Russia's Power Failure

When commodity prices were at a peak in 2007-08, and oil prices in particular hit $147 per barrel, Russian leaders declared their intention to make Russia an “energy superpower.” Not only did they expect a never-ending flow of petrodollars, but they intended to use Russia’s vast energy resources to reclaim a seat among the world’s most powerful nations. Being the main supplier of natural gas to Europe, they aspired to flex their political muscle and get their way by turning the spigots on and off.

To this end, Russia announced two new gas pipelines, the Nord Stream and the South Stream, to diversify delivery routes to Europe, and began building oil and gas pipelines to the Far East. As befits an “energy superpower,” Russia effectively pushed foreign companies out of key exploration projects.

Even under best-case scenarios for energy prices, using natural resources as a political tool has always worked poorly in the past, not just for Russia but for OPEC, Venezuela and other producers. Given today’s market conditions, Russia’s energy policies have proved nothing short of disastrous. But it could have been predicted — because “energy superpower,” like any “commodity superpower,” is a contradiction in terms.

Unpredictable Prices

Energy prices are remarkably hard to predict. Time and again, analysts fall into the trap of projecting existing trends forward. Back in 1973, months before the first oil shock, there were forecasts of an oil glut and dirt-cheap oil. The 1970s, conversely, were marked by fears that oil would run out by century’s end. Then, after such fears failed to pan out, oil prices rocketed in the first decade of the new millennium and we were told that this time the feared imminent shortages were genuine.

Today, we’re once more going through a period when oil supply is increasing and demand is sluggish or declining. There is suddenly talk of a green revolution that will permanently depress demand.

Such forecasts exacerbate cyclical price swings. They set into motion energy conservation efforts when prices are high, while also encouraging producers to invest ino exploration projects which come on line just when a fresh glut develops.

Oil-exporting nations benefit from high oil prices, but they are also their greatest victims, over-investing and taking on extra debt on expectation that petrodollars will flow in indefinitely. Their debt problems, in turn, hurt creditors and their need to service debt at a time when prices are low forces them to dump more oil into already oversupplied markets.

Russia presents a classic example of such overreach and over-commitment, and financial problems that will plague it in the near future are already becoming evident. But in Russia’s case, the wasteful and misguided spending has been exacerbated by outsized political ambitions.

Russia’s perennial squabbles over natural gas transit through Ukraine and Belarus, which in recent winters left Europe shivering, convinced EU governments to look for new supplies just as Russia prepared to sink some $20 billion in the construction of two new pipelines running westward.

Spending in the East

In 2009, Russia opened its first plant producing liquefied natural gas (LNG) in the Far East. But plans to conquer the U.S. market, where Gazprom, Russia’s state-owned natural gas monopoly, aspired to capture a 10 percent market share, have been put on hold. The main problem has been that demand for LNG in the U.S. has declined and prices have been driven down by a sharp increase in the production of natural gas from shale. Gas and oil from shale is still costly to produce and environmentally dangerous, but these are technological problems that are being rapidly solved, potentially swamping oil and gas markets over the long run.

The Asia-Pacific market is a legitimate place for Russia to sell its energy, but it has also been a trump card Russia hoped to play to frighten its European customers by showing that it can find alternative markets for its oil and gas. Late last year, Prime Minister Vladimir Putin opened the first stage of the Eastern Siberia-Pacific Ocean pipeline, which will deliver oil from Western Siberia to China. The cost has been put at $12.2 billion. China, meanwhile, took full advantage of Russia’s desire to do business. It has obtained a highly advantageous, secure long-term contract for oil in exchange for a $25 billion loan.