The political economy of Russian oil and gas

Reuters

An employee talks on a portable radio set at Bashneft - Novoil refinery in the city of Ufa, April 11, 2013.

Article Highlights

  • Diminishing oil and gas supplies could cause serious problems in Russia's economy.

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  • Russian oil and gas revenues amounted to $215B last year.

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  • For Russia, doing nothing in the face of lower oil and gas revenues carries enormous social and political risks.

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One of the two largest oil producers in the world, Russia accounts for 12 percent of global output. Last year it again surpassed Saudi Arabia by pumping almost 10.4 million barrels per day (BPD). It is also one of the world’s largest exporters of oil, with nearly 5 million BPD. With the world’s largest proven reserves of natural gas, Russia is also the top producer of natural gas, accounting for about 20 percent of the world’s total. The centrality of hydrocarbons to Russia’s economy is hardly a new issue, but it is one well worth revisiting today. On the one hand, new technologies are making natural resources cheaper and more abundant, threatening billions of dollars of the Russian state’s revenue. At the same time, to maintain the current level of production, not to mention increase it, Russia must make huge investments in exploring and recovering oil from virgin deposits (“greenfields”) of the east Siberian region and the Arctic shelf. Russia’s ability to meet both challenges will affect not only its preeminence as an energy supplier but also its ability to wield oil and gas as geostrategic tools. With a likely significant thinning of oil and gas rents, at stake might be the stability of the regime and perhaps even its survival.

Key points in this Outlook:

  • One of the world’s two largest oil producers and the leading provider of natural gas to Europe, Russia has increasingly used its revenues from energy exports to strengthen the Putin regime.
  • As new, cheaper energy providers emerge and the market becomes leaner and more competitive, Russia needs to lessen its dependence on profits from these resources if it is to avoid stagnation and possibly an economic crisis. 
  • The regime needs to implement deep institutional reforms to create a better investment climate and diversify the economy, but in doing so it risks undermining the authoritarian “vertical of power.”

 

Vladimir Putin’s commitment to oil and gas as the mainstay of Russia’s progress stems from a deep and abiding conviction about its importance to the nation’s economy. Long before he came to power, he had believed that “the restructuring of the national [Russian] economy on the basis of mineral and raw material resources” was “a strategic factor of economic growth in the near term.”[1]

In an article published a year before he became president, he reiterated that Russian mineral resources would be central to the country’s economic development, security, and modernization through “at least the first half” of the 21st century.[2] In Putin’s view, the only way for Russia to achieve economic growth of 4 to 6 percent per year—the tempo he deemed minimally necessary for Russia to reduce its lag behind the developed countries—was via “extraction, processing and exploitation of mineral raw resources.” This was the key to Russia’s becoming “a great economic power,” Putin believed.[3]

For Putin, oil and gas were also paramount politically as guarantors of the security and stability of the Russian state. As he put it, “The country’s natural resource endowment is the most important economic and political factor in the development of social production.” Furthermore, the “raw material complex” was the “basis for the country’s military might” and an “essential condition” for modernization of the military-industrial complex.[4] Finally, he believed the mineral extraction sector of the economy “diminishes social tensions” by raising the “level of well-being” of the Russian population.[5]

Oil, Gas, and the “Putin Doctrine”

State control or outright ownership of the oil and gas industry became a central element in the “Putin Doctrine,” which postulated the recovery of the state’s political, economic, and geostrategic assets following the antitotalitarian revolution of late 1987–91.[6] The state was to become again the only sovereign political and economic actor in Russia, with the private sector, civil society, and its institutions mere objects.

Putin saw as nonnegotiable the state’s control of “rent flows” from the sale of mineral resources, with nonstate property rights remaining “contingent.”[7] Almost a decade and a half later, the authors of an influential analytical report on the composition and division of labor in the Kremlin’s Politburo singled out “long-term natural gas contracts, and the management of the natural gas industry in general and Gazprom in particular” as one of only two areas “under Putin’s direct control.”[8] (The other sector was the largest banks.)     

In pursuit of this agenda, the Putin regime has effected a steady accretion of the state’s sway over the oil industry. (Unlike oil, Russia’s natural gas production escaped large-scale privatization in the 1990s. As a result, the majority-state-owned Gazprom dominates the sector with 78 percent of the national output and has a pipeline and export monopoly.[9]) The key to the effective state takeover of more than half of Russian oil output was a dramatic expansion of the majority state-owned Rosneft, headed since 2010 by Putin’s confidant and former KGB officer Igor Sechin. Starting as a minor company that the government tried and failed to sell in 1998 because nobody wanted it, Rosneft skyrocketed in 2004 after it took over the key assets of Russia’s formerly largest and privately owned oil corporation, Yukos, which the Kremlin had bankrupted, broken up, and sold at rigged auctions.[10]

"For Putin, oil and gas were also paramount politically as guarantors of the security and stability of the Russian state."Since Rosneft bought Russia’s third-largest private company, TNK-BP, for $55 billion this past March, it has become the largest publicly traded oil company in the world by output.[11] As a result, the state share of Russia’s oil production increased from 20 percent in the early 2000s to 56 percent today, with Rosneft accounting for 48 percent of the total.[12] The increase in the state ownership paralleled a steady rise in overall production, which reached a post-Soviet record of 10.5 million barrels per day, or 518 million tons per year, in November 2012.[13]

