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For Russia, high energy prices a necessity, not a luxury

The Kremlin does not take political dissent with good grace. Last December, Vladimir Putin, then prime minister, now president for the third time, was rattled by the mass protests after the parliamentary elections, which some voters suspected were rigged.

Since then, he has cracked down on the non-believers. Three young women, members of the band Pussy Riot, were sentenced to two years in prison after belting out an anti-Putin song in a Russian Orthodox cathedral.

Opposition activists have been jailed, some under dubious circumstances. On Saturday, about 50,000 protesters are expected to gather near the Kremlin to denounce the political crackdown and call for Mr. Putin's resignation.

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No wonder the Kremlin is ramping up public spending even as its debt-choked European neighbours are doing the opposite. Russia's social contract, in which the masses agree to stay out of the Kremlin's way as long as living standards rise, appears to be demanding more and more helicopter drops of bundles of cash. If the spending slows down, the Kremlin's fine balancing act may fall apart.

Mr. Putin's government can afford to spend as long as energy prices remain buoyant. Increasingly, Russia is an oil and natural gas economy. It is roughly tied with Saudi Arabia as the world's top oil exporter. State-controlled Gazprom, the world's biggest gas producer, is one of Russia's biggest export earners and supplies about half of Europe's gas consumption.

Much to the Kremlin's delight, oil prices have held up remarkably well in the face of the feeble American economic recovery, the recession in the 17-country euro zone and slowing growth in China. On Friday, Brent crude, the best measure of global prices, traded at more than $117 (U.S.) a barrel, about three times its post-2008 low.

But Russia's energy equation isn't as simple as that. Just as surging U.S. shale oil and shale gas production are threatening Canadian energy exports, European shale gas and supplies from North Africa are threatening Russia's gas stranglehold on Europe. And shale oil, no matter where it is produced, will have a dampening effect on global oil prices. The United States is becoming an energy superpower. That doesn't mean that the country will suddenly become an energy exporter. It does mean that its energy imports will continue to shrink, denying export opportunities for Russia, OPEC and Canada.

Oil and gas prices, and market share, can make or break Russia. The Russian economic collapse of the 1990s was largely driven by sinking crude prices, which dipped below $11 in 1998. Russia duly defaulted that year, wiping out most of its banks and sending the ratio of national debt to gross domestic product to more than 80 per cent. Russia was saved when oil prices reversed direction, reaching $147 before the 2008 financial crisis hit. The energy bonanza – oil contributes about 50 per cent of federal government revenues – pushed down its debt to a mere 10 per cent of GDP (Italy's is 120 per cent).

The embarrassment of riches proved irresistible to the government. Spending on social programs, pensions, the military and special projects surged. Russia just spent an obscene $20-billion renovating Vladivostock, the port city on the Sea of Japan, for this month's Asia-Pacific Economic Co-operation forum, and will spent a similar amount to fix up Sochi in Russia's deep south for the 2014 Winter Olympics. High energy prices have gone from a luxury to a necessity.

Various analysts estimated last year that the Kremlin's "break-even" oil price – where the budget balances – at about $100 a barrel. It has no doubt climbed since then. The Economist Intelligence Unit recently put the budget-clearing figure at $120. Citibank has calculated that every $10 decline in the price of oil reduces the Russian government's revenues by $20-billion.

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The Kremlin must be terrified that their energy gusher will turn into a trickle as the shale oil and gas revolution takes over the planet. European shale is nowhere near as developed as that of the U.S., but the reserves are there. Take Poland. Last year, the U.S. Department of Energy put Poland's gas reserves at 171 trillion cubic feet, or about seven times the annual consumption in the U.S., the world's biggest market. The estimate by the Polish Geological Institute was considerably less, but no matter how you cut it, Poland is emerging as a huge threat to Gazprom's gas export machine.

So is the European Commission's just-launched anti-trust investigation into Gazprom. The EC competition's directorate, which almost never loses an abuse-of-dominance case, is examining whether Gazprom is hindering the free flow of gas in Europe through "no-resale" clauses and damaging competition by preventing third-party access to its pipelines. It is also examining Gazprom's standard practice of linking gas prices to oil prices, which has protected the company from the gas-price crunch.

Already, Gazprom is letting some of its biggest European customers renegotiate long-term contracts. There is little doubt that Gazprom's best days in Europe are over. If the rise of shale oil hurts Russia's oil exports, the Kremlin is going to have a miserable time balancing its budgets.

Which brings us back to the rise of political dissent in Russia. The protests are getting more frequent and the Kremlin's crackdown more brutal. If it's this bad now, what might it be like if the government can no longer use lavish spending to raise living standards? If the value of Russia's energy exports decline, protests like the one that landed Pussy Riot in prison could become commonplace. In 2009, when he was president, Dmitry Medvedev, who is now prime minister, called his country's dependence on energy "primitive." Today, he could add that it's socially dangerous.

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