Lack of energy sector reform holds back Russian economy

Lack of energy sector reform holds back Russian economy

Russia remains a leading worldwide energy exporter, but its energy sector remains a laggard in desperate need of modernization. Governmental corruption and a restricted domestic market both stand in the way of infrastructure improvement.

Global attention on Russia’s actions toward Ukraine has pulled the dynamics of Russia’s economy into the spotlight.

Much of the talk has been focused on Russia’s overall poor economic performance and its economic model which is heavily reliant upon energy. Indeed, the importance of natural resources to the country’s economy is hard to overstate, with oil and gas accounting for 70 percent of total goods exports, and oil and gas revenues accounting for nearly half of the federal budget.

This reliance and overall lack of economic diversification makes Russia’s economy and future extremely dependent on the price of these two entities. Recent shifts in global energy production and demands present a problem for the country, as does growing inefficiency in the sector.

Russia has managed to capitalize on its vast reserves and geography to catapult it into the front ranks of energy exporters, leading the world as a natural gas exporter and averaging 10.8 million barrels of oil per day in 2012.

Yet while its energy exports (and its reliance on them for revenue) have grown significantly, there is still tremendous inefficiency.

According to the European Bank for Reconstruction and Development (EBRD), Russia ranks fourth as a CO2 emitter and has an energy intensity 2.5 times higher than average. Put simply, Russia uses twice the energy per unit of GDP than comparable producers. In 2008 alone, Russia could have saved as much as 30 percent of the oil and natural gas it consumed, had it been more efficient.

Aside from the overall environmental costs and their potential to create instability, the growing inefficiency is likely to sap productivity and overall economic strength from an increasingly vulnerable sector in an increasingly vulnerable economy.

Modernization is essential to reforming Russia’s energy sector and ensuring its future. To achieve this, some key steps may greatly help to increase energy efficiency.

Removing price subsidies and cross subsidies could lead to greater incentives for reforms. It could also help attract the level of foreign investment necessary for the level of modernization required.

Another helpful step would be increased cooperation between Russian state companies and other entities, which could improve competition and technological advances in data maintenance. As with the elimination of certain subsidies, the goal is to create incentives for state-owned companies which are typically slow to adapt to market conditions.

Another key aspect of modernizing Russia’s energy sector is providing essential infrastructure improvements. Poor infrastructure contributes to loss in production and an inability to garner productivity gains in both refining and exploration. Nearly 40 percent of Russia’s fossil fuel based power plants are over forty years old. Compared with 28 percent in the U.S., 22 percent in the EU, and 12 percent in Japan, this is an astoundingly high number.

By some estimates, electricity transmission losses are nearly double what they are in the U.S., due to outdated infrastructure. Losses in heating generation and distribution are thought to be even larger. In addressing its infrastructure inadequacies, Russia would free up additional energy for imports while improving local communities and making the sector more nimble

Given its dependency on the energy sector, Russia needs modernizing reforms. However, with the deep structural problems in the Russian economy, it will be no easy task. With rampant corruption, money allocated to infrastructure would likely face poor allocation.

While recent events may result in greater momentum for those receiving Russian oil— and particularly gas— to push for greater energy independence, such a push could bolster calls for greater efficiency in Russia’s energy sector. Yet the present political situation in Russia, combined with the great extent of reforms needed, could hurt the chances of modernization.

About Author

Sean Durns

Sean Durns worked as a research assistant to a former high ranking Pentagon official and the Director of National Security Strategies at a DC based think tank. His analysis has been referenced by a variety of media outlets including The Wall Street Journal, Roubini's EconoMonitor, OilPrice, and many more. He holds a M.Sc. in History of International Relations from the London School of Economics where he focused on US foreign policy, security studies, and energy security.