On thin ice: thawing permafrost dampens Russia’s economic growth prospects

There are many reasons why one might decide against buying a house in the Siberian city of Norilsk: the Sun doesn’t rise for three months each year; the name of the neighbouring town translates as either ‘forbidden place’ or ‘death valley’; and it’s so cold that the bodies of the Gulag prisoners who built it are said to be perfectly preserved beneath a memorial at the foot of Mount Schmidtikha.

It’s fair to say that it’s no place for the faint-hearted. At the very least, buying a house in such a dark, icy wasteland should be good value for money, but even this is no longer the case. “The population of the city used to be 300,000, give or take,” Nikolay Shiklomanov, Associate Professor of Geography and International Affairs at the George Washington University, told World Finance. “Nowadays, it’s 180,000… so you would expect that the housing market should be pretty light – that there should be lots of empty spaces – but now they’re experiencing some acute housing shortages because so many of the buildings there are critically deformed.”

Warming to the idea
The unenviable situation Norilsk finds itself in is not a unique one within Russia. More than half of Russia’s entire territory is covered by permafrost. As this ground thaws, it’s not just buildings that are in danger, but also pipelines and other oil and gas infrastructure vital to Russia’s economy.

Greasing the wheels
Russia is sometimes referred to as a petrostate, but as analysts like Michael Bradshaw – a professor of global energy at Warwick Business School – point out, this obscures the specific and complex role that oil plays in the Russian economy: “Russia has a fairly substantial economy that is not resource-based. However, it’s increasingly clear that large sectors of the industrial economy are tied one way or another to the resource economy.”

While GDP and employment in petrostates such as Saudi Arabia revolve around oil and gas revenue, Russia has a relatively diversified economy. For example, the services sector makes up a larger share of Russia’s GDP than oil and gas (see Fig 2). Nonetheless, oil and gas revenues are still crucially linked to the non-oil economy in Russia, accounting for 40 percent of government income, according to the International Renewable Energy Agency (IRENA).

The wealth generated by oil and gas – known as oil and gas rents – is extracted by the state and channelled into strategically important sectors or the economy more broadly, either in the form of taxes paid to the government or as subsidies for other goods and services. This system, however, means Russia can only prosper so long as oil prices are high.

As such, its economy is extremely vulnerable to sudden changes in oil demand and supply. “If you go back to the 1980s, one of the factors that led to the eventual collapse of the Soviet economy was the fall in oil and gas prices and the loss of substantial rent to the economy,” Bradshaw told World Finance. “That volatility, of course, continued through the 1990s and 2000s, at times supporting the Russian economy and at times punishing it.”

One obvious way of reducing Russia’s exposure to oil shocks is through economic diversification, but such reform is made difficult by the fact that non-oil sectors are so heavily reliant on oil and gas rents. Moreover, beneficiaries of this system are reluctant to change the status quo. “Russia has been spectacularly unsuccessful in seeking to diversify its economy,” Bradshaw explained. “There’s been an awful lot of rhetoric, particularly under [Dmitry] Medvedev’s presidency, but very little change.”

In this regard, Russia has faced some major setbacks. EU and US sanctions – imposed after Russia’s annexation of Crimea – limit the country’s ability to secure funding for new oil projects and import the hi-tech equipment needed for Arctic exploration. As Aalto points out, this presents a significant hurdle to Russia’s Arctic oil ambitions: “It is not feasible to explore, extract and develop much without international partners. In the Arctic, 80 to 90 percent of technology has been foreign, compared to 40 to 50 percent elsewhere in Russia before import substitution policies started big-time in 2014… Russian actors have been forced to [borrow] old equipment from Asia, and it is not in plentiful supply.”

Infrastructure can be adapted to help reduce thawing, but this is expensive, particularly when done at scale

“Nobody in their right mind in Russia will ever even consider building something like Norilsk again,” Shiklomanov said. “Now the question is, how do they maintain it? And should they maintain it or not?” Some analysts would argue not. Over the past few decades, there has been a steady exodus of people from the Far North and Far East to the bright lights of Moscow and St Petersburg. The small mining town of Vorkuta in the Komi Republic, for example, has a dwindling population of about 60,000 residents, down from 217,000 in the late 1980s.

One of the most basic reasons people are shunning these Arctic cities is the severe conditions. The coldest temperature ever measured outside Antarctica was recorded in the Yakutia region of Siberia. The other problem is that these cities are extremely remote – it takes 40 hours by train to get from Vorkuta to Moscow.

In their book The Siberian Curse: How Communist Planners Left Russia Out in the Cold, Fiona Hill and Clifford Gaddy argued that cities in the Far North and Far East are a hangover from the Soviet Union, and that Russia must abandon them for the sake of economic progress: “People and factories languish in places communist planners put them – not where market forces would have attracted them. Russia cannot build a competitive market economy and a normal democratic society on this basis.”

In many ways, these cities are frozen in time – snapshots of a Soviet past. Few people moved there by choice; most were driven there by fear and ideology. Under Stalin, hundreds of thousands of people – many of whom came from Baltic countries – were deported to this remote and hostile territory. As Gulag prisoners, they built Norilsk and other cities like it. Repopulating these areas feels like a step into the past – one last desperate attempt to relive the days of Soviet industrialisation.

The cold, hard facts
If Russia’s ambition to repopulate the Far North and Far East is backwards-looking, then so is its drive to exploit the fossil fuel resources there. Over the past decade, the cost of renewable energy has fallen drastically; assuming this trend continues and nations remain committed to decarbonisation, then it’s highly probable that the world will soon phase out fossil fuels. Consequently, the reserves of oil and gas that Russia is so desperately trying to retrieve from beneath the permafrost will decline in value.

“We are looking at a future of constrained demand and continuing supply,” Bradshaw told World Finance. “In that world, where oil prices are lower… new production in Russia outside of the established regions – be it in East Siberia or offshore – could be more expensive. In other words, you’re ploughing a lot of money into supporting an oil and gas industry that’s delivering less and less income.”

Russia has chosen to continue its resource dependence at the expense of long-term economic growth opportunities. Its plans to push industrialisation in its most inhospitable regions indicate that the country is yet to move beyond its Soviet past and set its sights on becoming a knowledge economy, rather than a resource-based one. In a world where oil and gas are no longer the arbitrators of global economic power, Russia could find itself falling further behind nations that prioritise alternative energy resources and technological progress.