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Prospects for Russia’s Energy Market

Prospects for Russia’s Energy Market

Both during and after World War Two, analysts recognized the vital role played by energy resources – petroleum, natural gas, and coal – in calculating national power and a nation’s ability to endure an international crisis. Economic development and industrial production are largely determined by success in securing these crucial energy components. More recently, nuclear power has joined the ranks of essential energy resources.

Working through Rosatom, the Russian state-owned nuclear corporation, Moscow has become a world leader in the construction of nuclear reactors. In 2018, it opened Akademik Lomonosov, which enjoys the distinction of being the world’s first floating nuclear power plant. By developing not only domestic nuclear facilities but also cultivating foreign markets in Egypt, China, Turkey, Bangladesh, and Uzbekistan, Russia has greatly enhanced prospects for strengthening its geopolitical position. However, in spite of this optimistic promise for the Kremlin’s interests, it is vital that these ambitions be tempered by a concern for preserving global nuclear governance norms avoiding the creation of international instability

Energy dependence 

It has long been recognized that Vladimir Putin’s political prospects are dependent on the price of oil and gas exports and other energy resources. As Russia’s revenue from this commercial activity rises, the more secure the Putin regime will be and, if the price per barrel falls below a certain level, Putin might quickly lose political power. With 40% of the federal budget of Russia coming from the export of oil and gas, the Kremlin is extremely vulnerable to market changes.

This problem is exacerbated by Putin’s decision to make the military the primary focus of investment while neglecting fundamental measures to reform the process by which it generates revenue. Because of Russia’s military involvement in Ukraine, Crimea and Syria, its dependence on oil revenue represents a long-term concern. This worry, however, is currently offset by the low oil production costs in the Russian petroleum industry – they are lower than those of Saudi Arabia - as well as the consequences of the ruble crisis of 2014 which resulted in a weak ruble that helped the country’s export situation.

In 2012, Matteo Verda prepared an analysis of the phenomenon entitled “Russian Oil and Gas Sector: Political and Economic Prospects”. While most efforts at a comprehensive study have a remarkably brief shelf life, Verda’s work has endured and his observations are relevant today as they were in 2012.

Verda’s analysis rests on two basic assumptions. The first is the need for continued development of Russia’s European market and the second is recognition that without multi-level diversification Russian cannot maintain its current position within the energy sector. While there is no doubt that Russia will continue to export gas to Europe, there will always be a question about how much it will sell in the European market. As of now, Russia commands about 40% of the European market and, according to a Bloomberg report, is likely to maintain that for the immediate future. 

Market issues 

By 2018, the overall market indicators of most significance to Russia were encouraging after several years of negative values. Although the United States has been able to set new highs in oil and natural gas production – thus pressuring prices downward – it was apparent from reports in late in 2018 that the price of petroleum was once again rising. The years from 2014 until 2016 were devastating for Russia as the price of crude oil fell by more than 30%.

What this means in practical terms is that, by the end of 2018, the price of Brent crude had risen from approximately $40 to $50 per barrel to as much as $70 per barrel. After several years in which refinery investments declined, the energy sector now must work to increase production in order to take advantage of a reduced supply and rising prices. Market profitability has also been improved by a move both in Europe and the United States to allow contracts that are not destination defined. As a result, it is now possible to change shipping destinations in order to take advantage of more favorable conditions that might appear in a different market.

However, by late 2018, there were indications that Russia was considering a decrease in its production in order to drive the price up. For this initiative to work, Russia must work in cooperation with the OPEC states. While the year ended with the Saudis having increased oil production to record levels, the Russians would like to convince the Saudis to join them in decreasing output. Of course, a Russian-Saudi agreement to decrease production could be undermined if other countries opt for a production increase in order to take a short-term advantage of the likely higher prices. 

Geopolitics matter 

In this respect, there is an increasingly obvious indication of the way in which the objectives of Russian foreign policy and Russia’s domestic economic needs complement each other. Russian involvement in Syria, a policy which brings the Kremlin into conflict with Washington, illustrates this interaction. Russian military operations in Syria and Russian military and economic aid to Syria have greatly increased prospects for Assad’s survival. Not that long ago, analysts were confidently predicting the collapse of Assad’s brutal regime.

While this prospect is alarming to human rights activists, it would likely signal a return to at least limited stability for what has become one of the world’s most uncertain governments. The long Syrian war has greatly contributed to a refugee crisis that has undermined much of European society. However, an Assad victory will also reduce the instability that has resulted in the collapse of governmental and economic institutions in Syria. A reduction of that instability has enabled the Syrian government to offer incentives to the Russians if they agree to participate in the reconstruction of the country’s energy sector. One dramatic illustration of this effort was the 2017 offer by the Syrian government to arrange for sharing profits from its petroleum industry with a firm owned by a close Putin associate. Under some circumstances, the Russian company would receive up to 25% of the profits.

While Syrian production has never been of great value to the Russian petroleum industry, these recent prospects could improve Russia’s geopolitical situation. An especially important concern is that expanded Russian influence over the flow of Syrian petroleum would mean that EU countries would have to deal with Russia before they could make purchases from petroleum exporters. Moreover, a continuing Russian presence in Syria would facilitate the maintenance of Russian military bases. Through naval bases and air fields, Russia would be able to boast its largest military contingents outside Russia itself and to challenge Western actors, be they economic or military, in the region. 

Modernization 

One important market indicator is the extent of proven Russian oil reserves. Previous estimates focused primarily on Western Siberian reserves even though they had been exploited since the 1970s. By 2005, Russian authorities were reporting that there were also abundant reserves in Eastern Siberia. However, there has been an assumption that the Russian classification system did not correspond to the standards employed by the Society of Petroleum Engineers. Therefore, beginning in 2016, the Russians began to employ a new classification system that was more consistent with international standards. Although this adjustment is a component of technical issues relating to the quantity of Russian oil reserves, it has the additional impact of integrating the Russian petroleum industry into global arrangements. Moreover, the introduction of these standards for evaluation of Russian reserves will improve Russian prospects for foreign investment in this vital sector of its economy.

Finally, another important part of this process of system modernization is the effort to end use of the dollar as the currency of the petroleum trade. Following his 2018 reelection, Putin declared his intention to free the Russian economy from the power of the US dollar in the international commodities markets. While this initiative is motivated economic concerns, it has an equally significant political objective.

Vladimir Putin intensified this initiative at a time where there were two political concerns. The first concern was Putin’s determination to diminish the impact of the US dollar on Russia’s economy. As long as the dollar is tied to the pricing of oil in the global market, Russia will play a secondary role. This is an economic objective that also increases the Kremlin’s political stature in comparison with the United States.

A second political concern is that this initiative comes at a time when the Trump Administration imposed anti-Russian sanctions. At the same time, the US gave waivers to its allies to import more Iranian crude without becoming the target of sanctions, an action that would undermine the Russian petroleum industry. In 2018, President Trump also encouraged Saudi Arabia to increase its oil production and the country responded by increasing its production levels to an all-time high. 

Photo credit: pxhere.com

 
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OEconomica No. 1, 2016