Putin’s Ukraine victory may be short-lived

Why Russia risks overplaying its hand in a fast moving energy market.

Putin has achieved what he wants in Ukraine. The Russian president has established that in eastern Europe, he cannot be ignored. We don’t yet know if Ukraine will survive intact, or atomise like Yugoslavia, but with militias arming themselves, and Russian propaganda “stirring the pot”, stepping back from the brink is becoming increasingly unlikely. However in seeing off pro-Western influences on his doorstep, Putin has unwittingly focused attention on the weakening of what has been his trump card – his control of energy supplies in Europe.

The suffering of the Ukrainians merely forms part of a much greater power play between East and West over Putin’s desire to effectively reinstate the old Soviet Union. Much of Putin’s leverage rests on controlling oil and especially gas supplies to Europe via pipelines crossing Ukraine and its neighbours. He and his oligarch friends have become billionaires from their control of Russian resources, particularly energy. (Putin’s wealth was estimated by the respected Peterson Institute for International Economic at $41 billion some years ago). US policy, which we sometimes dismiss as ineffectual, is leading to an imminent change in the balance of power in world energy supplies, and to significantly reducing Russia’s dominance of Europe’s energy markets.

Between 2007 and 2012, US shale gas production increased by 50% to almost 40% of all domestic production. Similarly between 2008 and 2013, US crude oil production increased by 50%. The US is now an energy superpower, rather than an energy-dependent supplicant. Last year the US surpassed Russia as the number one energy producer in the world. Next year it will surpass Saudi Arabia as the number one producer of crude oil in the world. The worries expressed in recent years about “peak oil”, have once again been confounded by a series of technological innovations. But is not just in the US, the world energy market has changed. Australia will soon surpass Qatar as the largest global supplier of liquefied natural gas (LNG) and by 2020 the US and Canada together will be exporting close to Qatar’s current LNG capacity.

As production continues to increase, it will put significant downward pressure on global oil and gas prices, thereby significantly helping energy importers such as Ireland, but also China, India, and other Asian states and reducing the political leverage that energy suppliers such as Russia and OPEC (the Organisation of the Petroleum Exporting Countries) have wielded for decades.

Increased US and Canadian oil production will also have significant impact on the global price of oil. With possible increased production in Iraq and other producers, and with the need for increased production by many OPEC members to meet the needs of their rapidly growing populations, this could lead to massive falls in the price of oil, which according to one estimate, could drop by 20% or more. [America’s Energy Edge the Geopolitical Consequences of the Shale Revolution, by Robert D. Blackwill and Meghan L.O’ Sullivan, Foreign Affairs, March/April 2014.]

Economically the biggest winner in all of this is the US. The McKinsey Global Institute estimates that by 2020, unconventional oil and gas production could boost US GDP by between 2% and 4%, or approximately $382 -$690 billion, and create an additional 1.7 million new permanent jobs. Energy accounts for roughly half of the US trade deficit, which can now be expected to reduce significantly. Further, US gas is amongst the cheapest in the world giving a significant competitive edge to its steel and petrochemical industries. The political impact of this hugely diminished reliance on energy imports, will give the US much greater geo-political flexibility, and increase its bargaining capacity with Middle East energy producers, Russia, and Asian energy consumers.

The biggest loser is Russia. According to America’s Energy Information Administration, oil and gas exports make up 70% of Russian annual exports, and 52% of the Russian federal budget. Sustained falls in energy prices, particularly oil, could have a seriously destabilising impact on the Russian political system. Even at current energy prices, the Kremlin has been under pressure over its reduced economic growth. A significant fall in energy prices would place in doubt the unofficial “deal” in Russia, giving Putin and his cronies political control and access to immeasurable wealth in return for continually improving living standards for the general populace.

Putin is only too aware of this negative scenario for Russia, and this my have been part of his calculus in determining to annex the Crimea which has significant oil and gas reserves offshore. Likewise his stance on Ukraine as it becomes clear that both it and Poland have significant domestic shale reserves which could dramatically change their energy consumption position, and therefore their leverage vis-a-vis Russia.

For energy consumers such as ourselves, this energy revolution is likely to have significant positives. However short-term energy interruptions due to negative political developments in the Middle East and Gulf area, and in other producers such as Venezuela, cannot be ruled out, even if longer term trends are positive. The effect on international relations between major powers, such the US, Europe and Russia, over the next decade will be profound. And we in Ireland might well ask ourselves if our squeamishness in exploiting our own energy resources is short-changing our children and grand-children’s futures?

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