Deep freeze: Putin has put Russia’s future in doubt

It’s easy to see why Russian President Vladimir Putin is dangling an impossibly massive investment opportunity in front of US President Donald Trump. Russia’s energy exports lifeline is atrophying, threatening its capacity to fund the war in Ukraine without permanently and severely damaging its economy and society.

There’s a sense of urgency, even desperation, in Putin’s offer of joint venture projects with the US that he has claimed could be worth $US14 trillion (about $20 trillion, or eight times the size of the Russian economy) as the fourth anniversary of his invasion of Ukraine ticks over.

He’s also offering to return Russia to the US dollar-based international financial system it has been frozen out of – and has desperately diversified away from – since its foreign currency reserves were seized at the onset of the war and the dollar’s dominance was used to impose an escalating series of sanctions on its economy.

Trump – for reasons of ego, not strategy – wants a deal that ends the war on his presidential CV. The extremely transactional “America First” president does love a commercial deal, so one between Trump and Putin that sacrifices Ukraine, or at least a slice of its territory, can’t be ruled out.

Ukraine and the European Union, of course, will have a different outcome from the peace negotiations in mind.

Behind Putin’s efforts to end the war on his terms is an economy being stressed to levels that could condemn Russia to permanent economic winter unless it can release the shackles imposed by the West’s sanctions. It needs a deal not just to collapse Ukraine’s defences or for Putin to claim victory but to give itself an economic future.

Russia’s economy, before it invaded Ukraine, was petrodollar-driven, with oil and gas exports accounting for almost half the government’s revenues.

According to an independent research group, the Centre for Research on Energy and Clean Air (CREA), Russia’s revenues from crude oil exports are now 27 per cent below pre-invasion levels, having dropped 18 per cent, or about $143 billion, over the past 12 months. It’s also experienced a 6 per cent fall in the volume of its oil exports.

The squeeze on Russia’s energy exports tightened significantly last year, when the US sanctioned two of the country’s largest oil companies and threatened importers of Russian oil with financial sanctions, causing refineries in India and, to a lesser extent, China – by far the biggest buyers of Russia energy since the invasion – to significantly reduce purchases.

That Western sanctions have taken so long to choke Russia’s energy revenues relates to how reliant Europe was on Russian energy, particularly gas, when the invasion was launched. The EU wasn’t able to immediately end that dependence.

In the past 12 months, however, according to the Helsinki-based CREA, the EU’s imports of Russia’s fossil fuels amounted to €14.5 billion ($24 billion). That is still substantial, but 36 per cent less than it bought a year ago.

The sharp decline in oil export revenue is being driven by both lower volumes and lower prices, with the G7’s floating cap on Russian oil and US sanctions combining to force Russia to offer substantial discounts to a shrunken pool of buyers.

Last week the price of Russia’s flagship crude, Urals, was trading just above $US40 a barrel – more than $US26 a barrel less than the price of Brent crude.

The fall in energy revenue is hitting government revenues hard, nearly halving them to around 24 per cent of the overall revenue base and forcing a government whose financial management has generally been highly conservative to run budget deficits.

This year Moscow is budgeting for a deficit of about 2.6 per cent of GDP, although it will probably need a rebound in global energy prices – and increased output from its oil fields and refineries now being targeted by the Ukrainians – to avoid a blowout. Russia is currently producing about 300,000 barrels of oil a day less than the production ceiling it is allowed by the OPEC+ cartel.

Without access to international debt markets, Russia has had to raise taxes and draw down the most liquid assets in its strategic reserves to maintain funding for the war. Spending on its military and security now accounts for about 40 per cent of all government spending.

Russia’s sovereign wealth or “rainy day” fund had about $US113 billion of liquid assets in it before the invasion. Despite the extraordinary surge in the gold price (Russia has been selling significant volumes of its holdings to raise cash) those assets now amount to only about $US55 billion, with Russian economic think tanks saying they could be exhausted in just over a year at current oil prices.

If Trump doesn’t throw Putin a lifeline and the West maintains (or hopefully tightens) the existing network of sanctions, the plunge in revenues will steadily choke the Russia economy, which the International Monetary Fund has forecast will grow at only 0.8 per cent this year.

That economy is now disproportionately devoted to the war effort, which is consuming vast amounts of revenue, manpower and capital and stressing the non-military sectors of the economy in the process.

The military and those businesses and people related to it are doing relatively well, but are diverting financial and human resources and generating inflation in wages and prices that are having unpleasant outcomes for the rest of the economy. Almost all growth in the economy is military-related – the rest of the economy is shrinking,

To hold down a war-influenced inflation rate of about six per cent, its central bank’s policy rate is 15.5 per cent. Moscow has increased its value-added tax to 22 per cent, raised taxes on small businesses and is considering new wealth taxes to maintain a war effort whose production is now flat-lining and just keeping up with the losses of hardware (and personnel) in Ukraine.

Unless it wants to maintain a wartime economy in perpetuity, when the war eventually ends Russia’s non-military economy and its capacity will be substantially degraded and diminished.

The cost of the war and the dramatic structural changes it has wrought are condemning the country – which has an ageing and shrinking population, trends the losses in the war have accelerated – to a stagnant future at best.

In the meantime, with companies squeezed by high interest rates, increased labour costs, weakening domestic demand and reduced access to foreign technology and capital, bankruptcies are rising and non-military sector workers are experiencing income and job losses. Financial stresses within the economy are rising.

Four years ago, Putin thought the invasion would be a walkover. Today, Ukraine is just holding on with EU support (the US, under Trump, ceased its contribution) but, while paying an awful price in lives and infrastructure for its resistance, the longer the war goes on the more, and more lasting, damage is being done to its aggressor.

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