The Bear Is Back: Rising Oil Prices Raise Russia's Global Influence

July 16, 2008

Oil, natural gas and the political power of Vladimir Putin have brought Russia back from its precipitous economic collapse in 1998 and left the former communist nation bristling with cash, pride and unprecedented global influence.

That is the richly researched and entertainingly written message of "Petrostate" by Marshall I. Goldman, a Wellesley College economics professor and a senior scholar at Harvard's Davis Center for Russian Studies.

Subtitled "Putin, Power and the New Russia," Goldman's narrative documents Russia's dramatic 10-year conversion from debt-ridden den of corruption to a cash-rich nation that, still, sports an unseemly underside of brutal power politics.

The ruble roars back

Timing has been everything as Putin, president Jan. 1, 2000, through March 2008, rode the rising tide of fossil fuel prices. Goldman writes: "With production and exports down by almost 50 percent and crude oil prices hovering at a low of $10-$12 a barrel, Russia had trouble paying its bills, and as a consequence suffered a massive financial collapse. On August 17, 1998, the government defaulted on its debt and most of the country's private banks closed their doors and locked their vaults."

But by 2005, oil was at $70 a barrel and the once-pathetic ruble was roaring back along with Putin's increasingly large footprint on world affairs, one that has increased further as fuel prices skyrocket.

Putin, a former KGB spy and chief of the KGB's successor, the FSB, became prime minister on Aug. 9, 1999, under ailing President Boris Yeltsin, who appointed him president on Jan. 1, 2000 (Putin was formally elected that March). Putin just became prime minister again, since the March 2008 election of President Dmitri Medvedev.

It is no coincidence that Medvedev, a former Kremlin chief-of-staff and first deputy prime minister also was board chairman of state-controlled (more than 50 percent of shares government-owned) gas giant Gazprom. Formed in August 1989 from the Ministry of the Gas Industry, Gazprom is Russia's largest corporation and the world's third largest, behind Exxon-Mobil and General Electric.

Marshall writes that Putin and other KGB/FSB alumni carry a cachet of power and toughness in Russian politics; Putin used it to bolster his power at the expense of wealthy business executives and unruly regional governors, and to establish state control over the media.

Putin used his galvanized power to capitalize on rising global demand for gas and oil.

"When Putin took over as prime minister in August 1999, the capitalized value of the nation's publicly traded stocks amounted to $74 billion," Goldman notes. "By 2006, the capitalized value exceeded $1 trillion." The result is what Goldman calls a Russian "energy superpower" that can exercise great economic and political influence over world affairs.

Waxing of Russian power

That waxing Russian influence has come as the United States has waned because of its growing trade deficit; increasing dependence on imported fossil fuels; its deepening public debt, much of it held by creditor nations rising in financial strength; and the nearly 50-percent devaluation of the dollar since America went back into annual government deficits in 2001.

"[Russia's] emergence as a new super energy power overlaps with the weakening of the United States as we have squandered our manpower and resources in Iraq," Goldman writes. "Russia under Putin, on the other hand, has developed a new hubris that is not based on mere bluster."

Russia's growing might, Goldman writes, is evidenced by the fact "that as of mid-2007, with more than $420 billion in the state treasury, Russia had the world's third-largest holdings of foreign currency reserves and gold, behind only China, with more than $1.4 trillion, and Japan, with $900 billion."

When most people think of the world's great reserves of oil, they think of Saudi Arabia and other members of OPEC, but Goldman writes that "by 2006, Russia was out-pumping Saudi Arabia. Just as in the periods from 1898 to 1901 and 1975 to 1992, Russia once again became the world's largest producer of petroleum."

As of 2006, the United States imported 3 percent of its oil from Russia, up from 2.2 percent in 2004 and likely to increase. Russia has the largest reserves of natural gas in the world. Although U.S. natural gas needs are largely self-supplied, with supplemental imports from Canada, Europe is another story.

Goldman describes Gazprom's gas empire as a monopoly with "a spiderweb-like maze of natural gas pipelines reaching from East Siberia west to the Atlantic Ocean and from the Arctic Ocean south to the Caspian and Black seas."

The Russians linked their gas pipeline system to Western Europe in 1985, despite the Reagan administration's failed efforts to dissuade General Electric and England's John Brown Engineering firm (President Reagan even lobbied ideological soul mate Prime Minister Margaret Thatcher) from selling the Soviets the compressor technology they lacked.

Russia now supplies gas to 40 percent of German households. The Baltic states and Finland purchase all their gas from Russia.

The obvious suspicion is that the Russians can withhold oil and gas supplies to further their political aims, a notion Putin frequently has discounted. Goldman cites Putin's June 2007 statement at the Balkan Energy Cooperative Summit: "For four decades now, despite the serious and truly global changes in the world, Russia has never broken a single one of its contractual commitments."

Goldman disagrees: "Such assertions ... overlook the fact that the Soviet Union in its day and Russia after 1991 have frequently terminated the shipment of energy supplies when a customer chose to oppose Soviet or Russian political or economic objectives. Yugoslavia under Tito, Israel in 1956, Finland in 1958, China in 1959, Latvia in 1990, Lithuania in 1999 and 2006, and Estonia in 2007 had their petroleum deliveries cut off. Later, Putin's regime halted or reduced the flow of natural gas supplies to Ukraine, Belarus, Georgia, Moldova, and even Bosnia."

