Oil, Gas and Bluster
By Anthony de Jasay
I. False Front
The truth is that 1991 happened not because consumer demand was not satisfied, but because Gorbachev and the other modernisers in the Party and the Army relaxed it to make it more innovative and competitive with the capitalist West and in so doing, inadvertently undermined the authority of the apparatus that enforced obedience to the regime. The result was not revolution, but a shambles. “Red directors” stole the state factories and mines they had directed, KGB officers became their firms’ “security” officers, contract killers or both at the same time, the armed forces were starved of resources, but at the same time centralism declined and regional autonomy began, and the rudiments of a civil society surfaced.
Under Yeltsin’s easygoing presidency, economic policy was relatively liberal. Anatoli Chubais, the privatisation czar, made haste to get state property into private hands to drain the government of power and prevent any relapse into dictatorship, and did so even at the expense of tolerating monstrous corruption and the rise of an oligarchy. The outlines of a bourgeois order have nevertheless began to show.
During these years, the price of crude oil fell from the mid-50s to reach bottom at $15 a barrel in 1998. Russian oil output that peaked at 12 million barrels/day back in 1982 when oil used to fetch $66, declined to half that level by 1998. The joint effect of the two nosedives was, of course, devastating; Russia defaulted on its international obligations and stood ashamed and humiliated before the world. Looking weak, losing the respect, admiration and if possible the awe of others, was manifestly something that hurt the Russian people far more than had the “lack of consumer choice” in the drab treadmill of the Soviet years.
At this juncture, in August 1999, enters Vladimir Putin, a wholly undistinguished ex-KGB officer. He takes over from Yeltsin as acting president and is elected president by the dutiful people the following year. The oil price gains 40 per cent in 1999 and continues to recover, as does production that gradually climbs to just under 10 million barrels/day, a level which for the time being is the limit of its capacity. Price, not output, proves to be Putin’s fabulous luck. By 2006, the average barrel fetches $65, by 2007 it reaches $100 and money is streaming into Russia.
During his first four-year term, Putin moves cautiously, allows economic policy to be influenced by sensible economists and is praised by (“classical”) liberals in the West. The growth rate of GDP is 7 per cent or better. Urban wages increase at double-digit rates, and more Rolls Royces and Bentleys are sold in Moscow than in any other city in the world. Admittedly, property is not wholly secure, the borderline between business and gangster rule is fuzzy, and German Gref, the economics minister (who has since lost his post and has become a banker) declares that Russia “lacks one factor of production, the rule of law”. But during his second term Putin, increasingly confident, uses the judiciary as his obedient tool to retake for the state the ownership of “strategic” enterprises and control over many more. Shell violates Russian environmental standards (!) and is evicted from its multi-billion investment on Sakhalin island, BP is refused a pipeline linkup to the Gazprom network in the North, cannot produce the gas that it has no means to deliver, and loses its licence and its investment, TNK BP does not respect the Russian labour code (!) and management control is wrested from it, and so on.
Putin explains his doctrine at length: ownership may be state or private, but the management must accept the state’s close guidance so as to serve the national interest. (He also mentions, casually, that since Mahatma Gandhi is gone, he Putin is the only real democrat in the world). The state’s guidance is mainly carried out by a solid network of siloviki, ex-KGB or ex-Army men, who often hold posts both as directors of enterprises and government officials at the same time.
Much of this looks bad, but most commentators accept it as something that works, for the growth record of the Putin years is unblemished. Or is it?
When Putin “took the reins” in 1999, GDP was $894 billion. It grew to $1490 billion by 2007, a rise of $600 billion. During the same time span, the value of oil production at world market prices rose from $45 billion to about $350 billion, an increment of $305 billion. Natural gas was responsible for perhaps another $40 billion. The calculation is not quite fair to Russia, for not all oil and gas enters into GDP at world prices, but all in all, it looks as if up to a half of economic growth during Putin’s first two terms was due to the hydrocarbon windfall. Allowing for some catch-up effect after the abysmal 1998-99 period, Russian performance is at the lower end of the group of “emerging” economies.
For some additional perspectives, see Bruce Bueno de Mesquita on Reagan, Yeltsin, and the Strategy of Political Campaigning, an EconTalk podcast with host Russ Roberts.
This finding fits perfectly into the Russian historical pattern. Like the false fronts of the rickety stores and hotels of the small towns of the American West, Russia has always presented a false front to the world. Potemkin put up stage-prop villages to embellish territory taken from the Turks, and wrote his name indelibly into history to stand for fraudulent make-believe. The practice of the false front took on gigantic proportions during the Soviet era, fooling the CIA into quite derisory overestimates of Russian economic and military strength. It also gave the Russian people something that satisfied them more than a more ample choice of consumer goods might have done: it gave them pride, a sense of righteousness and of being feared by the wicked America. The rising value of hydrocarbons is not a lie, but the claim of successful economic management is one. The flood of money that has inundated Russia serves as a false front, masking their intrinsic weakness. Except for the extraction of natural resources, industry is catching the “Dutch disease” of petroleum exporters. There are more fundamental weaknesses, too. Male life expectancy at birth is 58 years, the population is falling by 700,000 a year, public health is a disaster, under-investment in electricity foreshadows a great power shortage, and bad reservoir maintenance hastens the coming decline of oil production. The morale of the army is poor and its equipment is getting obsolete. If the generals are to get new high-tech toys, the pile of accumulated oil money ($400 billion in currency reserves and $100 billion special reserve) may quickly melt away in a near future where oil production may be declining and the oil price may not come to the rescue. If there is no flood tide of oil and gas money, there will still be the old Russian standby of bluster which gives the people the delightful sensation of being feared. In February 1945, a battle-weary brace of Soviet soldiers told the present author that they are about to take Berlin, after which they will go on to take Paris and London. Nikita Khrushchev told the capitalists of the West that Soviet superiority will “bury them”. General Borisov, commanding the Russian peacekeepers (!) on Georgian soil, in August 2008 told a French reporter: “Let the Americans come here, we will kill them all”. Putin promised to give all aggressors a “bloody nose “and warned America “not to push us around”. His docile assistant, President Medvedev, made it clear that Russia did not care a fig about what Europe said or did in response to Russian moves in Georgia. Such bluster involves no risk, flatters the people’s vanity and is the surest means of cementing popular support for the regime. It also upholds the traditional device of the tall false front hiding the modest building.
