Oil Prices Should Worry Putin More Than Western Sanctions

This week, as falling oil prices have hammered the Russian economy, President Vladimir Putin has warned repeatedly that his country, a nuclear superpower, must not be "blackmailed." He was talking about economic sanctions, but there is a different lesson he should be drawing right now and it has nothing to do with the U.S. or the European Union.

Putin's response to the sanctions, imposed to dissuade him from further aggression in Ukraine, has been to shore up the big state companies and banks most affected. To compensate these businesses for their losses, as sanctions have squeezed them out of international credit markets, the government has raided the state budget, the pension fund and privately held companies. Smaller businesses are being crushed, accelerating a long-term trend under Putin in which Russia's economy has become ever more concentrated in state hands and reliant on natural resources -- especially oil and natural gas.

When times are good, these resources are a source of immense power and wealth. They were the engine that drove Russia's extraordinary 7 percent average annual growth from 2000 to 2008, cementing Putin's popularity. An abundance of natural gas, in particular, has also allowed Russia to punish or reward other countries by imposing high or low prices, or by simply cutting them off.

That pipelines game continues unabated. On his way to today's talks on the Ukraine crisis in Milan, Putin attended a military parade in Serbia celebrating Belgrade's liberation from German occupation in World War II. He used the occasion to discuss building the South Stream gas pipeline, which the EU has blocked since the Ukraine crisis developed but is popular in Serbia and other countries that would gain by hosting it. He also warned that the European Union may lose its gas supply this winter.

The flipside to all this energy wealth, however, is that Russia's economy has remained too dependent on energy prices: The sector accounts for about half of government revenues and a quarter of gross domestic product.

Russia's annual budget loses about $2 billion for every dollar fall in the price of oil -- a hit that couldn't come at a worse time. Sanctions, a falling ruble, rising inflation and rapid capital flight are already helping to push the economy toward recession. Although Putin himself will survive -- he has $450 billion in reserves and a population thrilled by his annexation of Crimea -- Russia is not getting any stronger. No wonder Finance Minister Anton Siluanov recently said Russia "simply cannot afford" its ambitious $500 billion rearmament program.

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