Belmont Club

The fire in Russia

A flare for energyMost of Russia’s current power and influence comes from its production and control of energy. According to the DOE, “Russia’s economic growth over the past seven years has been driven primarily by energy exports, given the increase in Russian oil production and relatively high world oil prices during the period.”

“Russia’s economy is heavily dependent on oil and natural gas exports. In order to manage windfall oil receipts, the government established a stabilization fund in 2004. By the end of 2007, the fund was expected to be worth $158 billion, or about 12 percent of the country’s nominal GDP. According to calculations by Alfa Bank, the fuel sector accounts for about 20.5 percent of GDP, down from around 22 percent in 2000. According to IMF and World Bank estimates, the oil and gas sector generated more than 60 percent of Russia’s export revenues (64% in 2007), and accounted for 30 percent of all foreign direct investment (FDI) in the country.”

Russia’s major market for natural gas is Europe. These Department of Energy maps depict the existing and proposed routes of Russian pipelines not only to Europe, but to all points. One key difference between Russia’s pipeline-based natural gas distribution network and a system based on tankers is that Russian gas has to transit sovereign countries. This is contrast to the shipping which enjoys freedom of navigation on the world’s oceans. Pipelines must be protected continuously and persistently along their entire length unlike shipping which occupies a moving dot on the vast ocean and around which defenses can be concentrated. Pipelines moreover, cannot be easily rerouted. Ships, by comparison, can select alternate routes in responses to changes in the weather or obstruction. Russia must resort to a combination of bribery and threat to ensure that its energy exports get safe passage.

Natural gas is used primarily for heating and electrical power generation. Nuclear power, which fills a similar market niche, produced half as much as conventional thermal generating power in Europe in 2005. For North America it was only over a quarter. Nevertheless Europe is a heavy user of Russian natural gas, as is shown in the table below.

Customers

But nothing stands still and Russia’s natural gas production will decline unless it can successfully develop new fields and new routes. The DOE writes:

Gazprom’s natural gas production forecast calls for modest growth of 1-2 percent per year by 2010. Russia’s natural gas production growth reflects its aging fields, state regulation, Gazprom’s monopolistic control over the industry, and insufficient export pipelines. … Based on EIA analysis, Gazprom’s production from its largest four fields is expected to decline by around 1,800 Bcf in the next four years. Gazprom’s targeted production for 2011 is an increase of around 1,000 Bcf from 2007 levels. … Domestic gas prices in Russia are only around 15-20 percent of the market rate at which Russia’s gas is sold to Germany, and Gazprom lost around $420 million in 2006 on domestic natural gas sales. Low prices have impacted the gas industry’s ability to finance capital spending and have hurt incentives to increase efficiency.

As old fields decline and production moves to fields in Siberia and the Barent’s Sea, Russia’s logistical calculus will become even more complicated. Selling off a depleting resource in order to fund a transitory condition of prestige among sullen neighboring countries and to keep domestic prices low may prove a difficult strategy to sustain. Recent reports for example that Russia is distributing passports in the Ukraine to people of Russian ethnicity may support Moscow in the short term. But in the long term it bodes ill for relationships in the area. In the medium to long term, the containment of Russia will focus around diplomatic efforts to draw countries around its periphery into arrangements with the West and to do with energy policy. Energy is Russia’s strength and its Achilles’ heel.


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