Contracts with state-controlled enterprises in Russia provide no guarantee against arbitrary moves, states Goldman, who further observes a longstanding Soviet/Russian pattern: "Concessions made at a time when Russia is weak and prices are low are invariably invalidated once prices rise and Russia regains its strength."

Chinks in Russia's armor

There are chinks in the Russians' energy armor, however, Goldman writes.

From the earliest years in the fossil fuel business, Russians have been dependent on foreign-supplied technology to extract and transport their oil and gas efficiently. Long before the aforementioned reliance on Western compressor technology to pipe their gas, the Russians' oil-drilling technology has been chronically inferior, which opened the door for foreign corporations to get a piece of the Russian profits, though not of Russia's oil and gas.

Secondly, being commodity-rich tends to make any nation less likely to develop manufacturing technology in general. Citing "Dutch Disease," Goldman notes that such nations as Russia and Saudi Arabia tend to accumulate commodity-fueled wealth and to use it to buy manufactured goods from other nations such as Japan and Switzerland that, lacking commodity wealth, have great motivation to develop manufacturing technology.

"Once the Dutch found natural gas off their North Sea Coast, the relative prosperity it brought came at the expense of the country's manufacturing section." Gas exports boosted Dutch currency and undercut prices of foreign imports, so Dutch manufacturing declined along with domestic employment, Goldman reports.

Norway also has natural gas but understood the negative impact energy export revenue can have, Goldman writes. "Norwegians have made a determined effort to shelter the rest of the economy from this energy windfall. They have set aside export revenues in a special fund to hold down inflation and prevent their currency from gaining too much value."

American readers cannot help but wish the United States had such a problem -- not to mention the wisdom to handle it.

So far, Goldman writes, Russia has not inoculated itself from Dutch disease, because of the lack of what Wellesley economist Karl Case terms "a moral infrastructure" of commercial laws and moral codes that are taken for granted in longstanding market economies.

Thirdly, Russians, the Saudis and other nations rich in fossil fuels would stand to lose market share if the rest of the word aggressively developed renewable wind and solar power, alternative fuels and conservation. For the foreseeable future, their revenues will flow freely as energy-voracious China and India base their economies on fossil fuels despite their short-term environmental shortcomings and their long-term economic and political pitfalls.

Goldman says the Russians inevitably will "pile up more and more dollars and euros" and use their cash advantage to acquire and expand overseas assets. For example, in 2000, Russia's large privately owned LUKoil corporation bought almost 3,000 gas stations in the United States from Getty Oil and Mobil.

Although these acquisitions did not include Getty and Mobil oil wells, Goldman writes that such a purchase might not all bad, despite the likely protectionist reaction: "Russian investment in the U.S. energy sector -- at least in petroleum production, refining and servicing -- is a good idea. The Russians are more likely to export petroleum to use and avoid any halt in deliveries if they have operations in the United States ... At the same time, of course, the properties Russians buy in the United States can serve as hostages if that should ever be necessary to offset similar pressures on U.S. companies in Russia."

A challenge to the world order

Goldman packs a tremendous wealth of historical background, economic data and business and political analysis into the 209 pages of text of "Petrostate," along with 14 pages of back notes and source citations, and a six-page glossary of people and companies.

International deal-makers and investors would ignore "Petrostate: Putin, Power and the New Russia" at their peril. Goldman argues that Russia's extraordinary liquidity and status have empowered Russia to challenge the world order.

In a June 2007 speech, Putin called the World Trade Organization and the International Monetary Fund "archaic, undemocratic, and awkward" and said the United States, the European Union and Japan run the world like a private club. The EU selects the head of the IMF, and the United States nominates the World Bank chief.

Putin has questioned why the dollar and the euro serve as world currencies.

He has knocked NATO for opening bases on former Warsaw Pact territory. He has criticized President Bush -- who fawns over Putin and his young successor Medvedev -- for pursuing unilateral policies in Iraq and Eastern Europe.

"The tone and content" of Putin's comments toward "countries that were once enemies of the Soviet Union would have been unthinkable nine years ago," Goldman writes.

"Petrostate" concludes: "There was not much the targets of his attack could do but smile and seek to import more of Russia's gas and oil."

Bottom Line according to Marshall Goldman:

  • Russia is on the way up in terms of oil, gas and financial strength.
  • Vladimir Putin's rule could not have been better timed to capitalize on Russia's oil and gas. His influence has helped Russia exploit its resources to the max.
  • Despite Russian assurances to the contrary, the USSR and now Russia have not been bashful about throwing around their fossil fuel weight to influence politics outside their borders; nor have they been reticent to play rough in the world of capitalism. Let the buyers of Russian stocks and the business people making deals in Russia beware.
  • While the ruble gains value, the dollar sinks, and Russian challenges to the preeminence of the euro and the dollar can only be expected to become bolder and more frequent.
  • A U.S. push toward renewable energy can only help it, economically and evironmentally.