Russia has the world's largest proven natural gas reserves and is constantly competing with Saudi Arabia as the largest oil producer. The country supplies a third of European oil and natural gas demand and begins to export more for the hungry energy markets of East Asia. The energy sector is much larger than commercial assets for Moscow; it has been one of the pillars of stabilization in Russia and an increase in its power for more than a century. The Kremlin regards energy security as a key issue for Russia's national security, especially given the recent changes in the global and domestic trends that cast doubt on the power of the energy sector.
Throughout the Russian storiesThe country's energy sector was periodically strengthened and weakened. The management of this cycle has been at the center of Russian domestic and foreign policy since tsarist times. This historical burden is now on the regime of Vladimir Putin.
The imperatives of Russia and the energy factor
Russia is by its nature a vulnerable country surrounded by other great powers and without easily protected borders. In addition, Russia is a massive, mostly inhospitable territory, populated by various ethnic groups that are historically at odds with the centralized power of Moscow. This leaves Russia with a clear set of imperatives for strengthening the country and establishing it as a regional power. First, Russia must consolidate its societies under one power. Secondly, it must expand its power through its closest neighbors to create a buffer against other powers (the creation of the Soviet Union is a vivid example of this imperative in action). Finally, it must use its natural resources to achieve a balance with great powers beyond its periphery.
Russia uses various tools throughout history to achieve these imperatives, from agricultural exports to purely military conquests and intimidation. Since the end of the 1800s, Russia has added energy to the list of vital products that could be used to achieve its main strategic goals. By 1950, the Russian energy sector has become one of the main pillars of economic and political power.
Revenues from oil and natural gas exports show how the energy sector gave the Kremlin strength to unite the country. Energy export revenues for the Russian Empire flowed into the state treasury at the end of the 1800-s, where oil export revenues accounted for 7 percent of export earnings. These revenues rose to 14 percent at the end of 1920's in the early stages of the Soviet Union, and by 1950 accounted for half of Soviet export earnings. Currently, energy revenues account for half of the state budget. This capital inflow has been and continues to play an important role in the construction of Russia's military-industrial base, which is necessary to maintain its status as a regional - if not global - force. However, since the Russian government became dependent on energy, revenues also became too vulnerable.
In addition to export earnings, the energy sector has also contributed to the creation of a stable domestic industry. Domestic energy consumption in Russia is very high due to the very cold weather during most of the year, but, despite the inefficiency in the energy sector and energy production costs, the country's internal reserves allowed Moscow to provide its citizens and the industry in which they operate, low energy prices.
The energy sector also contributes to Russia's ability to expand its influence on its closest neighbors. Moscow's use of energy as a lever of pressure on buffer states differs from country to country: from managing regional energy production (as was previously done in the Azerbaijani and Kazakh oil fields) to subsidizing cheap energy supplies to countries and controlling energy transport infrastructure. Russia used similar strategies to form relations outside the former Soviet Union. For example, Russia is one of two major European energy suppliers and the only European supplier with large reserves of oil and natural gas with historically low prices. Russia's physical connection with Europe and the possibility of undermining any competition formed the basis for Moscow’s many relations with Europe.
Evolution of Russia's energy strategies
The usefulness of energy as a means for Russia to achieve the three main imperatives has changed over time, because Russia was forced to change its strategy depending on changes in national or international circumstances. Moscow’s strength lies in its flexibility in managing the energy sector.
The importance of Russian energy was realized at the end of 1800, when the monarchy saw great potential for the Russian empire, if it could develop this sector on a large scale. However, the empire had neither the technology nor the capital to lay the foundations of the domestic energy industry. As a solution, the monarchy lifted restrictions on foreign investment, inviting European and American firms to develop the Baku and Volga oil deposits. This led to a short period of warm relations between the Russian Empire and many Western partners, in particular, the United Kingdom, France and the United States. All parties soon realized that the only way to make the Russian oil business profitable, despite the high costs associated with the harsh climate and vast geography of the country, is to turn Russia into the largest producer. At the turn of the century, the Russian empire produced 31 a percentage of world oil exports.
