The Foreign Service Journal, April 2007

High world oil prices are likely to continue to bolster Russia’s wealth, strength and confidence in the short to medium term, but there are questions about the longer term. Russia has yet to adequately address fundamental problems left behind by decades of Soviet mismanage- ment of its economy. Some of these problems directly affect the future of Russia’s energy wealth. The oil and gas of the future lie in the vast, cold expanses of the eastern part of the country. In the earli- er phase of energy wealth — the 1970s and early 1980s — Soviet economic planners committed great mistakes by misdeveloping and overpopulating Siberia. To avoid repeating the same mistakes, Russian policymakers today need a comprehensive view to tackle the dual challenges of resource management and Siberian development. The issue is all the more important because today Russia faces a shortage of one asset that it has in the past pos- sessed in abundance — human beings. It is therefore worth examining Russia’s future in terms of how it deals with the challenge of managing its resources, its space and its people. Resource Plenty The benefits of abundant oil and gas reserves are easy to see. These resources turned Russia from a virtually bankrupt country after its 1998 financial crisis into one with real financial leverage today. The increase in wealth flowing into Russia from oil and gas is staggering. Consider the income from one component alone — crude oil exports. Revenues from foreign sales of crude in the four quarters prior to now-President Vladimir Putin’s appointment as prime minister in August 1999 were $14 billion. For the most recent four quarters, the corresponding number is over $150 billion. (By com- parison, in 1999 Russia’s total GDP in dollar terms was only $200 billion.) The growth in the total market value of Russia’s oil and gas is even more impressive. Figure 1 (p. 34) shows the value of these commodi- ties produced on the territory of the present-day Russian Federation from 1970 to the present. It is important to distinguish between the physical quantities of oil and gas Russia produces and exports, and the wealth generated from them. The wealth is due mainly to the increase in world prices: in the case of oil, from under $10 a barrel to over $60. The price increase overshad- ows the levels of physical production. The output of oil grew strongly from 1999 through 2003; but since then, as shown in Figure 2 (p. 34), growth rates have dropped sharply. Russia is not likely to resume strong output growth. It is estimated that the country invests only half as much in its oil and gas sectors as would be needed to sustain expansion of production over the longer term. For con- sumers throughout the world, the trend is disturbing. The price of oil that we all pay is determined by global supply and demand. Over the past few years, Russia’s increased production has been the most important addi- tion to the world pool of oil. (In fact, it almost exactly matched the increase in demand from China, the fastest- growing consumer country.) Without Russia, world oil prices would have been even higher. A fundamental question is whether the country is able, and whether it wants, to keep producing more. There are voices inside Russia that now argue explicitly that the country should not continue to expand produc- tion of oil. It is better to keep this precious resource in the ground, they say, as it will only become more valu- able as time passes. But even if Russia does attempt to expand produc- tion, it will face challenges of a qualitatively new dimen- sion. The increased oil pumped between 1999 and 2006 has been largely so-called “old oil” — that is, oil that had been left in the ground in mature fields. These are fields mainly in Western Siberia where infrastructure was already in place. The oil itself was there for a combina- tion of reasons. In the 1980s, desperate to pump as much oil as possible as quickly as possible, the Soviet oil industry followed a strict “skim the cream” approach. Taking only the easy oil, they left all the rest in the F O C U S A P R I L 2 0 0 7 / F O R E I G N S E R V I C E J O U R N A L 33 Clifford Gaddy is a senior fellow at the Brookings Institu- tion in Washington, D.C. His most recent books are The Siberian Curse (Brookings Institution Press, 2003) and Russia’s Virtual Economy (Brookings Institution Press, 2002). He is currently writing a new book with the work- ing title, Bear Traps: Pitfalls on Russia’s Road to Sustainable Economic Growth. The increase in wealth flowing into Russia from oil and gas is staggering.