Russia is a major player in oil and gas production worldwide. It is the second largest producer of natural gas and the third largest producer of oil, sitting on 80 billion barrels of proven oil reserves and a staggering 1688 trillion cubic feet of natural gas reserves—the largest natural gas reserves in the world. Given the size of Russia’s oil and gas assets and its position in world production, there is little doubt that oil and gas prices have a large impact on its economy. In this article, we will analyze the impact of oil prices, both high and low, on the Russian economy.
The Hydrocarbon Empire
In recent years, oil and gas revenues have made up nearly half of Russia’s national budget. Oil and gas prices tend to have a stable relationship where the price of gas rises and falls with the prevailing price of oil. This correlation is weaker over some time periods and stronger in others, but has held over time. When oil prices are strong, the government budget grows and Russia spends on infrastructure, social programs, and other national investments like defense. Conversely, low oil prices shrink the national budget in proportion to the price drop. So the clearest impact that oil prices have on the Russian economy is in shrinking or expanding the government budget.
That said, the impact on the Russian government is not immediate when oil prices drop. The government has a reserve fund to ride out market fluctuations, so short-term dips in the price of oil do not concern the Russian government nearly as much as a prolonged slide.
A Commodity Currency
In addition to the government budget depending on oil and gas revenues, the ruble, Russia’s currency, is also highly influenced by oil prices. This is another aspect of how the price of oil affects Russia’s economy. When oil prices are high and the government books are in the black, there is very little doubt about Russia being able to service its debts to investors and other nations. Weakness in the price of oil shakes market confidence in the national government and the currency, driving the value of the ruble down against other currencies. As much of Russia’s international debt is not in rubles, a devalued ruble is a double disaster for Russian finance. Payments must still be made in dollars or euros even as the exchange rate makes every payment that much more expensive.
In the 1998 ruble crisis, both the ruble and the Russian government needed to be propped up with international loans. During that time, the government suspended payment on outstanding debt and allowed the ruble to devalue. Low oil prices were one of the causes of the ruble crisis and the subsequent recovery of oil prices that followed helped the Russian economy stabilize once more. This correlation between the ruble and the oil and gas prices may have even strengthened over the intervening years as Russia has increased oil production.
A Concentrated Economy
The dominance of oil and gas in the government revenues is mirrored in Russia’s export mix. Around half of Russia’s total exports in terms of value are made up of oil and gas. Iron and steel come in at a distant second at less than 5 percent of the total export value. Having both exports and revenues driven by oil and gas puts Russia in a difficult situation. In a country with diversified exports, a weak currency has the upside of making export products more affordable for foreign buyers. But Russia does not have a major export industry, such as manufacturing or agriculture, which can benefit from a weak ruble. Russian exports of lumber and agricultural products do get more attractive to international buyers when the ruble falls, but the hole that low oil prices can punch in the economy and the national budget is far too large for any other Russian industry to fill.
More diversified oil-exporting nations like Canada and Australia have sectors like manufacturing, mining, and agriculture that benefit as their currency weakens in a weak oil price environment. While low oil prices do impact both the Canadian and Australian economies (Canada more so), the blow is tempered by expected gains in export-driven industries as currency dips makes those products more affordable. There really is no economic upside to this situation for Russia, as the lack of diversity in the Russian economy amplifies the importance of oil even more.
The Cost of Production
There are other nations that are similarly dependent on oil prices like Kuwait, Venezuela, and Saudi Arabia. With all of these nations, it all comes down to the cost of production. Saudi Arabia has the lowest cost of production at around $20 a barrel in 2014. Russia is about double that. This means that, at $40 a barrel, producers are breaking even at best. This is an important consideration as Saudi Arabia has the reserves and the production capacity to oversupply the market and drive the price down to a point where no one but Saudi Arabia is turning a profit on oil. Watching Saudi Arabia’s production decisions is critical for a country as economically dependent on oil prices as Russia.
On the whole, low oil prices are bad news for the Russian economy. Unlike the United States where dependence on oil is consumption driven, the Russian economy depends on the profitable production of oil to pay for the costs of government, prop up the ruble, and provide a majority of its exports. In short, the Russian economy grows or shrinks with the price of oil.