The Cost of Managing Commodities Politically

Russell Shor, a senior industry analyst with the Gemological Institute of America, relates a story over at Foreign Policy -- possibly apocryphal, possibly even from a John le Carré novel I've yet to read -- of a Soviet plan back in the early '60s to disrupt DeBeers, still today South Africa's largest diamond firm, by manipulating the world diamond market via the Soviets' own Russian diamond supply. "The plan proceeded apace until someone in the government realized that Soviet diamond mines supplied about a quarter of De Beers's rough diamond sales. Needless to say, if the plan was ever real, it backfired."

Shor sees the story, true or not, as a nice illustration of Russia's very real tendency to manage its indigenous commodities through politics rather than sound business sense. He has a great account of why Russia's diamond mining and marketing arm, Alrosa, began stockpiling uncut diamonds with the government last year rather than selling them in a collapsing market: Why not just cut the supply, instead, and drive prices up? One reason is, with its credit rating losing strength, Russia doesn't want to risk being short on supply in the event of a global diamond-buying run. But a big part of the problem turns out to be political: Alrosa's mines are in the semi-autonomous Sakha Republic, whose government owns almost 50% of the company. Sakha, along with Chechnya, is one of the few regions in Russia to have a semi-autonomous clause in its constitution, making the Kremlin chronically anxious about secessionism. Because securing higher diamond prices would disproportionately benefit the government of Sakha in the political sphere, the government in Moscow can't bring itself to pursue a win-win arrangement in the economic sphere -- at least not in the short term, as long as political trust remains low.

So how's Russia's habit of politically managing its commodities playing out with the biggest of them all -- oil and natural gas? According to The New York Times, not so well anymore. For years, the Kremlin's been trying to dominate natural-gas supplies and pipelines to Europe, as part of an overall game of building up its energy company Gazprom into a major instrument of economic and political power. And for years it's been working: Back in January, for instance, Russia blocked the flow of natural gas to Eastern Europe in the middle of a pricing dispute with Ukraine for the second time in three years, leaving thousands in the cold. But Moscow's same political commodity-management tactics are starting to backfire now that the economic crisis has cut global gas demand. Having locked Gazprom into long-term contracts for Central Asian gas at a cost way above current world prices, Moscow is stuck with millions of cubic meters of expensive gas that it can't stockpile or really do anything with but sell at a loss.

As Moscow's been pursuing its KGB dirty-tricks approach to indigenous-commodity management, Russia's come into dire demographic straits, with its population declining and mortality rate on the rise. You have to think the Kremlin has always at least entertained the idea that, say, oil prices might not stay high indefinitely. But they've obviously considered the opportunity costs worth it, as long as their approach advances the right political goals. If the same approach meanwhile stands to to impede Russia's long-term economic development, though, it's an open question as to how long Moscow will be able to politically afford geo-strategic indulgences like the ones we see in the diamond and natural-gas industries.