Russia Watch: An energy-driven Olympic giant

by: Arjen van Dijkhuizen , Hans van Cleef

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  • Russia’s re-emergence backed by energy wealth. Next month, Russia will host the 2014 Winter Olympics in Sochi. That will bring the Winter Games home to one of the giants in Olympic history. If we add up all the gold medals that Russia won at the Winter Olympics, including those during the Soviet era, it takes first place in the ranking table. The fact that Russia is hosting events such as the Olympics and the World football championships in 2018 is illustrative of its ambition to return as a key global player. Russia’s re-emergence is bolstered by its abundance of energy; in fact, the surge in energy prices has been the key growth driver in the first part of this century.
  • Some recovery expected after lacklustre 2013. After recovering from the global financial crisis in 2010 and 2011, Russian economic growth has fallen gradually to a disappointingly low 1.5% yoy in 2013, the lowest level since the crisis. We expect growth to accelerate to 2.5% in 2014, on the back of the global economic recovery and some recovery of investment, which also reflects the low base and some positive effects of the Sochi Olympics. Growth should gain further momentum in 2015, reaching 3%.
  • More investment needed to safeguard long-term growth. Looking forward, however, Russia needs to tackle a number of structural weaknesses and diversify and modernise the economy to sustain or even improve long-term growth prospects, although pre-crisis growth levels will remain out of reach. Key here are raising the investment ratio, improving the investment and business climate, enhance competitiveness, promoting diversification and innovation and developing the energy sector. However, we assume that economic reforms will likely remain unspectacular without more political reforms.
  • Rising costs and new investment challenge for Russian energy sector. As a producer of oil and gas, Russia is facing higher costs as easy oil and gas are diminishing. Alongside the fact that new investments are needed to reach new supplies, the existing infrastructure is facing the effects of a lack of competition. As a result, the energy infrastructure is out-dated while national energy companies are lagging in technology and deficient in investment funding. Russia needs to secure its existing demand from traditional European markets. Furthermore, it needs to invest in new supply and new infrastructure to service new, mainly Asian, buyers.
  • Lower gas prices and potentially lower market share form threat to future income. Buyers of Russian gas are pushing the country in the direction of loosening the oil link for gas prices. With global gas prices trading significantly lower, especially in the US, demand for Russian gas could come under pressure as buyers are searching for other alternatives. In order to maintain its market share, and thereby keep its exports at current levels, Russia needs to adapt a more flexible pricing policy. Meanwhile, Russia is also struggling to deal with the rise in domestic energy demand.