The Rise of the Russian Petro-Gas State

From less than 50 percent in the mid-1990s,[14] the share of commodities in Russian exports has grown to 70 percent today, with oil accounting for more than half of the export income.[15] Representing up to 30 percent of the country’s GDP and half of its GDP growth since 2000,[16] hydrocarbons provided at least half of the state’s budget revenues last year.[17] Five years ago, Russia needed oil prices of $50 to $55 a barrel to balance its budget, but Alexei Kudrin, former first deputy prime minister and finance minister, estimated the breakeven price at $117 per barrel last year.[18]

Russia’s dependence on energy exports—and, consequently, its economy’s vulnerability to commodity price fluctuation—was highlighted by the 2009 world financial crisis. As oil plunged from $147 to $34 per barrel, the resource-based economy contracted by almost 8 percent—the largest drop among the G20 top industrial nations.

Russia has begun to exhibit the signs of what economists call the “Dutch disease,” when overreliance on commodity exports depresses other sectors of the economy by starving them of investments and modernization while the increasing value of the national currency makes exports of other goods and services more expensive and thus less competitive in world markets. Industrial stagnation has even spread to the military-industrial complex, which, like in Soviet times, continues to be the state’s favorite sector and enjoys its continuous and very generous support. Despite this, according to a recent survey, only 20 percent of the Russian defense enterprise qualified as “modern.”[19]

As in virtually every other petro-gas state, the rise of the Russian one has been attended by corruption likely unprecedented even in the country’s far-from-pristine history. Venality and extortion have come close to
subverting or even paralyzing governance, social institutions, justice, and entrepreneurial activity. In Transparency International’s 2012 Corruption Perception Index, Russia was 133rd among 176 countries, worse than Belarus, Vietnam, and Sierra Leone and on par with Honduras, Iran, and Kazakhstan.[20]

Yet the most dangerous political legacy of the Russian petro-gas state is the centrality of oil and gas revenues, which amounted to $215 billion last year,[21] to the loyalty of two groups that are essential for the regime’s survival: the lower-income and elite segments. Trillion-ruble transfers help to maintain social peace in what is known as “Russia-2”[22]—poorer regions, especially the volatile and increasingly violent Muslim North Caucasus, small towns and rural areas, and the rusting “monotowns” (one-company towns) of Stalinist industrialization.[23]

The sporadic raising of meager pensions and salaries for the millions of Russians on the government payroll, including doctors and teachers (usually in the run-up to the Duma or presidential elections) is part of the same strategy. At the same time, oil and gas rents are a vital component in elite management under Putin’s neopatrimonial regime: a tacit but ironclad agreement between the Kremlin and the bureaucracies from top to bottom that permits the latter to enrich themselves at the treasury’s expense in exchange for their loyalty.

So long as the regime continues to regard export revenues as a palliative, if not a panacea, for economic, social, and political problems, they will impede or even obviate the need for economic and political modernization. “The problem of being a petro-state is that the natural resources trend corrupts the institutions,” said Sergei Guriev, rector of the New Economic School in Moscow and a leading expert on Russian political economy. “This is what is called the ‘resource curse.’ This is a trap, where democratic political and economic institutions do not develop because rents coming from natural resources provide incentives to the elite not to develop institutions.”[24]

Challenges to the Status Quo: Oil

But this status quo may not be sustainable indefinitely. After two decades of essentially living off the Soviet Union’s “legacy fields,” the “brownfields” (exploited deposits, as opposed to newly discovered ones, or “greenfields”) of western Siberia are “entering a long-term decline.”[25] Although Russia is not running out of oil, a leading expert believes it may be running out of cheap oil.[26] Instead, oil will have to be pumped from places that are “colder, deeper and more remote,”[27] such as the continental shelf in the Arctic, the ever more remote regions of eastern Siberia, the “deeper horizons” of western Siberia, or the Black Sea.[28]

"Although Russia is not running out of oil, a leading expert believes it may be running out of cheap oil."Yet the enormous upfront investments that such an effort would require are hard to come by when taxes on oil companies’ profits have greatly reduced the incentive to invest in new technology and greenfield exploration. After they pay the profit tax, value-added tax, mineral extraction tax, asset tax, charges for the use of subsoil resources, mandatory contribution to social funds, and export duties, Russian oil companies are effectively taxed at a 70 percent rate.[29] (By comparison, in 2011, Chevron and ExxonMobil were taxed at an effective rate of 42–43 percent in the United States.[30])

This policy leaves massive capital and technology transfers from Western multinational corporations as the key to sustaining the present levels of oil production. Among the more notable of such ventures was ExxonMobil’s agreement last year to invest, in a joint venture with Rosneft, $3.2 billion into the exploration and development of the Black Sea and the Kara Sea in the Arctic. In addition, with Rosneft’s acquisition of TNK-BP, BP ended up with almost a 20 percent stake in the Russian company.[31] (Rosneft promptly proceeded to “borrow” $10 billion from TNK-BP subsidiaries, in the process effectively robbing minority shareholders who held shares in these firms.[32])

Yet such deals fall far short of what is needed to ensure Russia’s continued status as an “energy superpower,” and the barriers to large-scale Western investments are formidable, if not prohibitive. Shale oil and environmentally “cleaner” liquefied natural gas (LNG) will likely push down oil prices, making greenfield investments less profitable. The worsening of relations between Russia and the West increases the risks as well. Then there is the 2008 law that restricts foreign control over companies operating in Russia’s “strategic industries” (certainly including oil and gas), in effect banning non-Russian energy firms from a majority ownership of any significant venture. (In the ExxonMobil-Rosneft deal, ExxonMobil owns only one-third of the venture.) Last but far from least, there is the memory of the Russian government’s forcing Royal Dutch Shell in 2006 to give up a controlling stake in its liquefied gas production project, known as Sakhalin-2, after Royal Dutch Shell and other members of the consortium had invested $9–11 billion in the venture over 12 years.

