Dwindling oil money may weaken Russian war machine this year

Destroyed Russian military vehicles in Kyiv. The lack of money will increasingly weaken Russia's war effort this year, and could in turn, impact its energy industries. AFP

“The great questions of the day will be decided by blood and iron,” said former German chancellor Otto von Bismarck. Russia’s President Vladimir Putin seems to believe the same but with the addition of the key element of oil. The progress of his campaign in Ukraine depends on the Russian economy and in turn, on its energy industries.

Last year was one of problems, but overall resilience, for Russia’s energy sector and economy in general. The Ukrainian drone campaign against its oil refineries caused some damage but did not seriously affect fuel supplies or exports. The economy grew significantly in 2023 and last year, at an estimated 3.6 per cent to 4 per cent. Unemployment has fallen to low levels of about 2.4 per cent. Military production has reached high levels.

That may encourage Mr Putin to believe he can continue the grinding campaign in eastern Ukraine and hope for a withdrawal of US support for Kyiv under incoming president Donald Trump.

Tatiana Mitrova, my colleague at Columbia University’s Centre on Global Energy Policy, concisely summarises some of the crucial metrics for last year. Oil production was slightly lower than in 2023 but that reflected adherence to Opec+ commitments. Even though prices for Brent crude, the international benchmark, were a little lower, profits from oil exports increased, as Russian companies managed to shrink the discount for sales to their key markets, India and China.

Gas production rose, as state pipeline export monopoly Gazprom was able to grow sales to China and Central Asian neighbours. However, profits have dropped because these are much less lucrative markets than Europe. Gazprom used to provide about 10 per cent of the government budget; it made a loss in 2023, though it returned to profit last year.

The coal industry, financially less important but socially prominent, had a bad year. Europe had already banned coal imports from Russia and last year’s falling prices and Chinese import tariffs saw sales volumes and profits plummet.

Overall fossil fuel export revenue, which peaked at about €39 billion ($40 billion) in March 2022 according to the Centre for Research on Energy and Clean Air, fell to a low of about €19 billion in July 2023 and has hovered a little above that monthly level since.

The electricity sector is also struggling. Ramshackle infrastructure and fast-rising demand to meet war industries saw profits almost halve. Areas of southern and far eastern Russia have been hit by power cuts. On February 8, the Baltic countries will finally disconnect from the Russian grid. Now, the strategic Russian exclave of Kaliningrad, sandwiched between Poland and Lithuania, has become an energy island itself.

Moscow may be approaching the limits of war production, as its battlefield consumption and losses of artillery, shells and armoured vehicles far exceed replacement. Defence producers compete with the army for personnel and both strip the rest of the economy of workers. This drives up wages. Inflation is reported at 9 per cent, and interest rates, raised to 21 per cent, are a problem for business investment. The rouble has lost a quarter of its value since mid-2022.

“The sinews of war are infinite money”, the Roman orator Cicero, observed. Officially, military spending consumes 41 per cent of the state budget and 7 per cent of gross domestic product; in reality, it is likely significantly more. At a budgeted $142 billion for this year, it equates to more than half of last year’s energy export earnings. Unable to raise money internationally, Moscow is drawing down its sovereign wealth fund and gold reserves.

Three things have already got worse for the Kremlin this year. First, Ukraine has stepped up its aerial campaign against the Russian fuel sector, most recently hitting the large, modern Taneco refinery in Tatarstan, which is more than 1,200km from the Ukrainian border.

Second, the US on Friday issued a wide set of sanctions targeting many of the tankers in the “shadow fleet” of ageing tankers that Russia uses to get its oil to market. They also cover two of the biggest Russian oil companies, Gazpromneft and Surgutneftegaz, and a Chinese terminal operator that receives Russian oil.

The White House suggests these measures could reduce Russian oil exports by as much as 1.5-2 million barrels per day in the short term, out of 7.8 million bpd total exports in December. Russia will have to scramble to find new vessels, possibly returning to Greek ships where the price of sales is capped at $60 per barrel.

Inspections are also tightening on the shadow fleet, that sails potentially risky routes through the Baltic and North Seas. Recent possible sabotage by Russia-linked ships of undersea gas pipelines and electricity and telecom cables will not encourage Europe to be lenient.

Third, Russia’s gas sector faces more problems. On January 1, the transit contract through Ukraine expired and supplies stopped. It means the cessation of Russian pipeline gas supplies to Europe, other than those moving through Turkey to south-east European states.

Europe is still the major buyer of Russian liquefied natural gas, which contributed about 10 per cent of Russia’s fossil fuel export revenue in December. The new US measures also target two smaller operational LNG centres, while earlier sanctions have tried to stop the large Arctic LNG 2 project from being completed. But, during a cold winter and having lost the Ukrainian pipeline option, Brussels is still reluctant to move to ban Russian LNG imports.

If substantial Russian oil is taken off the market, the response of the rest of Opec+ will be crucial. It could keep production steady and pocket the higher prices. Or, it could raise output, stabilising the market and regaining some sales, but at the risk of annoying its colleagues in Moscow.

Russia’s economy won’t collapse, and it will probably again find creative ways to sidestep sanctions, shuffling oil exports between producers and offering more discounts to customers. However, for all the blood and oil it has spent, the lack of money will increasingly weaken its war effort this year. Russian energy industries creak under the burden of deciding this great question.