The contribution of the energy sector to Russian GDP will decrease by nearly 50% over the coming decades. Although energy will continue to provide an important foundation to the Russian economy, it will cease to be an engine of growth. That is the main conclusion of Global and Russian Energy Outlook to 2040, recently published the Energy Research Institute of the Russian Academy of Sciences and the Analytical Centre of the Government of Russia. Researchers Anna Galkina, Vyacheslav Kulagin and Irina Mironova discuss the key messages from their study.
The energy sector has traditionally played an important role in the Russian economy, not only stimulating economic growth with revenues from exports but also providing consumers with access to energy at acceptable prices and supplying the needs of related sectors. The fuel and energy sector provides over 25% of GDP and almost 30% of the country’s consolidated budget, two-thirds of foreign exchange earnings from exports, and a quarter of total investment in the national economy.
Exports are vital to the health of the Russian energy sector. More than 45% of primary energy resources produced in Russia are exported, providing 70% of total export earnings. By 2012, customs duties and the mineral extraction tax on oil and natural gas amounted to half of federal budgetary income. Conditions on external markets therefore play a crucial part in the development of the entire Russian economy. Two factors are particularly important here: hydrocarbon prices and demand growth.
So how will export markets develop for Russia in the coming years? And can Russia reduce its heavy dependence on energy exports?
In our study, we have investigated three scenarios: our Baseline scenario, a scenario called New Producers, which assumes the entry of many new suppliers in international oil and gas markets, and a scenario called Other Asia, which assumes certain changing demand patterns in Asia.
The Baseline scenario in the 2014 edition of the Outlook saw some minor changes compared to 2013, in particular a slightly higher economic growth forecasts (3.5% compared to 3,4% last year), somewhat higher expected population growth as well as higher expected average energy intensity, especially for China. These revisions led to higher expected world energy demand.
In addition, energy demand shifts to the developing countries, which by 2040 will account for 65% or world GDP and 69% of world energy demand (Figure 1).
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014. P.18.
Figure 1 – Growth of population, GDP (PPP) and energy consumption by region, Baseline scenario
Developed countries, which actively implement energy saving technologies, will increase their aggregate energy demand by only 4.6%, and the bulk of this growth will happen during the period up to 2030, with stabilization of demand thereafter. Europe and developed countries in Asia will even see a decrease in energy demand.
China, which currently can be compared to the US market in terms of the volume of consumption, by the end of projected period will become the largest market, almost twice as large as the US market. The main growth in China will happen over the next 10 years, after which the pace of growth will slow considerably (down from 10% per year in 2010 to 1% by the end of forecast period, 2.1% annual average growth). After 2025, the center of demand growth will shift to India (2.8% annual average growth) and South East Asian countries. The Middle East and Africa will become large energy consumers as well. This will inevitably lead to a change in export markets for Russian energy suppliers.
Another factor that is expected to have a major impact on Russian energy exports is changing demand in Europe. What is new in the 2014 outlook is that there are stronger measures expected in Europe to diversify the energy mix and decrease dependence on gas supplies from Russia. Tensions in EU-Russia relations will inevitably influence their energy relations.
All in all, in our baseline scenario Russian energy exports will start to decline after 2015, with total exports returning to 2010 levels only post-2030, with an increasing share going to Asia. As Russian oil production peaks, after 2015–2020 the growth in the share of oil and petroleum products in the country’s energy exports will come to an end and be replaced by an increasing share of gas and increased export volumes of coal and electricity. (See below for more details.)
The New Producers scenario was inspired by the political process around Iran, which may lead to the entry of this country into international oil and gas markets in a big way. Together with the expected increase of production from unconventional resources, this could create a situation of oversupply and hence falling prices. This could have a major impact on Russian economy.
In the New Producers scenario we have assumed the most positive prognoses for oil production expansion in Iran, Iraq, Brazil and gas production expansion in Iran, Qatar, Turkmenistan and recently discovered fields in East Africa. Under these assumptions, the oil price will fall, but by no more than 4-9% (Figure 2). Gas prices will decrease in a differentiated manner – by 5% in North America, 9 to 16% in Europe, and 9 to 13% in Asia Pacific (Figure 3).
