Severe Economic Crisis in Russia Looms

The way bad economic news pours out of Vladimir Putin’s Russia, you could almost imagine the country might be run by a KGB autocrat with no business experience or training whatsoever.

But perhaps even more disturbing for Russians these days than the horrific extent of the bad news is the type of bad news they are getting, namely news that deals with the lynchpin of the Russian economy -- its energy sector.

Hydraulic fracking technology threatens to disengage the U.S. market from foreign imports, or even to turn the U.S. into an energy exporter despite its massive consumption. Plummeting demand would dramatically reduce prices, placing Russia in dire financial jeopardy since it depends on gas revenues to balance its budget. Already, the U.S. has overtaken Russia as the world’s leading producer of natural gas.

But that’s only one side of an energy vice that is rapidly closing in on Russia. From the other side comes a potentially devastating legal attack by the European Union on Russia’s state-controlled gas monopoly, Gazprom. Right now, Americans are paying one-fourth the price charged by Gazprom to its European customers, and the EU lawyers believe that Europe’s prices are high because of illegal practices of Gazprom in restraint of trade, particularly in Central and Eastern Europe. Recent EU victories over Microsoft and Intel indicate that it will pursue its case until Gazrprom is forced to pay massive penalties and substantially alter its business model, something that could have devastating consequences on the company’s bottom line.

Leading Russia analyst Anders Aslund points out:

In 2011 Gazprom was formally the most profitable company in the world with purported net profits of $46bn, but these profits were hardly real. Investment analysts opined that no less than $40bn disappeared through inefficiency or corruption. Gazprom’s cash flow was barely positive.

Transparency International routinely ranks Russia as the most corrupt major economy on the planet (most recently, 143 out of 182 world nations); without its huge profit margins, Russia corruption could push Gazprom to the brink of bankruptcy and beyond.

Aslund does not think Gazprom can survive. He points out that it has already abandoned development of its Shtokman gas fields in the Arctic, a project that was ballyhooed until recently as heralding the rebirth of Russia as a worldwide energy force. And he predicts that Gazprom will soon be forced to give up its other main development project, the South Stream gas pipeline. The more pressure Gazprom faces from corruption and American shale, the more its influence -- and that of Russia -- will dwindle.

The ripple effects are truly terrifying for the Russian economy. Already, the Financial Times reports:

Russia has a woeful record when it comes to investment. [S]ome 70 per cent of all foreign direct investment into Russia comes from offshore havens – meaning it is Russian flight capital returning home. Things are not much better for portfolio investment, where Russian shares have always traded at a steep discount to those of its emerging market peers.

In other words, almost nobody outside Russia is willing to invest foreign money in Putin’s dictatorial regime; Russia’s level of FDI ranks with tiny European states like the Netherlands and Belgium as a result, meaning it has no outside source of investment capital.