Tall Barriers and Belated Incentives

Russia has plenty of “tight oil,” (oil found in “low permeability” reservoirs, such as shale or tight sandstone, and usually requiring horizontal drilling and fracturing to access) including the brownfields of western Siberia. Yet its production faces severe structural constraints. Shale extraction requires technological and entrepreneurial agility (as well as strict cost control), which are associated with small and medium-sized independent companies operating in relatively benign legal regimes.[33] Instead, Russian shale oil is likely to be developed by the giant Rosneft, which is hampered by very strict regulations.

Absent an expansion into new fields or the successful adoption of new technologies for maintaining the old ones, Russia’s production may shrink by as much as one-fifth, from the current 10.4 million BPD to 8 million BPD as early as 2020.[34] In the opinion of a top expert, Thane Gustafson, sometime in the coming decade, the Russian state “could well see oil revenues decline, even as its reliance on them grows,” and the “tide of money” that has enabled the Kremlin to meet “everyone’s growing expectations” may vanish.[35]

In the last two years, the growing awareness of such gloomy eventualities has prompted the Kremlin to ease the tax burden on oil companies to stimulate investment in exploration and new technologies. In 2011, the government lowered crude oil export duties from 65 to 60 percent.[36] Tax relief seems also in the cards for shale and other “tight rock” energy production, as present draft legislation aims to reduce the mineral extraction tax to between 50 and 100 percent of the current tax.[37] In May 2012, Putin also suggested tax incentives for exploring offshore oil reserves.[38]

Click on the image for a larger, detailed look

Challenges to the Status Quo: Gas

Even more than Russian oil, natural gas rents are likely to shrink significantly in the coming years. In addition to Gazprom’s notorious corruption and mismanagement—Transparency International ranked it among the least transparent companies in the world[39]— funds available for investment are reduced by the politically dictated subsidization of domestic gas prices: Gazprom sells 60 percent of its gas domestically at a loss.[40] The hope for increased profits following a 15 percent rise in the prices of heating and cooking gas as part of this year’s “utilities reform” have been dashed by Putin’s limiting the utilities hikes to 6 percent. This price control is estimated to further reduce Gazprom’s profits by more than $300 million a year.[41]

Gazprom’s modernization and greenfield investments are also hampered by enormously expensive projects that seem motivated more by the Kremlin’s geostrategic ambitions than by a search for profitability. Thus, in an effort to bypass Ukraine, Gazprom completed the Nord Stream twin pipeline system under the Baltic Sea in October 2012 and launched the South Stream project, which includes a stretch under the Black Sea, in December 2012. The price tag for both projects is around $40 billion.[42] In the beginning of April of this year, Putin ordered Gazprom to revive the Yamal-Europe-2 project, which would construct yet another gas pipeline bypassing Ukraine, from the Belarusian border via Poland to Slovakia.[43]

The immediate challenge to natural gas rents, however, is a sharp loss of profit because of the competition from alternative modes of production made possible by new technologies. The latter includes “horizontal drilling” to tap shallow but broad deposits and hydraulic fracturing (or “fracking”) when sand, chemicals, and water, gel, or liquefied gases are injected under great pressure into shale rock formations to extract gas and oil. As a result, over the last decade US gas imports have shrunk by 45 percent. By contrast, Gazprom has yet to start tapping these resources. Instead, the company’s president, Alexei Miller, has repeatedly decried shale gas as a “myth” and a “well planned propaganda campaign.”[44]

The drop in US imports has freed up large volumes of natural gas and lowered prices on the world market. In addition, LNG transported by tankers from the Middle East has increased significantly, Europe’s reliance on LNG has expanded, and Europe’s LNG infrastructure has grown. The rapidly changing supply and price structure will be further altered by a possible (or even probable) transformation of the United States from an importer to an exporter of natural gas.

Among the most notable casualties of an increased supply and lower prices has been the Shtokman natural gas field in the Arctic Barents Sea, one of the world’s largest. Last August the members of the consortium—Gazprom, France’s Total, and Norway’s Statoil—quietly abandoned the project, which was to produce LNG to export to the United States, because it became unprofitable.

The Shrinking European Market

To make up for domestic corruption and inefficiency, Gazprom needs large profit margins in Europe, where it used to sell gas at a 66 percent profit.[45] Just to break even, the firm needs to earn $12 per thousand cubic feet. By comparison, natural gas is sold at below $3 per thousand cubic feet in the United States today.[46] Even with the liquefaction and transportation costs, widely anticipated US exports of LNG to Europe are likely to cut deeper still into Gazprom’s margins.[47]

Meanwhile, the lower prices have forced Gazprom, which last year supplied a quarter of European gas, to renegotiate delivery prices to levels closer to those in the spot markets, where commodities are traded for cash for immediate delivery and where prices have dipped as low as half of those in Gazprom’s long-term contracts.[48] In addition, the Russian natural gas behemoth has begun to grant as much as a 10 percent discount on existing contracts.[49] Still, Gazprom saw its exports to Europe go down by 8 percent in 2012, to the lowest level in a decade.

