Radical market reforms based on price liberalisation

In 1991 the USSR ceased to exist. The new government of the now independent Russian Federation opted for radical market reforms based on price liberalisation, privatisation of state enterprises, severe budget constraints and free external trade. The results were immediate: hyperinflation wiped out savings, insiders or criminal structures took control of a large part of the economy and several million workers were not paid for months. Finally industrial production collapsed. In 1992 alone, the GDP fell about 15 per cent: Russia was hit by the worst economic depression probably ever in the industrialised world. Between 1989 and 1998, the GDP shrank by half, electricity generation dropped 30 per cent, natural gas consumption fell about 13 per cent and oil and coal consumption dropped by half. In short, Russia had moved from a state of crisis to one of catastrophe. The disintegration of the USSR fractured a largely unified energy system, built irrespective of regional borders.

Thousands of kilometres of pipelines, major oil terminals and a number of refineries were henceforth located in different independent states. The former Soviet republics, previously interdependent, experienced severe electricity, oil and gas shortages. Exports from Russia were sporadically cut off for chronic non-payment. Ukraine, then a major consumer of Siberian gas, was particularly hit by the energy crisis. In Russia, the whole economy was trapped in a debt spiral: energy firms were owed the most, as large quantities of electricity, oil and gas deliveries had not been paid for. Shortages in jet fuel and gasoline caused transport dysfunctions. In some regions, notably in the maritime province (Vladivostok), winter electricity cut-offs of indebted public services and households became frequent and had dramatic consequences. Grain crops could not be harvested, as impoverished farmers could not afford fuel. The domestic energy supply became a significant issue of national security and a matter of survival for the nation. All this forced the government to adopt the law on the state regulation of tariffs for electricity and heat in 1995. The total debts to national energy providers, however, continued to rise to new record levels. Meanwhile, energy companies accumulated large tax debts to the federal budget and failed to pay salaries to their own workers. In 1996 nearly half a million Russian coal miners went on strike demanding over $200 million in back wages. By the end of 1996, the total debts owed to energy suppliers reached $58 billion.

The same year, several well-connected bankers bankrolled Mr Yeltsin's re-election campaign in exchange for the country's most valuable assets, notably in the oil industry. The odd kleptocratic economic system that was neither a free market democracy nor the state-regulated one had been formed with collusion between the Kremlin and the oligarchs. Paradoxically, it was the financial crash of 1998 that marked a turning point in the development of the Russian economy. The devaluation of the rouble boosted domestic production; the growing world price of oil helped to reduce the external debt and provided the state budget with taxes from export revenue. Under the presidency of Vladimir Putin, the ‘commanding heights' of the economy were redefined: political power was consolidated and centralised, the state tightened control over strategic sectors while the further privatisation of the energy sector (notably, electricity generation) was pursued along with some other neo-liberal policies. Since 1998 the macroeconomic indicators have improved significantly and political stability has been achieved. However, the radical transformation of Russia had a deep impact on industry and indeed on all spheres of the society. Radical changes took place in the oil industry in the years following the dissolution of the Soviet Union. At the initial stage of the reforms, the vertically integrated oil companies were created out of production units and refineries previously under the control of the Soviet Ministry of Oil. That is how LUKOil, Surgutneftegaz, Yukos, TNK (Tyumen Oil Co.), Sibneft (Siberian Oil) and Rosneft (Russian Oil) appeared between 1992 and 1995. During the 1990s, the share of state ownership gradually decreased from 100 per cent to zero in most of these firms. Rosneft remained the only national company fully owned by the state, and was partially privatised only in 2006 when it conducted a successful $10.6 billion initial public offering (IPO). A number of other companies, such as Tatneft and Bashneft were controlled by the autonomous republics of Tatarstan and Bashkortostan (Volga-Urals region).

During the loans-forshares schemes between 1995 and 1996, a small group of insiders and bankers took control of Yukos, Sibneft and TNK for only a fraction of their real market price. However, the privatisation and liberalisation of the Russian oil sector did not bring about the needed investments. More than that, they failed to modernise the oil sector sufficiently to ensure sustained growth. The overall efficiency of the industry dropped dramatically: while production fell from its peak of 568 Mt in 1988 to 300 Mt in 1998, the number of employees increased from about 130,000 to almost 300,000 workers. In other words, the productivity measured by output per person decreased several times in the last decade. The situation in geology and oil prospecting became deplorable: for example, by 1998 deep exploratory drilling had decreased five fold. At the same time, oil companies (Yukos, TNK, Sibneft) managed by financiers were actively engaged in profit maximisation through ingenious financial schemes and in skimming off the easiest oil that yielded high rates of production increases. These activities coupled with aggressive tax evasion were clearly oriented to boost the market capitalisation for later sell-offs instead of securing the longterm development of the industry.

The world crude prices that hit rock bottom in 1998 provided favourable market conditions a few years later. In fact, in 2003 half of TNK's assets were sold to BP in a deal worth $6.75 billion; in 2005 Sibneft was sold to Gazprom for $13 billion. In 2004 the arrest of the CEO of Yukos prevented the mega sale of the strategic stakes of the company to Exxon Mobil for an estimated $25 billion. In the words of Marshall Goldman, the author of The Piratization of Russia: Russian Reform Goes Awry: ‘if most American robber barons had at least created something out of nothing, the Russian oligarchs added nothing to what already was something'. By 2002, Russia became a top oil producer again. Nevertheless, the current oil production in Russia is unlikely to reach the peak accomplished in Soviet times and the rhythm of production is slowing down.

For some experts, the use of recovery techniques will just accelerate the depletion, as Russia's proven oil reserves are limited. It has also been noted that the recent upsurge in oil extraction mostly comes from oil that was not extracted during the chaotic 1990s. By and large, it is unclear whether Russia will be able to maintain its oil production growth over the next decades given that virtually no new significant oil field has been discovered and that investment in oil prospecting remains abnormally low.

Radical market reforms based on price liberalisation

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