TOPICS > Politics

Energy-rich Russia Hit Hard by Global Financial Crisis

BY Admin  July 1, 2009 at 12:30 PM EDT

Pipelines in Russia; AP photo

During Vladimir Putin’s tenure as president, Russia enjoyed an annual growth rate of 7 percent, according to the CIA World Factbook, using its abundant energy resources to leverage both economic and political power with the rest of the world.

But when the world economy began to tank in 2008, declining demand for commodities like oil and natural gas threatened Russia’s resurgence as an energy superpower.

In the first five months of this year, Russia’s economy shrank by more than 10 percent, the Associated Press reported.

In a grim assessment of the nation’s financial difficulties, Deputy Economic Minister Andrei Klepach told the Russian press that an only 6 percent decline in gross domestic product this year would mark a “heroic achievement for the economy.”

According to the Energy Information Administration, Russia is the world’s largest energy producer and boasts the largest known natural gas reserves. It ranks second to Saudi Arabia in oil production.

From military to energy power

After the collapse of the Soviet Union in 1991, Russia slogged through a decade of political and financial instability. The economy hit a crisis point in 1998 as the value of the ruble dropped precipitously.

When Putin became president in 2000, worldwide energy prices skyrocketed to as much as $140 per barrel, and Russia began to reap the benefits of its biggest cash crop — energy.

Boasting more than 75 billion barrels of oil and a fifth of the world’s known natural gas reserves, Russia offered an exciting economic climate for investors — despite concerns over the government’s hand in controlling businesses and the media.

Putin is often credited with leading Russia through this boom period, in which the country paid off billions of dollars in foreign debt and experienced unprecedented prosperity. In Putin’s eight years as president, wages for the average Russian rose from $80 to $640, according to the AP, paving the way for higher standards of living and the rebirth of cities such as Moscow, which has since become one of the most expensive capitals in the world.

After years of political turmoil that left many Russian citizens poor and discouraged, many observers saw the emergence of a new sense of national pride in the renewal of their economy.

Collecting funds from oil export taxes, the Finance Ministry began a Stabilization Fund in 2004 worth billions to protect oil revenues for future generations and to pay down foreign debt.

In a 2004 report for the Foreign Policy Center, analyst Fiona Hill declared that revenue from oil and gas had transformed Russia from a failing military state into a renewed economic power, putting Russia “back on the global strategic and economic map.”

These achievements led the World Bank to declare that Russia had achieved “unprecedented macroeconomic stability” in 2007.

Energy-related political disputes

Although some analysts contend that Russia’s economic recovery was less the result of Putin’s policies and more an effect of oil prices, they have no doubt that Putin translated the newfound wealth into a political advantage for the former Soviet Union.

Russia still supplies Europe with a quarter of its natural gas and is the sole provider in many Eastern European countries, running pipelines through neighboring nations like Ukraine and Belarus.

A number of recent disputes with pipeline-hosting countries have led some in the international community to accuse Russia of wielding its control over energy resources to raise its political clout.

In 2006 and again in early 2009, state-owned gas producer Gazprom entered into a dispute with Ukraine over raising its deeply discounted gas prices to market prices, prompting Russia to temporarily cut off the energy supply into the country until Ukraine repaid its debt. Other European countries receiving gas from the Ukraine pipeline also saw a drop in their supplies.

The largest natural gas company in the world, Gazprom, became a private company in the 1990s but is still tied to the government. Russian President Dmitry Medvedev is a former Gazprom chairman.

In an interview with the BBC in 2006, Eurasia Group analyst Cliff Kupchan said, “I would describe the mindset right now among the Russian political elite as infused with ‘petroconfidence.'”

According to Steven Pifer of the Center for Strategic and International Studies, energy resources have become vital to the Russian sense of national identity and political standing.

“There’s an old saying from years ago that Russia has two allies; its army and its navy,” Pifer says. “People began to say that Russia’s two allies are oil and natural gas.”

Russian economy shrinking

During Russia’s oil boom, some analysts cautioned against the government’s evident dependency on the energy economy.

A 2005 Council on Foreign Relations background report warned, “Moscow’s maneuvers have validated charges that Russia’s economy is unhealthily tied to oil, a commodity whose value fluctuates widely.”

The dependency can have major economic ramifications. For every $1 fluctuation in the price of oil, Russia’s government can gain or lose about $1.7 billion a year, Merrill Lynch economist Yulia Tseplayeva told the New York Times.

The global economic downturn has hit Russia harder than almost any other nation. The country’s 8 percent growth rate in 2008 vanished in the first part of 2009, shaking confidence in Russia’s strength as an emerging economic power, according to the Times.

According to Pifer of CSIS, Russia’s reliance on energy prices as a source of political leverage has been especially evident since the financial slowdown. “A year ago when oil was up at $140 a barrel, Russia looked a whole lot more assertive than it did a few months ago when prices dropped.”

When the price of oil sank to $40 a barrel in late 2008, speculation grew as to whether Russia would be forced to newly diversify its economy. The drop in oil prices has also forced Russia to begin dipping into its massive rainy-day fund, which is the third largest in the world behind China and Japan.

Unemployment has soared as energy plants closed, and the Kremlin has kept a close eye on the possibility of social unrest in industrial towns. Several protests have popped up in recent months, the most notable of which occurred after factory closures in Pikalyovo put hundreds of people out of work in June, according to Bloomberg News.

But the Medvedev administration has said the closures are due in part to the irresponsibility of businessmen, and that oil prices rising once again — in June they stood at about $70 a barrel — and the rebounding stock market are proof that economic recovery is on its way.

Although some instances of political unrest and small protests in towns are not uncommon, Pifer said the economic downturn has not really reflected a significant drop in popularity for the country’s leadership.

The Kremlin has put great stock in the ability of its billions of dollars in currency reserves to weather the financial storm, and to some extent it has, said Pifer. “Russia will be able to come through this a lot better than if it didn’t have those reserves.

“Unless the industrial world moves away from the need for oil and natural gas, Russia is ready to supply them with the energy that they need,” he added.