Oil and Gas in the Capitals

	Vol. 231 No. 1
JACQUES SAPIR, CONTRIBUTING EDITOR, FSU

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Russian President Dmitry Medvedev’s speech on Nov. 12 has attracted a lot of interest. He called for a “modernization” drive for the Russian economy. This has not been the first speech on this topic, either by Medvedev or by his predecessor, Vladimir Putin. Medvedev’s speech elaborated on his Sept. 10 “Go Russia!” article, which had already aroused considerable interest and which the administration says had been the most commented-on paper on its website. Still, delivered as the solemn Address to the Nation, the speech was a very significant event.

Medvedev’s concept of modernization is the spinal cord of the speech, and occurs more than 20 times within it. It is beyond doubt that modernization is a vital issue for Russia—that production and export of commodities have assumed too large a role in the economy and that the process of innovation is not well enough developed in Russia.

While the speech rightly emphasized these points, it went beyond that, embracing the now fashionable opposition between “old” and “smart” industries. But things are much less clear-cut. There is considerable room for innovations and high-technology processes in so-called “traditional” industry. In the production of steel or aluminum, one can introduce high-tech innovations. The development of biotechnologies does not take place in isolation from agricultural production. Biotechnologies are extremely important in the development of new ways of processing food, but also in deriving new products from traditional ones, like the fusion of alimentation and medicine. It is also obvious that in some industrial sectors, like car building and aerospace, the application of new technology is extremely important.

There was also a focus on energy efficiency, which made the speech a radical break with the past. The Russian economy is wasting energy. The turn toward a true energy-efficiency strategy is an important one for Russia and, contrary to what is often thought, is certain to be very profitable. Energy wasted today could be sold tomorrow.

Russian energy efficiency is about one-third of what it is right now in European countries like France and Germany. The opportunity cost of this wastage is truly horrendous and is likely to rise with higher energy prices.

Wastage is pervasive. It happens at the extraction and the processing stages. It happens in the industrial sector, which is still operating based on old Soviet standards of cheap energy. It also happens at home, where, for each calorie consumed, the heating system has to produce 2½ calories.

Experts at the Institute of National Economy Forecasting have computed the current annual level of energy wastage at 240 Bcm of natural gas; 340 billion kW-hr; 89 million tons of coal; and 43 million tons of oil and refined products.

A common joke in Russia is that the main oil and gas fields are in the cities. Exaggeration aside, there is more than a bit of truth to that. The enormous cost of putting new fields into production could be, at least in part, offset through a major surge of energy efficiency.

If the Russian economy is to continue growing in a catching-up process, internal energy consumption will balloon out of control if a serious effort isn’t made on energy efficiency. This effort will be instrumental in maintaining the current energy export capacity.

The government’s Energy Strategy for 2030 handbook, the latest of a series produced every five years to outline its energy priorities, shows some direct implications. The most important is certainly the huge gap between the “base” consumption and possible reductions due to efficiency, which has important consequences for the country’s export potential. If Russia wants to keep its capacity to export energy on a massive scale, it has no alternative other than to greatly improve its energy efficiency.

However, Russia is facing a form of what economists call Dutch disease. Private investors are reluctant to invest outside export sectors, and the whole modernization drive is more or less stalled, except within the public sector. The exchange rate of the ruble tells the story: In real terms, according to the Central Bank, it increased by nearly 50% from January 2005 through June 2008. The global financial crisis brought a sharp devaluation, but not an enduring one. At present, the ruble is again more than 35% higher than its January 2005 value.

This overvaluation is the direct result of the liberalized currency exchange system, and strengthening the state sector is an attempt to compensate for this exports-induced overvaluation.

Only a return to a current-account-only convertibility system—with some exceptions for long-term foreign investment—along with the creation of a special exchange sector for exporters will be able to support a modernization policy on the scale and scope envisioned by Medvedev. WO