Aug. 29 (Bloomberg) -- Russian stocks are approaching $1 trillion in value, an emerging-market record, mostly because of the country's burgeoning oil industry.

``Russia has a great potential,'' said Jacob Grapengiesser, who helps manage $4 billion at East Capital Asset Management AB in Stockholm. ``There has been political stability, the economy is strong, and things are getting better for people, not just the market.'' The firm has about half its holdings in Russia.

The Russian Trading System Index has surged 88 percent over the past 12 months. OAO Gazprom, the country's natural gas monopoly, ranks as the world's third-largest company at $276.9 billion, behind Exxon Mobil Corp. and General Electric Co. and ahead of Microsoft Corp. and Citigroup Inc.

Investors have looked past deterrents such as President Vladimir Putin's seizure of OAO Yukos Oil Co. to reclaim control of the energy industry. The Russian index, a dollar-denominated gauge of 50 companies, is the third-best performer in the past year among 80 benchmarks tracked by Bloomberg.

Russia's market capitalization on Aug. 16 reached a record $946.2 billion, 15 percent larger than South Korea, the next biggest emerging market, at its peak in May, according to data compiled by Bloomberg. A July share sale by OAO Rosneft, a state oil producer, added $68 billion in value to the market.

Best in World

Shares of Moscow-based Gazprom, the world's largest natural- gas producer, have jumped 60 percent this year.

Stocks are rallying as the country's economy heads for an eighth straight of expansion. Gross domestic product may grow 6.5 percent this year, according to Economy Minister German Gref.

``Reaching $1 trillion is realistic,'' said Nerea Heras, who manages $193 million in European emerging-market stocks at Axa Investment Managers in Paris. About 55 percent of that is in Russian equities. ``Macroeconomic figures in Russia are among the best, not only in emerging markets, but also in all of the world.''

The country's biggest companies outside the oil and gas industry include OAO Sberbank, Russia's biggest lender; OAO Unified Energy System, the national power utility; OAO GMK Norilsk Nickel, the world's largest nickel miner; OAO Cherkizovo Group, Russia's largest meat producer; and OAO Mobile TeleSystems, eastern Europe's No. 1 mobile-phone operator.

Urals Crude

The price of the country's main oil export, Urals crude, has soared 164 percent in the past five years. The surge has boosted earnings prospects for energy producers in Russia, the world's second-largest crude exporter behind Saudi Arabia. During the past 12 months, it's up 17 percent and touched an all-time high of $73.63 a barrel on Aug. 7.

``I am not surprised by market valuations,'' said John Lomax, an emerging markets strategist at HSBC Holdings Plc in London. ``Given high oil and gas prices it is likely to continue this way. The Russian market may come down a little but in the long term it will outperform other emerging markets.''

Institutional investors are according Russia a bigger place in their portfolios.

Morgan Stanley Capital International said this month it will almost double Gazprom's weighting in the firm's Emerging Markets Index to 5 percent in September, making it the biggest component of the benchmark. The firm took the step after Putin dropped limits on the stock's foreign ownership. About $3 trillion in investments is benchmarked to MSCI's indexes.

Vanguard Buys

Vanguard Group, the second-largest U.S. mutual-fund manager, last week added Russia to the countries in its $9.6 billion Emerging Markets Stock Index Fund. Previously Vanguard excluded Russia on concern that it was too hard or risky to trade in. The country now warrants inclusion in the fund, the Valley Forge, Pennsylvania-based firm said.

Record initial public offerings in Russia also helped boost the value of the market. Russian IPOs may total $18.3 billion this year, surpassing the record $4.6 billion in 2005, according to Renaissance Capital, a Moscow-based investment bank. Rosneft's July IPO raised $10.6 billion, making it the world's fifth- largest public offering. OAO Magnit, a food retailer, raised $368 million in April.

Moscow-based Rosneft in 2004 bought the largest unit of Yukos, which was seized and auctioned by the government to help recover more than $30 billion in tax claims against Yukos.

Yukos once was Russia's biggest oil exporter, and the government's seizure of the company and prosecution of its founder, Mikhail Khodorkovsky, raised concern that Putin didn't respect private property rights. Yukos was declared bankrupt Aug. 1. The Moscow-based company, valued at $43 billion less than three years ago, now has a market value of $1.8 billion.

Dependent on Commodities

``The case with Yukos has clearly hurt the market, but it's over,'' said Grapengiesser. ``People have moved on from that period of time.''

To be sure, many investors say that Russia's nominal market value of $942.2 billion overstates its size, because it includes shares owned by the state and thus not available for trading. The government, for example, owns more than 85 percent of Rosneft, more than 50 percent of Gazprom and almost 64 percent of Sberbank.

Index providers such as MSCI exclude shares held by the government and other equity not available for trading. The firm counts only $178 billion of Russian market value in its stock indexes.

The market also is captive to swings in commodity prices, which may be depressed by slower economic growth in the U.S. and China, according to Guenter Faschang from Vontobel Asset Management in Vienna.

`Bubble' Fear

`The risk is quite high that the U.S. and global economic growth will slow,'' said Faschang, who manages about $1 billion. ``This will cut demand for commodities and raw materials, and their prices will go down.'' The firm has been selling holdings in Russia and eastern Europe.

Gref, the economy minister, in March said he was ``very afraid of the formation of a so-called bubble'' in the stock market.

The RTS has risen 12 percent since then, and it's outperforming other emerging markets this year even after a slump in May and June. The Russian index is up 46 percent year to date versus an 8.3 percent gain for MSCI's emerging markets index.

Concern about political stability in the country as Russia prepares for presidential elections in 2008 may also weigh on the stock market, said East Capital's Grapengiesser.

``The risk of course is commodity prices and who will succeed Putin,'' he said. ``I don't think it's going to be much of a problem, but with Russia, you never know.''

To contact the reporter on this story: Maria Ermakova in Moscow at mermakova@bloomberg.net.

Last Updated: August 29, 2006 07:23 EDT