Tue, Jun 21, 2016 page9

• Russia’s failure to address post-oil era would see economy stall

  • By Vitaly Kazakov
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  It is difficult to overstate the importance of the oil industry to the Russian economy. Globally, Russia is competitive in defense products, space launches, nuclear power, mineral resources and information technology. However, none of these industries compare to oil and gas exports. To the average Russian, the nation’s economy seems to be structured around exchanging barrels of oil for cars and smartphones. The trouble, of course, is that as oil prices have plunged, those barrels buy ever fewer imports.

  Oil revenues, as with revenues from most commodities, are cyclical and sudden drops are not unusual. However, it would be a mistake for nations like Russia to assume that prices are to rise again. A recent drop in prices is indicative of an unprecedented structural change in the energy sector — one that is to have significant political implications for oil-producing nations.

  During the 20th century, oil was a limited resource; its price, it seemed, could only go up. As easily accessible oil was exhausted, extracting from new, ever more marginal sources became progressively more expensive. As prices rose, the lucky owners of low-cost oil and gas fields — notably Russia and producers in the Middle East — were able to capture increasingly large margins.

  However, as is often the case, high prices and human creativity combined to provide alternatives to a limited commodity. The energy industry has seen technological breakthroughs originating both within the industry, such as the shale-oil revolution in the US, and outside of it in the form of cheap, renewable energy.

  In the most favorable locations, wind power and solar power can cost as little as US$0.03 per kilowatt-hour, while “green” consumer goods are becoming ever more competitive. In March, for example, the fully electric Tesla Model 3 was unveiled and priced at a relatively reasonable US$35,000. Within a month, preorders exceeded US$14 billion, making it the most successful product launch in history.

  As new sources of energy become increasingly competitive as well, the oil industry’s price dynamics are set for a fundamental shift. Energy production is no longer to be tied to a scarce, ever more expensive resource; on the contrary, as with other technology industries, prices are likely to continue to drop.

  This technological revolution is likely to have serious political implications. For much of the 20th century, developing nations had two paths for economic success. One was to adopt the principles of Western capitalism, allow foreign capital to flow in and exploit the comparative advantage of cheap local labor resources to find a niche in the emerging globalized economy. The other path was to discover and develop abundant petroleum resources, sit at the bottleneck of booming global economic growth and extract the available rents.

  The petroleum industry’s economic characteristics have shaped the political landscape in oil-producing nations. Governments in regions blessed with cheap oil have sometimes considered the resulting revenues as a sign of divine favor and spent money as if it would never run out.

  Some people, such as former Saudi Arabian minister of petroleum and mineral resources Ahmed Zaki Yamani, said that this approach was not sustainable.

  “Thirty years from now, there will be a huge amount of oil — and no buyers,” Yamani said in 2000. “The Stone Age came to an end not for lack of stone, and the ‘oil age’ will end long before we run out of oil.”

  However, until recently, such warnings were almost invariably ignored.

  Only as the end of the boom has come into sight has the need for change been widely recognized.

  In Saudi Arabia, the task to fulfill this generation’s “different dreams” for a post-carbon future has fallen to Saudi Deputy Crown Prince Mohammed bin Salman. In Russia, Russian President Vladimir Putin recently appointed former Russian deputy prime minister Alexei Kudrin to write a new, liberal economic program for the nation.

  In crafting their reforms, both nations’ governments would be wise to bear in mind that the energy industry is just one of many examples of how technology is making scarce resources — whether capital, labor, or a given commodity — increasingly irrelevant. The economics of the 21st century is being defined by the exponential trajectory that characterizes the growth of knowledge and technology.

  The path to growth taken by nations such as China is slowly being closed off, as cheap labor becomes less of an advantage in a global knowledge economy. The new catch-up growth is based on replicating the US institutional framework and investing in education and technology hubs in the style of Silicon Valley.

  If a nation’s economy is to flourish, it needs to produce knowledge and create the most favorable environment for converting that knowledge into growth. In terms of policy, that means emphasizing education and implementing institutional reforms. Top priorities should include establishing the rule of law, particularly the creation of a strong, independent judicial system that can protect property rights adequately.

  Sadly, knowing the way forward is not the same thing as taking the correct path. In the years between the end of Russia’s industrialization in the 1960s and the introduction of Perestroika two decades later, the nation experienced a long period of stagnation. Broad-based reluctance to carry out the reforms needed for a post-oil world could lead to similar malaise in the years to come.

  Vitaly Kazakov is director of the Masters in Energy Economics program at the New Economic School in Moscow.

  Copyright: Project Syndicate
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