Russia in 2020 Could Spell ‘Game Over’ for Putin

Russia in 2020 Could Spell ‘Game Over’ for Putin

Guest blogger Christopher Jackson looks at the long-term implications of Russia’s weakening oil industry and growing domestic instability.

Since 1990, Russia has experienced something of an escalator ride in the nation’s fortunes. The Russian economy has bounced back from near bankruptcy since the beginning of the Putin years, largely on the back of a vast overhaul of its oil and gas industry, which has fuelled the increasing spending demands of Putin’s various administrations. But is Russia about to experience another rollercoaster drop in the next decade? Here are a few reasons why Russia is facing a perfect storm in 2020:

‘It’s the Economy, Stupid,’ or more accurately, ‘It’s the Oil Price’

For most of Russia’s history the economy has been driven by its main industries, which have exported the vast resources at the state’s disposal. But in recent years the dependency of the Russian economy on oil and gas exports has become truly staggering. Not only does Russia’s oil and gas industry now account for 49 percent of the state’s revenues, but Russia also requires two-thirds of its gas production be allocated to the domestic market.

The situation becomes far worse when we examine Russia’s much discussed export of oil and gas products. Of Russia’s 600 billion cubic meters (bcm) of gas produced every year, around 140bcm is exported to Europe, of which Germany and Ukraine account for 70bcm of exports combined (at 30bcm and 40bcm, respectively). In other words, Russia relies on Germany and Ukraine for around 34 percent of its gas sales, while Ukraine accounts for nearly 19 percent of Russia’s gas exports. Furthermore, the pipelines that transfer Russia’s gas to the EU market currently use Ukraine as a transit nation. Thus, for anyone who remembers the 2009 gas crisis in Europe, this is why Russian planners are so concerned about their gas position.

Even if Russia is able to construct its South Stream project to reduce its reliance on Ukraine as a transit hub, it will not only be competing with the EU, which has aggressively tried to challenge Russian gas hegemony, but also with the alternative gas pipeline running the Turkish-Bulgarian border to Austria, Nabucco West.

Nevertheless, the main concern for the Russian economy relates to the price of oil. With the U.S. shale gas market boom –  estimated to increases U.S. gas production by 25 percent by 2020 – there will be an inevitable decline in demand for oil-related products on the international market, especially as other BRIC nations seek their own domestic means of energy production. In addition, the climate change agenda and the effects of air pollution in major cities are increasingly leading developing nations like China to seek gas as an alternative to oil. The problem for Russia however is that, simply put, it receives such a good price from Europe that it will not accept the terms China and others are offering.

The implication of a fall in oil prices is a significant reduction of Russian state revenues. If the price of oil and gas declines then Russia will face a choice: to reduce its current output to maintain the price level (assuming the rest of OPEC does likewise) or to maintain its output but at a reduced profit (and in some cases certain projects will come close to making losses). Both would be disastrous for Russia’s spending pledges, including its $800 billion armed forces modernisation programme.

But the energy crisis is not just linked to the state revenues from oil and gas. The World Bank’s latest report on the ECA and FSU states has indicated that they will need to invest $1.5 trillion into maintaining and modernising energy infrastructure within the next twenty years, which will require a large increase in the price of electricity. This then leads to the next problem of the Russian economy: a large proportion of high energy intensity industries, whose main advantage is price competitiveness, in no small part due to low energy prices.

Increasing Domestic Instability and Declining State Security Resources

These economic concerns spill over into politics. Vladimir Putin’s reelection was considered by many to be a non-competition. He was too strong, too popular and too well connected to lose.

It is true that for many Putin is still deeply popular, but the same is certainly not true of his lieutenants and it is their increasingly public misdemeanors that are starting to significantly chip away at the regimes support base. Putin’s sense of uncertainty was perhaps best displayed by the significant international attention and media coverage generated by the Russian punk rock band “Pussy Riot.”

While Russia has often suppressed riots and domestic violence, it is the impact of declining state revenues that will suddenly lead to difficult strategic decisions on where Russia spends its resources. If the state continues to focus its funding on internal suppression, it will inevitably have to reduce its spending on the planned military modernisation programme, something which will surely reduce the global reach of the Russian military and certainly the extent to which it can intimidate its neighbours.

Furthermore, if Russia does retrench domestically, will this lead to more aggressive actions by those states that currently have territorial disputes with Russia? Any increased belligerence by states like Georgia and Azerbaijan would be embarrassing for Moscow. Even the latest Russian fighter jet project, a symbol of its super-power aspirations, could be threatened if it fails to find suitable export partners and the number of orders, expected to be 100 or fewer, drop below its already low levels.

Demographic Issues

Russia has always incorporated a large number of ethnic minorities and different faiths, and while it is facing a marked decline in the birth rate of European, orthodox Russians, its minority populations (Muslim minorities, especially) and immigration rates from central Asian states continue to grow.

This again will start to stir domestic tensions, where the state has historically underinvested in the East and often concentrated its investments into a few key cities like Moscow. Furthermore, regional hotspots like Chechnya may become emboldened to push for further regional autonomy if the region’s population continues to grow whilst the typically more Slavic and European population of western Russia declines.

Underinvestment in regions with high birth rates, which will require greater state resources for health care and education as well as state and/or private investment to create job opportunities for a rapidly increasing young workforce, will create a policy headache for a state with limited alternatives to state spending or oil and gas sector jobs. Both seem certain to decline.

Squaring the Circle

Russia is facing a perfect storm by the end of this decade with no solution in sight. The Russian state cannot generate internal investment without an end to the rampant corruption that eats away at public confidence in the state bureaucracy and decimates the ability of financial institutions to invest sensibly in growth prospects.

But more fundamentally, Russia lacks a functioning rule of law. No company today can invest in Russia without the concern of expropriation or state interference and those that have tried have often been burnt badly in the process, including BNP-TNK and Shell and its development of Sakhalin island. This hampers any serious private sector investment and again places the onus of investment squarely on the Russian state.

While Russia may be having its moment in the spotlight as a superpower in the Syrian conflict, it is worth waiting to see what happens next. Keep an eye on Russia and 2020. The Russian roller coaster may just be about to drop.

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