closely resembles the Scandinavian Statoil or its sibling Gazprom.