Oil magnates awash in cash are increasing their hold on the national economy through a spending spree on stocks that is starting to scare major Western investment houses just as they are mulling a return to the Russian market, analysts and investment bankers warn.

The trend toward consolidation has been discernible since privatization tsar Anatoly Chubais failed to create a broad base of public ownership a decade ago through his much-hyped privatization voucher auctions, which were dubbed "the sale of the century" for valuing at $5 billion the entire might of the nation's industrial inheritance from the Soviet Union.

Although the nation's first real stock market was created as a result of those auctions, the plan to give each citizen a stake in the new Russia was derailed by hyperinflation, which forced millions of workers to sell their vouchers to Soviet-era managers and other well-connected insiders often for just enough to buy a meal.

Ten years on, the stock market consolidation kick-started by the voucher system appears to be accelerating -- widening the gap between rich and poor with increasing speed. Now, economists say Russia has become an anomaly among its emerging market peers, due both to the pace of market consolidation and to the dominating role that energy, its most easily exportable resource, plays in the process.

"Russia's market structure is not typical, it's extreme," said Ian Hague, director of the Firebird Fund, a $200 million Russia-dedicated hedge fund based in New York.

A new study by Alfa Bank found that the number of shares in Russian companies available on bourses -- the overall market "free float" -- will soon fall under 27 percent, down from 30 percent just a year ago.

Alfa estimates that management and connected "insiders" now control just over 46 percent of Russia's $134 billion equity market, with strategic investors holding 11.5 percent. The remaining 15 percent is owned by federal and regional governments.

And just three sectors -- oil and gas, telecoms and electricity -- collectively make up nearly 90 percent of the entire market, with oil and gas companies alone accounting for 71 percent.

The dominance enjoyed by insiders increased further this year as loaded oil tycoons moved to snap up strategic stakes in electricity monopoly UES and its regional subsidiaries, or energos, ahead of a sweeping overhaul of the sector, as well as in longtime blue chip Surgutneftegaz, an oil major closely guarded by its secretive and hidebound management.

Chubais, now the CEO of UES, said last month that strategic buyers, allegedly including metals tycoon Oleg Deripaska, had bought 10 percent of his company on the market, while other oil and metals barons, including SUAL and Yukos, have been buying up large chunks of shares in several strategic energos. And a recent bidding war for Surgut sent the company's market capitalization soaring, from just under $7 billion at the beginning of April to more than $10 billion at the beginning of May. When the dust settled, the free float of Surgut's common shares had shrunk by about 17 percent.

"Takeovers and the vertical integration of various kinds of businesses are reducing the number of liquid tradable shares," Firebird's Hague said.

Not only is the free float shrinking, but foreigners own about 80 percent of what is left, thanks to the fear most Russians still have of trusting their money with financial institutions.

"We are now at a stage where the wealth of conglomerates is such that they are expanding their influence over the rest of industry," said Hans Jorg Rudloff, the deputy chairman of Barclays Asset Management.

While at Credit Suisse First Boston a decade ago, Rudloff, a key player in the formation of capital markets in Eastern Europe, sent two employees, Stephen Jennings and Boris Jordan, to Moscow to scout possible deals. Jennings and Jordan became key architects of the privatization process and eventually founded Renaissance Capital, one of the most successful investment banks in the country.

"From an organizational point of view," the extreme consolidation Russia is experiencing "is clearly not desirable for a market economy," Rudloff said by telephone from London. "It is even less desirable for [foreign] investors."

Indeed, despite the surge of buying by domestic tycoons that has lifted total market capitalization by 20 percent since the start of the year, not all investors are cheering.

"There is a lot of demand, but there's not enough supply," Hague said. "From our point of view, it is good because we already have positions in the market and the buying is pushing up prices, but it limits our ability to expand."

Christopher Weafer, Alfa Bank's head of research and the author of the report, said the recent surge of domestic buying could make big global investment banks think twice about coming back into the market, which most left after the economic collapse of 1998.

"The risk is that over the next couple of years, between now and growth in the IPO business, the market will actively shrink," Weafer said.

"The huge investment funds that have been waiting for Russia to get investment grade status are going to find there is nothing for them to buy," he said, citing giant U.S. pension fund Calpers as an example.

Market consolidation is not only bad for portfolio investors, analysts say, but for the economy as a whole, as increasing financial clout gets parlayed into political clout, raising the risk of diminishing transparency and market rules being ignored.

"Consolidation of ownership can drive faster growth in the short term but in the mid term it's potentially a huge problem," said Roland Nash, head of research at Renaissance Capital. "Concentration of assets in a small number of hands without sufficient institutional leverage from the government could lead to a loss in transparency, abuse of monopoly power and adverse influence over politics."

The diversification by oil barons into different sectors of the economy also raises questions about whether cash flows are being surreptitiously switched from one company to another without the knowledge of minority investors, Nash said.

"Where is Yukos getting the money to buy stakes in the energy sector?" one Moscow-based investment banker said. "Lack of transparency in diverse holding structures allows company cash to be transferred for the benefit of the owner."

Concentration of ownership and the dominance of the market by just one sector "give Russia a much higher risk profile and could mean big global investors will continue to stay away," Weafer said.

Energy sector dominance has meant that if global houses are investing in Russia it is mainly as part of a global oil and gas play and not as part of a portfolio for investment in the Russian market, said Philip Poole, head of emerging market research at ING in London.

"Investors in Russia are left with a high concentration of risk," he said. "There are a limited number of exposures, which makes it hard to apply diversification techniques.

"What has been disappointing is the lack of development in the services and small business sectors," he said.

Investment bankers say this lack of development leaves the Russian market looking very different from its emerging market peers.

"Russia only has four sectors that are listed on the MSCI," said London-based investment banker Robert von Rekowsky, referring to Morgan Stanley's benchmark index used by investment houses to make weighted investments in emerging markets.

"South Korea has 20 different sectors. Service sectors like hotels, insurance and banks are a big black hole for Russia," von Rekowsky said.

"It's a huge anomaly."

Although Russia's so-called oligarchic ownership structure has been often compared to South Korea's chaebols, the major financial-industrial groups that hold sway over Seoul, the analogy is "misleading," says Harvard economist Rafael La Porta, who studies corporate ownership around the world.

He said Russia is more comparable to Mexico, as both countries have similar per capita incomes much lower than South Korea's and neither country has a developed legal system.

"Ownership is concentrated because control is very valuable as people steal a lot when laws are undeveloped -- the courts don't work in Mexico, where laws are undeveloped just like in Russia.

"There is no question that widely held ownership is not feasible in an undeveloped country.

"At the end of the day, South Korean core shareholders don't have as much control over cash flows as Russian core shareholders do," La Porta said, adding that corporate ownership in South Korea is much more disperse than in Russia.

(The Moscow Times 13.v.03)