Bad News

In early October, the Wall Street Journal published the results of a global data survey of energy markets. The data shows that this year the U.S. surpassed Russia in oil and gas production. Quoting the International Energy Agency (IEA), the newspaper reports that this July, the U.S. production of oil, gas, and related fuels exceeded 22 million barrels per day, while Russia produced about 21.8 million barrels per day. This also means that for the first time since 1982, the U.S. has produced more natural gas than Russia. In terms of crude oil, the U.S. is still a little bit behind Russia—10.3 million barrels vs. 10.8 million (Saudi Arabia leads with 11.7 million barrels), but over the last three years, the gap between the two countries has decreased by several times.

The recent success of the U.S. energy sector has been driven by the “shale gas revolution” that put the country’s energy dependence to an end and caused global shifts in oil and gas markets all over the world. Over the last five years, U.S. oil imports have decreased by 15 percent, gas imports by 32 percent. The IEA estimates that by 2035 the U.S. will become the largest natural gas exporter in the world, surpassing Russia. Only a few years ago, such a turn of events would have seemed improbable—today, it’s reality.

It is getting harder for Russia to deny evidence of global shifts in the energy market. On numerous occasions, Alexei Miller, CEO of the Russian gas monopoly Gazprom, has claimed that the U.S. “shale gas revolution” is temporary, a bubble that will burst soon. But many energy experts, even in Russia, have a different opinion. The same Wall Street Journal article mentioned above quotes Tatiana Mitrova, head of the Oil and Gas Development Department of the Institute of Energy Studies at the Russian Academy of Sciences, who said: “Russia looks like the main loser in the global market.” According to the institute’s forecasts, starting in 2015, Russian gas exports stand to decrease by 25–30 percent, leading to a gross domestic product (GDP) drop of $100 billion.

Meanwhile, the Russian economy continues to sag. In September, the International Monetary Fund (IMF) estimated Russia’s GDP growth forecast at 1.5 percent this year. This is the third time the IMF has downgraded its forecast for Russia—earlier this year, its estimated growth rate for the country was 3.8 percent. This slowing down of its GDP growth rate is a troubling sign for Russia. But recent escalations of political strife in Syria and the Middle East at large have prompted discussion about the possibility that military conflict in this region might cause a sharp increase in oil prices, effectively creating an “opportunity window” for Russia, as about 40 percent of the Russian budget and 70 percent of its export proceeds come from the oil and gas sector.

In theory, high oil prices could help launch the economic modernization that the Russian government has been constantly promising since the mid-2000s, including cutting inflation, decreasing budget spending, improving the investment climate, and eventually reducing the country’s dependence on exports of crude materials. In reality, though, such an outcome is impossible. And there are a variety of reasons for this.

Middle Eastern Paradox

Oil prices are usually determined by the following factors: global demand, speculative pressure on financial markets, and geopolitics. The global recession brought oil prices down, and even though global demand is slowly recovering (there’s been growth in the U.S., Europe, and especially in China), it hasn’t reached its former level yet. Therefore, we shouldn’t expect drastic changes in oil prices. The only factor impacting oil price fluctuations today is speculative pressure caused by various crises, including military conflicts.

For example, last year after the U.S. and the European Union imposed sanctions against Iran, oil prices jumped by 20–30 percent, reaching $110 per barrel. Iranian threats to block the Strait of Hormuz, a narrow strip of water that provides access to the Persian Gulf (17 million barrels of oil, or 18 percent of global demand, are transported through the strait), also contributed to the price hike. Still, by the beginning of 2013, prices had gone down again.

This year, escalation of the Syrian conflict has pushed oil prices to another increase. The upward trend reached its peak in August, after Bashar al-Assad’s government allegedly used chemical weapons against civilians, causing the deaths of 300 to 1,500 people. The U.S. addressed its allies and called for punitive military action against the Syrian government. In anticipation of the military intervention, oil prices went even higher.

