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Corruption, Power, and Oil: The Russian Legacy of Fossil Fuel Production

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Fossil fuel

Russian Oil Production

As a major global producer and exporter of oil, natural gas, and coal, Russia’s economic growth is primarily driven by its fossil fuel reserves. With a post-Soviet Union record of 11.3 million barrels of oil produced per day in 2018, Russia is the world’s second largest oil producer, only behind the United States (Clemente, 2019). In 2016, oil and natural gas revenues alone accounted for just over 36 percent of the country’s federal budget revenues (EIA, 2017).

When oil prices hovered around record highs in the early 2000s, Russia’s gross domestic product (GDP) surged by over 15 percent, which brought in billions of dollars to its treasury, boosted its citizens’ personal incomes by nearly one-third, and substantially enhanced Russia’s position in the world (Aron, 2006). However, because of Russia’s dependence on hydrocarbon production, many economists and energy analysts highlight Russia as a prime example of what is known as a petro-state, where an economy is so intertwined with fossil fuel production that it consistently undergoes a series of boom and bust periods.

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Corruption and Dependence

Russia is often included on the list of countries that have been impacted by the so-called “natural resource curse” the argument that wealth from an abundance of natural resources would undermine a country’s economic stability and democracy. Because the country’s oil and fossil fuel industries are largely controlled by a handful of oligarchs and influential politicians, some economists view Russia as an authoritarian government that will continue to impair democratic institutions for the foreseeable future.

Russia’s current political system is equally distorted by dependence on fossil fuel exports since the government is often referred to as bloated and corrupt, while private sector innovation is lacking, and public life is impacted by an array of repressive policies (Gustafson, 2012). Moreover, Moiss Nam, the Editor-in-Chief of Foreign Policy Magazine, and a prior trade and industry minister for Venezuela, has said, “Russia’s future will be defined as much by the geology of its subsoil as by the ideology of its leaders” (Treisman, 2010). The combination of Russia’s enormous oil, gas, and coal reserves, coupled with weak public institutions, have the tendency to produce poverty, exacerbate inequality, and incentivize corruption. Tom Friedman, a prominent columnist for the New York Times, frequently references the close relationship between natural resource commodity prices and democracy in oil-rich countries. He has even gone as far as saying that higher oil prices would equate to less freedom for average citizens in oil-rich countries like Russia (Treisman, 2010).

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The Soviet Union Legacy

The former Soviet Union set the stage for Russia’s current economic dependence on the fossil industry. Because of its advanced technological and industrial power, the Soviet Union was not thought of as a petro-state. Although, as the Soviet Union began to disintegrate, natural resources, primarily oil and natural gas, were seen as some of the last commodities of value for Soviet leaders. Therefore, when the Soviet industrial system collapsed, modern-day Russia was left with an economy that was centered around the fossil fuel industry. As Russian manufactured goods continued to become less competitive on the global market, the country began to shift even more of its resources toward the development of its massive fossil fuel reserves. What differentiates Russia from other petro-states of the world is that the Russian oil industry is reinforced by established scientific and engineering institutions that are led by well-educated professionals, bureaucrats, and highly accomplished technologists.

As a major industrial power that is dependent on the fossil fuel industry, oil and gas profits have fueled widespread corruption, loosened budgetary discipline, and aggravated the pathologies commonly associated with the “resource curse” (Gustafson, 2012). An essential component that has shaped Russia’s current political and economic relationship with the fossil fuel industry is the long and tenuous departure from the grip of the former Soviet Union. The Soviet legacy resulted in physical, cultural, technological, and political implications for Russia’s oil and gas industry (Gustafson, 2012). While the fossil fuel industry that Russia inherited from the Soviet Union was technologically advanced, it was also significantly inefficient and politically corrupt. The Soviet Union’s dependence on a small number of large oil fields in West Siberia, coupled with unconventional practices used to maximize production of those fields, severely hindered Russia’s ability to enhance production in other parts of the country. Moreover, the significant plunge in oil prices during the 1980s created an economic crisis for the Soviet Union that was later inherited by the Russian government (Treisman, 2010).

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Boom and Bust

Russian oil production, which led global production up through 1987 with 11.4 million barrels per day, declined significantly over the next eight years, before collapsing to a low of 6 million barrels per day in 1996, which was slightly more than half of the Soviet Union’s production peak (Gustafson, 2012). The inefficiencies of Soviet-era fossil fuel production resulted in the development of what became known as a “dark barrel” of oil because of the low-quality diesel, fuel oil, and low-octane gasoline that was wastefully consumed in vehicles and home furnaces without a concern for environmental impacts or human health. Moreover, in an effort to spur production in the West Siberian Bazhenov shale layer during the 1980s, the Soviet government spent a great deal of time and resources trying to stimulate oil production by detonating small nuclear devices underground (EIA, 2017). Despite these efforts, the Soviet government made very little progress on developing shale oil projects.

While the Soviet Union was once one of the world’s leading oil producers, the legacy of its unconventional oil and gas production efforts has hindered Russia’s ability to enhance the efficiency and modernization of its fossil fuel production. Another issue with Soviet-era fossil fuel production was the fact that their oil and gas industry was run almost entirely by geologists and petroleum engineers, whereas other global oil and gas leaders also employed a vast number of lawyers, economists, financial analysts, and other business professionals that helped to continually transform and adapt the industry.

