ECONOMY
Russia Facing a Maelstrom of Economic Problems as the War Enters Fifth Year
March 3, 2025
- Igor Lipsits
Professor, Dr.Sci. (Economics)
The Russian economy meets the start of the fifth year of the Russia-Ukraine war significantly weakened. It is increasingly weighed down by sanctions, war-related fiscal profligacy, declining oil production and exports, and cost and capacity issues in the military-industrial complex, argues economist Igor Lipsits.
This is a shortened and translated version of an article originally published by the Moscow Times.
After the outbreak of the full-scale war in Ukraine, two schools of thought emerged as to Russia’s prospects. The first held that Russia would flourish and rebound as it broke away from the West, severing ties that were harmful to domestic production, and, having asserted itself as an aggressive player, began to strengthen its position on the global stage. It would become richer and stronger, and a Russian renaissance would follow. This was the view promoted by pro-Kremlin commentators.
The second school of thought (subscribed to by your author) was that Russia was courting an economic disaster. How severe it would be was impossible to say with certainty – it depended on the sanctions the West would impose.
The first school, convinced Europe could not survive without Russian oil and gas, believed the West would not introduce any serious sanctions. In short, the West would betray Ukraine just as it supposedly had in 2014. Indeed, most analysts – even independent ones – said as much. The second school believed Europe would begin to disengage itself from Russia.
There is a clear historical analogy: in 1973, after the Yom Kippur War, OPEC countries stopped shipping oil to Israel’s allies. The West responded asymmetrically: faced with high oil prices, it began actively pursuing energy conservation and, within 5-10 years, reduced the energy intensity of its economies by 30%. Demand for oil fell. The Arabs realized it could not bring the West to its knees – the West was able to resist and find ways to adapt.
In 2022, I predicted something similar would happen and the West would begin learning to live without Russia.
Four years have passed, and Russia has not flourished. Europe has discovered it is possible to live without Russia, receiving LNG from the US and Qatar. Sure, it had to rewire its gas infrastructure, but this was merely a technical challenge, and it was gradually tackled. Europe has neither frozen nor collapsed from the lack of Russian gas and oil.
After the outbreak of the full-scale war in Ukraine, two schools of thought emerged as to Russia’s prospects. The first held that Russia would flourish and rebound as it broke away from the West, severing ties that were harmful to domestic production, and, having asserted itself as an aggressive player, began to strengthen its position on the global stage. It would become richer and stronger, and a Russian renaissance would follow. This was the view promoted by pro-Kremlin commentators.
The second school of thought (subscribed to by your author) was that Russia was courting an economic disaster. How severe it would be was impossible to say with certainty – it depended on the sanctions the West would impose.
The first school, convinced Europe could not survive without Russian oil and gas, believed the West would not introduce any serious sanctions. In short, the West would betray Ukraine just as it supposedly had in 2014. Indeed, most analysts – even independent ones – said as much. The second school believed Europe would begin to disengage itself from Russia.
There is a clear historical analogy: in 1973, after the Yom Kippur War, OPEC countries stopped shipping oil to Israel’s allies. The West responded asymmetrically: faced with high oil prices, it began actively pursuing energy conservation and, within 5-10 years, reduced the energy intensity of its economies by 30%. Demand for oil fell. The Arabs realized it could not bring the West to its knees – the West was able to resist and find ways to adapt.
In 2022, I predicted something similar would happen and the West would begin learning to live without Russia.
Four years have passed, and Russia has not flourished. Europe has discovered it is possible to live without Russia, receiving LNG from the US and Qatar. Sure, it had to rewire its gas infrastructure, but this was merely a technical challenge, and it was gradually tackled. Europe has neither frozen nor collapsed from the lack of Russian gas and oil.