Meanwhile, the sales of Gazprom’s main competitor in Europe, Norway’s majority-state-owned Statoil, are up
16 percent. The disparity is largely due to Statoil’s more flexible pricing that brought at least half of its contracts down to the spot market level.[50] For the first time, Statoil is catching up to Gazprom’s diminishing sales in Europe, exporting 88 billion cubic meters of natural gas as compared to Gazprom’s 113 billion cubic meters.[51] In the first nine months of last year, Gazprom’s profits fell by 12 percent compared to the same period of last year, and operational costs increased by 18 percent.[52] Overall, between 2008 and 2012, Gazprom lost 53 percent of its market value.[53]

Europe is becoming less hospitable legally and politically as well. Last year, the European Commission started an antimonopoly investigation of Gazprom, including possible price fixing. Should Gazprom be found in violation of antimonopoly laws—a very distinct possibility—it will have to open its pipelines to competitors, alter its “pricing formula,” in which the price of gas is linked to that of oil, and pay up to $14 billion in fines.[54] Further aggravating the situation, last September, Putin issued a decree prohibiting Gazprom from cooperating with the EU investigators.

Uncertain Alternatives to Europe

Gazprom has been attempting to make up for the decreasing prices and shrinking demand in Europe by increasing sales to the East, most of all China, but the prospects are uncertain at best. China already imports far cheaper gas from Turkmenistan via a recently constructed pipeline.[55] Furthermore, with the estimated largest deposits of shale gas in the world, China could well be close to self-sufficiency by the time the currently planned pipeline from Eastern Siberia materializes.[56] As a result, Russia and China have repeatedly failed to agree on the price for the putative imports.[57]

Despite the uncertainty, Putin has directed Gazprom to develop for export to China the giant virgin Chaya­dinsk field in Yakutia in northeastern Siberia. With the construction of a pipeline to Vladivostok and a LNG plant there, the project is estimated to cost $40–65 billion, likely pushing the delivery price to as high as $15 per million British thermal units (BTU), a universal energy equivalent compared to $3 per million BTU in the United States.[58]

"To make up for domestic corruption and inefficiency, Gazprom needs large profit margins in Europe."Similarly, shale gas appears to obviate any prospects for increasing Gazprom sales to Ukraine, the second-largest European consumer of Russian gas after Germany. By the time Ukraine’s current contract with Russia runs out in 2019, Russia’s southwestern neighbor, which last year bought 33 billion cubic meters of gas from Gazprom, may see its needs for Russian gas significantly, if not dramatically, reduced. At 1.2 trillion cubic meters (42 trillion cubic feet), Ukraine has Europe’s third-largest shale gas reserves, and this past January Kiev signed a $10 billion deal with Royal Dutch Shell to extract shale gas from a field in Eastern Ukraine. Although, as with other European shale gas prospects as a whole, the Ukrainian deposits are not likely to be developed as quickly as those in the United States, the project (which is estimated to produce between 7 billion cubic meters and 20 billion cubic meters within five years) is an important step toward reducing Ukraine’s energy dependence on Russia.[59] In the meantime, seeking to further lessen its dependence on Gazprom, last year Ukraine began to buy more natural gas from Germany (via Poland and Hungary) and LNG from terminals in Turkey (via Bulgaria and Romania). Kiev is also looking to triple extraction from the Black Sea to 3 billion cubic meters by 2016 and plans to build a LNG terminal to process 10 billion cubic meters from either Qatar or Azerbaijan.

Signs indicate that the Kremlin may be preparing to significantly reduce Gazprom’s role, with an eventual absorption into the omnivorous Rosneft a distinct possibility. The head of Rosneft, Igor Sechin, has already suggested splitting the formerly sacrosanct “national champion” into extracting and transporting companies. (As a leading Russian daily put it, “Gazprom is being readied for a surgery.”[60]) Rosneft is planning to raise its natural gas output to 100 billion cubic meters (3.5 trillion cubic feet) by 2020—this is over 20 percent of the Russian gas market.[61] In addition, Rosneft and Russia’s largest privately owned natural gas company, Novatek, are said to be joining forces to break Gazprom’s export monopoly by working on an LNG project from Arctic fields.[62] (Rosneft is also reportedly talking with ExxonMobil about constructing a liquefied natural gas plant for exports to Asia.[63])

The Urgency of a “New Model of Economic Growth”

To Putin’s Kremlin, which like all restoration regimes is preoccupied almost exclusively with the here and now rather than a long-term strategy, the political implications of diminished oil and gas revenue may seem distant and avoidable. Indeed, Russia’s macroeconomic position today is quite solid. The country’s budget is balanced; hard currency reserves are second only to China’s; inflation, while rising, is still among the lowest levels in the country’s post-Soviet history; and the public debt is only 12.2 percent of the GDP. And of course, as a leading expert puts it, there is still enough oil for the regime to feel “comfortable.”[64]