As the importance of the energy sector of the Russian Empire grew, it became clear that internal stability in Russia had a strong influence on it. The Bolsheviks used the energy sector in their attempts to overthrow the monarchy in the early 1900s. The oil-producing regions were one of the main centers in which the Bolsheviks operated, because energy was one of the few industries with organized workers. In addition, the Bolsheviks used the network of railways on which oil was transported, to spread propaganda throughout the country and abroad. In the 1904 year, when the Russian Empire dealt with the uprising in St. Petersburg, the Bolsheviks set fire to the Baku oil fields. This led to a two-thirds reduction in oil exports from Russia, which made Moscow and foreign markets pay attention to the link between vulnerability to oil exports and internal stability (the authors made a mistake in the date and decision-making center, because in tsarist Russia the capital was Petersburg - translator's note).
Modern energy strategies began to take shape after World War II. The Soviet Union was one of two global hegemones towering over divided Europe, and Moscow saw no obstacles to achieving dominance in the global energy sector. Between 1950 and 1960, Soviet oil production doubled, making the Soviet Union the second largest oil producer in the world and a major supplier for both Eastern and Western Europe. Revenues from oil exports began to account for almost half of Soviet export revenues.
Since the Soviet Union carried out massive oil production, and the Soviet system maintained low labor costs, Russia was able to sell its oil at prices almost 50 percent lower than oil from the Middle East. Oil subsidies to the Soviet bloc, and then to the countries of Western Europe, helped Moscow to undermine the Western regimes and strengthen its position on its own periphery - this strategy in the CIA called the Soviet economic offensive. For the Soviets, the issue was not to make money (although the money was paid), rather it was the formation of a sphere of influence and undermining in the West. This strategy was still costly, since Moscow did not receive as much income as it could, and inefficient oil production quickly depleted the fields.
In 1970, oil prices rose due to a series of crises, mainly in the Middle East. At the same time, Russia already felt the tension from supporting the massive Soviet Union. The regime of the Soviet leader Leonid Brezhnev had a choice: to use high world prices as a reason for price increases in Eastern Europe and for the benefit of the Soviet economy, or to continue subsidizing the Eastern bloc so that he was obliged to Moscow, and not to push him to look for other sources of energy . It was a choice between two imperatives: Soviet national stability and retention of the buffer zone. In the end, Moscow decided to protect its own interests and in the year 1975 raised the price of oil for its customers, ensuring further growth based on global market prices. By 1976, oil prices in the Eastern bloc were almost twice as high, although they remained lower than world prices. However, the rather high price made some countries of the block take loans.
Soviet attention to maintaining high revenues from energy sales continued until the middle of the 1980s, when these revenues accounted for almost the entire monetary inflow of the Soviet Union. But the Soviets came under a double blow in the middle of the 1980s, when oil prices collapsed and the West declared an embargo on Soviet oil, which led Saudi Arabia to oil markets. In addition, the Soviet Union is extremely lagging behind the West in the field of technology, in particular, in the energy and agriculture. In response to this, starting in 1985, the Soviet Union began to move closer to an energy market economy, raising prices for the Eastern Bloc and demanding hard currency to pay and allowing foreign companies to reenter the energy sector.
But Russian shifts in strategy were not deep and timely enough to prevent the collapse of the Soviet Union. Within ten years after the fall of the Soviet bloc, the Russian power industry fell into disrepair. The liberalization of energy, which began under Mikhail Gorbachev in the 1980-s, came in a terrible state under Boris Yeltsin in the 1990 year. As a result, production fell by half, and the energy sector of Russia was divided between foreign groups and the new class of Russian oltigarks.
