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Archive for November 2008

GAZPROM AND PUBLIC SECTOR INEFFICIENCY: IS IT A POINT CARRIED TOO FAR?

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By Ranjan Sreedharan
13 Sept. 2008

It is not unfair to say that the present Russian Prime Minister (formerly the President) Vladimir Putin is widely detested in the west. Indeed, some of us would be tempted to add ‘Yes, particularly after Georgia.’

I believe that is unnecessary. Even before Georgia (and without getting into the complexities of the crisis in the Caucasus), Putin was a figure of hate in the US and as much so in Britain.

The British attitude displayed by its politicians cutting across party lines and its media — including the voices on the centre-left like those of the Guardian and the Independent — has its origins in the perceived injustice meted out to British oil companies like BP and Shell. It became particularly shrill during the time the Litvinenko murder case was front page news, with allegations that the polonium trail led all the way to Moscow (and by implication, the Kremlin and Putin). Moreover, hordes of extremely wealthy but unloved Russians have descended upon London in recent years, buying up premium property and much else.

As for the Americans, they are clearly nostalgic for those days under Yeltsin when Russia did more or less what it was told to do.

The extraordinary lengths to which the media and the academic establishment on either side of the Atlantic can go to – or the depths to which they are willing to descend to – in order to deny Putin any credit for Russia’s post Yeltsin revival, has to be seen to be believed. There is now something of an industry engaged in producing lengthy papers and dissertations seeking to prove that Russia has not done so well under Putin as the world tends to believe (never mind that 80% of Russians think the same as well) and that had it not been for the revival in oil prices, Russia would by now be an economic basket case. Once the oil price boom goes bust … so this theory goes (very close to wishful thinking, if I may add), Russia will be left with nothing more substantial than a begging bowl.

Okay, I’m exaggerating, but there was a recent article in the Guardian where the author – a respected journalist (Edward Lucas) from the Financial Times – called Russia a ‘fascist kleptocracy’. I did not bother to check on what he had said about Russia under Yeltsin when loot and plunder of state resources was the order of the day.

Much of the diatribe against Russia is political and has to do with the perceived roll-back of democracy and democratic freedoms under Putin as compared to the Yeltsin era, which for many in the west, was the golden age of Russian renaissance.

There is also harsh criticism of the economic record of Putin which claims that whatever has been achieved in Russia in recent years was despite Putin and facilitated entirely by the boom in energy prices. It does not matter that when Putin came to power in 1998, Russia had a GDP of US$ 200 billion and when he stepped down from the Presidency this year, it had increased manifold to US$ 1,400 billion.

One of the main planks on which the criticism of Putin’s economic record rests is the role he has played in expanding the state sector in the economy, particularly in energy. State owned companies with a proven track record of inefficiency have expanded and displaced an efficient and well run private sector. At this point, the example is given of Gazprom, the state owned oil and gas company which under Putin has become a behemoth and succeeded in wresting back control of much of Russia’s oil wealth from the oligarchs and from the western (unhappily for Britain, mainly British) oil giants.

We are told that this has led to a sharp decline in efficiency whose long term consequences are now beginning to tell with a stagnation in output levels to be followed in the near future with a real decline in production.

So far, it’s all very good. I like to believe I am second to none in my faith in a market driven economy where the means of production are owned predominantly by private hands. I think it is easy to understand why government ownership of a manufacturing concern can have such disastrous consequences. The negative influences are many and begin with a bureaucratic culture that shirks responsibility and avoids hard decisions. There is a lack of responsiveness to market demands and an inability to adequately reward innovation and achievement (or punish the lack of it). The overpowering bureaucratic culture also throttles your risk-taking ability without which no business can flourish. The result is a company that slowly bleeds and bleeds the public exchequer.

But, and this is the moot question, is it all just the same for an oil company? Here is why I believe it is not.

To begin with, there is the question of quality of output. This is a simple point. In the case of crude oil (and unlike in the case of a manufactured product), it cannot be any different. Whether drilled by Gazprom or by the efficient western oil conglomerates, what comes out of the ground is black gunk, without anything in it to distinguish the inefficient Gazprom product from the hi-tech western product.

Then we come to the question of efficiency, which in the oil industry can be of two types, ‘exploration efficiency’ and ‘extraction efficiency’.