Yet, even apart from the all-but-inevitable and significant diminution in energy export revenues, the dangers of the Russian economy’s continuing and growing reliance on gas and oil have been increasingly obvious both to government and independent experts. Six weeks ago in Moscow, I was struck by a wide consensus that an average 3 percent growth since 2009 (and projected for this year as well) is totally inadequate to address the country’s social, economic, political, and demographic problems. “The 3 percent of economic growth satisfies no one,” wrote a leading Russian political daily.[65] “If we want to be competitive, to be able to solve social problems, Russian economy must grow faster than the world’s average,” Putin said this past January.[66] Since then, the Russia’s growth estimate for 2013 has been revised down to between 1.8 and 2.3 percent, with the same “anemic” growth predicted for at least the next few years.[67]

Another element of the consensus I found was the need for “a new model of economic growth” to replace the current energy-based structure. Within the current economic model, according to Grigory Yavlinsky, an opposition leader and economist, significant investments geared toward long-term returns—without which diversification is impossible—are “enormously risky, often bordering on insane.”[68] Furthermore, the centrality of commodity exports means a dangerous dependence on commodity prices, as the GDP plunge during the 2008–09 world financial crisis demonstrated. The country must modernize and diversify. Even Putin and Medvedev have paid lip service to the urgency of transforming the country’s economy from one that is extraction-based to one founded on technological innovation.

Yet, everyone also seemed in agreement that such a transformation is at least as much a political problem as an economic one. Oil and gas dependence renders political and social institutions all but impervious to modernization. Modernization and diversification, watchwords in Moscow, are impossible without enormous and potentially short-term destabilizing institutional change. Diversification requires “good political institutions,” argued Sergei Guriev: property-rights protection, independent, competent and fair courts and good financial markets[69]—none of which Russia has today at even a minimally sufficient level.

At least in the short run, reducing dependence on oil and gas revenue will mean sweeping and politically fraught reforms in welfare and pension systems and cutting back on subsidies to Russia’s poorer regions, the monotowns, and unprofitable industries. It would also mean a sharp reduction in military expenditures, instead of embarking on the $770 billion, 10-year “rearmament” program announced by Putin last year.[70] Moving away from gas and oil must also entail overhauling the taxation system, filled with ad hoc tax breaks for the state’s “pet projects,” and replacing it with a predictable “profit-based” system,[71] which will assure potential foreign and, most importantly, domestic investors, who last year took over $56 billion out of the country.[72] If fully implemented, such reforms will erode the Kremlin’s control over the economy, courts, and, inevitably, politics.

No Good Options for the Kremlin?

The alternative is to maintain the present economic and political arrangements in the hope of another spike in oil prices, perhaps as a result of a Middle East war caused by Iran’s pursuit of nuclear weapons. The Kremlin’s clear preference for the status quo over far-reaching reform was reaffirmed by Dmitri Medvedev’s presidency, with its often-soaring liberal rhetoric and virtually no practical steps toward implementation.

Yet doing nothing in the face of lower oil and gas revenues also carries enormous social and political risks. These include diminution, in real terms, of the already very modest expenditures on health care and education. With an effectively bankrupt state pension fund and a rapidly aging population, the Kremlin’s ability to prevent a full-blown pension crisis will require a huge influx of gold and hard currency reserves. At a time when soaring household utility prices (tariffs) are a leading source of dissatisfaction with the regime,[73] the diminishing energy revenues will endanger the regime’s ability to subsidize the costs.

"Doing nothing in the face of lower oil and gas revenues also carries enormous social and political risks."Similarly, smaller subsidies would also mean still-greater volatility in the North Caucasus, much of which is in the throes of a low-intensity fundamentalist uprising and plagued by unemployment, especially among young males. In Chechnya, Russia for years has placated its dictator, Ramzan Kadyrov, with subsidies amounting to roughly 90 percent of the republic’s budget, and no one can predict how Kadyrov will react when the flow of cash begins to dry up.[74]

Finally, among the most destabilizing consequences of the continuing dependence on oil and gas will be the Kremlin’s declining ability to secure the elites’ loyalty. Fiercely protective of their share of the politically apportioned riches of Russia’s state capitalism, powerful clans will squabble to secure the same share of a diminishing pie, in the process threatening the stability of the regime. “Putin’s unchallenged power” rests on a tripartite foundation: “oil and gas money, the Federal Security Service, and television,” a Russian observer noted last December.[75] Today, one leg of this tripod is beginning to look wobbly.

These may not be the challenges of tomorrow or the day after. Yet in the medium term and longer term, trends in technology and the global economy, as well as the country’s own economic, social, political, and demographic dynamics, seem to have conspired to leave the Kremlin no good, risk-free choices.

I am grateful to research assistants Daniel Vajdic and Katie Earle, editor Christy Sadler, and designer Claude Aubert for assistance in editing and producing this Outlook.