The situation has changed under the leadership of Vladimir Putin in 2000 year. One of the first items on Putin’s agenda to stabilize the situation in the country was to consolidate the energy sector under state control. This meant a radical return from liberal politics two decades earlier. The government actually nationalized most of the energy sector under the roof of three state giants: Gazprom, Rosneft and Transneft. The Kremlin has become more aggressive in negotiating supply contracts with the former Soviet republics and Europe, forcing them to take large volumes at extremely high prices, because these customers did not have alternative sources of energy. The Kremlin has also begun to cut off energy supplies to some markets, blaming troublesome transit countries, such as Ukraine, in order to form other political negotiations.
Although Moscow’s energy strategy has become rather aggressive, it has helped Russia become stronger and more stable. Energy revenues increased due to high world prices for oil and natural gas, which Europe paid. Russia received surplus funds for transfer to its political, social, economic and military spheres. Energy policy also helped Russia to strengthen its influence in its former suburbs and forced Europe to retreat from containing Russia's recovery. Of course, the financial crisis that swept Europe and Russia in 2008, reminded Russia of its largest energy customers, when oil prices fell and demand began to decline.
Problems of maintaining energy in Russia
Russia's main problem is its vulnerability to energy price fluctuations. Considering that half of Russia's budget consists of energy revenues (of which 80 percent from oil sales and 20 percent from natural gas), the government can suffer greatly if energy prices fall. The Kremlin has already reduced budget planning, based on oil prices to $ 93 per barrel, not $ 119 - although even at that price, the government is playing a game of chance. Stratfor is not engaged in business forecasting of oil prices, just historical models show that major international crises and fluctuations in the global consumption and production model have repeatedly had a sufficient effect on oil prices and on Moscow's income, destabilizing the situation in the country.
Revenues from gas exports are also currently under question. Because of the alternative supplies of natural gas supplied to Russia's largest consumer, Europe, the Kremlin has been forced to reduce prices in recent months. This year, Gazprom plans to provide 4,7 billion dollars to European consumers - approximately 10 percent of Gazprom's net revenue - as a concession due to lower prices.
In its current configuration, Russia's energy sector is under attack. Consolidating the industry mainly under two large state-owned enterprises had many advantages for the Kremlin, but after ten years of consolidation, shortcomings have accumulated. With small options in the field of natural gas in Russia, the giant company Gazprom is lagging behind in technology and is considered unfriendly to foreign investment. The oil giant of Russia, Rosneft, recently began to develop into a larger monopoly like Gazprom, which could lead to its falling into a similar trap. With future energy projects in Russia requiring more advanced technologies (due to location and environment) and more capital, and Gazprom and Rosneft need modernization and foreign investment.
Corruption is also a major factor, since, according to various estimates, from 20 to 40, percent of Gazprom’s revenue is lost or associated with inefficient operations. Rosneft has similar problems. This loss would not affect the sustainability of Moscow’s previous high energy income, but sustainability will not be in the future if energy prices fall or support and expansion of the energy sector becomes more expensive. The Kremlin probes Gazprom, although with the culture of corruption that runs through Russian history, the Kremlin can do little to eliminate violations at this firm.
In addition, Europe’s dependence on Russian energy is decreasing. The lack of natural gas was felt throughout Europe during the Russian-Ukrainian crises 2006 and 2009, which was a reminder of how vulnerable European countries were due to their dependence on natural gas exports from Russia. Both unilaterally and within the European Union, European countries began developing strategies that would allow them to mitigate not only Europe’s vulnerability to disputes between Moscow and intermediaries in transit, but also a general dependence on energy from Russia.
Accelerated development of new and updated liquefied natural gas plants is one such effort. This will give some countries - Lithuania and Poland, first of all - the possibility of importing natural gas from suppliers around the world, bypassing Russia's traditional leverage related to geographic proximity. This is especially important in light of the accelerated development of unconventional methods of natural gas production in the world, in particular, shale reserves in the United States. The development of the pipeline project, which will bring non-Russian Caspian natural gas to the European market, is another attempt - although less successful today - to reduce Europe’s dependence on Russian gas.
