This changed dynamic not only helps insulate Europe from Russia’s use of natural gas for political reasons, but it also brings benefits in a noncrisis environment. Both the creation of options to secure alternative sources of gas and the increase in the fluidity of markets have given European consumers new leverage over prices and the way they are determined. The most obvious example is, again, that of Lithuania. Before the arrival of the Independence, Lithuania paid the highest price for Russian gas of any country in Europe, despite being on Russia’s doorstep. Not coincidentally, Russia decided to drop the price it was offering to Lithuania for its gas by a fifth only months before the Independence arrived and during negotiations between Lithuanian companies and Norway’s Statoil for LNG. In the end, Lithuania received Norway’s LNG for less than it had paid for Russian gas in 2013, and Russian gas for even less than the Norwegian gas.
The benefits to European consumers go well beyond those secured by Lithuania. The pressures created by new resources flowing into European markets have caused Gazprom to give in on pricing. Despite insisting publicly that maintaining the price Gazprom gets for its gas sold abroad is the company’s top priority, Russia has already made significant accommodations in this area. By directly and indirectly introducing more natural gas into markets that was sold at a spot price (rather than at an oil-indexed one), the unconventional boom gave European buyers leverage to renegotiate the price stipulated in their long-term contracts. This pressure was particularly acute in 2009 and 2010 when much of the LNG exports that were intended to flow to the United States suddenly sought a new home, as burgeoning domestic production of shale gas in America essentially eliminated the need for the United States to import.
As Gazprom points out, new pricing mechanisms may not always work in favor of European consumers; the spot price for natural gas could rise above the oil-indexed one, depending on the price of oil. But in general, Europe can count on paying somewhat less for the same amount of natural gas bought from Russia.
Fly in the Ointment
While Europe is reaping many of the benefits of the unconventional boom in the realm of security, it will find itself at a disadvantage in the domain of economic competitiveness. Today, Europe has some of the highest costs of electricity found worldwide. Such costs are the result of Europe’s dedication to decarbonization and to fighting climate change. Europe has in fact been very successful in bringing down its level of carbon emissions. Although the population of Europe is 60 percent larger than that of the United States and its economy is nearly the same size, Europe uses one-third less energy than America and emits 40 percent less CO2. But Europe has curbed emissions somewhat at the expense of its competitiveness. Extensive commitments to renewable energy sources, in the absence of a truly functioning system for putting a price on carbon, have limited demand for natural gas and its ability to play the role of a “bridge” from a fossil fuel based economy to a decarbonized one.
This imbalance between the competitiveness of Europe and the rest of the world will likely grow wider, as inexpensive American natural gas continues to entice investments to the United States from other parts of the world, including, possibly, Europe. Energy-intensive European companies could be tempted to relocate across the Atlantic as long as energy prices vary so dramatically. The disparity is most evident in comparing natural gas prices in the United States with those in Germany; as of 2014, natural gas prices in Germany were three times higher than such prices in America. The implications of this gap for competitiveness will become even more evident should efforts to negotiate a trade deal between Europe and the United States be revived. In allowing greater access to one another’s markets, an American-European trade partnership could make such energy price differentials more obvious as American companies with lower energy costs gain greater access to the EU market.
* * *
The annexation of Crimea in 2014 signaled to the world that it was dealing with a different sort of Russia—one that was focused more on at least creating the appearance of restoring former glories than it was on maintaining good economic and political relations with its neighbors to the west. Although countries such as the Baltics and some in Eastern Europe had been acutely aware of their vulnerability, Russia’s actions in Ukraine provided a wake-up call for the continent as a whole. The threat posed by Russia to the security and well-being of Europe came into sharper relief than it had been at any time since the Cold War. On the security front, a lagging NATO was rejuvenated; on the energy front, Europe snapped to attention from its meandering, lethargic pursuit of energy security.
Europe still depends heavily on Russian energy, but it is much more resilient to potential fluctuations of those flows, whatever the reasons for them. This achievement is in part due to the efforts of European countries and institutions to change regulations, build more infrastructure, and coordinate more closely. Yet, the new energy abundance also deserves some credit for Europe’s enhanced fortunes, although not necessarily in the ways initially anticipated. European shale gas production—while originally promising—has and will continue to be a bust. U.S. LNG exports, made possible by the shale boom, will bring some relief, but will unlikely be truly transformative. What will end up mattering most is the greater resilience and more options Europe now has as a result of the new energy abundance. In transforming global natural gas markets, the unconventional boom helped Europe remove impediments to the development of a common energy market and provided Europe with greater options for the sourcing of its energy needs—both at peacetime and in times of crisis.
The new energy abundance does not and will not enable Europe to disentangle itself from Russia and its gas. But just as the quest for energy independence is a distraction for the United States, a focus on eliminating Russian gas exports to Europe would be watching the wrong screen. Rather than obsessing about the need to sever the gas link with Russia, Europe and its allies should appreciate that the new energy environment does something almost as useful: it makes that trade much harder to politicize. In transforming the natural gas markets from favoring the seller to advantaging the buyer, the energy boom has helped make Europe less vulnerable to one of Russia’s long-standing foreign policy tools—the political manipulation of natural gas markets.