Eugene Uhanov / Unsplash
Selling oil at a loss
We now see that OPEC, along with the US, is squeezing Russia out of the global oil market. Russia’s share of global oil trade has begun to decline, by 1-2 percentage points so far. Yet Russia’s position in the market has fundamentally changed. Four years ago, it was powerful, representing the main independent force within OPEC+ and, broadly speaking, a comanager of the market. Today, it continues to sell oil, but it no longer dictates or determines anything.
Russia has effectively been pushed into a near monopsony, with only two major buyers – India and China, both stronger than the seller and able to dictate terms and prices.
In recent months, OPEC+ has raised production quotas for all countries. But Russia cannot produce as much as it is formally allocated because it has nowhere to send the additional oil. In January, Russian oil production declined for the second consecutive month. Output was almost 300,000 barrels per day below the level agreed to with OPEC+.
Global prices are falling as OPEC seeks to increase supply while demand remains high, even as Russia’s earnings from oil exports are shrinking. Russian oil is expensive, with production costs currently at $39-45 per barrel, including the mineral extraction tax. Other countries have significantly lower costs and can thus reduce prices more aggressively. Some Russian fields are already operating at a loss: the combined costs of production, transportation and insurance exceed the price at which the oil can be sold.
This is the unexpected and alarming result of four years of war: Russia has reached a point where the oil business is unprofitable.
Today, Russian oil companies generate profits only on their sale of petroleum products. Lukoil has asked the state for tax relief. Surgutneftegaz is in poor financial shape. Rosneft’s profits have plummeted. Gazprom Neft is openly complaining about the situation. At the start of 2026, the oil industry faces a crisis: roughly half the companies are unprofitable, with losses totaling RUB 575 billion in 2025 through November. Some smaller firms have already begun bankruptcy proceedings.
Russia’s oil fields are old. Development of the West Siberian fields got underway in the late 1960s. According to estimates of Russian geologists and Gazprom Neft CEO Alexander Dyukov, to extract one ton of oil in West Siberia today, 30 tons of water must be injected underground and 31 tons of well fluid lifted to the surface. More than 60% of Gazprom Neft’s production is already attributable to such hard-to-recover reserves. The Russian Ministry of Energy estimates that by 2030 the share across the entire industry in Russia will reach around 80%. This means the cost of producing almost all Russian oil will be $40-45 per barrel, while it looks set to be sold at a much lower price. The price of a barrel of Urals is around $60 currently, while discounts are steep, with reports suggesting that the Chinese are paying as low as $25 per barrel.
Thus, the Russian oil industry is now selling its output at a loss. It simply has nowhere else to send it. The sector has long been geared toward exports, with roughly half of production shipped abroad. If exports decline, there is no alternative outlet for such vast volumes of oil. Storage is limited. If refineries are under attack by Kyiv, oil cannot even be delivered to them. Transneft’s pipelines are full. Tankers loaded with oil are idling at sea.
Russia has reached a point where it cannot produce oil for technical – rather than purely economic – reasons. The pillar of the Russian economy, which contributes the most to state coffers, is beginning to crack.
One should not be misled by the officially reported share of oil and gas revenues in budget revenues. When state statistics show it is 22%, this is misleading. As per Russian budget methodology, only two items are classified as oil and gas revenue: the mineral extraction tax and export duties. Profit tax paid by oil companies, VAT on the sale of oil and petroleum products, personal income tax paid by those employed in the sector, and excise taxes on gasoline and diesel are all excluded.
The reality is that oil and gas’s contribution to Russian GDP and fiscal revenues is enormous and dominant. Thus, the current unraveling of the oil industry amounts to pulling the economic rug out from under the Russian state.
We now see that OPEC, along with the US, is squeezing Russia out of the global oil market. Russia’s share of global oil trade has begun to decline, by 1-2 percentage points so far. Yet Russia’s position in the market has fundamentally changed. Four years ago, it was powerful, representing the main independent force within OPEC+ and, broadly speaking, a comanager of the market. Today, it continues to sell oil, but it no longer dictates or determines anything.
Russia has effectively been pushed into a near monopsony, with only two major buyers – India and China, both stronger than the seller and able to dictate terms and prices.