What is more, the cheaper new supplies will temporarily push out part of Russian (and US) supplies, particularly in the period 2020-2025 (after that Russia and the US will recover market share). Russia could lose 70 billion cubic metres (bcm) per year, roughly a third of its current exports. Thus, the key risk for Russia in the New Producers scenario is not so much to be found in the price level, but in the shrinking market niche that is left for Russian oil and gas exports.
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014. P.18.
Figure 2 – Equilibrium oil prices, Baseline scenario and ‘New Producers’ scenario
*Weighted average price between the prices of long-term contracts linked to alternative fuels, and spot prices
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014. P.95.
Figure 3– Equilibrium gas prices, Baseline scenario and ‘New Producers’ scenario
By contrast, the Other Asia scenario shows relatively positive outcomes for the Russian energy sector: the resources of supplies become scarce, leading to favourable outcomes for producers and allowing for increased exports to Asia.
The main hypothesis for this scenario is changing demand patterns in Asia. There are some grounds to expect that China and India may follow a somewhat different scenario than generally expected, and one of the reasons for this is changes in the coal market. Coal is the main element in the energy mixes of these two countries, and both may encounter supply shortages due to peaking of domestic production (not so much because of resource scarcity, but mainly due to infrastructure constraints and growing production costs). Against the backdrop of continued rapid growth in energy demand in these countries, they will be faced with an energy shortage, which will have to be covered by imported coal or alternative energy sources.
This will most likely lead to increased consumption of gas, nuclear energy, and renewables, but also increased imports of coal (in total 280 mln t per year) and gas (200 bcm per year), leading to radical changes in world trade in both coal and gas markets. Out of all potential coal suppliers, Russia has the best opportunities of increasing the production and export of coal, with the main limitation being the cost of transportation. But Russia should be able to increase its exports several times over. Additional demand for gas will be met by Russia (+60 bcm exported), Australia (+50 bcm), Middle East (+20 bcm), South America (+15 bcm), North America (+10 bcm) and Africa (+10 bcm).
Thus, the Other Asia scenario is much more optimistic for Russia in terms of external market conditions – the increased capacity of foreign markets and the expansion of particularly Asian demand for Russian energy resources will boost the development of all sectors of the energy industry. In this scenario, there is a projected increase in Russian energy exports of 20% by 2040 compared to 2010 levels (Figure 4).
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014. P.112.
Figure 4 – The Russian Federation’s net exports by energy resource type, Baseline scenario and Other Asia scenario
Oil and oil products
The Russian oil industry did not suffer heavily from the global financial crisis, thanks to newly introduced tax incentives and reduction in prices resulting from the devaluation of the rouble. Thus, the economic environment remained sustainable for the oil companies. The subsequent rise in global oil prices even allowed for the revival of their investment programmes.
Nevertheless, Russia will not be able to keep oil production at current levels. Large-scale investment in exploration and new technologies will be needed. In the Baseline scenario, production of oil and gas condensates reaches a peak and gradually declines, from 523 mt (million tonnes) in 2013 to 522 mt by 2015 and then to 468 mt by 2040 (Figure 5).
Oil refining volumes in Russia will also decline after 2015. This will be caused primarily by a glut of oil products on the European market. After 2020, a gradual recovery of primary oil refining in Russia is expected (up to 280 mt by 2040).
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014. P.133.
Figure 5 – Oil and gas condensate production in Russia by key producing regions, Baseline scenario and Other Asia scenario
Reduction of the level of production and the aforementioned increase in refining volumes projected in the Baseline scenario will lead to a drop in Russian crude oil exports (from 245 mt in 2010 to 185 mt in 2040). There will also be a change in the destination of exports: Europe’s share will decline from 73% in 2010 to less than 50% by 2040, while the importance of the ‘eastern vector’ of Russian oil exports greatly increases: in the Baseline scenario, in 2040 exports to the Asia Pacific reach 85–90 mt and will exceed exports to Europe.
