Russia: Special Report - Regional take-off

Russia's fast-growing regions promise much for foreign investors: they are resource-rich and hungry for private investment.

by World Business
Last Updated: 23 Jul 2013

Kendrick White is something of a pioneer among foreign investors in Russia, who, historically, have focused on the western tip of Russia, Moscow and St Petersburg. White's firm, Marchmont Capital Partners, believes the next frontier of investment is in the regions: "Regions are a bit of a black box. They haven't had the culture to do much self-presentation and to try and seek out investment. That is changing as companies from Moscow and abroad reach out to them. Now regional firms have to adapt and modernise to survive. So where two years ago I was pleading with local firms to let me invest, now they are much more hungry for capital."

A good example is Tatarstan in the south-west of Russia, on the Volga. Tatarstan has large reserves of oil, and a rich legacy of petrochemical companies and other large industries left over from the Soviet era. However, until now it has been a closed region, in which the economy was dominated by the local administration. That's changing now, according to Rustam Minnikhanov, prime minister of the region: "Our region is one of the most prosperous and fast growing in Russia. We have some of the best companies in Russia based here, such as Tatneft, the fifth-largest oil company in Russia; Nizhnekamskneftekhim, the largest petrochemical company; Kamaz, the largest manufacturer of trucks; and Akbars Bank, the 10th biggest bank in Russia. All these companies are now actively seeking foreign partners for joint ventures or for equity investment."

As the region's supply of oil reserves begins to dwindle, it is embarking on a huge programme to develop its petrochemical facilities so that all Tatar oil is refined in the region. The biggest project of this type is the $5 billion development of the NNPZ refining facility in Nizhnekamsk, in the east of Tatarstan. It will refine oil from Tatneft, owned by the regional administration, which will have a 40% stake in the project. The plan for the facility was developed by Tatneft in co-operation with global engineering company Foster Wheeler.

Umberto della Sala, CEO of Foster Wheeler's global engineering and construction team, says: "This is one of the biggest petrochemical refinery projects in the world." The bulk of the money for the project will come from Western banks. BNP Paribas is the international financial consultant for the project and is preparing financing for the deal, which NNPZ CEO Kamza Bagmanov says is likely to be project financing.

The project will also receive generous support from the federal government, which has selected NNPZ to be one of the first Public Private Partnership (PPP) projects to receive support from the federal investment fund. The ministry of economic trade and development has selected six PPP projects to receive a total of about $3 billion in federal support, in the expectation that private capital will put in at least double that amount to finance large-scale infrastructure projects.

Roland Nash, chief strategist at Renaissance Capital, calls PPP projects "the great white hope of the government in the quest to regenerate infrastructure". The government's PPP drive presents foreign investors with many opportunities. Last year Ernst & Young won the contract to organise the auction for a $15 billion PPP project to build a new high-speed motorway between Moscow and St Petersburg. Western construction firms, including Jarvis and Balfour Beatty, are among the front-runners for the mandate to build the road, though local firms such as Basic Element are also strong competitors.

Basic Element recently bought stakes in German construction firms Hochtief and Strabag, in order to gain access to their technological expertise, which in turn will help it win such PPP contracts. The company's spokesperson, Konstantin Panin, says: "We consider the opportunities in the construction sector to be enormous. Since 2005, annual federal spending on roads and other programmes in our sector has doubled. The country's infrastructure needs will grow. What's more, participation in infrastructure projects in Russia tends to be much more profitable than in other developing markets."

But PPP has its sceptics. A source at the EBRD, which is notably absent from the list of participants in the PPP programme, says: "PPP is a very new sort of financing even in the West, and is subject to risks of conflicts of interest. That's even more the case in Russia." Russian Aluminium, the biggest aluminium company in the world and owned by Basic Element, has already won federal support for a PPP project to construct a $3 billion hydro-electric dam and aluminium smelter in the central Siberian region of Krasnoyarsk.

Asian investors have also shown interest in participating in PPP projects. Russia's new development bank has signed deals worth a total of about $10 billion with various Chinese firms, including the China Development Bank, to support infrastructural development in the regions. Asian investors may be more comfortable with Russia's state-driven model of economic development; it is one that has been pursued relatively effectively in many Asian markets, such as China, South Korea and Singapore. Indeed, many talk of Russia now following the Singapore model of economic development, using state-owned holding companies to finance investment and special economic zones to attract private investment.

The huge economic growth in China is providing Western investors with opportunities in the regions on China's border. Peter Hambro, CEO of Peter Hambro Mining, says that about 80% of his Russian business is done in Amur, on the Chinese border: "The Far East of Russia has tremendous potential. The Amur region has just 1.2 million people, but on the same land mass on the other side of the Amur river, there are 58 million people. And they are all hungry for the resources the region has, such as electricity, coal, gold and iron ore. The prospects for business in the region are truly exceptional."

Peter Hambro has also acquired two banks in the region, Kolyma Bank and Far East Bank, which, says Hambro, are making good profits because of the expansion of retail lending in the region. In other words, the consumer boom is not confined to Moscow, but has already spread to other cities, including Novosibirsk, Kazan, Krasnodar, Yekaterinburg, Nizhny Novgorod and Surgut. The streets in these cities are lined with advertising billboards, enormous new shopping malls are being constructed and sushi restaurants, hamburger stalls and multi-screen cinemas proliferate.

This regional development has attracted many Western financial firms. Raiffeisenbank, the Russian branch of Raiffeisen International, was one of the first to expand regionally. Oxana Pantchenko, head of corporate banking at Raiffeisen, says: "In Russia, where clients and banks operate in several time zones, a strong regional presence plays a key role. Moscow enterprises and companies are actively branching out, and local regional businesses are growing as well. Our acquisition of Impexbank last year gave us a large regional branch network, which has saved us time."

Regions and cities vary in terms of the sophistication and investor-friendliness of their local administrations. Some, such as Krasnodar, Tatarstan, Nizhny Novgorod and Krasnoyarsk, are clearly well placed in terms of natural resources and dynamic administrations. The federal government is also moving to a model of regional development in which it rewards those regions that attract the most private investment.

With the Moscow market reaching saturation point and rents becoming astronomical, the Russian regions really might be the next frontier for foreign investment.

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