The Wall Street Journal, By Andrew Langley, 28 July 2008

Tough talk on one resources company and inaction toward chaos at another have dealt a harsh blow to Russia's investment case, as investor concern turned toward the political environment.

Russia's failure to cool the gloves-off battle for control over oil company TNK-BP, coupled with Prime Minister Vladimir Putin's outburst toward miner Mechel, slammed the Russian stock markets Friday.

That left the benchmark RTS index, already stuttering amid falling commodities prices, languishing at a six-month low and in bear-market territory, with investors jumping for cover and some even drawing comparisons to market situation of a few years ago surrounding now-bankrupt oil producer Yukos.

On Friday, the RTS index slid 5.6% to 1951.29, down 15% on the year and 22% from the May 19 record. A bear market is frequently defined as a 20% decline from an index's peak. Sales were indiscriminate, with blue chip stocks such as Gazprom, Rosneft and Sberbank down 4% to 5%.

"We've had three pieces of bad news and the risk premium has gone up," said one Moscow-based broker. He was referring to the departure from Russia of TNK-BP Chief Executive Robert Dudley amid visa problems, Mr. Putin's comments against Mechel, and allegations by an exiled fund manager that fraudsters had made off with $230 million in taxes having stolen three of his companies.

The damage was done Thursday evening as the chief executive of BP's Russian joint venture left the country following continued run-ins with authorities over his visa, a situation that many observers link to a dispute between the U.K. oil major and its billionaire local partners. Russian officials, at least publicly, have refused to step in, with the negative buzz surrounding the saga largely to blame for recent outflows of international funds by portfolio investors.

Exacerbating the market tension, Mr. Putin criticized Mechel's pricing policy for coking coal, saying the company charged domestic customers double the international price in the first quarter and ordering an antitrust probe. "Putin's attack was couched in terms that suggest a personal conflict the question now is whether it will turn out to be a shot across the bow and quickly heeded, or a second Yukos affair," said UniCredit strategist Julia Bushueva.

The massive tax claims and criminal proceedings that accompanied the attack on now bankrupt oil producer Yukos prompted international investors to abandon Russia in droves. That company's former owner and Chief Executive Mikhail Khodorkovsky remains in prison for tax evasion and recently appealed for parole as new President Dmitry Medvedev begins an overhaul of the legal system.

Adding to the negative atmosphere was Hermitage Capital Management boss Bill Browder, once Russia's biggest portfolio investor but now banned from returning after repeatedly criticizing the country's corporate-governance environment. Mr. Browder, now based in London, is continuing to rail against the system from afar.

"The last train carrying the optimists out of Russian equities has just left the station," said UralSib strategist Chris Weafer.

Although many observers in Moscow expect that situation to ease as Mechel acts on Mr. Putin's remarks and amid a consensus among analysts that a state-run energy company will buy the Russians out of TNK-BP, the already-flimsy confidence in Russia's market was shaken.

Indeed, investors are re-evaluating the risk premium they assign to Russia. "Applying the Yukos-era equity risk premium would lower our fair value For Russian stocks by around 25%," Renaissance Capital said.

"The current market P/E of 8.7 may no longer offer a sufficient discount," warned UniCredit, referring to the overall price-to-earnings ratio. P/E ratios are used as a valuation metric; by contrast, the Standard & Poor's 500-stock index in the U.S. has historically traded at a P/E in the mid- to upper-teens.

The Washington Post, by Jackson Diehl, 28 July 2008

Though he had been handpicked by Vladimir Putin, Dmitry Medvedev's inauguration as Russia's president in early May inspired some in the West to hope for real change in the Kremlin. The expectations rested largely on Medvedev's background as a law professor who, unlike Putin, had no history with the Soviet KGB. There was also his surprisingly strong rhetoric about the "legal nihilism" that he said was holding back Russia's "modern development." "We must achieve true respect for the law," the 42-year-old president declared shortly after being sworn in.

Nearly three months later Medvedev already has established a pretty strong track record on legal affairs both domestic and foreign. Unfortunately, it is precisely the opposite of what he led his would-be admirers to expect.

One of those might have been Robert Dudley, chief executive of the oil company TNK-BP, which is a joint venture between British Petroleum and a group of Russian oligarchs. Dudley was forced out of Russia last Thursday by what he called a "series of unprecedented inquiries, investigations and checks," including government officials' refusal to renew his work permit and visa.

Dudley and BP are nominally embroiled in a power struggle with their Russian partners, who claim that TNK-BP, Russia's third-largest oil company, has been poorly managed. But this supposedly private business dispute has been marked by relentless and one-sided intervention by the Kremlin's law enforcers. Since March, Dudley has been told that he's under investigation by the interior ministry for tax evasion and notified by prosecutors of a probe into alleged labor violations. His offices were raided by the FSB, the modern-day KGB. The labor inspectorate imposed a fine. A court order annulled the visas of 148 BP technicians.

There's little doubt among foreign diplomats about what's motivating this onslaught: The government intends to force BP to turn over control of the oil company and its reserves to a state-owned firm. Similar tactics were used to pressure Royal Dutch Shell to deliver control of a gas project to Gazprom in 2006. Before that were the tax cases and criminal prosecutions that Putin used to destroy and confiscate the Yukos oil company and send its founder, Mikhail Khodorkovsky, to a Siberian prison camp.

Khodorkovsky, who has spent nearly five years in prison, was another one who hoped Medvedev would be different. He recently filed a request for parole, for which he became eligible in October 2007. Medvedev could have signaled a clear break with the past by ending the persecution of a man who provoked Putin's wrath by promoting democracy and the rule of law. Instead, he blandly told foreign journalists this month that Khodorkovsky's case should be handled by "law enforcement authorities." Prosecutors duly filed a new set of charges that could keep Khodorkovsky imprisoned for many more years.

So much, then, for domestic reform. What about international law? After all, Medvedev issued a new foreign policy doctrine this month that cited "the supremacy of law in international relations" as one of three top priorities. Ask a Russian diplomat what that means, and you'll hear a lecture about how the United States should be constrained by international treaties and prohibited from taking any action -- such as recognizing the independence of Kosovo or sanctioning Zimbabwe -- not authorized by the U.N. Security Council, where Moscow has a veto.

Yet the law still doesn't seem to matter when it comes to Russia's oil and gas contracts with European countries, which Putin regularly used as a tool for bullying. Just ask the Czech government, which on July 8 signed a deal with the United States to base a missile defense radar on its territory. The next day its oil supplies from Russia mysteriously dropped 40 percent, a blatant violation of the legal agreement between the two countries. Russian officials blamed unspecified pipeline problems -- only to report last week that Putin, in his new capacity as prime minister, had ordered the resumption of deliveries.

More serious is the predicament of Georgia, the former Soviet republic that has embraced democracy and sought NATO membership. Since shortly before Medvedev took office, Russian warplanes have been systematically violating Georgian airspace, shooting down Georgian drone aircraft on several occasions. In breach of a U.N.-sponsored agreement, Moscow has dispatched security forces to the separatist region of Abkhazia and granted legal recognition to its self-declared government. U.S. and European officials believe a concerted effort is underway to provoke the Georgian government into an armed confrontation.

Perhaps Medvedev isn't really in charge of Russian foreign policy or relations with foreign oil companies. Maybe he can't control what charges his prosecutors choose to bring, the regulatory actions of the labor ministry, the tax investigations of the interior ministry or even visa decisions. Whatever the case, this Russian president is already in danger of making "legal nihilism" the byword for his administration.