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Saudi Oil Weapon Bites On Russia’s Strategic Projects

    As I have argued since March, a Saudi-US policy of depressing oil prices combined with sanctions is the best way to push back at Russian revanchism. Recent updates have followed the arrival of these falling prices, but this update looks at the tangible effects of the policy.

    The effect on the Russian domestic economy is well documented. The falling oil price has struck at the value of the ruble, which is now trading at 57.5:$1, compared to a rate in the mid-30s in most of 2013. As a result the cost of servicing external debt has rocketed, prompting the central bank to spend $80bn propping up the currency and raise interest rates to 10.5%, to little effect. Economists are now predicting recession in Russia next year, combined with soaring inflation and capital outflows.

    It is hard to predict how this will affect Russia’s internal politics, and it may be that propaganda remains effective in blaming the West rather than Putin’s policy of aggression. Much less attention, however, has been paid to how the sanctions are directly curtailing Russia’s activities in Central & Eastern Europe.

    South Stream cancellation

    The most striking example is Putin’s snap decision to cancel the South Stream pipeline, which was planned to bring Siberian gas across the Black Sea, over Turkish territory and into the Balkans and Central Europe. South Stream was to receive $50bn of funding from Gazprom, allowing Russia to isolate Ukraine, increase European reliance on Gazprom and shower money on engineering and pipe-making firms owned by the elites of Bulgaria, Serbia and Hungary.

    Putin tried valiantly to give the impression that EU regulatory intransigence was the reason for withholding Gazprom’s resources and investment, and this was certainly a factor. But a far greater motivation must have been finances. The $50bn was to have been raised on the international debt markets. Not only is Russia’s access to these markets now constrained by sanctions, but the rates it can expect are far higher than 12 months ago. Financing from cash reserves is also out of the question, now that the country's state finances are in disarray; the state-owned oil firm Rosneft has requested a $49bn bailout from state reserves just to service existing debt, the cost of which has increased hugely in recent months.

    Since energy is Moscow’s best and favourite lever in Central Europe, this can only be good news. It is true that Central European states have high levels of dependency on Russian gas, and plainly more Russian gas is not the solution. The end of South Stream should now re-energise alternatives such as new Liquefied Natural Gas (LNG) import terminals in Croatia and other Balkan states and the dormant Nabucco project to pipe Azeri gas into the region. On top of this, Russia’s financial constraints may force it to pull out of other subsidized energy projects in the region, such as Hungary’s $10bn Paks 3 nuclear power station. The net result should be a steep decline in Russia’s influence over its former vassals in Central Europe.

    But Russia’s strategic reverses go much further than that.  Putin announced that Gazprom would instead pipe its gas into a ‘commercial hub’ in Turkey, for which Turkey would receive a discount on the price it has paid for its gas hitherto. This means than Gazprom is abandoning a long-standing objective of selling direct to customers without intermediaries – Russia’s commercial and geopolitical loss is Turkey’s gain. On a smaller scale, this is reminiscent of Zbigniew Brzezinski’s insight that Russia is sleepwalking into a neo-colonial relationship with China: in walking away from co-operative Western customers, Russia has chosen to place itself at the mercy of far less charitable ‘partners’.

    It is hard to avoid the conclusion that the Kremlin is in disarray and that decision-making is becoming increasingly erratic in the face of quiet but surprisingly resolute resistance from the West and Saudi Arabia.

    Oil price outlook

    The bad news for Russia is that the outlook for oil prices appears weaker and weaker. This week the International Energy Agency cut its demand growth forecast. In combination with still-growing US production and Saudi determination to keep prices low, it means that prices next year are likely to fall yet further. Today Brent crude was trading at $63.12/barrel – a fall of 40% since July.

    This seems extraordinary and there are some who doubt how much further oil can fall. But it is worth remembering that in the early 2000s oil was under $10/barrel. It might not fall so far this time, but it would be a brave trader who bet on a floor having been reached.

    The reasons for this drop in prices are numerous, including weak demand and unexpectedly strong production in places like Libya and Iraq. But there is no doubt that low prices are a Saudi policy, as seen in the Kingdom’s continued practice of discounting below the market price and its equanimity at the OPEC conference in late November. The question, then, is why the Saudis are taking this position.

    The policy can best be described as a rope with several strands. Since Saudi has modest military power (not to be confused with vast military spending), its influence on oil prices is its best means of shaping the world. At this point low prices serve Saudi strategic interests in the following, inter-related ways:

    • Reining in Russia, whose support for the Assad regime and Iran brings it into direct conflict with Saudi interests (with a break even price of around $100/barrel)
    • Putting pressure on Iran during nuclear negotiations (with a break even price of over $150/barrel)
    • Using joint economic action against Russia to rebuild the strategic partnership with the US, which the Saudis fear could be undermined by a rapprochement between Washington and Tehran
    • Racing to lock in Asian market share through long-term supply contracts
    • Deterring investment in alternative energy and unconventional oil and gas (especially shale), thereby shoring up the market for Saudi oil in future decades

    This would suggest that the stress on the Russian economy is likely to intensify for the foreseeable future. It would be hoped that Putin would relent in Ukraine and accept that Russia does not own the country – the only thing that is being asked of him. Unfortunately, it is far more likely that he will respond with yet more incursions into the air space of the Baltic and Scandinavian states and barely-veiled threats to deploy nuclear weapons. This is not ideal, but the attrition that low oil prices are inflicting on Russia’s military adventures, rearmament plans and energy projects mean that his schemes are increasingly constrained. 

    Neil Barnett has 15 years' experience as a journalist in Central and Eastern Europe (CEE) and the Middle East, writing for the Telegraph, the Spectator and Jane's Defence Weekly. He covered the 2004 Orange revolution in Ukraine and the conflict in Iraq and has written a biography of Tito. He now runs Istok Associates, a risk consultancy specialising in CEE and the Middle East. He is the author of "Deploying the Saudi Oil Weapon" for the Centre for Policy Studies. 

    Neil Barnett has 15 years' experience as a journalist in Central and Eastern Europe (CEE) 
    and the Middle East, writing for the Telegraph, the Spectator and Jane's Defence 
    Weekly. He covered the 2004 Orange revolution in Ukraine and the conflict in Iraq and 
    has written a biography of Tito. 
    He now runs Istok Associates, a risk consultancy specialising in CEE and the Middle 
    East.

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