Exploration efficiency: As the name implies, this is essentially the success rate in discovering new oil fields, in striking oil within a given exploration area. No doubt about it, the private sector has a clear advantage over the state owned entities. For example, in India, for a long time the state-owned ONGC had a monopoly over drilling and exploration rights and the last time they did anything worthwhile was Bombay High, way back in the seventies. Once exploration was opened up to private and foreign participation, there has been a spate of discoveries, from oil in Rajasthan to gas (and lots of it) in the Krishna-Godavari basin.

Having said as much, it is worth noting that while inefficient exploration leads to output below what should have been achievable, it really may not harm the country in the long run. Because the undiscovered oil remains below the ground for discovery by, and for benefit of, a future generation, it may well be doing a favour to the next generation. In a sense, in India, we were lucky that ONGC was inefficient in discovering new oil fields. True, this compelled us to import more oil but we did so mostly when the price was about US$ 30 per barrel.  Now that we are face to face with crude prices of US$ 100 and more, the new discoveries will allow us to substitute for a much more expensive import.

Extraction efficiency: This is the efficiency with which you operate an oil well. Given the recoverable reserves in a particular well, how much of it are you able to extract and get above ground. The western oil companies possess superior technology that enables them to recover more from a given well than what a state owned outfit like Gazprom can manage. Now, unlike as in the case of exploration inefficiency, the loss on account of extraction inefficiency is a real, quantifiable loss to the country and to the world economy at large because what is lost here is lost for good.

So, how much does the country concerned (be it Russia with Gazprom or Venezuela with PDVSA lose on account of this inefficiency?

Here is my conclusion. Not a whit.

Because the superior technology of the western oil companies comes at a price, extracted by way of a share of the total production. Very often this goes up all the way to a fifth or more of the total output, and this, after all the initial costs have been recovered. Now, if Gazprom operates an oil well with 60% extraction efficiency, there may well be western oil companies which can improve it to say 75% extraction efficiency, but if the price for that is a 20% share of the total output, it becomes a price worth not paying.

Therefore, in order for the country (be it Russia or Venezuela or Iran) to be a loser from state control of its oil sector, the loss on account of extraction inefficiency has to exceed the share that would otherwise accrue to the western oil company.

In real life, my own guess is that this does not happen. This partly explains why in recent years so many of the western oil companies have been compelled to renegotiate their production sharing contracts with various governments around the world and settle for reduced terms.

There is another side effect too. By acting as a constraint on supply at a time of surging demand, the lower output from inefficient extraction can possibly lead to higher prices in the international markets, thus additionally compensating the countries concerned.

Put it all together, and here is a case where conventional wisdom is turned on its head.

Written by Ranjan Sreedharan

November 19, 2008 at 6:14 pm

Posted in Uncategorized

George Bush and his legacy, why he still has hope

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Cochin, India: 18 Nov. 2008

It is fair to say that when George Bush leaves the White House in two months time, he will do so not with a feeling of dejection at his colossal failures. Instead, he will carry with him a sense of deep hurt and injured pride that his accomplishments are so seldom acknowledged by his countrymen and the world at large. Indeed, in these the twilight days of his disastrous presidency, it is likely that he subsists entirely on that fond hope of politicians (the unlucky and the incompetent alike) that history will judge them far more kindly than their contemporaries have.

At the moment, it does seem a very tall order. A fairly recent (April 2008) survey of 109 professional historians[1] in the United States revealed that over 60 percent of them rate him to be the worst American president ever. This will not come as an eye-popping surprise to anyone. After all, here is a man who possessed the contra-Midas touch. Everything he touched has turned unfailingly into dust.

He began by breaking up the existing international order and sullying America’s image in the world. He followed it up by wrecking the economy, accumulating massive amounts of national debt and topped it off by bequeathing a banking and financial crisis so acute, it draws comparison with the Great Depression. Finally, and we know it now that the elections are over, the Republican Party is rudderless and almost in tatters, having lost heavily in the Congressional elections as well. George Bush, it may be said, broke the world, broke America and broke his own party.

And yet, all is not lost as yet. Indeed, going by historical precedent, there is still hope that history will take a kinder look at what Bush has wrought.

To begin with, the legacy of an American president for that matter, just about any other position is not only about what he has done or what his achievements and failures are. It is also in large measure, about what his successors do after taking over from him. A weak, inefficient successor tarnishes your legacy, because the failures are allowed to fester without course correction. Equally, a capable successor burnishes your legacy because he builds on your accomplishments and corrects or covers up for your failures.

In the case of George Bush, there is no denying that the failures are many and massive. To ensure the kinder, gentler look from history, he badly needs a strong, capable successor who can methodically address the many loose ends he will surely leave behind, and who can be counted on to undo some (if not all) of the damage already done. In Barack Obama, George Bush may have exactly such a person.

