Russia is for investors?

Sometimes, investors are just blind.  It is not that they don't know better; rather they actively choose to ignore pertinent information to the contrary.  Or perhaps greed takes over and reason goes out the window.  What brings this to mind is a bit of interesting news today.  BP, the large British oil company, and it's Russian partners, TNK, have agreed to "settle their dispute".  The Russian economy has been growing quite rapidly since the commodity boom began, as Russia is one of the world's top oil exporters, among other minerals.  It's stock market has also been on fire for a number of years as a consequence, compounding at 34% for each of the last five years.  Take a look:



So what's wrong with making some money?, you ask.  Well, for starters when you invest in something, you are essentially entering into a contract with another party.  For example, you provide your money to be used to build a shopping mall.  You expect the real estate firm who takes your money to use it to actually build a mall and to properly share the profits or losses with you.  If they instead invest in gold or decide to build houses instead, you can seek remedy through the courts- they didn't honor the contract.  This concept is called rule of law.  It means that a society has rules, laws and means to enforce laws so that contracts and transactions are honored.  Without it, you wouldn't do business there or you seek very high rates of return to compensate for the risk. 

Now, Russia was supposedly turned into a democracy in the '90's.  It opened its markets and economy to foreign investment and professed a strong rule of law different and more western than the Soviet days.  Yet in the past five years or so, Russia has repeatedly changed its laws, found non-existant loopholes or simply disregarded them.  Both the Kremlin and the Oligarchs are guilty of conspiring to accomplish these acts, but political will and influence has trumped contracts many times recently, particularly with the energy companies.

BP is just one of several to think it had legitimate contracts in place.  Indeed, those contracts and agreements were probably technically rock solid.  However, when a sovereign nation decides to honor contracts only when it wants to, technically rock solid doesn't mean anything more than a blank piece of paper.  You see, BP has roughly 25% of its production coming from the BP-TNK joint venture and has agreed (forced?) to slowly cede control to the Russian owners.  BP will not exit gracefully from this gaff.

All this brings me to the 'duh' moment: It has been clear for years now that Russian rule of law does not value contracts unless they are convenient for the Russians at that time.  So why would BP or investors send money into Russia?  Probably greed and a willingness to selectively view the facts.  As Colbert is fond of saying, "A wag of the finger" to BP and any other westerner gambling with Russian investments.  FYI, here is what happened to the Russian stock market as these gamblers began to figure it out- down some 40% in about 3 months.  Sometimes, you are better off taking the high road and letting others gamble, particularly since most people would be late to this trade- getting in on Russia since 2006 would leave you with a loss now.  At least you will sleep better knowing that the facts of the situation trump speculation in the long run.