Putin’s Petroleum Problem

How Oil Is Holding Russia Back—and How It Could Save It

Last winter, a wave of mass demonstrations suddenly broke the surface calm of Russian politics. A new middle class, born of the oil-based prosperity of the last decade, took to the streets to voice its opposition to the perceived corruption of the political elite, especially United Russia, the ruling party of then Prime Minister Vladimir Putin. For a time, as the protest movement gained momentum, the very foundations of the regime appeared to shake. But in the March 2012 presidential election, Putin managed to win comfortably in the first round, and despite widespread charges of manipulation, even the opposition conceded that he had earned a convincing victory. 

The unprecedented protests and Putin's return to the presidency renewed speculation about whether Russia will keep moving toward political and economic modernity or lapse back into Soviet-style stagnation instead. The answer to that question can be found in the country's most important economic sector: oil. Since the collapse of the Soviet Union, the Russian government has become increasingly dependent on revenue from oil exports. It taxes the lion's share of the profits of producers and transfers them to the rest of the economy through state-mandated investment programs and state-funded welfare, pensions, and subsidies. The spectacular growth of state income generated by oil has helped keep Putin in power, enabling him to secure the support of key interest groups and maintain, at least until recently, a high level of popularity. 

For now, high oil prices are keeping this system running. But sustaining it requires a steadily expanding stream of revenue from commodities, especially oil. In the coming years, however, oil profits are more likely to shrink than grow. For the past two decades, Russia has coasted on an oil legacy inherited from Soviet days. The assets of that era are now deteriorating. Russia is not running out of oil, but it is running out of cheap oil. Much of the oil still in the ground will be more difficult and costly to find and produce. As expenses go up, profit margins will decline. At the same time, the oil industry will have to spend more of its remaining profits on its own renewal. 

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