In the face of biting Western sanctions and an unforeseen and rapid fall in the price of oil, Russia has been forced to acknowledge some unpalatable truths about its creaking, energy-dependent economy.
However, it was only at the eleventh hour, facing a shrinking economy, record capital flight, rising inflation and a new rouble crisis, that Russia’s leaders decided that the world’s ninth-largest economy needed a new energy and economic policy. Over the past year president Vladimir Putin and his premier, Dmitry Medvedev, have criss-crossed the world, visiting global leaders and potentates in the quest to foment and cement major new energy deals.
Few emerging markets have been overlooked during their grand tour. In Latin America, they visited Argentina and Venezuela, troubled economies hamstrung by poor relations with the US; in south Asia, India and Pakistan, energy-poor nations seeking new allies in an uncertain world; in Europe, Hungary and Greece, struggling states run by
populist leaders long admiring Putin’s strongman style. Beyond that lies a diverse grouping of countries either amenable to Russia’s approaches or lacking a specific resource or technology in which Russia excels or abounds, from Thailand to Argentina and Turkey to South Africa.
And then there’s China. When the two countries signed a $400bn gas deal in May 2014, it was widely viewed as a breakthrough deal between the two nations and the first sign in the post-Soviet era that Russia was willing to pivot away from its traditional economic allies in Washington, London and Berlin.
Each side had something to offer: Russia had the hydrocarbons; China, the cash. For more than a decade the two had flirted with one another without quite committing.
SMILING PUTIN
Only after Western sanctions began to bite, hampering the ability of Russian lenders and energy groups to raise fresh US dollar financing, did Moscow finally come to the table, pledging to pipe 38 billion cubic metres (bcm) of Siberian gas each year to mainland China from 2018. Putin smiled and announced a glorious new dawn for Russia’s economy and energy apparatus.
But for all the topline glamour, those tie-ups also camouflage the nature, scale and nuance of the challenge now facing Russia’s shifting, energy heavy economy. For one thing, while written up as a game changer, Russia’s pivot toward Asia in general, and China in particular, is merely the continuation of a long term trend. Russia has been quietly diversifying away from Europe for years. In the third quarter of 2011, Germany and the Netherlands consumed around 30% of all exported Russian oil, according to data from economic provider CEIC. By the third quarter of 2014, that share had fallen to 22%. Over the same period, China’s share of Russian oil rose to 14% from 9%, with combined exports to Japan and Korea doubling, to 10%.
Vladimir Sklyar, head of research at investment bank Renaissance Capital, sees this as a long term process, as a rising Asia replaces a sluggish and directionless Europe in Moscow’s affections. “Russia is changing its partners,” he says. “It’s a slow and gradual process that isn’t happening overnight, but you are seeing a shift away from Europe and the West and a simultaneous rapid development and build-out of ties with new Asian partners.”
Adds Tatiana Orlova, strategist, Russia & the CIS at RBS Markets & International Banking: “Major domestic oil and gas producers like Rosneft and Gazprom are reorienting themselves toward the eastward shipment of more Russian oil and gas production. China is the clear target, the biggest game in town. But Russia is also keen to use the country as a gateway into other markets across the region, [including] Korea to southeast Asia. This marks a clear change in the long term direction of Moscow’s energy trade.”
LOOKING SOUTH AND EAST
Russia is also looking south and east at new options. In February, deputy premier Dmitry Rogozin announced that Russia and India were looking to build a pipeline between the two countries. Two months later, Pakistani petroleum minister Shahid Khaqan Abbasi said Russia and his country had inked a $2bn deal to build a 1,100 kilometre-long gas pipeline stretching from central Siberia to the port city of Karachi.
The Russian president is also stepping up efforts to secure new routes into Europe, a market that will continue to remain, notes Liza Ermolenko, emerging Europe economist at London-based Capital Economics, “a vastly important market for Russian gas producers for years if not decades to come”.
Stymied by Brussels in his attempts to finalise the South Stream pipeline, which would have involved the transmission of Russian gas into Austria and Italy via the Black Sea and Bulgaria, Putin in December abruptly switched tack.
During a state visit to Ankara, he signed a memorandum of understanding with his Turkish counterpart Recep Tayyip Erdogan. Scrapping South Stream, Putin said Turkey would become a key buyer of Russian gas and also a regional hub, serving markets in southeastern Europe.
A determination to secure new energy pacts is also forcing Russia to reach far back into the Soviet playbook and to accept some unusual deal structures. Over the past three decades, Russia has eschewed import substitution deals that involve the exchange of oil and gas for other commodities, preferring to sell energy directly to wealthy European sovereigns.