NINE
* * *
* * *
* * *
Russia
More Petulant, Less Powerful
A podgy academic from Moscow and son of a children’s book author, Yegor Gaidar was an unlikely figure to marshal Russia through the tumultuous years immediately following the collapse of the Soviet Union. As the chief architect of Russia’s “shock therapy,” Gaidar became to many Russians the face of the crippling near hyperinflation of the 1990s. Yet to others, he simply had to manage an impossible situation. Russia was in a severe political and economic crisis when the reform-minded Gaidar took control. To his credit, the nation did not collapse into civil war, widespread starvation, or bloodshed during his tenure as finance minister and then acting head of government.
Gaidar died in 2009 at the age of fifty-three from a blood clot, having been in poor health after he was suspiciously poisoned while eating breakfast in Ireland three years earlier. Before his death, Gaidar wrote a powerful and revealing book claiming that the real cause of the Soviet empire’s demise was not the arms buildup spurred on by the United States under President Reagan. Gaidar attributes the collapse—as well as the peaceful manner in which Moscow let events in Eastern Europe unfold—to persistently low oil prices. The earlier collectivization of agriculture meant that the Soviet Union needed foreign exchange for grain imports to feed its people. The low oil prices throughout the 1980s, combined with stagnant Soviet oil production, created a regime-threatening crisis because the government could not finance these essential food imports. If Gaidar were alive in today’s era of energy abundance and stubbornly lower prices, he would almost certainly predict gloom and doom for his homeland.
Gaidar’s prediction would be one of
many prophecies about how the low-price-energy environment will damage Russia. Some have suggested that economic calamity will force the removal of Putin in a palace coup. One expert, Dmitri Trenin of the Carnegie Moscow Center, has in effect compared Russian president Vladimir Putin to Nicholas II, Russia’s last czar, who was executed by the Bolsheviks in 1918. Other analysts see the plunge in energy prices as a natural curb on Russian foreign policy adventurism. Optimistic commentators see the period of low prices as “an opportunity to set democratic governance frameworks” for Russia.
These possibilities are intriguing, if a little simplistic. Yet, as in other parts of the world, the most anticipated consequences of the unconventional boom are not necessarily unfolding as predicted and, if they are, they are less significant than expected. In contrast, many of the most meaningful implications of the boom turn out to be surprising or even unforeseen. Russia is no exception.
The new energy abundance is, in fact, creating significant economic troubles for Russia, particularly in the context of sanctions. These difficulties will also have a real impact on the trajectory of domestic events. But they do not seem poised to rock the status quo in the short term. Instead, the new energy abundance is shaping and will continue to shape Russia’s foreign policy more than internal politics. The previous chapter showed how new energy dynamics are making it harder for Russia to politicize its energy trade with Europe. But the affront to Russian power does not end there. While increasing Russia’s impetus to meddle beyond its own borders as Putin seeks to deliver psychological benefits to the population in place of economic ones, the new energy abundance also dampens the country’s prospects for becoming an Asian power and further weakens its standing in Central Asia.
None of this suggests that Russia can be ignored in the coming years. Russia’s nuclear arsenal alone, especially when coupled with an increasingly risk-taking leader, will ensure that Russia absorbs considerable time and attention from Western policymakers. But it does imply that Russia will not be in a position to remake the liberal international order on its own—despite its clear desires to—and has less leverage to bully others into joining it to do so.
Stirring the Domestic Pot
Yekaterina, from the Siberian city of Omsk, was the first caller to get through to President Putin during his fourteenth annual Direct Line television and radio broadcast in April 2016. She lamented the poor state of infrastructure in her hometown, complaining “it’s just one pothole after another.” Over the course of the next four hours, Putin answered questions and took petitions from eighty of the more than 2.5 million Russians who sought to speak to the president. In addition to many questions about foreign affairs, Putin addressed queries about inflation, low wages, consumer fraud, property taxes, bank loans, product quality, the cost of medicine, wage arrears, and the decline of traditional industries—just to name a few. At one point, the host of the show asked a man to wrap up his question by reminding him that “brevity is the sister of talent.” The questioner responded, “I can’t stop. I need to unload, really.” Although Putin certainly knew Russia was in economic dire straits before the show, his interaction with average Russians could have only reinforced that sense.
By the time of the broadcast, Russia was in its third year of economic slowdown or decline. The economy had shrunk by 3.6 percent in 2015 and was on track for another year of contraction, albeit more modest. Gross national income per capita had dropped by nearly a quarter in just two years. The number of Russians living in poverty had risen by 20 percent, or by more than three million people, undoing all of the gains achieved in this area over the previous eight years. Some of this decline can be attributed to the international sanctions put in place against Russia in the wake of its annexation of Crimea and interventions in Ukraine. But sanctions are estimated to account for significantly less than half of the economic decline in 2015; the bulk of the economic hit came from declining energy prices. Russian finance minister Anton Siluanov agreed, emphasizing, “First and foremost, the decline of oil prices has an impact”; he estimated that Russia loses up to $100 billion a year as a result of a 30 percent decline in the price of oil.
