This week world oil prices hit their highest level since 1990 – more than US$40 a barrel for Brent crude, and US$35.70 a barrel for Russia’s Urals blend. This is a result of continuing strong demand due to China’s ongoing boom and the US economic recovery, plus worries about supplies given the conflict in Iraq. OPEC fears that the current price spike is a speculative bubble, but many experts think that high prices could be sustained for the rest of the year.
High oil prices of course mean more money in the bank for Russia. Russian producers are racing to cash in on the boom. In the first quarter Russian oil output rose 10 percent, while exports outside the CIS surged 18 percent to 8.5 million barrels per day – 10 percent of world demand. Export pipelines are close to full capacity, and Russian companies are scrambling to increase shipments by rail and by sea. (Rosneft is transferring crude from small vessels to big tankers in Arctic waters.) (Vedomosti, Rossiiskaya gazeta, May 14)
The government is positioned to get a lion’s share of the windfall. In the wake of the Yukos scandal, the parliament passed legislation in late April increasing the natural resources royalty by about US$3 billion, and hiking the sliding scale of the oil export duty from 40 percent to 65 percent of receipts above US$29 barrel (based on a two month moving average). From June 1 the export duty will rise from US$35.2 to US$41.6 per ton, then to US$55 from August 1. (Kommersant, May 6)
But Moscow is not without its share of skeptics pointing to the downside of the current oil boom. On the political front, Boris Nemtsov argues that there is an inverse correlation between the price of oil price and the state of Russian democracy. The more revenue the government gets from oil, the less attention it pays to the interests of business leaders or civil society more generally.
Many economists, such as Vladimir Mau, argue that Russia is suffering from a terminal case of Dutch Disease – that is, dependence on energy exports drives up the value of the currency and makes investment in manufacturing uncompetitive. Hence the worry that Russia’s economic recovery will only last as long as the world oil price continues to rise. The most energetic proponent of this view is Andrei Illarionov – who also happens to be President Putin’s economic advisor.
However, Illarionov’s Cassandra-like warnings are only one side of the story. First, it should be remembered that oil accounts for only 30-35 percent of Russian export earnings and a similar proportion of federal budget revenues. This is a lot, but half the level of Mexico or Venezuela, not to mention Kuwait. Natural gas accounts for another 20 percent of Russian exports, but gas is sold through twenty-year contracts and is less prone to price fluctuations.
Second, the over-valued exchange rate is only one factor among many that explains the sluggishness of investment in domestic manufacturing (bureaucratic interference, lack of clear property rights, bad management, etc.). The reluctance of businesses to invest, and the current slump in the Russian stock market (which has fallen 26 percent in the past month), are due above all to fears, in the wake of the Yukos affair, that the state might start repossessing privatized businesses (Ekspert, May 10).
Third, the government has been taking steps to prevent the Dutch disease by sterilizing capital inflows. Putin has promised “not to fall asleep under the warm blanket of petrodollars” (Wall Street Journal, March 26). Hence Russia has paid down ahead of schedule US$10 billion in IMF debts, and has created the oil stabilization fund, which is expected to grow to US$13 billion by the end of the year. These measures seem to be working, though skeptics point to worrying signs of resurgent inflation. Money supply surged 50 percent in 2003. Officially, consumer prices rose at an annual 10.8 percent in the first quarter of this year, but this figure may not be reliable (since it excludes real estate and luxury spending). So, there is a risk that the Dutch Disease could show up in the form of an inflationary surge.
Short term, there is no doubt that high oil prices ease the financial pressures on the Russian government. And long term, the high oil prices will make investment in Russia’s costly and risky new oil fields all the more attractive. It’s getting from the short term to the long term that people are worried about.