Analysis

Inertia might put Russian energy on a diet

On January 7, Russia’s former Deputy Energy Minister and well-known economist Vladimir Milov gave a speech at Columbia University about Russia’s woes in a time of low oil prices and Western sanctions. Paolo Sorbello gives this account of Milov’s argument.

Vladimir Milov. Photo by Creative Commons license. Created by AleAlexander.

Vladimir Milov.
Photo by Creative Commons license. Created by AleAlexander.

Milov’s intervention was bold and direct, a rollercoaster of facts and numbers. Reciting all manner of energy figures he had memorized over the course of the year, Mr Milov depicted a bleak picture for Russia’s oil and gas complex. Although oil prices have become a problem for all energy-exporting countries, Russia’s production costs are still low, which leads Mr Milov to argue that another set of issues is holding Russian energy back: the inefficiency of the centralised system and Western sanctions.

Central to Mr Milov’s accusation was the inefficiency of the infrastructure Putin created with the centralisation of the energy industry, which has continued for the entire Putin era, from Rosneft in the 1990s to Bashneft last November. According to the expert, bureaucracies are eating up capital that could have been otherwise used for investments in new, “green” fields.

Instead, Russian companies have focused on “brownfields” first developed in the 1980s, which have already reached a plateau in their lifespan and are starting to yield lower and lower quantities. In addition, big state-owned companies tend to behave conservatively and only explore regions that are closely connected to the existing grid. “Bashneft’s creativity in the Volga region is what distinguished it from Moscow’s behemoths, and allowed the small private company to have a better performance,” he argued.

Given that lifting costs are still pretty low for energy companies, especially in the oil sector, businesses in that industry won’t necessarily be as hurt by the lower oil prices as might be expected, according to Mr Milov. Instead, the state-driven economy will take the hit.

“The political and strategic inertia will quickly consume the state budget, by draining the Sovereign Wealth Fund, which was precisely accumulated through oil and gas revenues for ‘rainy days’. However, the original concept regards rainy days for people’s pensions and subsidies, not for the same companies that filled those coffers. This way it’s like they have never been taxed! It’s only a matter of months before Gazprom follows Rosneft’s example and pledges for a huge injection from the SWF.”

According to Mr Milov, another uncomfortable matter for the Russian energy sector is the level of sanctions that the West has posed. Given that nothing changes with US sanctions, “Moscow is banking on the idea that the EU won’t renew sanctions after they expire in July 2015.”

Mr Milov thinks this is a daring bet. “Sanctions have a more influential role in the current economic crisis than the oil prices plunge: Western credit was keeping Russian banks afloat.” Now that credit lines are closed, even lifting the sanctions next July will not help reduce the risk perception. In Mr Milov’s words, the fact that China is ready to lend money for Russia’s enormous projects is a “myth,” as Beijing generally only lets countries borrow capitals to finance the imports of Chinese goods and services. Meanwhile, ordinary Russians are suffering because the rouble crisis slashed their purchasing power.

Mr Milov argued that the Russian oil and gas sector has lived through a period of inertia and the peak period has passed. “You won’t see anything catastrophic next year or the year after in terms of production. But in the long term we will notice how the curve has already traced the downward turn,” Mr Milov assured. He predicts that several projects will be abandoned or scaled down, and some corruption scandals will emerge.

Towards the end of the hour-and-a-half meeting, Mr Milov summed up the issue with a popular joke emerged during the Soviet crisis of the 80s and again during Russia’s financial crisis in the 90s: “A father comes home and tells his children that his salary won’t be enough to support the family. The children ask: ‘Does this mean you will drink less, dad?’ The father replies: ‘No, it means that you will eat less.’ The Russian energy sector, after years of sweeping problems under the rug, might soon be faced by a similar problem.

Paolo Sorbello is Chief Editor at Energy Brains and Deputy Editor at The Conway Bulletin.

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