Two weeks ago, the movers and shakers in the oil-producing universe tried to convince the world they were on the cusp of a truly significant agreement that would slow the financial hemorrhaging of the market. Instead, they delivered nothing more than a slight ripple in a growing, fetid pond. The Saudis with deep pockets and untold cash reserves were able to claim that OPEC discipline had triumphed over Russian cockiness and Putin’s ill-advised scheme to free ride on OPEC without abiding by the rules. Moscow believes it got a win by bringing the United States to the table and forcing countries like Mexico to agree on cuts. But the overall drop in production, barely 10 million barrels per day (bbl/d), pales in comparison to the steadily declining daily consumption of oil in excess of 25M bbl/d, with the bottom nowhere in sight. The historic drop in oil prices this week makes it clear that there is little the Saudis or Russians can do to halt this downward spiral.
As the global economy and oil prices began to reel from COVID-19, Russia decided to protect its oil revenues by breaking off cooperation with the Saudis, a policy that it had pursued since the drop in oil prices in 2014. This was a return to the traditional Kremlin policy of free riding on disciplined OPEC production cuts designed to bolster oil prices when global demand drops. Not surprisingly, when Moscow decided to drop its deal with OPEC, Riyadh responded not by decreasing production, which it would have done if the Kremlin had gone along, but increasing it, which drove the price of a barrel of oil down precipitously. This too was nothing new. The Saudis have used this tactic within OPEC for years when other oil producers cheated on agreed production limits during periods of slack oil demand.
These decades-low oil prices—combined with a glut of gas on the world market—will begin to take a significant toll on the Russian economy, which depends on fossil fuel for over 60 percent of its exports and over 30 percent of its GDP. When the price of oil collapsed in 2014, it led to major inflation in Russia, a net importer of goods that many other countries actually produce. In just a few months the ruble plunged relative to Western hard currency. The same is happening now. On March 3, just before the Kremlin oil decision, the ruble traded at 64 to the U.S. dollar. Since then it has depreciated by 25 percent to 80 to the dollar. The impact of oil prices flirting with $15 per barrel for the foreseeable future, and a gas glut that makes what Russia used to charge seem like a far-off fantasy, will have substantial implications for the Russian economy.
In a further sign of Russian eagerness to shore up its fossil-based economy, and to get around the targeted and effective U.S. Nord Stream 2 sanctions (which caused the Russian-contracted Swiss firm to pull out of the deal), the Russians have re-engaged the Danish Energy Agency to take another look at the agreement, which would allow Russia to complete the final 100 miles of gas pipeline in the Baltic Sea. The Danes—rightly concerned that pipeline-laying vessels using anchors would cause an untold environmental disaster in the Danish economic zone—would only agree to the dynamic positioning of pipe-laying ships. Moscow is scrambling to find a homegrown alternative or get the Danes to remove their “no anchors” caveat. The delays in completing Nord Stream 2 coincident with a drop in gas prices makes it less likely that Russia will be able to recoup their pipeline investment for a very long time. And it is by no means certain that the project will be completed.
The question is whether this economic gut punch will have an impact on the Kremlin’s adventurist foreign policy. Russia’s ability to invade, occupy, and annex the territory of its neighbors—Moldova, Georgia, and Ukraine—is often tied to Putin’s version of a cost-benefit analysis. In Moldova, where both Russian troops and Russian-backed separatists control over 10 percent of the territory, Russia engaged in an exceedingly violent and deadly conflict over Transnistria in the early days of Moldovan independence, overwhelming the relatively tiny Moldovan military. The costs to Russia were minimal.
Russia’s invasion of Georgia occurred when oil was over $100 a barrel and the most well-trained and equipped Georgian forces were deployed in Iraq. Once again, the Kremlin blamed the invasion on so-called separatists in Abkhazia and South Ossetia, who were never known to possess the type of sophisticated military equipment Russia claimed they had used. The costs to Russia were higher because Putin underestimated both the will and training of Georgian forces, but still quite manageable because the Western reaction was weak. There were no Western sanctions. Then French President Sarkozy negotiated a ceasefire friendly to Moscow and the West did nothing as Moscow violated that ceasefire.
Putin went into Ukraine—oil was again at $100 a barrel—because he once again anticipated an easy win. It is true that he faced no real opposition in seizing Crimea. Ukraine, under Western pressure to do nothing, permitted the Kremlin’s little green men to take the peninsula. The West responded with condemnation and weak sanctions. But then Putin miscalculated, believing that there was substantial support in Donbas for some form of separation from Kyiv and that he could launch a covert war relying principally on local fighters. That did not pan out, and Russia was surprised by strong Western sanctions. While those sanctions have not persuaded the Kremlin to cease its aggression in Donbas, they have helped deter escalation, and they cost the Russian economy over 1 percent of GDP per year. This is a substantial economic hit, but one that Putin has been able to carry—until now. The new COVID-19 economic normal and the tanking fossil fuel market, combined with Ukraine and Russia’s Nord Stream 2 gas pipeline sanctions, may be more than Putin can tolerate.
Out-of-area deployments have added to the costs of Putin’s foreign policy. While the Russian government has declined to provide comprehensive information estimates, the Moscow Times put it at $4 million per day or over $1.4 billion per year. This too used to be manageable, but the price tag will grow as Iran’s own economic woes, exacerbated by the heavy toll of COVID-19, may force Moscow to play a larger role and pay a larger amount to stay in the Middle East. Can Russia sustain its current operational tempo on all these fronts in the face of what will be a massive loss of income?
While the economic pain may have yet to cross Putin’s threshold, Russia, like every other country, will succumb to this new reality. Putin’s official popularity ratings have dropped to the low 60 percent range and, perhaps more importantly, for over a year polls have shown that a large majority of the Russian people think the country is going in the wrong direction. They also think that more resources should be spent on domestic problems and that Russia should pursue policies that improve relations with the West.
Putin, of course, is no democrat; he can choose to ignore public opinion. But with oil prices at inconceivable lows, the Kremlin will have to make serious decisions on where to invest what will be increasingly limited resources. Russia’s military has historically been more active when fossil fuel energy prices soar and less so when they fall. When the economic crunch hits, Russia tends to cut back on training and exercises (often with devastating consequences) before it disrupts actual operations. But this is no ordinary shift in market forces. It is a combination of Putin’s hubris in starting an oil war he thought he could win combined with a crisis nobody saw coming. Something will have to give. Recovery will be difficult for almost every country, but especially so for a country almost solely dependent on carbon earnings.