Rosneft's motto, 'energy for growth', sums up one of the driving forces behind the spectacular performance of the Russian stock market, which rose 85% in 2005 and grew more than 40% in 2006. The lesser-known business trend in Russia, however, has been 'investing with the state'. Flabby companies in strategic industries of which the state has (or is in the process of getting) control were among last year's best performers, and investors who went along for the ride have done particularly well. While the Russian market went up by 85%, shares in oil giant Gazprom and Sberbank, the state-controlled retail bank, ballooned by more than 150%.

The Russian state owns over 30% of all quoted Russian equities – the biggest single owner. The top-10 listed stocks account for 75% of the total market and the top 20 account for a 90% share. The state has direct or indirect interest in most of these companies and its involvement is steadily increasing. Three years ago the state owned or controlled 20% of the total value of the listed stocks in Russia. 'Strategic' acquisitions by the state and state-controlled companies, and a relatively good performance by the state companies, have boosted its share to more than 30%. Today, the Russian state owns or controls 60% of the electricity sector, 50% of the listed banking sector, 50% of fixed-line telecom companies and 35% of the oil and gas sector. The major state-controlled companies, apart from Gazprom and Sberbank, are Rosneft, UES, Sviazinvest and various defence-related companies. Many have benefited from lengthy spending sprees on acquisitions.

Since President Vladimir Putin came to power in 2000, he has consolidated the Kremlin's control over the 'strategic industries', especially oil and gas. As a result, many previously unknown people have been propelled into positions of control of Russia's (and the World's) most powerful companies, supported by political heavyweights such as Igor Sechin, deputy head of the Presidential Administration and Gazprom chairman and Russia's first deputy prime minister Dmitry Medvedev. This symbiosis is one of the foundations of what has been called 'managed democracy' in Russia. Putin makes use of people like Sergey Bogdanchikov, CEO of Rosneft, and Alexei Miller, CEO of Gazprom, to drive Russia down his chosen path and to adjust the balance between private companies and the state.

Both Rosneft and Gazprom appeared in early 1990s as a result of a hefty sell-off that was launched by President Yeltsin's decree. At that time, Bogdanchikov was working as the general director of Sakhalinmorneftegaz, an oil and gas company in Sakhalin, and Miller held various low-key positions in St Petersburg, his home city. Bogdanchikov, after having worked on Sakhalin Island for many years, became Rosneft's vice-president in 1997, responsible for the company's projects on Sakhalin Island. As a result of the 1998 financial crisis, the company's management was reshuffled by its parent, the state, and Bogdanchikov was appointed president. Coincidently, Rosneft produced its first barrel of commercial crude in Sakhalin, for which Bogdanchikov was responsible, in the same year. Since his appointment, he has launched a number of cost-cutting initiatives, reconstructed some of the company's refineries and oil fields and started production in new areas, but the real breakthrough came in 2004, when the so-called 'Yukos affair' started and Rosneft ended up with Yuganskneftegaz, Yukos's major oil unit. As a result, the company's oil production rocketed from 433,000 barrels per day in 2004 to 1.5 million in 2005. Its 2005 net income was $4.2bn on revenue of $24bn. The company did its IPO in London in summer 2006.

Bogdanchikov's recent successes stem from his relationship with 46-year-old Sechin, an old ally of Putin from St Petersburg, who is known for his support of renationalisation of strategic industries by the state. Although Putin has repeatedly stated that Rosneft is competing on a level playing field against other companies in Russia, it is undeniable that Rosneft is not only a business entity but also a political creation, which will play an increasingly important role in Russia's foreign policy, especially if Putin gets a role there after stepping down as president in 2008.

Miller and Gazprom's story is somewhat different. Miller came to Moscow in 1999 as part of Putin's team. After briefly serving as deputy minister of energy, he moved to the company in 2001, supported by Medvedev. Miller now finds himself heading the world's sixth most valuable company, which as well as providing most of the gas to the former Soviet Union and eastern and central Europe, supplies a quarter of the EU's gas needs. In November, Italian energy firm ENI agreed to cede 3% of Italy's retail gas market to Gazprom in exchange for extending contracts to sell gas to ENI until 2035. The pair also agreed to look for and develop new fields together in Russia and Africa.

Despite such confident plans, Russia's economic future always has a question mark hanging over it. The country's political system is inherently weak and the state's reclaiming ownership or control of the main industries is preserving its weaknesses. While there will be no going back to communism and the state's growing role is not necessarily bad for business (as demonstrated by sky-rocketing share prices of state-controlled companies), such a system is bound to lean towards inconsistent domestic and foreign policy and arbitrary application of the law. High oil prices only reinforce the imbalances and encourage Russia's foreign policy to be quite aggressive, which may eventually provoke a backlash. The country, and investors, may currently be enjoying a boom but it will not last forever.

Pavel Erochkine is co-author of Russia's Oil Industry.