II. Unspoken Threats
At the time of the upheaval about Georgia and its separatist provinces Abkazia and South Ossetia in August-September 2008, it was widely noticed that in trying to find a common tone of European protest to Russia, the U.K., Sweden, the Baltic states and Poland advocated a very stern language, but were pulled back by Germany and Italy. It so happens that Germany and Italy are markedly more dependent on Russian natural gas than the rest of Europe. It was also remarked that President Medvedev found it useful to remark that sanctions would do more harm to Europe than to Russia, though he refrained from elaborating what kind of harm he had in mind.
Nor do European energy administrators speak explicitly of dependence on Russian natural gas when they call for a more integrated gas transport grid and the diversification of sources of supply. But each knows what the other is thinking of.
For more on natural gas extraction and transport, see “Natural Gas Regulation”, by Robert J. Michaels, in the Concise Encyclopedia of Economics.
Natural gas is more awkward to transport and more restricted in use than oil. As a result, it is worth only between a half to three-quarters of oil of equal thermal value. One thousand cubic meters of gas corresponds to 6 barrels (boe) but may fetch only about $300 dollars in North America. In Europe, the bulk of the gas is priced in long-term interstate contracts with complex formulae linking it to the free market price of oil with a lag. Prices actually paid vary widely. Russia has recently been charging the Ukraine $180/1,000 cubic meters and is talking of renewing the contract at $400/1,000 cubic meters, while it is understood to be buying natural gas from Turkmenistan at $13/cubic meters—a healthy spread indeed.
The economics of Russian natural gas is not easy to unravel. In 2006, the country produced 612 billion cubic meters (3.7 billion boe) and consumed 430 billion of that. This seems inordinately high—five times the consumption of Germany whose GDP is twice that of Russia. The explanation is the obvious one: the domestic price is kept at a small fraction of the export price. The result is appalling waste, most conspicuously in heating, but presumably in industrial use as well. Gazprom has a monopoly of both export and all pipeline transport (which gives it the whip hand over non-state sellers). The pipeline network leaks from countless joints and closures (as does the oil pipe network of Transneft).
Gazprom has done relatively little to raise its output, which seems strange in the light of its strong ambition to raise exports to Europe and the sharply higher needs that are forecast for the Russian power utilities. One is led to suppose that Gazprom expects the government to allow it to raise the domestic price nearer to the export market level, thus reducing home consumption and release several hundred billion cubic meters for export. Alternatively, Gazprom may have secret doubts about Europe’s capacity or willingness to buy very much more Russian gas.
Currently, Europe’s own production from Norway, the UK North Sea, and Holland is running at about 210 billion cubic feet, imports from Russia at 150 billion, from Algeria 33 billion and from a variety of overseas countries in the form of liquefied natural gas (LNG) 49 billion. LNG is expensive to produce and transport, but has greater potential to expand than piped gas thanks to vast unexploited reserves in the Persian Gulf and other areas. If need be, LNG could greatly reduce European dependence on Russian gas, but it would take a decade of building LNG plants and ships for this to happen. It would happen if Gazprom tried to squeeze Europe by ratcheting up the price. LNG can be considered as the long-run counter-move to Russian moves of this type. The threat of the moves and the countermove are unspoken but no doubt understood.
All of Gazprom’s exports to Europe are delivered by pipelines that pass through the Baltic states, Belarus, Poland or the Ukraine. These countries are getting Russian gas at “friendly” prices. If Gazprom tries sharply to raise the price and enforces its demand by cutting off supplies, the transit countries can still draw gas from the pipeline that was meant for Russia’s paying customers in Germany, Austria and Italy. The Ukraine has done this in recent years, giving Gazprom a bad name as an unreliable supplier.
In order to get off this hook, Russia is seeking to bypass the transit countries with two new pipeline projects. One, Northstream, would go from Russia under the Baltic sea directly to Germany, the other, Southstream, under the Black Sea to the Balkans and then to a hub in Austria and Hungary to Italy.
Southstream is also meant to trump Nabucco, a $7.8 billion European project that would draw gas from Kazakhstan and the Caspian Sea and carry it via Azerbeijan, Georgia and Turkey to the Balkans, avoiding any Russian territory (assuming that Georgia remains an independent state). Nabucco would open in 2013 with a capacity of 8 billion cubic meters/year, rising in due course to 30 million/year. At first sight, Nabucco looks uneconomic, far from sure of getting enough supplies to fill it to capacity, and many doubt that it will in fact be built. Even if it were, it would make little difference to Europe’s energy balance. However, to judge from Russian blustering and cajoling to persuade Hungary and Austria to throw all their support behind Southstream and let Nabucco drop, even the puny competition of the latter is perceived in Moscow as a threat or at least an insult.
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For more articles by Anthony de Jasay, see the Archive.