Notes

1. Vladimir Tikhomirov, “Teoriya truby” [The Theory of the Pipe], Ogonyok, January 16–22, 2006, www.ogoniok.com/4928/5/.
2. Vladimir Putin, “Mineral Natural Resources in the Strategy for Development of the Russian Economy,” trans. Harley Balzer, Problems of Post-Communism (January–February 2006): 49, 50.
3. Ibid., 49.
4. Ibid., 50.
5. Ibid., 51.
6. Leon Aron, “The Putin Doctrine,” ForeignAffairs.com, March 11, 2013, www.foreignaffairs.com/articles/139049/leon-aron/the-putin-doctrine. For a more detailed exposition of the “Putin Doctrine,” see Leon Aron, “Structure and Context in US-Russian Relations at the Outset of Barack Obama’s Second Term,” AEI Russian Outlook (Winter 2013), www.aei.org/outlook/foreign-and-defense-policy/regional/europe/structure-and-context-in-us-russian-relations-at-the-outset-of-barack-obamas-second-term/.
7. Clifford G. Gaddy, “The Russian Economy in the Year 2006,” Post-Soviet Affairs 23, no. 1 (2007): 42, www.brookings.edu/~/media/Files/rc/articles/2007/01russia_gaddy02/01russia_gaddy02.pdf.
8. Evgeny Minchenko and Kirill Petrov, “Report: The Large Government of Vladimir Putin and ‘Politburo 2.0,” Minchenko Consulting Communication Group, October 3, 2012, http://minchenko.ru/netcat_files/File/Big%20Government%20and%20the%20Politburo%202_0.pdf. Emphasis is in the original.
9. Gazprom, “About Gazprom,” www.gazprom.com/about/.
10. “After Yukos: The Far-Reaching Legacy of the Yukos Affair,” The Economist, May 10, 2007, www.economist.com/node/9167397.
11. Thane Gustafson, “Russian Oil Industry at a Crossroads as Infrastructure Ages,” International Herald Tribune, December 4, 2012.
12. Ibid.; and Anders Aslund, “How Putin Is Turning Russia into One Big Enron,” Moscow Times, November 21, 2012.
13. Henry Meyer and Agnes Lovasz, “Russia Faces Economy Trap as Oil Decline Looms, EBRD Says,” Bloomberg, December 14, 2012.
14. Ibid.
15. Gustafson, “Russian Oil Industry at a Crossroads.”
16. Thane Gustafson, “Putin’s Petroleum Problem,” Foreign Affairs, November/December 2012.
17. Halia Pavliva and Vladimir Kuznetsov, “Prosperity Adds More Gazprom as Putin Pushes Improvement,” Bloomberg, March 7, 2013, www.bloomberg.com/news/2013-03-06/westman-ending-10-year-gazprom-hiatus-russia-overnight.html; and Margarita Assenova, “Russian Energy Review in 2012: Consolidating State Control in an Uncertain Market,” Jamestown Foundation, January 18, 2013, www.jamestown.org/single/?no_cache=1&tx_ttnews[tt_news]=40333&tx_ttnews[backPid]=620.
18. Andrew E. Kramer and David M. Herszenhorn, “Former Russian Minister Warns of Economic Ebb,” New York Times, June 23, 2012, www.nytimes.com/2012/06/24/world/europe/former-russian-finance-minister-warns-of-recession.html. See also “After the Storm: Trends to Watch in Russia in 2013,” The Power Vertical blog, Radio Free Europe/Radio Liberty, January 2, 2013, www.rferl.org/content/after-the-storm-trends-to-watch-in-russia-in-2013/24813957.html.
19. Pavel K. Baev, “Capital Flight from Russia Tells a Tale About Regime Failure,” Eurasia Daily Monitor 10, no. 35 (February 25, 2013).
20. “Corruption Perceptions Index 2012,” Transparency International, www.transparency.org/cpi2012/results.
21. “Reserve Fund to have 2.6 trln rubles following Feb 1 top-up,” Russia & CIS Business and Financial Newswire, February 1, 2013, http://business.highbeam.com/407705/article-1G1-317303228/reserve-fund-have-26-trln-rubles-following-feb-1-topup.
22. See, for example, Kirill Rogov, “Stsyenariy ‘Rossiya-1’” [Scenario “Russia-1], Vedmosti, February 8, 2012, www.vedomosti.ru/opinion/news/1497088/strategiya_rossiya1; Mikhail Dmitriev, “Avtor Doklada o Politicheskom Krizise: Prognoz Dlya Vlastey Neuteshitelen” [The Author of a Report on the Political Crisis: The Forecast Is Hardly Cheerful], RIA Novosti, March 14, 2012, http://ria.ru/interview/20120314/593787664.html; Lev Gudkov, “Delegitimation of an Authoritarian Regime: Mass Protests and Controlled Elections” (presentation, Center for Strategic and International Studies, Washington, DC, June 4, 2012).
23. Leon Aron, “Darkness on the Edge of Monotown,” New York Times, October 16, 2009, www.nytimes.com/2009/10/17/opinion/17aron.html, and Leon Aron, “Russia’s ‘Monotowns’ Time Bomb,” AEI Russian Outlook (Fall 2009), www.aei.org/files/2009/10/19/RO-Fall-09-g.pdf.
24. As quoted in Meyer and Lovasz, “Russia Faces.” A distinction should be made between the “Dutch disease” and the “resource curse” of petro-states. Although both stem from the same source of highly valued commodity exports, the Dutch disease refers mostly to economic consequences of overreliance on commodity exports (such as an overvalued currency, decline in manufacturing, and drop in noncommodity exports) and not to the corruption of political and social institutions. The Dutch disease may strike solidly democratic states without subverting their political and social order. By contrast, in transitional or unstable democracies the “resource curse” almost inevitably corrupts institutions, hampers democratic progress, and bolsters authoritarianism, as, for instance, in Russia or Venezuela.
25. Thane Gustafson, “Putin’s Petroleum Problem,” Foreign Affairs, November/December 2012.
26. Ibid.
27. Gustafson, “Russian Oil Industry.”
28. Gustafson, “Putin’s Petroleum Problem.” See also the interview of the Deputy Minister of Energy, Kirill Molodtsov in Galina Starinskaya, “Komanda Minenyergo formirooyetsya, a s nyey boodyet formirovat’sya i komanda moyego bloka” [The Team of the Ministry of Energy Is Being Put Together, and My Sector’s Team Is Being Organized As Well], RBK Daily, April 8, 2013.
29. Ernst & Young, “Oil and Gas Tax Alert: Russian Federation Oil Tax Reform,” September 2011, www.ey.com/Publication/vwLUAssets/Oil-and-Gas-Tax-Alert-September-2011/$FILE/Oil-and-Gas-Tax-Alert-September-2011.pdf; Joe Carroll, “Russia’s Oil Lead Challenged as Taxes Strangle Drilling,” Bloomberg, March 5, 2013, www.bloomberg.com/news/2013-03-05/russia-s-oil-lead-challenged-as-taxes-strangle-drilling.html.
30. Kathleen Hoffelder, “Tax Rates: The Haves and Have Nots,” CFO, April 17, 2013, www3.cfo.com/article/2013/4/tax_effective-tax-rate-mulford-federal-tax-rate-chevron-johnson-johnson-home-depot.
