Russian Lunskoye-A platform preparing to drill off the northeast coast of Sakhalin Island
Editor’s note: The following opinion article originally appeared in Transitions Online: Regional Intelligence, an independent regional intelligence publication based in Prague. It has been reproduced here with permission of the author, who would also like to offer special recognition to Professor Peter Rutland for help with research related to the piece. The original publication of this article can be found here.
What OPEC Wars, Sanctions, and the Arctic Mean for the Future
For decades, Russia’s status as the world’s dominant energy producer has been unchallenged and its economy has thrived on the basis of prodigious and self-replenishing oil and natural gas reserves. These reserves are some of the largest in the world and production is at a post-Soviet record high. Perennially strong natural gas exports have long been the envy of the petroleum-producing world and Russia’s booming energy sector powered a decade of rapid growth through the early 2000s. Its trillions in revenues over the decades have allowed Russia to exercise greater domestic control, modernize its military, raise the overall standard of living, and vastly improve its infrastructure. Accounting for 98% of all profits made by Russian firms and 68% of total federal revenues, the robust energy sector has long been the backbone of the Russian economy and a source of great national pride.
Today, it appears as if the traditional bulwark of the Russian economy may be its undoing. Overdependence on oil and natural gas has been squeezing Russia dry and no amount of increased production or reserve releases is likely to help as the embattled energy sector is beset on all fronts. US and EU sanctions on Russian energy, financial, and defence sectors in the wake of the annexation of Crimea have taken their toll. Poland, Ukraine, and the Baltics are pursuing pipeline projects and energy independence to insulate themselves from Russian influence. Much of Western Europe has turned to the United States, the powerful new player on the energy exports stage, having just recently eclipsed Russia as the world’s largest oil producer following the massive American shale boom. Crude oil’s global price shock and OPEC’s price dumping in key Russian energy markets have both dealt serious blows to the economy. The long-term viability of the monolithic Russian petrostate has been called into question on numerous occasions by economic theorists and domestic policy makers alike; it now appears as if they were right to be concerned.
In the face of these pressures, the Russian economy has contracted violently, with the value of the ruble plummeting against the dollar. As Russian officials race to diversify and adjust to the new reality of lower oil prices, it is becoming increasingly clear that Russia suffers from an acute case of ‘Dutch disease’; the energy sector’s decades-long economic stranglehold has made industry sclerotic, uncompetitive, and heavily reliant on state subsidies. Despite efforts to strengthen Russian industry through expensive and large-scale R&D initiatives, meaningful modernization is slow in coming as weak and opaque institutions stymie progress. Russia is now faced with the unenviable task of having to buttress and ultimately overhaul the much more underdeveloped sectors of its economy, all in the face of debilitating sanctions, a depreciated ruble, and an ever-growing budget deficit.
More than outside pressures plague the weakened petroleum empire; the former economic heavyweight faces equally pressing problems from within. Russia’s Soviet-era oil fields need constant and expensive maintenance efforts just to hold production at current levels and the state-run petroleum companies are notoriously inefficient. Rosneft shelled out billions last year to aggressively ramp up drilling efforts only to see production rise by an anemic 1%. The long-term oil production prognosis is disheartening in the extreme; the Russian Energy Ministry has stated that oil production may fall by as much as 50% by 2035.
New sources of oil and natural gas have also been hard to get ahold of. Finding these fields and undersea pockets isn’t difficult and promising discoveries have already been made in Siberia and the Arctic, but extraction is expensive and Russia doesn’t have the resources or the equipment. Loans from Western creditors are no longer an option due to the sanctions and, while China has expressed a willingness to provide funding for the projects, this would be contingent upon receiving a significant equity share.
This strings-attached deal might be Russian energy’s last, best hope. In 2015, China became the largest importer of Russian oil as Beijing seeks to diversify its energy production and move away from dependence on Saudi Arabia. Overland oil supply routes from Russia and Central Asia are of significant strategic importance and enhanced energy cooperation between the two countries, expanded beyond the existing framework agreements, would help to lessen the effects of the loss of the Western markets.
Unfortunately, the curative capabilities of a stronger Chinese partnership are limited. Poor Russian oil extraction infrastructure has caused numerous delays in joint large-scale energy projects and the once-promising Power of Siberia pipelines have stalled in the face of design flaws, equipment failures, and contractual disagreements. Exploration of new oil fields has also been delayed until 2021 and most of the proposed Chinese investment ventures are still in their framework agreement stage. While at least some of these major energy infrastructure projects will be completed and will eventually make Russian oil a more attractive option for China, Beijing has indicated little to no interest in Russia’s natural gas. China is able to produce almost 70% of the LNG (liquid natural gas) it consumes and total demand is down for the first time since 2006.
China is clearly not a panacea for Russia’s energy crisis, though stronger energy agreements will help to alleviate some of the damage. Russian institutional overhaul and diversification away from the energy sector are painful but necessary steps that the country will need to take to correct serious structural flaws in its post-boom economy. The course-correct will be slow and will likely involve a smaller state presence to avoid crowding out private investment and encouraging rent-seeking, but Russia will have little choice in the matter if it hopes to emerge from this period of economic turmoil and shake itself out of its torpor as a paralyzed resource economy.
Matthew Finkel is a sophomore at Wesleyan University, majoring in Government and Latin American Regional Studies with a minor in International Relations.