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Russian Energy, Part 1: The Foundation of Power

6 MINS READOct 15, 2012 | 10:45 GMT
Special Series: Russian Energy
Stratfor

Editor's Note: This is the first installment in a three-part series on Russia's energy sector. Part 1 will cover the Russian energy industry from the 1990s through the Putin era; Part 2 will discuss upcoming national policy changes; and Part 3 will examine Russia's oil and natural gas giants and their relations with Europe.

In mid-October, Russian President Vladimir Putin's new energy commission will meet to discuss changes to the structure of Russia's state-controlled energy sector. The outcome of their debates will have repercussions far beyond the oil and natural gas industry, affecting Russia's budget, other industrial sectors, relations with Europe and even the Kremlin's internal balance of power.

Russia's position as the main energy exporter to Europe and the revenue those exports have generated are largely responsible for the country's resurgence since the chaos that followed the collapse of the Soviet Union in 1991. However, the Kremlin's consolidation of power over the energy sector has led to inefficiencies, corruption and mismanagement on a large scale. Now, Putin's commission will be faced with decisions on reforming those institutions while also maintaining stability and leveraging Russian energy wealth to preserve Moscow's power and influence in the decades to come.

The Energy Industry's Role

Russia is the world's second-largest oil producer and second-largest natural gas producer, and it has the largest reserves of natural gas. Beyond its direct benefits, the country's energy resources have provided Moscow a useful tool for international relations, political patronage, financial independence, aiding other sectors of the economy and being the largest source of jobs in Russia. But because the Kremlin uses energy as the default solution for so many problems and needs, the way it is structured and run is not always practical or efficient by Western standards.

When Putin first came to power in 1999, the Russian energy sector was chaotic, split between various Russian oligarchs and foreign firms and falling behind in technological capabilities. Starting in 2003, the Kremlin implemented a massive campaign to consolidate the country's energy sector under state control, bolstering two major firms — Gazprom for natural gas and Rosneft for oil.

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Initially, the consolidation was undertaken for two reasons: to purge the oligarchs and foreign firms not under the Kremlin's control from the energy sector and to create large energy firms that could be tapped for other uses by the Kremlin. This process stripped some of Russia's most powerful people of their assets and influence, sending some to jail, others into exile and leaving a handful in their position but dependent on Moscow's favor.

The plans for energy industry consolidation were part of a larger effort to eliminate any viable opposition to the Kremlin or Putin and to deprive any potential rivals from using the country's energy sector as a power base. Additionally, by limiting the ability of foreign energy firms to work in Russia, the Kremlin felt it was keeping Western influence out of the country's most important strategic sectors, which Moscow felt had taken advantage of the post-Soviet chaos for their own financial benefit. By the mid-2000s, the Russian energy sector had been mostly taken over by Gazprom and Rosneft, which together accounted for nearly half of the Russian government's revenues.

While this process was occurring, the Russian government began using its new state-controlled energy giants as a powerful tool for influencing the behavior of downstream European states that depended on Russian energy exports. The Kremlin used energy negotiations as a way to shape its relationships in Europe. This process involved tactics such as energy cutoffs in the depths of winter, mysterious and conveniently timed pipeline ruptures, discounts in pricing for Russia-friendly states and new pipelines to skirt around states not accommodating to Russia's wishes. Naturally, the politicization of Russian energy has led to a pushback within Europe and attempts to diversify away from Russian oil and natural gas supplies. This process has been long and painful, and while it is starting to produce results, energy remains the Kremlin's strongest tool in relationships with European states.

Splitting the Sector Among Clans

As Gazprom and Rosneft grew in their importance, so did the competition within the Kremlin for control of the companies and their respective sectors. Putin ended up giving responsibility for each sector to a different power center within the Kremlin: Gazprom was run by the civilian technocrats and businessmen known as the civiliki, while Rosneft was run by former or current members of the security establishment, known as the siloviki. Putin placed limits relative to the overall power of the clan. The weaker civiliki clan held control over Gazprom, which produces about 80 percent of the natural gas in Russia and operates the entire natural gas export infrastructure. The stronger siloviki clan's hold over Rosneft only gave it approximately 24 percent of the oil market and no control over export infrastructure, though the clan is closely aligned with export oil pipeline operator Transneft. By giving the less powerful firm to the siloviki, who have enormous influence in the Russian defense and security sectors, it maintained a relative parity between the two clans.

This division of the Russian energy sector provided balance between the clans, enormous wealth to the government and influence over foreign consumers for the past decade. However, the system also harmed the Russian energy sector in many ways. Appointing bureaucrats without the appropriate expertise to run each firm has led to mismanagement and abuse of their positions for personal financial gain. Both firms are behind in technological expertise due to the lack of internal competition and cooperation with more advanced foreign firms. In addition, the Kremlin's use of energy revenue for other state spending has limited each firm's ability to invest in new technology or research and development. Finally, Russian politicization of energy has forced many European states to try to diversify away from Russian supplies — something that will be a factor in Russia's overall ability to influence Europe in years to come.

The Kremlin has been able to weather these problems for many years, but it now seems that such vulnerabilities are catching up to Russia, prompting the government to seriously consider how to restructure its energy sector for the first time in a decade. Such changes have the potential to reverberate through Russia's foreign relations, internal politics, financial stability and beyond.

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