Putin’s Petro State Approaching Empty

Russia faces two challenges that will affect its preeminence as an energy supplier and its ability to wield oil and gas as geostrategic tools. At stake are the stability of the regime — and perhaps even its survival.

Russia faces two challenges that will affect not only its preeminence as an energy supplier but also its ability to wield oil and gas as geostrategic tools. New technologies are helping other countries develop their own natural resources more easily and inexpensively, threatening billions of dollars of Russian state 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. The likely result is a significant thinning of oil and gas rents — jeopardizing the stability of the regime and perhaps even its survival.

President 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.”

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. 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, he believed the mineral extraction sector of the economy “diminishes social tensions” by raising the “level of well-being” of the Russian population.

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. The state was to again become the only sovereign political and economic actor in Russia, with the private sector, civil society, and its institutions mere objects.

The Rise of the Russian Petro-Gas State

From less than 50 percent in the mid-1990s, the share of commodities in Russian exports has grown to 70 percent today, with oil accounting for more than half of export income. Representing up to 30 percent of the country’s GDP and half of its GDP growth since 2000, hydrocarbons provided at least half of the state’s budget revenues last year. 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. Russia’s dependence on energy exports 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.

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. 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.

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, 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” — 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.

The sporadic raising of meager pensions and salaries for the millions of Russians on the government payroll 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.

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.” Although Russia is not running out of oil, a leading expert believes it may be running out of cheap oil. Instead, oil will have to be pumped from places that are “colder, deeper and more remote,” 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.

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. (By comparison, in 2011, Chevron and ExxonMobil were taxed at an effective rate of 42–43 percent in the United States.) 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.

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. 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.)

READ ENTIRE ARTICLE HERE: http://www.american.com/archive/2013/june/putins-petro-state-approaching-empty

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