Dalan McEndree has a BA in history, MA in European History, M.Phil. in Russian and Soviet history, Soviet economics, and International economics, and MBA in finance and marketing. He also studied at the East European Institute of Berlin’s Free University and the U.S. Army Russian Institute in Garmisch, Germany (now the George C. Marshall European Center for Security Studies). His career has focused on the Soviet Union and Russia, and has included fifteen years in Russia as a U.S. diplomat, in business, working both for international and Russian businesses, and in consulting. He is also the author of several self-published Russia-focused murder mysteries, and two satires.
President Putin’s recent moves in the Middle East—to shore up Bashar al-Assad’s regime in Syria through deployment of combat aircraft, equipment, and manpower and build-out of air-, naval-, and ground-force bases, and the agreement in the last week with Iran, Iraq, and Syria on intelligence and security cooperation—could contribute to Russian efforts to combat the myriad negative pressures on Russia’s vital energy industry.
Live by Energy…
Energy is the foundation of Russia, its economy, its government, and its political system. Putin has highlighted on various occasions the contribution Russia’s mineral wealth, in particular oil and natural gas, must make for Russia to be able to sustain economic growth, promote industrial development, catch up with the developed economies, and modernize Russia’s military and military industry.
Even a casual glance at the IMF’s World Economic Outlook statistics for Russia shows the tight correlation since 1992 between GDP growth on the one hand and oil and gas output, exports, and prices on the other (economic series availablehere). According to the IMF’s 2015 Article Iv Consultation-Press Release and Staff Report, published August 3, oil and natural gas exports comprised 65 percent of exports, 52 percent of the Federal government budget, and 14.5 percent of GDP in 2014. Including their domestic contribution, hydrocarbons represent ~30 percent of GDP.
While oil and natural gas are crucial to Russia, Russia’s crude and natural gas are crucial to its neighbors on the Eurasian landmass. Russia supplied about 30 percent (146.6 bcm) of Europe’s natural gas in 2014, and about 25 percent of its crude (3.5 mmbbl/day) in 2013. Russia’s oil and natural gas are also important to its Asian and Central Asian neighbors.
It is not only the commodities that make Russia crucial, but its massive land-based infrastructure for their distribution throughout the Eurasian landmass. As Tatiana Mitrova, head of the oil and gas department, Energy Research Institute, Russian Academy of Sciences, pointed out regarding natural gas in The Geopolitics of Russian Natural Gas:
"Russia has a unique transcontinental infrastructure in the heart of Eurasia (150,000 km of trunk pipelines), which also makes it a backbone of the evolving, huge Eurasian gas market (which could include Europe, North Africa, the Commonwealth of Independent States (CIS), Caspian Sea region, and Northeast Asia). Control over the transportation assets in this region together with vast gas reserves make Russia the key element of this new market.”
The land-based oil distribution network is smaller, but also important. The 4,000 km Druzhba pipeline delivers about 1 mmbbl/day of crude to Europe—about 30 percent of total shipments to Europe. In the Far East, Rosneft shipped 22.6 million tons of crude to China in 2014 through the East Siberian Pacific Ocean (ESPO) pipeline.
The Russian government continues to seek to extend and expand the natural gas distribution infrastructure—into Europe, with various proposed pipeline projects (Nord Stream 2, Turkish Stream 2, 3, and 4, South European Pipeline), and into China, with two large pipeline projects, Power of Siberia Pipeline (to supply China from East Siberia), and the proposed Altai pipeline (to supply China from West Siberia).
…Death by Energy
In the last few years, the threats to Russia’s energy industry have multiplied and intensified. They pose an existential threat to the industry and therefore to the Russian economy:
- The revenues Russia can earn from its crude and natural gas exports face intense pressure. The Saudi decision to let the market set prices and to pursue market share, has led to steep declines in crude and petroleum product prices. The decision also has impacted natural gas export prices negatively, since, for Russia’s long-term supply agreements, they wholly or partially are indexed to oil prices. The transition in Europe to hybrid natural gas pricing models (which take European spot hub prices into account) also has pressured natural gas pricing. (Natural gas data from Gazprom).