Left to his own instincts and judgement, George Bush would have preferred John McCain. But then, if there is an enduring lesson from the Bush presidency, it is that it is possible for one man’s gut feelings to be consistently wrong, even when he holds the highest office in the land.

George Bush hoped that John McCain would succeed him as president. He did not get his wish. I believe he has been fortunate. At a time when what America needs above all is day-to-day competence in its president, John McCain ran on a platform whose primary offering was more of muscular American leadership with no sense of this country’s diminished circumstances. In contrast, Obama appeared to be the more level-headed choice, if only because he had a better grasp of how much the country has fallen.

And here is an irony. Thanks to George Bush not getting his wish, his legacy stands a better chance of that kinder look from history that he so craves.

There is a recent parallel Bush can take heart from. These days, whenever Americans are asked about their great presidents, a name that consistently figures among the top is that of Ronald Reagan. There is a feeling that Reagan won the cold war for America and that his reign marked a period of quiet prosperity. Actually, the truth is a little more complex. When Reagan came to power, America was the largest creditor nation in the world. When he stepped down, America was the largest debtor nation in the world. During his eight years in office, the country’s national debt increased three-fold to US$ 2.9 trillion dollars, with the federal budget running up massive deficits year after year. Reagan was, however, lucky that when he stepped down, the economy was still doing okay. His vice-president (the senior George Bush) who succeeded him, was not so lucky. By the time he went up for re-election, the economy was in a serious recession and he lost tamely to Bill Clinton (remember the line “It’s the economy, stupid.”)

And yet, if Reagan is remembered kindly today, credit must also go to the Clinton presidency which revised taxes, kept spending in check, presided over the largest peace-time expansion ever in the economy, and methodically turned a chronic budget deficit into what seems unimaginable now a surplus. Once this was done, it was so much easier to look kindly at the Reagan presidency.

However, the biggest failure of the Reagan years is something few Americans are even aware of. Under Reagan, America was actively involved in funding and arming the Afghan Mujahedeen who were then fighting the Soviet army. It led to defeat for the Soviet Union and was judged to be a great success. It is also claimed that the cost imposed on the Soviet Union by this action was one of the reasons for the subsequent collapse of the Soviet empire.

Whatever be the truth about the Soviet collapse, it is a fact that the Mujahedeen were soon to transform themselves into the Taliban and that one of the less prominent figures in the Mujahedeen who happened to receive substantial American help (routed through the Pakistani military) was Osama bin Laden. What happened next is too well known to require reiteration. Okay, in politics, your enemy’s enemy is very often your friend. But equally, it is also plain good sense (not to mention good policy) to look a little closely at exactly who this enemy’s enemy is, and ask a few hard questions about what he really stands for. It was a remarkable failure of the Reagan presidency that no such foresight was shown. Thanks to this gross negligence, we have an area in New York that today goes by the name “Ground Zero”.

As for George Bush, talk about lack of foresight being likely to create many more problems in the future is premature. His eight reckless years at the helm have given rise to too many burning problems that require immediate attention. Therefore, while it is likely that America will continue to pay a price well into the foreseeable future, chances are like Reagan before him Bush will not be blamed for these.

And then, if Barack Obama’s administration turns out to be a competent, capable effort, able to extricate America from Iraq, restore the country’s standing in the world and bring order to its failing economy, it is conceivable that in 15 to 20 years time, people in America will begin to forget how bad things really were under the Bush presidency.

And then, George Bush will have his wish, with historians and academics looking back on his reign with sympathy for a simple man who boldly set out to do what he thought was right without fear of the consequences. Who knows, one day Iraq may actually become a modern, progressive Democracy. Trust the American right-wing then, to rush to proclaim, “all thanks to Dubya”. Not long afterwards, count on a legend to spring up around Geroge Bush as the American president who brought freedom and democracy to the people of Iraq.

Sounds far fetched? Remember, Reagan is already lionised as the American president who won the cold war for America. Never mind that an economic system where planners and bureaucrats were setting some 24 million[2] different prices, would have imploded on its own, sooner than later.


[1] Surveyed by the History News Network of George Mason University, http://hnn.us/articles/48916.html

[2] Thomas Sowell: Basic Economics, A Common Sense Guide to the Economy, Chapter 2, page 17

Written by Ranjan Sreedharan

November 18, 2008 at 11:43 am

Posted in US and the world