Opinion
Leaking barrels
Given the drop in oil prices, hard structural changes to the Russian economy might be unavoidableThe drastic fall in oil prices, from as high as $120 to $55 per barrel, has come as a surprise to many. Does this have anything to do with Russian action in Crimea and its support for rebels in Ukraine? Or is it just a reflection of economic sluggishness in major industrial economies as well as the availability of new sources of supply, primarily shale oil in the US. The answer is not clear, though it seems likely that the intersection of politics and economics cannot be ignored.
Shale oil production in the US has received a boost because of rising prices in the past. The simple logic of price mechanism tells us that when the price of a product rises rapidly there is an incentive to look for competing alternatives. In the case of oil, this means new technologies that were ignored in the past because they were too expensive. Further, the US’ determination to reduce dependency on foreign imports helped shale oil.
The Russian angle
For oil-producing nations, like Russia, the high price of oil was a bonanza that was available to win over peace and stability on the domestic front as well as pursue foreign policy objectives that needed resources. President Vladimir Putin’s policy of trying to keep countries in the neighbourhood under the Russian sphere of influence, both on the economic and political front, required resources to help friends and punish allies reluctant to follow his lead. When oil prices were high, the implementation of this policy was not difficult.
Decreasing oil prices have suddenly emerged as a serious impediment to Russia in pursuing its foreign policy objectives in the region. Even though Russia is a high income nation, its economy is heavily dependent on natural resources. Over 50 percent of the Russian budget and 70 percent of exports come from oil and related products. Naturally, the rapid decline in oil prices has had an adverse impact on the growth of the economy, which is expected to decrease by five percent in 2015. Other worrying aspects are the decrease in government revenue, increase in the rate of inflation because of a rise in import prices, massive capital outflow due to a sense of panic and uncertainty among the rich, higher interest rates to stem capital outflow and expensive debt services.
It is interesting to note, however, that the ruble flow of income from oil remains somewhat satisfactory, because the depreciation of the ruble has closely followed oil prices. The Russian central bank, drawing on its experience in ruble devaluation leading to growth in the late 90s, does not seem to be in a mood to exhaust the substantial reserve of hard currency—over $350 billion—trying to limit the magnitude of devaluation out of national pride. The attitude of the governor of the Russia’s central bank seems to be to give the market enough flexibility so that important structural changes in the economy become unavoidable.
Dealing with the drop
Will Russia be able to ride over the present crisis? And it is a crisis that the Russian president seems to be aware of, since he has recently announced that he has even taken a cut in his salary in view of the economic condition of the nation.
Awareness of the crisis is the first step in its solution. However, other steps will probably depend upon both the internal power balance as well as external pressure from the West. For the next six months to a year, the trend in oil prices is going to be crucial. If oil prices again rise to anywhere between $70- 80 a barrel, the need for structural changes in the economy will probably be ignored. The decline in oil prices will affect investment, especially shale oil in the US, and therefore, future supply. One study estimates that over 80 percent of shale oil production in the US will remain profitable even in the $50-60 per barrel range. However, if oil prices decline to below $40 per barrel, shale oil energy bonds will then be junk and many facilities will have to close.
It is hazardous to forecast oil prices in the future, but given the investment already made in shale oil, continuous search for cost-effective technology, the reluctance of the Saudis to curtail oil production, and the trend towards fuel efficiency, it seems that oil prices will remain in the $50-60 range over the next few months. This means that for the Russian economy, hard decisions may be difficult to avoid.
Restructuring the economy
Russia is a highly unequal society and Moscow is often considered the ‘billionaire capital of the world’. Its wealthiest individuals—110 of them—own 35 percent of total assets held by Russian households. Putin is a democratically-elected leader but the Russian economy comes close to a form of crony capitalism that uses state power hand-in-glove with politicians for mutual benefit. When growth is high and the economy booming, as was the case in the early part of the first decade of the 21st century, the worst aspects of crony capitalism in Russia remained hidden from public view. But in an economic crisis of the kind that it is now facing, the structural weakness of the economy is coming into focus. To change it overnight is difficult but a diversified economy that relies less on oil and more on technological might will require a new determination to promote competition rather than crony capitalism. This will require a new faith in constitutional checks and balances and less reliance on the one man ‘democratic authoritarianism plus crony capitalism’ that Putin seems to relish.
Given the present crisis in Ukraine, it would not be far-fetched to think that the West sees the current oil prices as an impotant lever to deter Putin from his foreign policy objectives. This is one more reason to think that present prices will continue, since Saudi Arabia, which is a swing producer in terms of setting oil prices, has shown no inclination to reduce output so far. Putin will then have to prepare for hard times ahead and he may have to reinvent himself to manage internal politics. Whether or not he can achieve this transformation, given his ruling style, remains doubtful, but the undisputable fact is that in today’s world, economic pressure can sometimes be more effective than the barrel of a gun.
Lohani is a senior leader of the Rastriya Prajatantra Party