In recent months, OPEC+ has raised production quotas for all countries. But Russia cannot produce as much as it is formally allocated because it has nowhere to send the additional oil. In January, Russian oil production declined for the second consecutive month. Output was almost 300,000 barrels per day below the level agreed to with OPEC+.
Global prices are falling as OPEC seeks to increase supply while demand remains high, even as Russia’s earnings from oil exports are shrinking. Russian oil is expensive, with production costs currently at $39-45 per barrel, including the mineral extraction tax. Other countries have significantly lower costs and can thus reduce prices more aggressively. Some Russian fields are already operating at a loss: the combined costs of production, transportation and insurance exceed the price at which the oil can be sold.
This is the unexpected and alarming result of four years of war: Russia has reached a point where the oil business is unprofitable.
Today, Russian oil companies generate profits only on their sale of petroleum products. Lukoil has asked the state for tax relief. Surgutneftegaz is in poor financial shape. Rosneft’s profits have plummeted. Gazprom Neft is openly complaining about the situation. At the start of 2026, the oil industry faces a crisis: roughly half the companies are unprofitable, with losses totaling RUB 575 billion in 2025 through November. Some smaller firms have already begun bankruptcy proceedings.
Russia’s oil fields are old. Development of the West Siberian fields got underway in the late 1960s. According to estimates of Russian geologists and Gazprom Neft CEO Alexander Dyukov, to extract one ton of oil in West Siberia today, 30 tons of water must be injected underground and 31 tons of well fluid lifted to the surface. More than 60% of Gazprom Neft’s production is already attributable to such hard-to-recover reserves. The Russian Ministry of Energy estimates that by 2030 the share across the entire industry in Russia will reach around 80%. This means the cost of producing almost all Russian oil will be $40-45 per barrel, while it looks set to be sold at a much lower price. The price of a barrel of Urals is around $60 currently, while discounts are steep, with reports suggesting that the Chinese are paying as low as $25 per barrel.
Thus, the Russian oil industry is now selling its output at a loss. It simply has nowhere else to send it. The sector has long been geared toward exports, with roughly half of production shipped abroad. If exports decline, there is no alternative outlet for such vast volumes of oil. Storage is limited. If refineries are under attack by Kyiv, oil cannot even be delivered to them. Transneft’s pipelines are full. Tankers loaded with oil are idling at sea.
Russia has reached a point where it cannot produce oil for technical – rather than purely economic – reasons. The pillar of the Russian economy, which contributes the most to state coffers, is beginning to crack.
One should not be misled by the officially reported share of oil and gas revenues in budget revenues. When state statistics show it is 22%, this is misleading. As per Russian budget methodology, only two items are classified as oil and gas revenue: the mineral extraction tax and export duties. Profit tax paid by oil companies, VAT on the sale of oil and petroleum products, personal income tax paid by those employed in the sector, and excise taxes on gasoline and diesel are all excluded.
The reality is that oil and gas’s contribution to Russian GDP and fiscal revenues is enormous and dominant. Thus, the current unraveling of the oil industry amounts to pulling the economic rug out from under the Russian state.
Lydia Shim / Unsplash
Growth of public debt
Russia’s future is now being consumed by the war. Because the budget deficit is enormous, the state is financing the military-industrial complex by selling ruble local government bonds called OFZs. In other words, it is increasing the national debt, and it plans to continue doing so until 2042. According to the government’s own budget forecast, Russia will run a perennial budget deficit through 2042. To cover it, the Kremlin will keep borrowing.
Russians have yet to realize it, but they are doomed to spend one or even two generations paying off the enormous debt generated by the Kremlin’s war against Ukraine.
Russia’s public debt currently stands at RUB 30.5 trillion. Servicing it is already extremely costly, at roughly 10%. In other words, Russia is already paying around RUB 3 trillion a year, or close to 9% of total budget expenditures, in interest to bondholders. Meanwhile, the government plans to ramp up public debt dramatically in the coming years. By 2042, Russia’s public debt will reach RUB 230 trillion in the official base case and RUB 450 trillion in a negative scenario.