31. For more information about continued uncertainty in the Rosneft-BP relationship, see, “Picnic Time for Teddy Bears,” The Economist, April 6, 2013, www.economist.com/news/business/21575834-rosneft-bites-minority-shareholders-picnic-time-teddy-bears.
32. Ibid.
33. Gustafson, “Russian Oil Industry.”
34. Andrew E. Kramer, “Tax Overhaul in Russia Aims to Keep Country at Top of Oil-Producing Heap,” New York Times, October 10, 2011.
35. Gustafson, “Putin’s Petroleum Problem.”
36. Ernst & Young, “Oil and Gas Tax Alert.”
37. “Russia Tax Breaks for Shale, Offshore Oil Seen on Jan. 1,” Reuters, March 18, 2013, www.reuters.com/article/2013/03/18/russia-oil-tax-idUSL6N0C7FLT20130318.
38. Ibid.
39. Rachel Nielsen, “Gazprom Flops in Transparency Ranking,” Moscow Times, July 10, 2012, www.themoscowtimes.com/business/article/gazprom-flops-in-transparency-ranking/461951.html. See also Anders Aslund, “Why Gazprom Resembles a Crime Syndicate,” Moscow Times, February 28, 2012, www.themoscowtimes.com/opinion/article/why-gazprom-resembles-a-crime-syndicate/453762.html; and “Russia’s Wounded Giant,” The Economist, March 23, 2013, www.economist.com/news/business/21573975-worlds-biggest-gas-producer-ailing-it-should-be-broken-up-russias-wounded-giant.
40. Aviezer Tucker, “The New Power Map,” Foreign Affairs, January 9, 2013.
41. Olga Khvostunova, “How Gazprom Snoozed through the ‘Shale Gas Revolution,’” Institute of Modern Russia, February 5, 2013; and “Putin Seeks 6% Cap on Utility Prices,” Moscow Times, February 26, 2013.
42. Khovstunova, “How Gazprom Snoozed.”
43. Gazprom, “Gazprom Presents Proposals on Yamal–Europe-2 Project to Poland,” news release, April 5, 2013, www.gazprom.com/press/news/2013/april/article159657/.
44. Khvostunova, “How Gazprom Snoozed.”
45. Tucker, “The New Power Map.”
46. Ibid.
47. Alexander Gabuev, “Gaz i imidzh” [Gas and image], Kommersant Vlast, January 14, 2013.
48. Ibid.
49. Tucker, “The New Power Map.”
50. Mikhail Serov and Kirill Sakharyants, “Norvegiya vytesnyaet Rossiyu iz Evropy” [Norway Is Driving Russia Out of Europe], Kommersant, January 17, 2012.
51. Ibid.
52. Stefan Schultz and Benjamin Bidder, “Under Pressure: Once Mighty Gazprom Loses Its Clout,” Spiegel Online International, February 1, 2013, www.spiegel.de/international/world/gazprom-gas-giant-is-running-into-trouble-a-881024.html; and Khvostunova, “How Gazprom Snoozed.”
53. Saleksashenko, “Dvye istini” [Two Truths], September 25, 2012, http://saleksashenko.livejournal.com/163816.html.
54. See, for example, Andrew E. Kramer, “Putin Impedes European Inquiry of State Fuel Supplier,” New York Times, September 12, 2012; and Khvostunova, “How Gazprom Snoozed.”
55. “Turkmenistan Provides 50 Percent of Chinese Gas Imports,” Central Asia Newswire, June 13, 2011, www.universalnewswires.com/centralasia/viewstory.aspx?id=4241.
56. Tucker, “The New Power Map”; and Melissa Akin, “Gazprom Signals Possible Revival of Talks with China,” Reuters, December 11, 2012.
57. “Zubkov Says Gazprom Gas Price Talks with China Difficult,” Russia Beyond the Headlines: Asia, March 21, 2013, http://rbth.asia/business/2013/03/21/zubkov_says_gazprom_gas_price_talks_with_china_difficult_45353.html; and Gazprom, “Gazprom and China Sign Memorandum of Understanding on Gas Supplies via Eastern Route,” news release, March 22, 2013, www.gazprom.com/press/news/2013/march/article158716/.
58. Aslund, “How Putin Is Turning Russia into One Big Enron.”
59. Richard Balmforth, “Ukraine Set to Sign Landmark $10 Billion Shale Gas Deal with Shell,” Reuters, January 24, 2013; and Oleg Varfolomeev, “Ukraine Signs Agreement to Extract Gas Jointly with Shell,” Eurasia Daily Monitor, January 28, 2013.
60. Sergei Kulikov, “Gazpromu gotovyat khirurgicheskuyu operatsiyu” [Gazprom Is Being Readied for a Surgery], Nezavisimaya Gazeta, April 30, 2013.
61. See, for example, Atle Staalesen, “Rosneft, Novatek Join Efforts against Gazprom,” Barents Observer, April 26, 2013, http://barentsobserver.com/en/energy/2013/04/rosneft-novatek-join-efforts-against-gazprom-26-04; and Vladimir Soldatkin and Dasha Afanasieva, “Rosneft Targets Iraq, Squares Up to Gaz­prom,” Reuters, April 23, 2013, http://uk.reuters.com/article/2013/04/23/rosneft-capex-idUKL6N0DA2O220130423.
62. Soldatkin and Afanasieva, “Rosneft Targets.”
63. Ilya Arkhipov and Anna Shiryaevskaya, “Rosneft, Exxon Weigh $15 Billion LNG Plant to Vie with Gazprom,” Bloom­berg, April 11, 2013, www.bloomberg.com/news/2013-04-11/rosneft-exxon-weigh-15-billion-lng-plant-to-vie-with-gazprom.html.
64. Gustafson, “Putin’s Petroleum Problem.”
65. Vera Sitnina, “Postit’ v raskhod” [To Allow to Spend], Kommersant Vlast, April 8, 2013.
66. Ibid.
67. Katy Barnato, “Russia’s Economy Could Be Next Big Underperformer,” CNBC, May 16, 2013, www.cnbc.com/id/100739313.
68. Grigory Yavlinsky, “Prozrachnost’ kak put’ k diversifikatsii” [Transparency as a Road to Diversification], Vedomosti, February 13, 2013.
69. Sergei Guriev, as quoted in Meyer and Lovasz, “Russia Faces.”
70. Gustafson, “Putin’s Petroleum Problem.” See also “Putin: Russian Military to Get $770B Upgrade,” CBS News, February 20, 2012, www.cbsnews.com/8301-202_162-57381212/putin-russian-military-to-get-$770b-upgrade/.
71. Gustafson, “Putin’s Petroleum Problem.”
72. Gaidar Institute for Economic Policy, “Data Revision by the RF Central Bank Helps Capital Outflows from Russia Stay within the Official Forecast Level,” www.iep.ru/en/comments/peresmotr-danny-cb-pomog-ottoku-kapitala-ulozhitsya-v-oficialnye-prognozy.html.
73. See, for example, Russian Public Opinion Research Center (WCIOM), press release no. 1513, January 31, 2013, www.wciom.com/index.php?id=61&uid=759; and Levada Center, “2012 god v otsyenkah rossiyan - sobitiya, pyersony” [Russians Assess the Year 2012: Events and Persons], December 24, 2012, www.levada.ru/24-12-2012/2012-god-v-otsenkakh-rossiyan-sobytiya-persony.
74. Michael Schwirtz, “Russian Anger Grows over Chechnya Subsidies,” New York Times, October 8, 2011, www.nytimes.com/2011/10/09/world/europe/chechnyas-costs-stir-anger-as-russia-approaches-elections.html.
75. Vladimir Nadein, “Grimasy i gryozy Koshcheya Bessmertnogo” [The Grimaces and Dreams of the Koshshey the Immortal],” www.ej.ru, December 29, 2012.

