Oil and gas in the capitals

Once the Sochi games are over, it will be more than time to address one of the most disturbing issues of the Russian economy: the role and importance of natural monopolies. It has been in the forefront of economic policy since the beginning of the transition. It has become, again, a central issue, when the government decided to put a cap on internal gas prices1 for 2014 and probably 2015.

Looking at it superficially, it can be safely assumed that the Russian government made this decision for the sake of industrial competitiveness. It’s a policy that had been implemented after the 1998 financial crisis with good effect, and which contributed to the rebirth of Russian industry. Gas is obviously an important component for two important industrial activities: ferrous metals and chemicals. By introducing a cap on internal prices, and preventing them from increasing in 2014 and 2015, the government will automatically improve the financial situation of firms in this sector (and they are among the most important industrial exporters), but it will also improve those industries dependent on ferrous metal and chemical prices (car manufacturing, pharmaceuticals, fertilizers and agriculture). With improvement of the financial situation, one can expect a boost on investment in Russian industry as a whole. This is why such a policy has been advocated in Russia by various economists, including me.² 

Gazprom’s role in Russia’s gas sector. One could be forgiven for thinking that, in the trade-off between the largest gas producer (Gazprom) and other firms, the government has chosen to boost the competitiveness of the latter at the expense of the former. There is a grain of truth in that, but just a grain. Yet, the situation is actually much more complex.

It is well known that natural resources constitute Russia’s most important and significant competitive advantage. The country has 6% of the world’s oil reserves (not including shale oil) and 24% of its natural gas. The impact of the hydrocarbon industry on Russia’s economy is both obvious and frequently misunderstood. On one hand, oil and gas exports play a very important role in the balance of trade, and for the governmental budget. On the other hand, the impact of the hydrocarbon industry on GDP and employment is much smaller. Oil revenues are fluctuating between 9.5% and 11.5% of GDP, but they amount to 50% of budget income. It is clear that the hydrocarbon industry is a key sector for the government, but one of relatively low importance to the GDP.

The main issue, then, is to devise a policy enabling budget revenues to stay high, but without destroying the balance of internal producers. This is much easier said than done. The key issue is labor (and general) productivity in the oil and gas sectors. Only strong growth in productivity could allow budget revenues to stay at their current level (or even improve) and still keep prices low enough to boost the competitiveness of the rest of the industry.

However, this reiterates the necessity of a general reform of the gas giant, Gazprom. The issue has been on the table for years, but with minimal results. Every time the government has tried to implement reform, Gazprom has succeeded in deflecting the pressure. Today, it seems that the government is trying something different.

By introducing gas price caps, the government openly favors the domestic industrial users of natural gas. However, a hidden effect of these gas price caps is to favor companies like Novatek or Rosneft, which produce gas at considerably lower prices than Gazprom. This amounts to telling Gazprom management, “Either you, yourself, introduce reforms enabling you to lower the gas production price, or your company will slowly die, and will be dismantled and handed over to your competitors.” Already, Moscow is rife with rumors about changes in Gazprom management. It is well known that Rosneft is looking at Gazprom the way a bear looks at a sheep. The aim of price caps, therefore, is much more ambitious than a simple return to the policies implemented in the wake of the big financial crisis of August 1998.

What will the results of this policy be? In the short term, it is obvious that gas price caps will have a beneficial influence on Russian industry. It will promote growth and, more importantly, investment growth in 2014 and 2015. But will this policy succeed in making Gazprom reform mandatory? The political leverage that Gazprom holds, even if is declining, is still important.

By the way, it is dubious that Vladimir Putin will let Rosneft easily devour all or a large share of Gazprom. This would obviously give enormous power to Rosneft, which already is the largest Russian oil exporter, and the company with the brightest industrial future. But Putin’s frustration toward parts of the state bureaucracy, and Gazprom cronies, is slowly but steadily mounting. One cannot dismiss the idea that this frustration, now shared by more and more people, may give birth to some direct actions aimed at reshaping Gazprom management and destroying its remaining political leverage.

There certainly will be no move before the end of the Sochi Olympics. But, by early March, we may see some tidal shifts in Russia. 

REFERENCES

1. Pismennaya, E., “Putin bets on Gazprom purge as slowdown threatens legacy,” Bloomberg, Nov. 25, 2013, http://www.bloomberg.com/news/print/2013-11-24/putin-bets-on-gazprom-purge-as-slowdown-threatens-legacy.html

2. Sapir, J., “Soglasovanie vnytrennykh u mirovykh cen na cyr’evye produkty v strategii yekonomitchekogo razvitija Rossii,” [ Internal and World Price Dynamics for Raw Materials and the Russian Strategy for Economic Development], Problemy Prognozirovanija, n° 6 (129), 2011, pp. 3–16.