Russia’s public debt is extraordinarily expensive. If, for example, the US government were borrowing, it would pay about 4% annual interest on the bonds. In Japan’s case, the interest rate would be closer to 2%. In Russia, it has already reached 15-16%. As Russia’s debt grows, the cost of servicing it will rise even faster. This means that a very substantial and ever-larger share of Russia’s budget will go not to, say, health care, education, science, culture or roads, but to servicing old debt. And if the state were to stop servicing it, Russian banks would collapse, as they are the ones buying these bonds.
Generations of Russians will be paying off this debt. In addition to shorter maturities, 30-year bonds are being issued that will mature only in 2056. Thus, what will be an old war will drain the lifeblood out of the Russian economy for multiple generations.
Will the country be able to survive under such financial conditions? Of course, there are countries with very large public debt – take the US and Japan. But they are deeply integrated into global trade and have diversified economies, whereas Russia has little to offer the world except oil and gas. And even there, Russia is now being squeezed out of the market.
Impact of sanctions
Some sanctions have proven effective, while others are largely symbolic. For example, the oil price cap introduced in 2022 was meaningless from the outset. As soon as the cap was announced, I, as an economist, asked myself how the price of Russian oil exports would actually be determined. When I eventually discovered how it would be set, it seemed so absurd it could have been mistaken for a joke – the whole sanctions mechanism relied on self-reported attestations. Now, however, Europe has announced that it will abandon the cap and attempt to block Russian tankers. That is a more sensible approach.
Russian oil supplies to Europe, of course, have already been ended, which greatly pleases the Americans. They have now captured the European market and are unlikely to give it back to Russia after the war ends.
Other major developments concern India. Donald Trump promised to lower US tariffs on India, and in return Narendra Modi apparently promised to stop buying Russian oil. Until recently, India accounted for roughly 35-40% of Russian oil exports. Even if India were to reduce its purchases by just a quarter, around 10% of Russian exports would disappear. In addition, India has inked a trade deal with the EU, which will also attempt to persuade India to stop buying Russian oil. The greater it is squeezed internationally, the more Russia’s oil and gas sector becomes dependent on China. Naturally, the Middle Kingdom will demand ever larger discounts.
Recall that Russia’s earnings from ferrous metal exports are down, as well. Indeed, sanctions have affected many Russian export sectors, including, as far as I know, nitrogen fertilizers and aluminum. Timber, gold and diamonds have also been sanctioned – another example of Russia being unable to sell the natural riches it produces.
People often claim it is a good thing that Russia is now selling more gold to China. But they forget that, due to sanctions, Russian gold has been removed from the London Metal Exchange. It can now be sold only over the counter, through private transactions. The price at which China buys gold is determined primarily by China. The exact prices are not public, but one can reasonably assume they are significantly below global market prices.
Thus, after four years of war, Russia is weaker both politically and economically, having lost a substantial portion of its economic sovereignty.
Ability to continue the war
Even Russia’s military-industrial complex is beginning to feel the strain. Sergei Chemezov, the head of Rostec, said two years ago that many defense plants were struggling simply to “survive.”
Let’s look at defense procurement. The state orders a factory to produce, say, a tank. How much will it pay? There is no market price for a tank. This is a true monopsony – the state is the lone buyer. Prices are cost-based. Officials at the Defense Ministry calculate the cost of producing the tank: parts, labor, etc. They then add a modest profit margin for the manufacturer and set the price that the state will pay.
Suppose a plant accepts an order and is promised RUB 100 million per tank. It launches production. But some parts must be imported around restrictions, and these “gray imports” cost significantly more than the Defense Ministry’s price-setters assumed. Moreover, a tank takes months to build. The Finance Ministry, however, does not provide advance payments to cover the full production cost. Initially, advances amounted to 30%, but this quickly proved unworkable, and they were raised to around 50%. Thus, the plant must borrow the remaining 50% from a bank.