Given the lack of professional diversity among the Soviet Union’s fossil fuel industry executives, the transition from Soviet production to Russian production was further complicated. Following the downfall of the Soviet government, Russian leaders made a move to privatize its oil industry in an attempt to take more control of fossil fuel sector organization. Beginning in the latter half of the 1990s, privately-owned Russian oil companies started to finally drive growth for the Russian oil industry. A large number of international oil companies also made moves to enter the Russian market with differing degrees of success (EIA, 2017).

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A Turing Point for Success in the Fossil Fuel Industry

Beginning in the mid-2000s under the leadership of President Vladimir Putin, Russia’s political and economic system started to shift towards a more stable and prosperous model that helped the country become a global oil and gas industry leader. Even though the transition from the state-owned Soviet-era oil industry to the privatization of the Russian oil industry was the focus of scrutiny from American media outlets like the New York Times and the Washington Post, the transition to private control of oil and gas companies was an overall success for Russia. American criticism was directed at the possibility of future oligarchs controlling the majority of Russia’s oi reserves, which was partially directed at concerns about industry corruption, bribery, and fraud. While the privatization process was not a fair or impartial process by any measure, Soviet-era fossil fuel production was just as corrupt and impartial as the transition to privatization (Aron, 2006).

One of the companies in the spotlight during the Russian privatization era was YUKOS, which was previously a state-owned corporation that became largely controlled by Mikhail Khodorkovsky, a well-known oligarch who had been funding political opposition and civil society groups (Treisman, 2010). When Khodorkovsky first gained control of YUKOS in 1996, the company’s oil production was on a downward decline, salaries were being slashed, and bankruptcy negotiations had started. However, between 2000 and 2004, privatization led YUKOS to double its oil production and pay dividends to its roughly 60,000 shareholders in excess of $300 million in 2000, $500 million in 2001, and over $700 million in 2002 (Aron, 2006). Furthermore, the success of YUKOS also helped to bolster Russia’s economy as a whole. During the late 1990s and early 2000s, it was reported that tax revenue from YUKOS alone accounted for more than five percent of Russia’s national budget (Aron, 2006).

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The Success of Privatization

The astounding success of YUKOS was representative of the larger story with Russia’s privatized oil industry. Between 1999 and 2004, private sector oil production grew by 47 percent and reinvested $36.4 billion (about 88 percent of profits) in exploration, drilling, and technology upgrades (Aron, 2006). Interestingly, during the same period of time, the success of the private Russian oil companies started to spill over into the state-owned companies as well. Rosneft, the largest state-owned company in Russia at the time, increased oil production by 14 percent between 1999 and 2004 (Aron, 2006). However, after 2004, Russian oil production started to slow down, and in 2008, production declined for the first time since the early 1990s.

The Great Recession was particularly challenging for the Russian oil and gas industry. Since the Russian government’s primary source of income came from the fossil fuel industry, the collapse of oil prices sent shockwaves through the Russian economy. To make up for a loss in revenue, the Russian tax system started to wreak havoc on the country’s oil system. The Russian government’s 90 percent tax on company profits (the highest fossil fuel tax in the world) hindered oil company plans to invest profits into new oil fields, drilling operations, and new technology (Gustafson, 2012). The previous success of the Russian oil boom that was initiated by the widespread privatization of the oil industry was now threatened by the Russian government’s economic policies and attempts at quasi-nationalization, which amounted to the redistribution of oil wealth rather than allowing oil companies to focus profits on long-term efforts that would support the growth of the industry (Aron, 2006).

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Efforts to Regain Industry Strength

Russian state oil and natural gas revenues have declined significantly in recent years as a result of depressed oil prices. Rising economic concerns have also led to taxes being raised on the oil and gas industry, which has threatened the long-term health of the industry. In an attempt to raise revenue, the Russian government recently revealed that it would be selling shares in state-owned oil companies like Bashneft and Rosneft. In December 2016, Russia announced that it had sold a 19.5 percent stake in Rosneft for $11 billion to Glencore (a global commodity trader) and the Qatar Investment Authority (EIA, 2017). Furthermore, Russia also recently made an agreement with the Organization of the Petroleum Exporting Countries (OPEC) and several other oil-producing nations in an attempt to stabilize global oil prices. The agreement related to oil production cuts has been aimed at reducing the supply of oil on the global market, which should in turn raise prices.

While the plunge in oil prices has adversely impacted the Russian economy, the oil and gas industry is poised to continue to fuel Russia’s political economy for the foreseeable future. Studies suggest that higher oil prices have resulted in between one-third and one-half of Russia’s total economic growth since 1999 (Treisman, 2010). Since joining the OPEC-led initiative to prevent oil from flooding the global market, Russia looks primed to regain its strength as a global oil and gas leader. Russia’s oil exports surged 40% when compared to 2017, achieving a total value of $130 billion (Clemente, 2019). Moreover, with over 110 billion barrels of oil in proven reserves, Russia should be able to maintain its robust system of exports for decades to come.

Sources

Aron, L. (2006). “Russia’s Oil: Natural Abundance and Political Shortages.” American Enterprise Institute.

Clemente, J. (2019). “Does the U.S. Import Oil from Russia?” Forbes.

EIA. (2017). “Russia International Oil Analysis.” U.S. Energy Information Administration.

Gustafson, T. (2012). “Wheel of Fortune: The Battle for Oil and Power in Russia.” Harvard University Press.

Treisman, D. (2010). “Oil and Democracy in Russia.” National Bureau of Economic Research.

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