Outside the Box: Russia is the world’s biggest loser from oil’s crash, and that’s reason to worry

Outside the Box: Russia is the world’s biggest loser from oil’s crash, and that’s reason to worry

26 Apr    Finance News

Karl Marx wrote that “history repeats itself twice, the first time as tragedy and the second time as farce.” The collapse of the Soviet Union was not a tragedy, nor is what is happening in Russia now a farce. Still, the collapse of the Soviet Union was a defining moment in human history. Russia’s current struggle with itself doesn’t begin to rise to that level.

At issue for Russia is the collapse of oil prices CLM20, -7.20% CL.1, -7.20% BRN00, -1.89% . A country that depends so heavily on any one commodity, as Russia does, will always be vulnerable. Since the price of commodities is inherently volatile, determined as it is by the robustness of industrial powers, the exporter can neither control the price nor have an opportunity to generate investment capital on a systematic basis.

There was a time when Russia could use energy sales — or energy embargoes, as the case may be — to make Europe tremble. But now the world is awash in energy, and Russia’s recent efforts to reach an entente with the Saudis failed to support oil prices. The Russians have floated conspiracy theories of U.S. and Saudi collaboration designed to cripple the Russian economy with low energy prices and few markets, but that assumes that any conspiracy would need to lower prices. The supply of energy has surged, largely because of the U.S. energy sector, and demand did not keep up.

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The price of oil already was declining, but now the price has collapsed because of the coronavirus pandemic. The contraction of the global economy inevitably decreased the need for energy. Attempts by OPEC, an organization that in truth is irrelevant to today’s realities, to raise prices have failed. In the 1970s, demand surged and OPEC could manage the supply. Some among us will recall the Arab oil embargo, which defined the 1970s and was the opportunity for countries like the Soviet Union and Iran to create modern economies. The oil producers assumed that their power, and therefore income, would be permanent. But high prices generated a search for new sources of oil and gas, as well as new efficiencies in energy use, and the price fell dramatically in the 1980s.

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Now, the Soviet Union fell for many reasons — inefficiency and corruption had been mainstays of the system for decades — but things changed in the 1980s. For one, defense budgets soared as Moscow tried to keep pace with U.S. military development, particularly the legendary Star Wars project, as much legend as a project. For another, the price of energy fell, and the Russians were heavily dependent on energy sales. Russia was caught in a vise between defense spending and falling energy prices, and this ultimately undermined the basis of the Soviet Union.

After the fall of the Soviet Union in 1991, Russia faced the old challenge of building a modern economy rather than a Potemkin village of modernity. The first decade after the fall was chaotic as investment bankers and oligarchs appropriated the wealth under the banner of privatization. The emergence of Vladimir Putin, the former KGB agent who was tied into the oligarchy, should have led to a surge of modernization. Energy prices were reasonably high, and investment capital for a modern economy could, in theory, have been created.

Instead, investment capital was diverted for profit and safety outside of Russia, and Putin, who depended on the oligarchs for his power, could not do what he knew had to be done. Over time, his power surged and investment was possible, but as the process began to accelerate, the price of energy declined and with it the foundation for investment. In the past few days, it has totally evaporated.

Russia’s challenge now is to avoid collapse.

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Russia’s challenge is not building a new generation of hypersonic missiles, nor investing in advanced technologies. Russia’s challenge now is to avoid collapse. The Russian budget is distributed among its constituent regions, which pay the teachers and doctors and firemen. But with the decline of energy prices, Russia’s budget declines, and as it declines, the regions contract. Russia, a Third World country, has few counters to low energy prices.

Putin is a powerful leader, but his options are but two: the Stalinist one, which grips the country by the throat, or something else. The something else is essential, but urgency itself is not a solution. The Russians may muddle through, but the blow from energy prices is significant. The idea of building Nord Stream 2, for example, to bring natural gas from Russia to Germany is ancient history. Between the virus and energy prices, it is the last thing on anyone’s mind.

During my youth I worked in places that worried about Russian power. The ability of the U.S. military to exaggerate the power of Russia is in hindsight amazing. Back then, the Soviet Union was a cripple masquerading as a great power. I see that process repeating itself, both with Russia and with China (another story). It is always forgotten that the idea of the Potemkin village came from deep in the Russian soul. A czar was to tour a region, and to hide the poverty of the region from him, villages facing the railroad track were built — but only the fronts of the houses were put up. The facades gave the czar the illusion of Russian prosperity, behind which resided a far grimmer reality.

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The Russian people endure, and I am always told by Russians that the ability to endure means that Russia cannot be judged by foreign standards. It is true that the Russians endure and only rarely rise. But when they rise, as they did in 1917 or against the Germans in World War II and ultimately in 1991, they can dissolve things that seem immutable. The Russians say that they know how to survive a long hard winter. But at a certain point they snap, and with the value of oil a fraction of what Russia needs it to be to make do, let alone prosper, it is hard to see how the Russians will endure this winter of disease and poverty. So I think Marx got it wrong: The farce came first. The tragedy may come second.

George Friedman is chairman of Geopolitical Futures and author of “The Storm Before the Calm: America’s Discord, the Coming Crisis of the 2020s, and the Triumph Beyond.”

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