What happens to borrowing costs in wartime? They rise. Now, these loans are far more expensive than the cost-setters assumed. By the time the tank is completed, its actual cost may end up being RUB 120-150 million – yet the state will still pay only RUB 100 million. As a result, defense factories continue to fulfill orders, but they face chronic cash shortages.
They then begin delaying payments to suppliers. A landslide of arrears occurs. The Russian Union of Industrialists and Entrepreneurs, together with the Finance Ministry, has established a special commission to monitor the growing arrears problem across large state corporations. What will happen next? Suppliers left unpaid by the military-industrial complex will start to back away from orders or go bankrupt. What will replace them? Fixing the situation will not be easy. The Finance Ministry is already struggling to keep expenditures under control.
Moreover, the military-industrial complex has exhausted its existing production capacity. To increase output further, new defense plants must be built. For modern Russia, this may not be feasible at all, given the current dearth of workers, engineers and equipment. Many regions lack sufficient energy capacity to support new large-scale industrial facilities. According to official assessments, 24 regions have already been identified as facing high risks of electricity shortages, primarily in the South, Siberia and Far East federal districts. Rising consumption, driven by mining and industry, is outpacing the addition of generation capacity, creating a projected shortfall of up to 14.2 GW by 2030.
Sure, Russia has ramped up military production rapidly – faster than Europe – suggesting that a command economy in an undemocratic political system can mobilize faster in wartime than a market economy in a democratic political system. But Russia’s defense plants have reached their limit.
Russia’s future is now being consumed by the war. Because the budget deficit is enormous, the state is financing the military-industrial complex by selling ruble local government bonds called OFZs. In other words, it is increasing the national debt, and it plans to continue doing so until 2042. According to the government’s own budget forecast, Russia will run a perennial budget deficit through 2042. To cover it, the Kremlin will keep borrowing.
Russians have yet to realize it, but they are doomed to spend one or even two generations paying off the enormous debt generated by the Kremlin’s war against Ukraine.
Russia’s public debt currently stands at RUB 30.5 trillion. Servicing it is already extremely costly, at roughly 10%. In other words, Russia is already paying around RUB 3 trillion a year, or close to 9% of total budget expenditures, in interest to bondholders. Meanwhile, the government plans to ramp up public debt dramatically in the coming years. By 2042, Russia’s public debt will reach RUB 230 trillion in the official base case and RUB 450 trillion in a negative scenario.
Russia’s public debt is extraordinarily expensive. If, for example, the US government were borrowing, it would pay about 4% annual interest on the bonds. In Japan’s case, the interest rate would be closer to 2%. In Russia, it has already reached 15-16%. As Russia’s debt grows, the cost of servicing it will rise even faster. This means that a very substantial and ever-larger share of Russia’s budget will go not to, say, health care, education, science, culture or roads, but to servicing old debt. And if the state were to stop servicing it, Russian banks would collapse, as they are the ones buying these bonds.
Generations of Russians will be paying off this debt. In addition to shorter maturities, 30-year bonds are being issued that will mature only in 2056. Thus, what will be an old war will drain the lifeblood out of the Russian economy for multiple generations.
Will the country be able to survive under such financial conditions? Of course, there are countries with very large public debt – take the US and Japan. But they are deeply integrated into global trade and have diversified economies, whereas Russia has little to offer the world except oil and gas. And even there, Russia is now being squeezed out of the market.
Impact of sanctions
Some sanctions have proven effective, while others are largely symbolic. For example, the oil price cap introduced in 2022 was meaningless from the outset. As soon as the cap was announced, I, as an economist, asked myself how the price of Russian oil exports would actually be determined. When I eventually discovered how it would be set, it seemed so absurd it could have been mistaken for a joke – the whole sanctions mechanism relied on self-reported attestations. Now, however, Europe has announced that it will abandon the cap and attempt to block Russian tankers. That is a more sensible approach.
