In response to the Russian invasion of Ukraine, the United States and its allies have imposed sanctions that are threatening to strangle the Russian economy. The private sector has joined in and begun to impose a shock of its own. Citing revulsion at Russian President Vladimir Putin’s war of choice, Western energy giants with large investments in Russia have headed for the exits. On Feb. 27, BP declared its intention to unload its almost 20 percent stake in the Russian state-owned company Rosneft. Shell, Exxon and Equinor all soon followed BP out of Russia. Others are probably on the horizon.
Accusing Western governments of manufacturing political pressure on free enterprise, Moscow has announced controls to prevent the companies from taking their capital with them in a desperate attempt to keep the economy afloat. Putin’s government understands that this exodus threatens to undermine the productivity and efficiency of the Russian energy industry — which is the Kremlin’s cash cow.
But this departure of Western companies is just the latest chapter in a familiar pattern. The Russian energy industry has been a revolving door for foreign companies since it emerged in the late 19th century. Repeatedly, the Russian government has thrown foreign companies out, only to invite them back because homegrown companies have failed to match the competence of their Western counterparts. Yet when those companies return and restore productivity, Moscow’s fears about political consequences reemerge and they look to eject the foreigners once again. The main difference this time is that the foreign companies are leaving by choice. But this history indicates that their departure will deal an economic blow to Russia — one that may eventually lead to their return.
The modern Russian oil industry emerged in the 1870s when local companies drilled the first oil wells and established small refineries in Baku, today the capital of Azerbaijan. Led by the Swedish Nobel brothers and the Paris branch of the Rothschild family, foreign companies played a key role in transforming tsarist Russia into a global leader in oil production. They developed fields, built refineries, provided technical expertise and distributed Russian oil around the empire and abroad. Russia even surpassed the United States as the world’s largest producer for a brief window between 1898 and 1902. The Rothschilds sold their Russian holdings in 1912 to Royal Dutch Shell, making the British-Dutch giant a major player in the Russian oil scene.
An inflection point for foreign involvement occurred in 1920 when the Bolsheviks reconquered Azerbaijan and the Baku fields during the Russian Civil War and nationalized private oil holdings. But this created a problem for the Soviets — they did not have the technical knowledge, capital or equipment to keep the oil fields running. Oil production and revenue plummeted.
Moscow appealed abroad for help. The lure of profits persuaded companies such as the Barnsdall Corporation and the Anglo-Persian Oil Company (now BP) to break a boycott by the companies whose holdings the Bolsheviks had seized as well as those who feared that nationalization could set a dangerous precedent. Royal Dutch Shell, one of the leaders of the embargo, even broke ranks itself and bought Soviet oil.
Aided by the renewed foreign presence, Soviet oil production recovered by the mid-1920s. With the companies having served their purpose, however, the Soviets gradually revoked foreign concessions and forced them to leave once again by the following decade. Cooperation with capitalists did not align with Soviet leader Joseph Stalin’s push to construct a socialist society.
The Second World War disrupted Soviet production, leaving the Soviet Union a net oil importer until the mid-1950s. As Soviet production accelerated in the 1960s and 1970s, oil exports provided a crucial source of hard currency. With technology that lagged far behind the West and lacking the incentives of a free-market economy, Soviet energy production was wildly inefficient and wasteful. Yet the country’s enormous oil reserves still enabled the Soviet Union to become the world’s largest oil producer by the mid-1970s.
During the late 1960s and 1970s, Moscow also established a cooperative relationship with Western European companies and banks eager to exploit remote natural gas reserves in Siberia. The Soviets and Western Europeans were Cold War adversaries. But the prospect of Soviet natural gas proved too enticing to ignore during a decade of energy scarcity. The companies provided expertise and equipment that allowed the Soviets to reach reserves they could not have developed on their own, and the banks extended credits to the Soviet government to pay for the materials. The Soviet Union, in turn, paid the debt with earnings from the resulting exports. The commercial relationship also improved political ties. The arrangement was a win-win for all parties.
As the Soviet Union collapsed in the early 1990s, the state energy ministries became privatized. The Ministry of Oil Industry (Minneftprom) gradually divided into several private corporations including Yukos, Lukoil and Surgutneftegaz as well as the state-owned Rosneft. The Soviet Ministry of Gas Industry (Mingazprom) became a private joint-stock company known as Gazprom.
Hampered by low world-market prices and productivity, the post-Soviet energy industry stalled in the 1990s. Once again, Moscow turned to foreign companies for assistance. Western firms had advanced technology and expertise that Russian companies lacked that enabled them to tap into reserves in the unforgiving climate and terrain of the Russian interior and offshore.
Western companies clamored to get a piece of the Russian pie in the late 1990s and early 2000s. For example, BP struck a 50-50 partnership with the Russian company Tyumen Oil in 2003, and TNK-BP became the one of the largest oil companies in the world. Buoyed by rising demand for oil in the developing world during the 2000s, the recovery of the energy industry provided a boon for Russia’s new president — Putin — helping to resurrect the country’s economy.
Nevertheless, Putin viewed Western companies with suspicion. He did not oppose foreign investment, but he wanted to ensure that the assets did not give the outside companies control over the Russian industry.
Putin’s forceful opposition to Mikhail Khodorkovsky’s attempt to sell much of Yukos to Exxon and Chevron in 2003 illustrated the limits of what he would allow. For Putin, this deal would have given American companies too great a share of the Russian energy industry. The president also resented that Khodorkovsky attempted to use his wealth to influence Russian domestic politics. So he had Khodorkovsky arrested on manufactured charges that included tax evasion, embezzlement and fraud. Instead of the American companies, Rosneft acquired Yukos’s shares several years later.
Putin’s concerns about foreign control placed the Russian energy industry in a familiar position: Once again it sacrificed efficiency for loyalty. Known as “national champions,” large state-owned or state-controlled energy companies such as Gazprom and Rosneft prioritized the Kremlin’s interests over maximizing earnings. Putin used them to rein in the power of foreign companies. After purchasing TNK-BP in 2013, for example, Rosneft reduced BP to a minority stakeholder, leaving the British behemoth with the 19.75 percent share that it is now trying to divest.
The Putin regime has also resorted to bullying Western companies with onerous regulations and taxes. This political environment has dissuaded investments and darkened the optimism of the late 1990s and early 2000s. Western sanctions against Russia for its annexation of Crimea and support of separatists in Donbas in 2014 only added to the difficulties. Yet before Putin’s invasion of Ukraine, some companies had stuck it out because Russia’s abundant natural resources meant there was money to be made.
What is novel about the exodus today is that the companies are choosing to leave in protest rather than being pushed out. However, the resulting losses in efficiency and productivity for the Russian energy industry will be familiar. If history is any guide, eventually Moscow will try to entice Western energy companies to return as it eyes lucrative energy reserves that Russian companies lack the technology to extract.