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Adding to the revenue pain, natural gas export volumes have been falling, according to Gazprom (which has a monopoly on pipeline exports), as have domestic volumes within Russia:
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It is therefore not surprising that the aforementioned IMF Article Iv Consultation-Press Release and Staff Report projected sharp declines in 2015 and 2016 from 2014 levels for oil export revenues ($109.8 billion and $96 billion respectively) and natural gas export revenues ($12 billion and $14.3 billion respectively).
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Since these IMF projections are based on $60.1 and $65.8 per barrel prices in 2015 and 2016, oil export revenues will undershoot these pessimistic IMF projections, as crude prices are projected to stay below $60 through 2016 (EIA estimates for Brent are $54.07 and 58.57 in 2015 and 2016 respectively).
- The U.S. and European Union’s decisions to impose—and maintain—sanctions on Russia after its invasion and annexation of Crimea and invasion and informal annexation eastern Ukraine will pile more pressure on the Russian energy industry. They include bans on financing for and the supply of critical equipment and technology to important Russian energy projects. Novatek and its partners Total and Chinese National Petroleum Company still lack $15 billion of the $27 billion needed to finance the Yamal LNG plant. Denis Khramov, Russia’s deputy Minister of Natural Resources, said September 28 at a conference in Russia’s Far East that Rosneft and Gazprom are delaying some offshore drilling by two to three years because of sanctions and low oil prices. The sanctions are also impeding Gazprom’s ability to develop the Chayandinskoye and Kovyktinskoye fields in eastern Siberia, from which it plans to supply natural gas to China under the bilateral $400 billion, thirty year deal signed in 2014.
- Following the Russian invasion of Crimea and eastern Ukraine, The European Union is now even more determined to reduce its dependence on Russia for natural gas and to force Gazprom submit to EU competition rules. Europe has sought and continues to seek alternatives Russian natural gas (among them, U.S. LNG and Iranian pipeline and/or LNG). The European Commission, the European Union’s executive body, has refused to bless Gazprom’s proposed 55 bcm/year Nord Stream 2 natural gas pipeline project, citing existing surplus Gazprom pipeline capacity into Europe and insufficient future demand for Russian natural gas. Also, the EU Commission in April charged Gazprom with violating the EU’s anti-trust laws for anti-competitive practices and unfair pricing in Central and Eastern Europe. If found guilty, Gazprom could face substantial fines of around $1 billion. Even if Gazprom avoids fines and manages to reach a settlement with the EU, as it hopes to do, its European market share and pricing will remain under pressure into the future.
- The emergence of the U.S., along with Canada, as powerful crude, NGL, and natural gas producers is also a major concern for the Russian economy. This has transformed the U.S. from a market for Russian crude and natural gas (via LNG) to a global competitor. If, as seems increasingly likely, the ban on crude exports is lifted, U.S. crude will compete with Russian crude in several key markets. It would also force foreign suppliers to seek other markets for all or part of the exports they previously sent to the U.S. This in turn would intensify competition among these crude exporting countries for share in those markets. In regard to natural gas, its explosive output growth in the U.S. undercut Gazprom’s rationale for its Baltic LNG project (10 mtpa), turned the U.S. into a major (potential) LNG competitor in global LNG import markets, and, via the U.S. toll- and Henry Hub- pricing model, weakened Gazprom’s ability to insist on oil-indexed, long-term contracts.
Saving Russian Energy (and Russia) through the Middle East?
Putin’s moves in the Middle East could help Russia address the impact of these threats to the Russian energy industry. They potentially enhance the attractiveness of Russian crude and natural gas supplies compared to those from Saudi Arabia and its Gulf Arab allies.
In the selection of crude and natural gas suppliers, security is a key consideration for importers. Wary of U.S. naval power, the Chinese, for example, prefer pipeline natural gas supplies over seaborne LNG supplies. Importers therefore must take into consideration the potential threats to transport. In this critical area, Russia enjoys a decided advantage over Saudi Arabia and the Gulf Arab producers, which depend on sea transport through the Persian Gulf and the Red Sea to ship their oil and LNG.
Each of the three routes from these two bodies of water passes through a "choke point” (from the Red Sea, through the Suez Canal to Europe and through the Mandeb Strait to Asia, from the Persian Gulf through the Strait of Hormuz). By adding an airbase to their military presence in Syria, the Russians—coordinating with Iran, Syrian President Assad, and eventually possibly Iraq—would have the capability to disrupt shipments from Persian Gulf and Red Sea terminals.
