OP-EDS

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January 24, 2014

Unsustainable resource, sustainable economy

Despite bad press, Russia's economy is set to grow for the foreseeable future.

“If you want to find someone pessimistic about Russia, just talk to someone who grew up there.” I’m glad to have been spared the life experiences of my parents, but as someone who speaks the language and is otherwise culturally connected, I often keep up to date with what’s going on in the motherland, waiting for an improvement. With all the recent negative news about Russia in the press—gay rights, the Olympics, the Pussy Riot arrests, voter fraud, corporate corruption—you could describe me as a dutiful masochist. While social and political frictions make the headlines in Russian news, as an econ major I hold the conviction that if people have enough bread they’ll settle down to discuss Plato, and, like, democracy and stuff. The causative relationship between welfare and social unrest is undeniable, and in attempt to forecast how much more negative Russian news I will have to suffer through, I decided to conduct a macroeconomic analysis of Russia’s economy.

Unlike many countries affected by the global recession, Russia has weathered and rebounded from the crisis with a tenacity Europe and the United States can only envy, largely because of its core dependence on oil and natural gas exports, whose prices took only a year to rebound from the ’08 drop and are now close to historical highs. However, with 40 percent of its economy and a larger portion of its tax revenues dependent on state-controlled and privately controlled oil and natural gas production, Russia has a diversification problem; the five-year rise of oil prices has meant the difference between a surplus and a deficit, and worries about long-term downward pressure on natural resource prices have resulted in a bearish outlook on the part of investors. This has resulted in a steady outflow of capital from Russia in recent years. Although some concern is justified, I believe the market pessimism to be an overreaction and a massive opportunity cost.

That the Russian economy is heavily dependent on oil prices is a given. A vector autoregressive model run by Katsuya Ito from Fukuoka University found a Russian GDP growth/oil price elasticity of 0.46—a two-percent drop in oil prices would result in a one-percent drop in GDP, and vice versa. Downward pressures on oil prices arise from decreasing demand (most notably from Europe) and increasing production from other countries (the new easing of Iranian sanctions will increase its production by 400,000 barrels per day). However, OPEC has maintained a $100-per-barrel target and has kept a production ceiling accordingly. Since Russia is a price-taker in the oil market and has historically taken advantage of OPEC cutbacks, it will be free to produce as much oil as it can at the artificially high price.

With respect to natural gas, global prices have dropped but it can be inferred from long-term contract negotiations that the slide will soon arrest. Gazprom just signed an agreement to supply gas to China National Petroleum Corp for a price of $10–11 per million British thermal units (BTU), almost market price.

Another market concern about Russia is its ability to continue to produce cheap oil. Despite posting an oil and gas condensate post-Soviet output record of 523.28 million tons for 2013, mature Russian provinces are seen as being past their “peak oil” production which is projected to steadily decline, or at best be maintained as new provinces are developed. This gloomy perspective assumes that only Russian companies (many of which are state-owned) will drill only in Russia, neither of which is true in the long term.

Certainly, Russia’s Soviet-era energy infrastructure is aging and might be performing at or near capacity. Despite having the biggest world reserves, it isn’t capable of fully exploiting them, and a key opportunity lies in partnering up with more technologically equipped companies, in effect partially outsourcing production and over time acquiring new innovation techniques and industry standards. Such partnerships are mutually beneficial, as Russian companies see huge technological gains—a BPC Engineering–Capstone Turbine (Russia-California) partnership resulted in a system of cleaner burning of non-treated oil and gas—and companies like Exxon (which had a third straight annual drop in output) are able to find new reserves.

Russia is actively encouraging such partnerships. This year, it wrote into law a separate tax regime for offshore drilling and cut extraction duties. Russia is also lifting monopolies on natural resource extraction. Last month the December 1 rollback of OAO Gazprom’s monopoly on liquefied natural gas exports made space for Exxon’s slated $15-billion plant on Sakhalin Island.

Such efforts are paying off. Exxon Mobil Corporation and OAO Rosneft are set to start their first Arctic well this year, targeting a deposit that may hold more oil than Norway’s North Sea. It will kick off a series of landmark projects and cement an alliance begun in 2011. They also plan to frack shale fields in Siberia, sink a deep-water well in the Black Sea, and build a natural-gas export terminal in Russia’s Far East. The companies have also committed $43.2 billion to exploring three blocks in the Kara Sea and Black Sea and added licenses to explore areas of the Arctic’s Laptev and Chukchi Seas.

In addition to drilling for oil domestically, Russia is actively looking to establish foreign operations. Say what you will about Russia’s support for Bashar Al Assad, but it’s paid off economically. Two weeks ago the first Syrian-Russian offshore oil exploration deal was signed, a 25-year contract. Because Syria’s oil production has dropped by 90 percent due to conflict and international sanctions (which are skirted by this deal) and Russia is fully financing this oil exploration (as it will future ones since Syria can’t afford it), it will be in a position to grow market share and command high profits. Such political and economic alliances are favorable options for struggling economies and can give a leg up to state-owned companies. For example, in Venezuela a policy shift has been made toward favoring state-owned companies as a means of gaining political influence, resulting in an assortment of economic advantages for Russian subsidiaries that are now actively expanding their operations in the South American country.

Russia has made some attempts to diversify its economy—for example, by funneling government funds toward tech operations like the Skolkovo Initiative—but maybe it doesn’t need to. It makes little sense to compete in steel manufacturing when you’re sitting on an ocean of oil. Post-crisis productivity in all sectors has been growing at a stable 3 to 3.5 percent and labor force participation has seen an uptick as well. For all intents and purposes, the rest of Russia’s economy is stable. If it continues to maintain oil profits through joint partnerships with international drilling companies and leverages new opportunities abroad through political influence, investors’ fears will be eventually assuaged by the facts, and foreign capital will start flowing back into Russia before too long.

David Grossman is a first-year in the College.

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