RUSSIA - The Russian Supply Prospects & Resource Curse.

On March 16, 2006, the Carnegie Endowment for International Peace hosted a meeting entitled "How Sustainable is Russia's Future as an Energy Superpower?" with Vladimir Milov, of the Institute for Energy Policy. Carnegie Senior Associate Andrew Kuchins chaired the session. Milov's remarks are summarised below. (Summary prepared by Matthew Gibson, Junior Fellow with the Russian and Eurasian Program at the Carnegie Endowment for International Peace).

Today energy is the decisive driver of Russian foreign and domestic policy. Presidential aide Vladislav Surkov's speech to United Russia activists earlier this year showed the government was prepared to sacrifice everything to become an energy superpower. In Surkov's words, if you have long legs, you should do the long jump, not play chess. But the plan to become an energy superpower will not succeed. Not only will the Kremlin plan ultimately fail, but it is also causing harm.

The authorities promote the "energy superpower" idea instead of fixing economic and social problems. Sustainable development and international competitiveness have vanished from the agenda. Instead there is only this phantom idea, which holds out the promise of a footprint in the global geo-political landscape.

In discussing the resource curse, people normally mention weak institutions, corruption, and perverse political incentives. But Russia faces a more basic problem; it does not have enough resources. Only a few petro-states have enough resources per capita to create a good life for their people, and all have small populations. (Norway, Kuwait, the UAE, and Qatar are in this category). With Russia's large population, the state cannot rely only on resource revenue to promote development. Even if the state were to expropriate all oil profits, it would have only $80 per person per month to redistribute.

The Russian economy is extremely energy-intensive and the country's large territory imposes significant transportation costs, limiting export capability. So the Kremlin cannot build an economic and social policy on energy alone. President Vladimir Putin has abandoned the reform agenda of his first term. He has done nothing to address problems in banking, the army, pensions, and infrastructure. Now the government focuses only on the "national projects", i.e. redistribution. Such thinking is especially misguided given the problems in the energy sector.

Increasing state encroachment is undermining growth. While private companies continue to perform well, state enterprises stagnate. The return on assets in Gazprom and Rosneft is stable under 10%, well below average for the oil and gas industry. These companies have a lot of capital but cannot use it efficiently. Russia faces an investment crisis, especially in gas. In 15 years Gazprom has done nothing to develop the fields on the Yamal peninsula. It first received development licences for these fields in 1993. Having done nothing, Gazprom requested and received an extension of the licences in the late 1990s. Gazprom has again done nothing and soon the government will have to extend the licences again.

The OECD says Russia will not bring any new fields on stream before 2010, and 2015 is a likelier date. These new fields will require years of investment before they begin production. Production on Gazprom's two largest mature fields has declined 20% over the last six years. As a result Gazprom still has not restored its 1999 production levels, despite its many acquisitions.

The twin "national champions", Rosneft and Gazprom, both engage in non-transparent deals and carry enormous debt. This limits their ability to borrow and invest. Neither the Russian financial system nor Russian companies can develop capital-intensive green fields. In these circumstances Rosneft and Gazprom have made the worst possible mistake, closing the doors to international companies. Gazprom is dumping tons of cash into low-return sectors like electricity and businesses that require investment beyond its means. The Yukos case continues to afflict Russian energy. If Yukos' remaining oil assets had maintained their 2004 production levels into 2005, then overall Russian production would have grown 5%. But Yukos production declined, so overall production grew less than 2.5%. Yukos went bankrupt on Aug. 1, 2006 (see its background and the siloviki phenomenon in Vol. 63, OMT & Gas Market Trends No. 7).

The "energy superpower" concept is an illusion and, perhaps most dangerously, does not recognise the mutual dependence between Russia and its energy consumers. Because of political conflicts and declining production, future supply disruptions to Europe are likely. As a result, there will come a day when European gas companies demand elimination of the take-or-pay conditions in their Russian contracts. This will threaten Gazprom's ability to borrow. Putin's attempt to use energy to increase Russian influence could backfire in the long run.