Russia’s export channels are less susceptible to disruption. With the exception of LNG exports to Asia from Sakhalin, Russia sends natural gas to its customers via pipeline. About 70 percent of Russia’s seaborne oil exports are susceptible to choke points (shipments from two ports on the Gulf of Finland through the Baltic Sea to the Atlantic and one port on the Black Sea through the Turkish Strait/Bosporus to the Mediterranean), while 30 percent are not (pipeline shipments to Europe and ESPO pipeline shipments to the port of Primorsk near Vladivostok).
Putin’s moves also are strengthening Russia’s influence with OPEC. Russia already has extensive and close ties with Iran and Venezuela, and is now laying the basis for such ties with Iraq. Putin has aligned Russia with OPEC’s have nots–the members lacking financial resources to withstand low crude prices for an extended period and that have objected to Saudi policies (Iran, Iraq, Angola, Nigeria, Libya, Algeria, Ecuador, and Venezuela)—against the haves (Saudi Arabia, Kuwait, the UAE, and Qatar). He has continually supported Venezuelan President Maduro’s calls for an emergency OPEC meeting on prices and his efforts to persuade Saudi Arabia to reverse its policy. Most recently, in the beginning of September, Putin told Maduro that the two countries "must team up to shore up oil prices”.
In addition, Russia’s deputy prime minister in charge of energy policy, Arkady Dvorkovich, in the beginning of September made comments that, in tone and substance, mocked Saudi policy, saying that "OPEC producers are suffering the ricochet effects of their attempt to flush out rivals by flooding the world with excess output,” expressing doubt that OPEC members "really want to live with low oil prices for a long time,” and implying that Saudi policy is irrational.
Indeed, Russia can be seen as maneuvering to split OPEC into two blocs, with Russia, although not a member, persuading the "Russian bloc” to isolate Saudi Arabia and the Gulf Arab OPEC members within OPEC. This might persuade the Saudis to seek a compromise with the have nots.
A strategic alliance with Iran and Iraq offers Putin two more potential avenues to pressure the Saudis. They can test Saudi determination to defend their market share at any price and its wherewithal financially to do so. Iran claims it can raise crude output by one million barrels within six or so months of the lifting of sanctions. The Saudis may be calculating that Iran must first rehabilitate its oil fields and that Iran, cash poor, cannot do so quickly. If this is the case, Russia could step in, offer Iran financing, and force the Saudis to contemplate prices staying lower longer than they anticipated and therefore continuing pressure on their economy.
Russia also could cooperate with Iran and Iraq to take market share from Saudi Arabia in the vital Chinese market. As a recent Bloomberg article pointed out, Saudi Arabia, Iran, Russia, Iraq and other countries are vying intensely for sales to China, the second largest import market and the major source of demand growth in coming years. Coordinating their pricing and consistently offering the Chinese prices below the Saudi price, they could seek to win market share. Such a price war would pressure the competitors’ currencies.
Since the Russians allow the Ruble to float, Iran maintains an informal and unofficial peg for its Rial to the US$, and Iraq has indicated it is willing to adjust its peg if necessary, while the Saudis are committed to the Riyal’s peg to the US$, Russia, Iran, and Iraq would have any advantage over Saudi Arabia. To the extent that Iran and Iraq allowed their currencies to adjust, Russian, Iranian, and Iraqi revenues in local currency terms would not decline as much as Saudi revenues fixed in US$ (and might even increase) as their currencies depreciated.
Each of these opportunities offers the possibility to address the pressures on the Russian energy industry. However, Putin will have to play his cards carefully. Played heavy-handedly, he could intensify fears in Europe of excessive dependence on Russian energy supplies and awaken such fears in China. This could lead the Europeans and Chinese to search for other suppliers. In addition, mismanaged confrontation with the U.S. and Europe in and over Syria could lead to broadening and strengthening of economic and financial sanctions. Moreover, neither Iran nor Iraq will want to become overly dependent on Russia, which lacks the resources they need develop their energy industries.
Finally, the opportunities assume Putin’s gambits in Syria and with Syria, Iran, and Iraq in intelligence and security cooperation will succeed. And this, given the Soviet experience in Afghanistan and Putin’s experience in eastern Ukraine, is far from certain.