According to analysts of the Société Générale bank, should a military strike have taken place, oil prices could have soared up to $150 per barrel, reaching the 2008 crisis level. For almost two weeks at the end of August and into early September, the markets were waiting for news of war breaking out in Syria. Over this period, the price of Brent oil hit $117 per barrel, from less than $100 in June. Problems arising this summer in neighboring Libya, where the political situation has been deteriorating since last September, might have also contributed to the oil price increase.

It is noteworthy that investors were primarily concerned not with the disruption of oil production in Syria, which only produces about 50 thousand barrels per day (an insignificant amount in terms of global demand), but with the possibility that the conflict would spill over to the neighboring countries—Iran, Iraq, Turkey, Jordan, and Lebanon. Iraq, for instance, produces about 3 million barrels of oil per day—over 3 percent of global demand. Iran produces 2.7 million barrels and has control over the Strait of Hormuz. Even though Mahmoud Ahmadinejad is no longer president of Iran—this post is now occupied by the more moderate Hassan Rouhani—Iranian reaction to an American intervention in Syria, a long-term strategic partner of Iran’s, would be hard to predict.

Expensive and Gainless

It would seem that military action in the Middle East would play in the Kremlin’s favor: high oil prices are supposed to bring additional gains to the Russian budget. But as recent history has shown, oil price hikes are usually short-lived. Over the last few years, during military conflicts in Egypt, Iraq, and Libya, oil prices have followed the same trajectory: a short-term hike followed by a consequent drop. The thing is, members of the Organization of the Petroleum Exporting Countries (OPEC) are actually averse to high oil prices, because they create additional incentives for developing alternative energy sources, increasing energy efficiency, etc. Therefore, OPEC prefers to maintain the “golden mean”—keeping oil prices at about $90-100 per barrel. In the event of a military conflict, OPEC will be ready to release oil reserves to the market to stabilize oil prices at a comfortable level.

Even in a theoretical scenario in which oil prices jumped and remained at a high level, this would not be beneficial for Russia. Moreover, destabilization in the Middle East would cause trouble for Russia that would outweigh immediate gains from the oil price hike. First, Russia’s military exports to the region would drop. Second, today Russian oil companies enjoy tax benefits that are linked to lower oil prices, benefits that allow them to finance their investment projects. It took much effort to obtain these benefits, and an increase in oil prices would cancel out their gains. Third, as Finance Minister Anton Siluanov recently observed, any hike in oil prices only means that additional revenues of the oil and gas industry will be allocated to the Reserve Fund, and the regime of budgetary cost-cutting will not be cancelled. And lastly, if the current balance of power in the Middle East changes, a situation might develop in which Qatar could start to squeeze Gazprom out of the European market.

In other words, Syrian conflict will not bring any benefits to Moscow. For now, Geneva agreements between Russian Foreign Minister Sergei Lavrov and U.S. Secretary of State John Kerry have allowed us to avoid military strikes against Syria. And as soon as news broke that Russia and the U.S., alongside U.N. inspectors, would develop a plan to destroy Syria’s chemical weapons, oil prices went down again. In September, Brent oil lost 5 percent of its value. To be fair, in this case, another factor should also be taken into account: investors’ expectations of the U.S. government shutdown.

Overall, Russia’s dependence on oil prices became a moot point a long time ago. The country’s recent political history vividly demonstrates that despite a favorable economic environment, high oil prices, and a high rate of GDP growth (7-8 percent in the mid-2000s), the Russian government is incapable of implementing much-needed modernizations. Many reasons can be named, from a system of production that was developed during Soviet times to a lack of political will. The key reason is that all of the country’s strategic assets are controlled by a small group of political elites who gain colossal profits through various corruption schemes, have no incentive to change the established order, and will never let go of their power voluntarily. But global shifts in the energy market, the slowdown of the country’s GDP growth, and increasing social discontent inside the country leave this group little space in which to maneuver in the event of imminent crisis—which increases the political risks for Russia’s ruling elite.