How Russia Makes Its Money - And Why It Doesn't Make More

By Greg McFarlane AAA

Russia is more than twice as large as the contiguous 48 U.S. states, with an educated population and far more natural wealth than you’d expect to find in an area even as vast as 6.6 million square miles. Shouldn’t such a nation be the envy of the world, its undisputed superpower? Yet Russia’s gross domestic product per capita remains mired at an unremarkable 58th in the world (according to the most recent IMF figures), far lower than the inputs (literacy levels, access to capital) would indicate. How does Russia make its money, and why doesn’t it make more?

Since the 1991 dissolution of the Soviet Union, the Russian economy has fared better than those of most of the 14 other smaller republics of the former USSR. (The Western-friendly Baltic states of Latvia, Estonia and Lithuania, each now firmly ensconced as full members of the European Union, have fared far better economically.) Meanwhile, Russia’s economy, based primarily on extracting resources from the Earth, hasn’t translated into significant general wealth for its 144 million citizens.

Officially, Russia abandoned communism decades ago. But reality matters more than labels. While post-Soviet Russia ostensibly enjoys a market economy, its leaders have deemed its dominant energy sector too crucial to leave to the caprices of independent buyers and sellers. Oil, natural gas, electricity and more are under de facto control of the federal government. For instance, the Russian government owns a sliver more than half of Gazprom (LSE: OGZD), the world’s largest natural gas extractor. In fact, the publicly traded company is the successor of the Soviet Ministry of Gas Industry. Every sixth cubic foot of natural gas on this planet is processed courtesy of Gazprom, whose chairman just happens to be Russia’s former prime minister, Viktor Zubkov.

Russian Government Controls Energy

No matter the source of energy, the Russian government controls it, resulting in untold profits for the nation’s oligarchic class.

Inter RAO, the nation’s primary electric utility, is owned by a consortium of state-owned enterprises. The idea of energy extraction and refinement being open to private enterprise, something taken for granted in the United States, is quite literally a foreign concept in Russia.

Pop quiz: Which nation is the world’s largest oil producer? Hint: Saudi Arabia, the United Arab Emirates, Iraq, Kuwait, Venezuela, Canada and the United States are all incorrect answers. Russia’s oil production rivals only its natural gas production: it’s the world’s leader in both. The nation produces 10 million barrels of crude a day, through several companies. The largest of these include Rosneft (LSE:ROSN), Lukoil (LSE:LKOD), and Surgutneftegas (LSE:SGGD). While all three trade on the London Stock Exchange, Rosneft is owned 70% by the Russian government, and Surgetneftegas's ownership structure is all but impenetrable to outsiders. To quote Charles Clover in the Financial Times, Surgutneftegas shares “appear to be held in a complicated circular structure – like an Escher drawing in which each company owns another, which in turn owns another in the chain." (As for Lukoil, the Russian government divested itself of its last shares in 2004.) To interpret the sometimes convoluted logic behind how the Russian energy industry and its major players operate, one needs to examine its ultimate principal owners, the Russian government.

The majority party in Russian politics is United Russia, which was founded by President Vladimir Putin and holds most of the seats in both the national and most state legislatures. Officially, United Russia seeks to overcome "economic backwardness," according to an official party document sometimes referred to as "Go Russia." The document describes this backwardness as "an addiction to surviving off exporting raw materials" and "the certainty that all problems must be solved by the state," both listed ambitions seeming to contradict real-world activity. With a political class sworn to regaining the nation’s former stature (to say nothing of its former territory), it’s not surprising that the Russian government capitalizes on opportunities to invade its weaker neighbors that were once part of the Soviet Union. In 2012, Georgia. A couple of years later, a bigger prize: the Ukraine.

Ukraine Support Act Offers Only Tenuous Sanctions

In March 2014, shortly after Russia annexed the Ukrainian territory of Crimea with little resistance, the United States House of Representatives passed H.R. 4278, the Ukraine Support Act. The bill passed 399-19 before advancing through the Senate and to the White House for the President’s imminent signature. The bill provides support for Ukraine, a U.S. ally, but also calls for sanctions against the Russian aggressors.

Sanctions come in many forms and intensities, and an actual perusal of the bill rather than its summary shows how tenuous these particular sanctions are. In toto, the new ones the bill authorizes are as follows:

If the president believes a person “wields significant influence” over Russian foreign policy regarding the Ukraine (Section 202[a]), any assets that person has under the jurisdiction of the United States will be frozen.

Any such persons won’t get visas, and their current visas will be revoked unless they’re in the U.S. on United Nations business (Section 202[c][4]). Also, the responsibility of examining any of these significant influencers’ bank accounts has been laid at the feet of said banks (Section 204[a][2]).

That’s it. The bill calls for no restraint of trade, no large-scale economic punishment. Russia won’t export one fewer drop of crude oil to the U.S., nor will the U.S. reduce its refined petroleum sales to Russia. Only those Russian political higher-ups who have easily traceable assets in the United States would suffer, assuming any federal cabinet members or commission chairmen would be foolhardy enough to hold any American investments in the first place.

The Bottom Line

A large nation’s economy isn’t exactly adaptable to change when said economy is so homogeneous that two-thirds of its exports are either petroleum or its distillates. Given what’s essentially a one-note import business that operates at the mercy of global price movements, the paradox is that Russia leaves little opportunity for the populace to operate enterprise-free of government influence. Hence the Russian economy continues to sclerotize. All this in a nation with more raw potential than any other might hope for. As P.J. O’Rourke wrote in "Give War a Chance," Russia “has all the land and mineral resources national avarice could imagine. There’s no alibi for the place.”

You May Also Like

Related Articles
  1. Economics

    Investing In Russia: A Risky Game?

  2. Stock Analysis

    Bearish On The Russian Bear

  3. Stock Analysis

    Breaking Down the Halliburton Baker ...

  4. Economics

    How Weak Oil Prices Affect Airline Profits

  5. VelocityShares 3x Long Crude Oil ETN has the potential for huge returns, but there are several reasons why you might want to steer clear for now.
    Mutual Funds & ETFs

    A Leveraged Oil ETN For The Future (Just ...

Trading Center