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About the Author

 

Leon
Aron
  • Leon Aron is Resident Scholar and Director of Russian Studies at the American Enterprise Institute. He is the author of three books and over 300 articles and essays. Since 1999, he has written Russian Outlook, a quarterly essay on economic, political, social and cultural aspects of Russia’s post-Soviet transition, published by the Institute. He is the author of the first full-scale scholarly biography of Boris Yeltsin, Yeltsin: A Revolutionary Life (St. Martin’s Press, 2000); Russia’s Revolution: Essays 1989-2006 (AEI Press, 2007); and, most recently, Roads to the Temple: Memory, Truth, Ideas and Ideals in the Making of the Russian Revolution, 1987-1991 (Yale University Press, 2012).


    Dr. Aron earned his Ph.D. from Columbia University, has taught a graduate seminar at Georgetown University, and was awarded the Peace Fellowship at the U.S. Institute of Peace. He has co-edited and contributed the opening chapter to The Emergence of Russian Foreign Policy, published by the U.S. Institute of Peace in 1994 and contributed an opening chapter to The New Russian Foreign Policy (Council on Foreign Relations, 1998).


    Dr. Aron has contributed numerous essays and articles to newspapers andmagazines, including the Washington Post, the New York Times, theWall Street Journal Foreign Policy, The NewRepublic, Weekly Standard, Commentary, New York Times Book Review, the TimesLiterary Supplement. A frequent guest of television and radio talkshows, he has commented on Russian affairs for, among others, 60 Minutes,The Newshour with Jim Lehrer, Charlie Rose, CNN International,C-Span, and National Public Radio’s “All Things Considered” and “Talk of theNation.”


    From 1990 to 2004, he was a permanent discussant at the Voice of America’s radio and television show Gliadya iz Ameriki (“Looking from America”), which was broadcast to Russia every week.


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