x Abu Dhabi, UAEMonday 22 January 2018

Wheel of Fortune details the boom-to-bust oil industry in Russia

In his new book, Thane Gustafson looks at the travails of the Russian oil industry, from the late Soviet era to the present.

Modern-day Russia is "a country that exports oil, girls and future Nobel Prize laureates," remarked one minister glumly about his homeland. Oil has buoyed Russia's fortunes in the tumultuous decades following communism's demise, and even propelled it to short-lived heights in the mid-2000s, before crashing it back down to Earth again. As much as the symbiotic relationship between the state and the hydrocarbon industry has shifted since the Soviet years, they remain locked in a fierce battle for property, profits and power.

"The key to the fate of Russia," argues the Georgetown University professor Thane Gustafson in his book, Wheel of Fortune, "is the fate of Russian oil." Russia is the world's largest combined exporter of oil and natural gas, and its reliance on its export behemoth is unlikely to change dramatically in the future. This isn't an altogether grim prognosis, argues Gustafson, who otherwise attributes much of Russia's woes to its oil marketing. Russia can finally get it right too, he argues, by modernising and liberalising its oil industry in a dynamic global energy market. Otherwise it's in store for some very hard times, as the free ride is nearly over.

Gustafson surveys the travails of the Russian oil industry from the late Soviet era to the present. Since communism's fall in 1991, Russia has coasted on an oil legacy bequeathed to it by the Soviet Union. In the mid-1980s, the Soviets led the world in oil production. The inefficient, state-run colossus provided the regime with hard currency that propped it up, despite the fact that the industry was falling ever more behind the West in terms of technology, computing and communications. As the state began to teeter in the late 1980s, so did the oil industry, its output sinking steadily from a 1987 high to record depths in the 1990s.

When the Iron Curtain crashed down, the oilmen of the East and the West clashed, explains Gustafson, like two alien worlds. "To the Russian oilmen, the global oil industry was a confusing swirl of unfamiliar players, brash and fast-moving and diverse, and speaking strange tongues," he writes. The Russians' equipment was hopelessly outmoded and its entire oil-equipment sector, based in Azerbaijan and Ukraine, was lost when the former republics struck out on their own.

The Soviet Union's disintegration left a dozen weak, flailing states in its wake, one of which was Russia. The country struggled mightily throughout the 1990s as proponents of change locked horns with stalwarts of the ancient regime and the economy bottomed out. Positively, during the decade reformers created a private sector complete with a new legal code and property rights. Through privatisation the oil industry liberated itself from the grip of the state, even though the oil resources themselves, the pipelines and export levers remained in state hands.

This free-for-all, with the state prostrate, was the hour of the oligarchs. A handful of emergent tycoons, like the currently imprisoned Mikhail Khodorkovsky, became fabulously wealthy by snapping up the state companies at rock-bottom prices. Foreign oil companies became active in Russia and high-tech replaced antiquated Eastern Bloc machinery. For all their faults, the entrepreneurs orchestrated a renewal of the oil industry that the state never could have managed on its own.

But the state recovered, thanks in part to the work of the oligarchs. By 2000, Russia was back on its feet, thanks to rising oil production and soaring oil prices. A resurgent economy bolstered living standards as real incomes rose 2.5 times. Export revenues spurred consumer spending and growth. But for the wealthiest of all, the private sector oil barons, it was a boom during which they'd be stripped of their oil fields, landing the likes of Khodorkovsky in jail.

"Too many potentially powerful groups had been excluded from the initial division of the spoils of the Soviet system in the 1990s," explains Gustafson, "and they were bound to challenge the winners' control, using the coercive power of the state."

By 2003, the state was in the process of recapturing the family jewels. In 2004, Vladimir Putin came to power in the Kremlin. Shortly thereafter, foreign investment was restricted and many - but not all - of the oligarchs disempowered.

But the story doesn't end here. Russia's heady decade came to an abrupt end when the world economy stalled and oil prices bottomed out. This, Gustafson argues, is the fate of countries that rely on raw material exports.

In his analysis of Russia and its oil, though, Gustafson underscores that Russia is not a classic petro-state, as others argue. Countries that rely on a single raw material often experience cycles of boom and bust linked to commodity prices, high inflation and currency appreciation, as well as a corrupt, bloated state sphere. Politics, business and power revolved around the largesse of the export crop. This is also called "the curse of oil". But Gustafson warns that Russia has and the Soviet Union had an advanced industrial base, an educated workforce, and, before the Eastern Bloc's collapse, a diversified manufacturing sector. "What set the stage for Russia's massive dependence was the implosion of the Soviet industrial system," the author argues, "which left natural resources, chiefly oil and gas, as the chief remaining source of value, while Russian manufactured goods became even less competitive in global market than before."

Gustafson ominously warns Russia that it has to change its ways. It is more dependent on fossil-fuel exports now than ever before. Most of the easiest to extract, high-quality hydrocarbons, however, have already been exhausted. Russia's vast oil reserves are ultimately finite, and dwindling fast. "The Soviet legacy is now at the point of diminishing returns," he argues.

Thus Gustafson sees three competing options for Russia and its oil. The first is the high-tech modernisation of the entire economy, a vision that he associates with Russia's current prime minister Dmitri Medvedev. As president, before Putin grabbed the post back, Medvedev tried to make a name for himself independent of Putin by formulating an agenda of economic modernisation and diversification. His high-tech offensive revolved around getting Russia up to speed on the state-of-the-art in computers, nanotechnology, advanced medicine, nuclear power and space. He wants the revenues from the oil industry invested in high-tech manufacturing, rather than reinvesting them in the oil sector itself.

A second option is that of Russia's free-market liberals, namely a revival of the liberal market reforms of the early 2000s. They see more and more of the oil profits absorbed by the state. Russia can't make these changes in the old, paternalistic top-down way. Rather, the country has to be opened up for investment. Low inflation, a strong currency and strong property rights would provide a conducive climate for investors.

And then there's Putin, who ascribes to a traditional understanding of the nation's oil industry. According to Gustafson, Putin believes that oil is still abundant - Russia just has to look harder for it. Also, the purpose of Russia's oil, in the hands of big state-owned companies, is to finance the state and its budget. "In short," concludes Gustafson, "the state remains the engine of growth and progress. The job of the oil industry is to provide the fuel for it."

Even though Putin's grip on power looks as strong as ever, Gustafson notes that all three visions are represented in Russia's political class. Also, all three are critical of oil dependence and believe that Russia has to compete on the world market in other sectors.

Gustafson argues that Russia can't move too far away from oil. In anticipation of tough times, Russia has to return to its roots as a knowledge industry. The discovery of shale oil and gas illustrates how true this is. With innovations along these lines, Russia can turn its inheritance into something new that it creates itself. But the endeavour to shore up an ever more authoritarian state with the oil industry as a trump card, as many suspect is Putin's strategy, can't work as it has in the past.

Paul Hockenos is the author of Joschka Fischer and the Making of the Berlin Republic: An Alternative History of Postwar Germany.