Yet in April, Putin again showed his willingness to compromise and adapt, confirming a longstanding oil-for-assets barter programme that would see Russia buy up to 500,000 barrels of sour Iranian crude per day, in exchange for Russian grain, equipment, steel and construction materials. Analysts said Russia was likely to consume the Iranian oil internally, allowing it to earn marginally more in 2015 and 2016 from its own oil exports.
CHINESE MEGADEALS
Then there are last year’s China megadeals. Russia made much of the simplistic nature of these transactions, which, it said, would involve gas being piped from Gazprom to its mainland peer, China National Petroleum Corporation. Not so, some analysts say. Neither of the deals has been finalised and no price has yet been set. Charles Robertson, global chief economist at Renaissance Capital in London, warns that Russia might wind up earning far less than it expects or hopes. “The aim is for China to take the oil, but to offset the cost by shipping Chinese-made goods in the other direction and by building major infrastructure projects using Chinese engineers, technology and knowhow.” Adds RenCap’s Sklyar: “It may seem funny to see Moscow suddenly embracing the import substitution theme, as Putin had 15 years to make it work. But however long they waited, they are taking it seriously now.”
Perhaps more jarringly, Russia has attempted to inject renewed vigour into its faded alliance with North Korea, another unpopular regime. Russian mining groups were recently handed licences to exploit the Hermit Kingdom’s copper reserves in return for building much needed road and rail infrastructure. Russia, analysts said, also had its eye on building natural gas terminals on the country’s east coast, giving it another route into the lucrative east Asian market.
NUCLEAR OPTION
Perhaps the only area in which Russia has shown a willingness to formulate a clear and diverse global energy footprint is in nuclear power. The state owned nuclear energy firm Rosatom now has 29 nuclear reactors in various stages of production around the world, from the Middle East to Latin America to south and east Asia, more than its chief rivals, France’s Areva and Westinghouse of the United States.
Nuclear power has long been a quiet domestic success story. Even during the dog days of the 1990s, the Russian leadership remained committed to the industry, ensuring that it retained the best engineers and taking Rosatom and its suppliers on key state visits to emerging markets. “Despite the industrial malaise of the post-Soviet era, Moscow continued to take the nuclear sector seriously,” notes RenCap’s Sklyar. “It still boasts technology that’s as good and as cheap — if not cheaper — than any rival can hope to offer.”
He says Russia remains financially committed to supporting new, overseas nuclear power projects, despite the rising pressure of sanctions, noting: “If this is a national project, Putin will make the money available,” whether directly or via leading lenders such as Sberbank.
In comparison with Areva, which hasn’t struck a deal outside France since 2007, Rosatom has worked furiously in recent years to conclude billion dollar deals. It is building two nuclear power reactors in landlocked Jordan, set to be completed by 2022, and in Egypt, where it is building the country’s first nuclear plant in the northern port city of Alexandria.
In March, Putin inked a $10.8bn deal with his Hungarian counterpart, Viktor Orban, to build and install two reactors in the south of the country, a deal that raised Europe’s regulatory hackles.
Other countries in which Rosatom is working to boost its presence include Iran, where it is building two new reactors at the Bushehr site, and India, which in December signed an agreement to let the Russian state firm build 10 nuclear power generating facilities over the next two decades. Rosatom is also looking to peel open markets including Kenya, Ethiopia, South Africa, Brazil and Argentina.
ECONOMIC CONTROL
Rosatom allows Russia to work to its core strengths, notably harnessing the power and asserting political and economic control over its customers. The first point is easy to explain. Since ascending to the presidency in 2000, Putin has yoked leading corporates to the state, creating globalised firms, from Gazprom to Rosneft to Sberbank, that conform to the government’s policy.
The second factor is more compellin and curious. Few sovereign governments obsess about control quite so much as Russia’s. Gazprom’s falling out with Europe over South Stream occurred largely because Europe feared a single, Russia-controlled firm having such a chokehold over the regional delivery of gas.
Even in the nuclear power sector, Russia is keen to maintain control over its customers. Long after Rosatom has installed its plants, sovereign clients will still be wedded to Moscow, as Russian nuclear plants are powered by a specific type of molybdenum only produced at home. “Russian nuclear technology is built to ensure that it can only use Russian nuclear fuel,” says RenCap’s Sklyar. “You cannot switch to non-Russian uranium, and this ensures that customers have to buy Russian fuel for at least 20 years.” And why? “Because Russia likes to wield influence over the countries it does deal with."