The World

Putin’s Petro Problem

He knew the invasion of Ukraine would start an energy crisis. He never anticipated how that crisis would end.

An oil well at sunset near Nefteyugansk
Reuters

Russia’s role as the world’s second-largest producer of natural gas and third-largest producer of oil helps explain Russian President Vladimir Putin’s brazen decision to invade Ukraine—and why he will not immediately negotiate or back down.

But that doesn’t mean that he hasn’t badly miscalculated. Indeed, he may have severely overplayed his hand.

Let’s back up. Russia is a huge world power, in large part because of its hold on energy supplies. The country supplies 10 percent of the world’s oil and more than a third of the European Union’s natural gas.

Advertisement

Before invading Ukraine, Putin bet that the world’s dependence on Russian oil—as well as the West’s fear of inflation and instability in financial markets—would decrease other world leaders’ opposition to his attack.

Advertisement
Advertisement
Advertisement

He figured that sanctions on Russian energy exports would be too crippling. Fossil fuel prices would spike sharply. And that because the invasion would hit Ukraine’s pipelines, the market would be further disrupted—which, not coincidentally, would further ratchet up prices and Russian earnings.

These calculations were not left to chance. At the end of 2021, having built up foreign exchange reserves to close to $700 billion (the highest in the world), Putin tightened the delivery of gas to Europe and put Germany, especially, in a severe bind. Natural gas prices in Europe increased more than 40 percent from the lack of supply. Markets were spooked, and oil prices soared.

Advertisement
Advertisement

They are doing so again today. Oil prices soared from $75 per barrel to over $105, as of March 2. These exploding prices help explain why targeting Russia’s exports of oil and gas through sanctions are strikingly absent from the public discussion.

In short, the world has already been hit by an energy crisis because of what has happened in Ukraine. And direct sanctions imposed on Russian oil and gas could only result in mutually assured destruction of economic growth. (An emergency release of crude reserves has been far too small to help.)

Advertisement

In some sense, for Putin, this is all probably going according to plan. It’s a bonus, for him, that the invasion of Ukraine could also damage U.S. President Joe Biden’s chances for a successful economic recovery during an electoral year. Inflation in the U.S. has hit a 40-year high, and according to a new Washington Post–ABC News poll, 50 percent of Americans feel that Biden bears a “good deal” or a “great amount” of the blame.

Advertisement

To be clear, oil-driven price increases, including everything from gas and transportation to plastic products and foodstuffs, are not Biden’s fault. His first year in office resulted in record job gains, wage increases, unprecedented growth, and unparalleled poverty alleviation. But inflation is a unique economic phenomenon in that it hits every single voter (and nonvoter)—and the worse it gets, the further it unnerves an already anxious public. The president gets the blame.

Advertisement
Advertisement

But Putin has dangerously weaponized Russian energy to his own detriment over time.

First, the current disturbingly high gas prices, especially in Europe, are unlikely to be forgotten even if they cannot be avoided immediately. Global leaders who formerly believed that Russia would remain a reliable supplier of oil and gas after decades of energy interdependence have no doubt had considerable second thoughts.

Advertisement
Advertisement
Advertisement
Advertisement

Furthermore, even if U.S.-led sanctions on Russia have not specifically targeted the energy sector, Russia’s petro-economy is already badly disrupted. Germany has suspended the $11 billion Nord Stream 2 pipeline, of which Russia’s Gazprom owns a 50 percent stake (and was set to provide all of the gas running through it).

Russian oil producers are postponing tenders—their invitations to bid on oil—due to a lack of buyers, and Russian ships in Europe and Asia are being boarded and refused entry. BP and Shell have just abandoned huge multibillion-dollar projects in Russia. Maersk, the world’s biggest shipping firm, has stopped all container movement to and from Russia, and Britain has banned any ships with Russian connections from entering its ports. China could partially step into the breach, but due to the strong international response led by the Biden administration, no traders will want to be caught buying, shipping, or storing Russian oil.

Advertisement

Oil is not a spigot. An increase in supply cannot just be turned on. Several Russian banks have been disconnected from SWIFT, the international bank messaging system, and new sanctions on industrial parts that are used for energy product in Russia mean that some oil and gas wells may have to be shut down. It will take time and money to turn them back on.

Advertisement

All this will affect the Russian people.

Russia is a petro-state: Its domestic economy is dependent on the production and sale of oil and gas. In major petro-states, the distribution of excess profits from energy is the key to regime stability. And this is easiest when prices soar, like right now.

Advertisement

But even with high prices, the combination of some domestic anti-war sentiment in Russia and a perceptible opposition among elites already reveal fissures in Putin’s support. And the country’s acute dependence on energy exports is laying the groundwork for price volatility that will hurt Russia down the road.

Advertisement

Today, energy price volatility is at an all-time high as prices fluctuated from below zero in 2020 for the first time in their history to over $100 now—with some observers predicting temporary spikes of up to $150 to $200 down the road.

Such drastic fluctuations hurt markets (including stock markets), but they are especially damaging in petro-states. Russia is no exception. While there is no crystal ball regarding energy prices, extreme volatility assures more elite corruption and lower growth rates, and lessens federal spending that is available for assuaging an already antsy urban population. Russia has already seen what this can mean when oil production (and petrodollar earnings) fell a dumbfounding 9 percent per year between 1988 and 1992, contributing to the collapse of the Soviet Union and its own economy.

Advertisement
Advertisement
Advertisement

The current spike in energy prices encourages other countries to make new investments in gas and oil. This in turn will increase supply and drive prices down. There is always a time lag in this oil cycle, and the next plunge in prices will not occur immediately and will certainly be insufficient to help Ukraine now. But it will occur.

Petro-state regimes are paper tigers—appearing more powerful than they are. Thus, Putin’s gamble, fueled by hubris and petrodollars, gives the immediate impression of strength, but it is a grave miscalculation.

And unlike previous resource wars, we are at a different moment in history. The global movement toward sustainability is growing; the contribution of fossil fuels to climate change is now undeniable. Decarbonization targets are essential, and the demand for a more orderly climate-friendly energy transition is finally on the table. Thus, Putin’s blunder should eventually prove pivotal. Ironically, the leader of one of the world’s largest energy exporters has just made one of the strongest cases for ending the global addiction to fossil fuels.

Advertisement