Russian Energy Resurgence

By Gustavo Coronel l December 17, 2008

For many years, the Soviet Union and later Russia have been known to possess great resources of hydrocarbons, although much of it exists in extremely harsh and difficult physical environments: Siberia and the Artic Ocean. Also for many years this energy giant laid essentially dormant, not only due to the technical difficulties involved in producing the oil but also to the autocratic nature of the Communist regime that inhibited foreign investment. Management under the Soviets was rudimentary and oil exploration was measured not so much by barrels found but by how many meters were drilled.

After the Second World War Soviet energy production and later Russian production climbed steadily and by 1975 it had overtaken the U.S. production to become the largest oil producing country in the world. Today Russia produces about 10 million barrels per day, of which it exports 7 million barrels, becoming the world’s largest oil exporter. Whereas the Cold War had concentrated the efforts of Russian leadership in the production of nuclear weapons, the end of this confrontation marked by the 1991 collapse of the Soviet Union allowed Russia to shift its emphasis to industrial development, including the oil and gas sector.

By 1998 Russia was suffering under a deep economic crisis. Banks had failed and the Russian equivalent of the Dow Jones had declined from 571 to 39. In his book Petrostate Marshall Goldman recalls that millions of Russians had lost all their savings, including Mikhail Gorbachev. The tail end of this crisis coincided with the arrival of former KGB Colonel Vladimir Putin to power. By 2000 oil prices had started to increase rapidly and then-President Putin lost no time in putting his plans into action.

Putin’s two main political objectives included both the transformation of Russian commercial companies into industrial agglomerates, large enough to compete with U.S., Japanese and European companies along with the control of these companies by the state even if they were partially owned by foreign enterprises and the conversion of these agglomerates into “national champions” that would place the Russian national interest above all other considerations.   The Kremlin accomplished these objectives by playing political and economic hardball. Putin asserted control over the natural gas company Gazprom, although only partially owned by the state; closed down TV stations that dared to criticize him; took control of the oil company Yukos and placed its Chairman and CEO, Mikhail Khodorkovsky, and 25 of its executives into prison. Putin harassed foreign oil companies like Shell, Conoco, Total, Exxon and British Petroleum that had already made large investments in important oil and gas projects on Russian soil, forcing them to accept his terms.

Today the Russian oil and gas industry is firmly in Putin’s hands, with the state-controlled monopoly Gazprom becoming the third largest corporation in the world. An impressive network of oil and gas pipelines transports Russian hydrocarbons to all of Europe. Some European countries like Finland and Slovakia, as well as former members of the Soviet Union like Latvia, Lithuania, Georgia and Estonia are totally dependent on Russian natural gas for their energy needs, while other European countries are also significantly dependent on Russian gas.

As it has been the case historically, Russia is using energy as a political tool.  Tito’s Yugoslavia (1956), China (1959), Estonia (2007) and especially Ukraine (2007) experienced its effects in the past, while Georgia (2008) represents the most recent example of Putin’s grand strategy. Obviously the new Russian geopolitical weapon is no longer nuclear missiles, as in the days of Khrushchev, but oil and, especially, natural gas. Control is no longer over nuclear stockpiles but over pipelines. Even if the ownership of all pipelines is not in the hands of Russia, control of the transported hydrocarbons gives Russia a substantial advantage in the geopolitical game.

An example of this hegemony is the influence exerted on Germany’s former chancellor (1998-2005), Gerhard Schroeder, to favor the Nord Stream pipeline over non-Russian alternatives. This pipeline, running under the Baltic Sea from St. Petersburg to Germany was in the works for ten years. It would have increased substantially Germany’s dependence on Russian gas. Yet, Schroeder fell under Putin’s influence and became a champion for this pipeline. He was offered, once he was no longer chancellor, the chairmanship of the company that would run the pipeline, a $300,000 per year position. Other tactics used by the Russians include opposing systematically third party pipeline projects on environmental considerations that suddenly evaporate when Russian pipelines are proposed for the same region. There is no question that the political influence of Russia over its neighbors and even more remote European countries has increased significantly.

The other side of the coin poses at least three key questions: 1) Can Russia continue to be the only show in town for many more years in the European energy theater? 2) Can Russia continue to export seven million barrels or more per day indefinitely? and, 3) What will the decline in oil prices do to Russia’s position of pre-eminence?

The answer to the first question will be the object of a more detailed examination in a coming article, but suffice it to say that Europe is now aiming to reduce its dependence on Russian energy substantially by year 2020. The second question can be answered probably in the negative; Russia has some 80 billion barrels of proven oil reserves. At the current rate of production of ten million barrels per day, this represents a lifespan of approximately 20 years. Of course, these reserves will tend to increase in time but most probably far below the level required to keep the reserves-to-production index constant. In all probability, Russia will be forced to reduce oil production and exports within the next ten years. The answer to the third question is also not what Russia would like to hear. Russia has become a petrostate, just as Nigeria and Venezuela. This means that the country has grown even more dependent on income from hydrocarbon exports than its customers are dependent on Russian hydrocarbons. Declining oil prices are likely to persist for the next two to three years and will impact severely and negatively Russian economic and political life. In other words, an uninterrupted resurgence of Russia as a main actor in the global political scene is by no means assured.

Gustavo Coronel, who served on the board of directors of Petróleos de Venezuela (PdVSA), has had a long and distinguished career in the international petroleum industry, including in the USA, Europe, Venezuela and Indonesia. He is an author, public policy expert and contributor to

SFPPR News & Analysis.