This assessment comes as no surprise, given the extent of the price collapse and the extreme dependence of the Russian economy on oil and gas. In 2015, the energy sector accounted for nearly a third of the value-added in Russia’s GDP and for more than half of its export revenues. Energy sales and taxes provided one out of every two dollars funding Russia’s nearly half-a-trillion-dollar 2014 federal budget. Few economies outside the Gulf Cooperation Council (GCC) are more dependent on oil and gas revenues than Russia.
What may, however, come as a surprise is that the adverse effects of the unconventional energy boom on Russia’s economy began to be felt well before the price of oil began to waver. According to Russian economist Tatiana Mitrova, increasing supplies of American tight oil and shale gas bear much of the responsibility for ending the energy-driven growth model that Russia enjoyed for more than a decade. In 1999, when Putin first became president, Russian per capita income, as measured in current U.S. dollars, was not quite $13,000; by 2013, it had doubled. The near continuous rise in Russian GDP and GDP per capita over the first thirteen years of the century was fueled by the almost steady increase in global oil prices.
The “effortless” growth slowed dramatically with the stabilization—not even the decline—of the price of oil from 2011 to 2014. As discussed in Chapter Two, throughout these years, roughly one new barrel of American tight oil was produced for every one that was taken off the market due to geopolitical or other disruptions; the net effect was a “stabilization” of the price. Without the propeller of steadily rising prices, Russia’s energy-dependent economy began to sputter, tumbling from 4.3 percent growth in 2011 to less than 1 percent in 2014. Had the unconventional energy revolution not occurred, and oil prices been as high as $150 in 2013 as one study calculated they could have been, Russia would likely have been able to continue its energy-driven growth for some time.
Figure 9.1: Russian Prosperity and Oil Prices
Source: “GDP per capita, PPP (constant 2011 international $),” World Bank, data.worldbank.org/indicator/NY.GDP.PCAP.PP.KD; “Real Prices Viewer,” U.S. Energy Information Administration, www.eia.gov/outlooks/steo/realprices/.
For all the economic dislocation of 2014–2016, Russia has actually fared better under the double whammy of sanctions and low oil prices than most experts anticipated—and certainly better than Yegor Gaidar might have expected. Russia had several advantages that other energy export–dependent economies did not have, helping ease what was still an abrupt economic slowdown. First, Russia had the ability to increase its production and export of oil, which helped mitigate Russia’s “dangerous revenue losses,” in Putin’s own words. There are, however, evident limits to this strategy without significant further investment, which has not been occurring due to sanctions and low energy prices. Developing Russia’s own vast unconventional oil deposits more aggressively also could be an option, but it would require the lifting of sanctions and the application of foreign technology given the country’s difficult tight oil geology.
Russia was also able to draw on its Stabilization Fund, which was established by President Putin in 2004 to even out spending through times of low and high oil revenues. One of the successor accounts to the Stabilization Fund—called the Reserve Fund—proved critical a decade later in keeping sanctioned banks and companies afloat when they struggled to get access to financing. Yet, again, the fund does not provide a long-term security blanket for the Russian economy. Its size dropped by approximately $70 billion or more than four-fifths between mid-2014 and the end of 2016, and is expected to be exhausted during 2017. Finally, and most important, the government moved up the launch of its original plan to allow the Russian ruble to float freely from 2015 to the end of 2014, at least partially in the hopes that it would provide a shield against falling oil prices. The flexible exchange rate did cushion the shock of
dropping prices. Almost instantly, the ruble weakened to an all-time low, owing to both sanctions and falling oil prices, thereby yielding more rubles for every dollar earned by exports and mitigating the hit on government revenues that a lower price of oil and natural gas brings.
Figure 9.2: Russia’s Reserve Fund (billions of US dollars)
Source: The Economist Intelligence Unit, “Sovereign wealth fund declines sharply in December,” January 11, 2017.
Just because Russia’s economy did not implode under the weight of dual handicaps does not mean that the country’s economic future is bright. In January 2016, Finance Minister Anton Siluanov stressed that the budget needed to be cut a further 10 percent. He warned that a failure to do so could lead to a repeat of the 1998 crisis, when the economy went into free fall, triggering a rush on failing banks by panic-stricken Russians. With the 2016 budget predicated on $50 oil, only an increase in oil prices from where they were in mid-2016 could quickly help Russia get its fiscal situation back on firmer ground. Putin, speaking in December 2015, assured Russians that the worst of the economic crisis was over—although it was qualified with the big caveat if oil prices improve.
Given the new energy abundance, rising energy prices are a thin reed upon which to base the economic future of a country. However, as Andrey Movchan, a Russian economist, emphasized to me at an early morning breakfast in Moscow in October 2016, Putin still has many tools to deploy to keep the Russian economy from free fall. He could raid the country’s welfare fund for pensions, resort to expensive international borrowing, further rein in budget expenditures, or print money. Such moves could buy Putin more economic space, but none of them promise to return Russia to positive growth absent a more robust price of oil. This uncertainty about Russia’s economic future raises critical issues about both the country’s political stability and its prospects for needed economic reform.
Windfall Page 21