U.S. Fracking Threatens Russia’s Energy Dominance

Russia falls behind in natural gas industry

Vladimir Putin
Vladimir Putin / AP
August 14, 2013

The ongoing "shale revolution" in U.S. oil and gas production could prompt Russian President Vladimir Putin to institute economic and political reforms that would ultimately undermine his regime, experts say.

Putin largely relied on oil and gas production to fuel economic expansion during his first two presidential terms from 2000 to 2008. Hydrocarbons accounted for half of Russia’s GDP growth since 2000, according to a May report by Leon Aron, resident scholar and director of Russian studies at the American Enterprise Institute.

Russia is one of the two largest oil producers in the world, responsible for 12 percent of global oil output, and the world’s leader in natural gas production, accounting for 20 percent of global gas output.

However, there are signs that Russia’s energy dominance is increasingly vulnerable.

Russian energy giant Gazprom has lost more than $280 billion in market value since 2008. Experts on the country’s economy and governance attribute the decline to U.S. investment in the innovative oil and gas extraction technique of hydraulic fracturing, or "fracking," which dampened U.S. demand for imports and exerted downward pressure on global gas prices and Gazprom’s profits.

Russia’s overall economic growth slumped to just 1.2 percent in the second quarter, significantly lower than the economic ministry’s forecast of 1.9 percent.

"Russia’s business model for development over the next decade is trashed," said Donald N. Jensen, resident fellow at the Johns Hopkins School of Advanced International Studies’ Center for Transatlantic Relations, in an interview.

Fracking—the injection of a mixture of sand, chemicals, and water into shale rock formations to extract oil and gas—has positioned the United States to become a top energy exporter. April marked the sixth consecutive month for the U.S. as the world’s leading petroleum producer. The World Energy Outlook’s 2012 report estimated that the United States will become a net exporter of natural gas by 2020 and energy independent by 2035.

Russia has been slow to respond, Jensen said. Gazprom CEO Alexei Miller called the discovery of extensive gas deposits in shale rock a "myth" in 2010, adding that it would not displace conventional gas. The state-controlled company accounts for 78 percent of Russia’s gas output and has been widely condemned by transparency advocates for its corruption and mismanagement.

Jensen also noted that the abundance of natural gas in the United States induced Middle Eastern countries to redirect their tankers toward Europe, enabling countries like Germany to bargain with Gazprom and others for lower prices. Gazprom’s exports to Europe decreased by 8 percent in 2012 to the lowest level in a decade.

"The Europeans have a lot more wiggle room in terms of the kinds of deals they can get," Jensen said.

The European Commission also initiated antitrust proceedings against Gazprom to investigate allegations of price fixing, which could further erode the company’s market share in Europe. Other oil and gas importers, including Ukraine and China, have begun to explore their own sizable shale resources.

Unlike Russia’s oil companies, which were privatized in the 1990s to spur technological improvements and better manage the pace of production, Gazprom has retained a monopoly on the country’s gas development and exports. The company has suffered from the increased supply and lower prices of gas worldwide, scuttling an "unprofitable" project last year to produce natural gas exports for the United States from the Arctic Barents Sea, Aron wrote in his AEI report.

Russia might also be running out of "cheap oil," Aron wrote, noting that remaining oil reserves are located in "more remote" regions such as the Arctic’s continental shelf and the edges of Siberia.

Additionally, Russian oil companies are effectively taxed at a 70 percent rate—compared to a 2011 rate of 42-43 percent for Chevron and ExxonMobil in the U.S. This discourages innovation and technological updates, Aron said.

Russia’s economy has stagnated before because of energy troubles. Some economists posit that a decline in oil production was actually the chief cause of the Soviet Union’s demise.

Soviet oil production decreased by 40 percent between 1988 and 1989 from a high of about 12 million barrels of oil produced per day to a low of about 7 million barrels, resulting in a 90 percent devaluation of the Soviet currency, according to a 2011 post for Business Insider by Douglas Reynolds, professor of energy economics at the University of Alaska Fairbanks.

"It is clear why the Soviet Union rose to prominence as it was able to produce so much cheap oil upon which to base its economy. Oil smoothed out Soviet inefficiency. However, the Soviet Union fell when its oil production fell and it no longer had cheap, high quality energy," Reynolds wrote.

Russia’s current stagnation has even led confidants of Putin to suggest breaking up Gazprom, Aron reported. Igor Sechin, president of Rosneft, Russia’s largest oil producer, has lobbied for loosening Gazprom’s grip on production and proposed natural gas exports to Asia from Arctic fields. Putin has also proposed tax incentives for exploring offshore oil reserves, but has been reluctant to act.

"Among the most destabilizing consequences of the continuing dependence on oil and gas will be the Kremlin’s declining ability to secure the elites’ loyalty," Aron wrote.

"Fiercely protective of their share of the politically apportioned riches of Russia’s state capitalism, powerful clans will squabble to secure the same share of a diminishing pie, in the process threatening the stability of the regime."

Putin has likely resisted modernization of Russia’s energy economy because of the alternatives, according to Aron’s report. Less dependence on oil and gas revenue would translate into cuts to subsidies for Russia’s poorer regions, sharp reductions in military spending, and fewer tax breaks for the state’s "pet projects."

"If fully implemented, such reforms will erode the Kremlin’s control over the economy, courts, and, inevitably, politics," Aron wrote.

Some of those reforms might already be taking place. The New York Times reported Thursday that Putin’s regime has begun to release some of the more than 110,000 people incarcerated for "economic crimes" in Russia’s infamous prison camps, particularly white-collar businessmen, in a move to combat anemic economic growth

However, Jensen cautioned that Putin’s main concern is the optics of his regime.

"Putin wants to soften the appearance of power, but he also wants to maintain power," he said. "I wouldn’t take it too seriously."

Russia’s economic free fall will likely complicate Putin’s efforts to showcase his country at the G-20 summit next month in St. Petersburg. President Barack Obama has announced that he will not meet with Putin one-on-one ahead of the summit, citing the countries’ "lack of progress" on issues such as missile defense, human rights, and the granting of asylum to NSA leaker Edward Snowden.