How Does The Price Of Oil Affect The Russian Economy?

An Oil-Rich History

Russia is one of the world's largest major oil producers and has a long history of exploiting the commodity. Collection of seep oil in what is now Russian territory was reported as early 1264 by European explorer Marco Polo in the vicinity of the city of Baku in the Caucasus region when it was under the dominion of Persia.

The earliest drilling for oil in Russia was also reported in Baku in 1846 under the direction of Russian authorities. Drilling first took place in the region on a full commercial scale in 1873, and within three months the operations were reported to have produced 1.5 billion kilograms of oil. By 1875, with demand from the growing industrial revolution in Europe, an incipient oil industry was established in the area. Among others, it was led by the Nobel brothers Ludvig, Robert and Alfred, of Sweden, and the Rothschild family, of Germany.

The Nobel brothers eventually built one of the largest oil companies in the world at the time, Branobel. By the beginning of the 20th century, Russia was responsible for more than 30% of world production. Other companies involved in the then-developing industry in the country included Shell and the Russian General Oil Company. Together, the three companies accounted for 60% of the country's output. Most early production was located in the regions of Baku, Azerbaijan and Grozny, Chechnya.^[1]

The Soviet Era

Bolshevik revolutionaries overthrew the government of Tzar Nicholas in Russia in 1917, prompting a decline in the country's oil production. By 1920, the Soviet government seized oil production in the country and nationalised the oil industry. In 1928, the Soviet government initiated a series of five-year-long economic plans aimed at development of the national industry. Part of that effort included enlisting the aid of foreign companies to transfer drilling technology.

In the 1930s, oil production expanded to the Urals region and in the 1950s, it was widened to Western Siberia with the discovery of oil deposits there. Soviet investment was instrumental for construction of an extensive network of more than 60,000 kilometers of oil pipelines and 150,000 kilometers of gas pipelines later left to the Russian Federation.^[2]

The Russian Federation: A New Era For Russian Oil

With the fall of the Soviet Union in 1989, Russia opened up for private investment, and several private oil companies began operation in the country to lead a renewal of the region's oil industry. Oil output declined initially with the collapse of the Soviet Union to around 6 million barrels per day from 12 million previously, but in subsequent years it began to grow again in reflection of Russia's large potential for oil exploration.^[3] The companies Rosneft, Lukoil, Gazprom Neft, Surgutneftegaz and Tatneft now account for more than 70% of the country's oil production.^[4]

Geography of Russian Oil Production

Initially, Russian oil production was concentrated in the Caucasus region. Today the majority of Russia's oil production is located in Western Siberia and the Urals-Volga region. Western Siberia is by far the largest exploration area, producing 6 million of the country's 10 million barrel per day of output. The Urals-Volga region produces about 2 million barrels per day. Production has been growing, however, in East Siberia and the Far East of the country, including the regions of Krasnoyarsk, Irkutsk, Yakutiya and Sakhalin.^[5]

Together, East Siberia and the Far East produce about 10% of Russia's oil, a figure that has doubled since 2010. In addition to inland areas, Russia has increasingly been developing exploration projects in offshore areas, especially in the Arctic region.^[5]

An Energy Powerhouse

Russia currently rivals Saudi Arabia as the world's largest oil producer accounting for roughly 12% of the global supply. However, it ranks only 7th in proven oil reserves with a reported 80 billion barrels. It is the second largest producer of natural gas behind the U.S. Oil and gas sales have recently accounted for more than 60% of Russia's export revenues and 50% of federal tax revenues.

Russia exports around US$350 billion annually in oil and fuels compared with about US$170 billion in other goods. The country has benefitted especially in recent decades from global political instability and conflicts in the Middle East that drove up the price of oil to more than US$100 per barrel. The oil and gas industry accounts for around 20% of the nation's GDP. The makeup of its oil reserves is around 80% light sweet crude and 20% heavier grade oil. That ratio is expected to move toward heavier oil in the future.^[7]

Boom And Bust

Russia's bountiful supplies of oil and dependence on the commodity for export has been a double-edged sword. On one hand, the country enjoys a level of energy independence for its population of 143 million and US$2 trillion economy. That can be advantageous for its large agricultural sector and transportation throughout the country, which stretches across nine time zones.

However, the situation leaves the country vulnerable to global events, such as military conflicts and political turmoil in the Middle East and elsewhere, that have an impact on the price of oil. Further, global oil prices are normally quoted in the U.S. dollar, so the price of oil is frequently influenced by shifts in U.S. policy and the relative strength or weakness of the dollar. Fluctuations in the fortunes of Russian oil, for example, occurred following the U.S. intervention in the Middle East in the 1990s and 2000s with wars in oil-producing countries of Kuwait and Iraq.

An escalation of oil prices to unprecedented highs was caused by the troubles in the region, apprehension related to the Israeli-Palestinian conflict, and Western concerns over possible nuclear proliferation in Iran. With rising demand in China and other emerging markets, the situation helped push the price per barrel to over US$100 and created a windfall for Russia and other large-scale oil exporters. The favourable scenario was altered, however, in 2008 following the collapse of Lehman Brothers bank and the onset of a global financial crisis that undermined demand in both developed and developing markets around the world.^[8]

The Future Of The Russian Economy

The price of oil has fallen in response to the U.S. Federal Reserve's signal that it may raise interest rates, and the strengthening of the dollar as global investment returns to the U.S. after the potential for rising yields. With that factor and diminished oil demand around the world, oil prices have fallen to under US$60 per barrel, rapidly eroding Russian export and tax revenues. That was exacerbated by Western trade embargos imposed on Russia for its annexation of a portion of Ukraine.^[9]

The drama of falling oil prices for Russia was signaled at an economic forum in Sochi in October 2015 by Russian Prime Minister Dmitry Medvedev. He highlighted the need for the country to cut its dependence on oil exports by implementing reforms and stimulating more domestic manufacturing. But as the world's largest nation by territory, with 17 million square kilometers, Russia has vast regions to continue prospection for the commodity.

Oil sector analysts see particular promise in the possible expansion of production in the Eastern regions of the country, and in Arctic offshore regions developed in ventures with multinational oil company partners. Some analysts have suggested that with the decline of oil prices, the country may not have access to ample investment funding to develop new resources. The Russian industry may be aided if the global economy stages a recovery to boost the price of oil.^[10]

Forex Opportunities Related To Russian Oil

The possibilities for trading in Russia's currency, the ruble, in reaction to direction of oil prices may be plentiful ahead, depending on the Russian government's ability to manage the fallout from price volatility. In recent periods, the government has been forced to raise interest rates dramatically to offset the impact of diminished trade revenues from oil on the country's balance of payments. Traders may be able to find further opportunities in government oil policy announcements, oil production and export figures, or possibly new external factors that could limit Russia's ability to sell oil abroad as it seeks to diminish its dependence on the export market.

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