Russian oil supplies to Europe, of course, have already been ended, which greatly pleases the Americans. They have now captured the European market and are unlikely to give it back to Russia after the war ends.
Other major developments concern India. Donald Trump promised to lower US tariffs on India, and in return Narendra Modi apparently promised to stop buying Russian oil. Until recently, India accounted for roughly 35-40% of Russian oil exports. Even if India were to reduce its purchases by just a quarter, around 10% of Russian exports would disappear. In addition, India has inked a trade deal with the EU, which will also attempt to persuade India to stop buying Russian oil. The greater it is squeezed internationally, the more Russia’s oil and gas sector becomes dependent on China. Naturally, the Middle Kingdom will demand ever larger discounts.
Recall that Russia’s earnings from ferrous metal exports are down, as well. Indeed, sanctions have affected many Russian export sectors, including, as far as I know, nitrogen fertilizers and aluminum. Timber, gold and diamonds have also been sanctioned – another example of Russia being unable to sell the natural riches it produces.
People often claim it is a good thing that Russia is now selling more gold to China. But they forget that, due to sanctions, Russian gold has been removed from the London Metal Exchange. It can now be sold only over the counter, through private transactions. The price at which China buys gold is determined primarily by China. The exact prices are not public, but one can reasonably assume they are significantly below global market prices.
Thus, after four years of war, Russia is weaker both politically and economically, having lost a substantial portion of its economic sovereignty.
Ability to continue the war
Even Russia’s military-industrial complex is beginning to feel the strain. Sergei Chemezov, the head of Rostec, said two years ago that many defense plants were struggling simply to “survive.”
Let’s look at defense procurement. The state orders a factory to produce, say, a tank. How much will it pay? There is no market price for a tank. This is a true monopsony – the state is the lone buyer. Prices are cost-based. Officials at the Defense Ministry calculate the cost of producing the tank: parts, labor, etc. They then add a modest profit margin for the manufacturer and set the price that the state will pay.
Suppose a plant accepts an order and is promised RUB 100 million per tank. It launches production. But some parts must be imported around restrictions, and these “gray imports” cost significantly more than the Defense Ministry’s price-setters assumed. Moreover, a tank takes months to build. The Finance Ministry, however, does not provide advance payments to cover the full production cost. Initially, advances amounted to 30%, but this quickly proved unworkable, and they were raised to around 50%. Thus, the plant must borrow the remaining 50% from a bank.
What happens to borrowing costs in wartime? They rise. Now, these loans are far more expensive than the cost-setters assumed. By the time the tank is completed, its actual cost may end up being RUB 120-150 million – yet the state will still pay only RUB 100 million. As a result, defense factories continue to fulfill orders, but they face chronic cash shortages.
They then begin delaying payments to suppliers. A landslide of arrears occurs. The Russian Union of Industrialists and Entrepreneurs, together with the Finance Ministry, has established a special commission to monitor the growing arrears problem across large state corporations. What will happen next? Suppliers left unpaid by the military-industrial complex will start to back away from orders or go bankrupt. What will replace them? Fixing the situation will not be easy. The Finance Ministry is already struggling to keep expenditures under control.
Moreover, the military-industrial complex has exhausted its existing production capacity. To increase output further, new defense plants must be built. For modern Russia, this may not be feasible at all, given the current dearth of workers, engineers and equipment. Many regions lack sufficient energy capacity to support new large-scale industrial facilities. According to official assessments, 24 regions have already been identified as facing high risks of electricity shortages, primarily in the South, Siberia and Far East federal districts. Rising consumption, driven by mining and industry, is outpacing the addition of generation capacity, creating a projected shortfall of up to 14.2 GW by 2030.
Sure, Russia has ramped up military production rapidly – faster than Europe – suggesting that a command economy in an undemocratic political system can mobilize faster in wartime than a market economy in a democratic political system. But Russia’s defense plants have reached their limit.
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