In addition, a set of pan-European policies, including the Third Energy Package, began to give EU member states political and legal tools to mitigate Gazprom’s dominance in its natural gas supply chains. This common framework will also allow European countries to come up with a more united front for changing certain types of business activity, in their opinion, monopolistic. Here is an example of the EU Commission to investigate the pricing strategy of Gazprom in Central Europe. This, combined with EU funding for connecting the gas supply networks of the EU member states to Central Europe, has created difficulties for Russia to use natural gas prices as a foreign policy tool. This is a major change in the business that Moscow has been doing with the region over the past ten years, when it rewarded closer ties with Russia to low gas prices (like in Belarus) and raised prices for those who challenged it (the Baltic countries).
Finally, Russia faces a simple but serious possibility that the escalation of the financial and political crisis in Europe will continue to reduce energy consumption on the continent, or at least eliminate any possibility of consumption growth in the next decade.
Russia's next action
Putin’s administration is well aware of the challenges facing Russia's energy sector. Russia's attempts in the past decade to depend on energy exports, focusing on the development of industry, have not been particularly successful, and the country's retention is linked to the fate of its energy sector. Russia's strategy to use its energy exports as a tool of foreign policy and as a revenue generator is sometimes contradictory: to use energy in foreign policy, Moscow must be able to lower or raise prices and threaten to cut off supplies, which is anathema to the income-generating industry.
Global and regional circumstances have changed so much that Moscow was forced to designate a priority for one of the two vectors of applying its energy industry - and she definitely decided to keep herself able to earn income. The Kremlin has begun the development of a set of policies intended to adjust the country to the changes that will come in the next two decades.
First, Russia is reconsidering relations with key transit countries, which traditionally allowed energy to be exported to Europe. The construction of the Ust-Luga oil terminal on the Baltic Sea coast will allow Russia to largely bypass the pipeline system of Belarus and deliver oil and oil products directly to consumers. In addition, the construction of the Nord Stream gas pipeline under the Baltic Sea - and, ultimately, its twin South Stream through the Black Sea - will allow Russian natural gas to be sent around the Ukrainian and Belarusian transit systems, if necessary. These two pipelines will primarily provide for the supply of natural gas to the main European consumer markets in Germany and Italy, with which Russia seeks to maintain a long-term strategic partnership.
To provide supplies to its main European consumers, the bypass system will provide Moscow with vital energy income. This strategy of future flexibility in energy exports will also gradually reduce the leverage of Minsk and Kiev, which may resist Moscow’s attempts to unite them as vassal buffer states — Moscow still intends to pursue one of its few foreign policy goals through an energy strategy.
In addition, Moscow has adapted its energy strategy with European consumers amid growing diversification and liberalization of efforts. Gazprom began to expand the system of discounts on previously reserved natural gas for strategic partners such as Germany or Italy. The Kremlin knows that its only hope of preserving natural gas revenues in the face of a potential global shale gas boom is to block its customers with a competitive price and long-term contracts. Moscow will continue to show that it can offer European consumers guaranteed large volumes at low cost, which manufacturers and suppliers of liquefied natural gas can rarely afford.
Finally, Russia is paying considerable attention to the development of ties with the growing energy markets of East Asia, so diversification of the export portfolio should continue to increase in the European market. One of the common aspects for all of Russia's strategy over the next decade is the high capital required for their implementation; The Eastern Siberia-Pacific pipeline costs almost $ 15 billion. Despite the consequences of the financial crisis in 2009, Russia still has huge capital reserves for these large-scale projects, but these funds are not endless.
The Kremlin seems keenly aware of the problems that Russia will face in the next two decades, as the next energy cycle comes to an end. Unlike Brezhnev and Gorbachev, Putin was able to conduct an effective policy and strategy for change in the Russian energy sector. While Russia's dependence on high oil prices continues to trouble Moscow, Putin has so far been able to actively respond to other external changes in energy consumption and production - especially those that affect the European natural gas market. However, the long-term sustainability of the Russian model remains in question.