This means that we foresee a period of weakening interdependence of Russia and Europe in the liquid fuels market. Under these circumstances, Russian participants could start to withdraw from trading on western exchanges in favour of Asian marketplaces, and this process could eventually lead to the establishment of Russia’s own oil marker in Asia and the reduction of the influence of Brent prices on Urals prices.
One more noteworthy point is the increasing concentration of assets in the hands of state-controlled companies. At the beginning of the 2000s, private corporations owned key production assets; state-controlled Rosneft accounted for less than 5% of total production. Over the past decade, the proportion of state-controlled production (Rosneft, Gazprom Neft, and Slavneft) has increased to 50%.
Unlike the oil sector, the Russian gas sector was affected considerably by the global financial crisis. It experienced a 12% decline in production compared to 2008 levels, caused by lower domestic and external demand. This was further exacerbated by price levels, which did not recover sufficiently in external markets and slowed down in the domestic market. The ongoing implementation of excessively expensive investment projects with uncertain prospects for payback only complicated matters for the gas producers.
Looking ahead, there are four essential tasks before the Russian gas industry: to increase gas production by 35–50%, to expand the unified gas supply system eastwards for pipeline gas exports, to create an LNG production and transportation industry, and to expand its wet gas and helium processing capacity several times over.
In principle, the resource base allows for a substantial increase in production, but reserves will be more costly to extract. Looking ahead to 2040, production of natural and associated gas will increase from 649 bcm in 2010 to 870–970 bcm by 2040 (an increase of 33–49%) depending on the scenario (Figure 6).
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014. P.141.
Figure 6– Natural and associated gas producing provinces in Russia, Baseline scenario and Other Asia scenario
According to the Baseline scenario, Russia’s total gas exports will increase from 223 bcm in 2010 to 310 bcm by 2040 (388 bcm in the Other Asia scenario). The overall share of eastward gas exports will grow from 6% in 2010 to 30% in 2040 in the Baseline scenario and 40% in the Other Asia scenario. Therefore, a significant diversification of Russian gas exports is expected in terms of markets as well as methods of transportation.
European pipeline gas exports will stagnate. Nevertheless, they will continue to account for around 50% of Russian exports in 2040 in the Baseline scenario and 40% in the Other Asia scenario.
We see, then, that, on the one hand, the Russian energy sector faces new risks. The likelihood of unfavorable scenarios has increased. The Baseline scenario is already quite pessimistic for Russian prospects, the New Producers scenario even more so. On the other hand, there are also new opportunities. The Other Asia scenario shows potential for the Russian coal and gas export to increase.
But in all scenarios the energy sector, which has been the main driver of Russian economic growth, will see this role gradually decline. In the run up to 2040 its contribution to GDP will nearly halve (falling to 16% in 2040 down from 29% in 2010, see Figure 7).
Source: ERI RAS, ACRF. Global and Russian Energy Outlook Up to 2040. 2014, P.119.
Figure 7 – Dynamic and structure of Russian GDP, Baseline scenario and Other Asia scenario
Thus, the main conclusion of our study and the take-away for all readers is that the energy sector will no longer be able to be the driver of Russian economic growth. In the coming period the role of energy in the Russian economy will fundamentally change. Russian economic policy will have to face the necessity of reducing the country’s excessive dependence on oil and gas revenues. Policymakers will have to face focus more on developing the domestic market and reduce their orientation on exports. If they succeed, the energy sector will cease its role as the engine of the economy. Its function will rather be to provide a foundation for such development. The Russian energy sector will continue to make the same contribution to the economy in absolute terms, but other sectors will deliver the growth.
Anna Galkina, Vyacheslav Kulagin, Irina Mironova are researchers at the Energy Research Institute of the Russian Academy of Sciences.
The Global and Russian Energy Outlook up to 2040 is an annual publication produced jointly by the Energy Research Institute of the Russian Academy of Sciences and the Analytical Centre of the Government of Russia. The Outlook features various scenarios of global energy markets development and their implications for Russia. The 2014 edition has been published on 16 June.