How Russia Will Struggle to Keep Its Shipbuilders Afloat
Russia's rearmament plan for 2020 will reinforce the military emphasis of the Russian shipbuilding industry, at the cost of commercial vessel production.
Geopolitical and economic factors have substantially impeded Russia's ability to modernize its fleets, which will likely force Russia to prioritize the Northern Fleet.
Government programs to incentivize foreign private investment will focus on shipyards with limited risk of losing sensitive submarine technologies and greater importance to the expansion of Russia's surface fleet.
Focus on military conflicts in Russia's western periphery will likely be detrimental to the Pacific Fleet and to Russia’s budding Asia-Pacific policies.
Ships, shipbuilding and access to the sea define Russia and the influence it can exert. Since the 17th century, Russia’s shipyard industry has been in a perpetual state of flux as the country seeks access to water outlets through military conquest. The country's ability to secure and modernize warm water ports has been regularly disrupted by domestic and international conflict, often resulting in the destruction and degradation of the shipyard industry as a whole. The need to make war to protect its naval power has led Russia to prioritize its military shipyard industry above civil shipbuilding.
This was certainly the case in the Russian annexation of Crimea and in the support of the Donbas separatist movements to retain control of the port of Sevastopol, which forced Ukraine to cut off export of important components and shipyard services to Russia critical to its naval modernization program. To make matters worse, a slew of economic problems has hampered Russia's efforts to modernize its military and civil shipyards. Moscow will do its best to selectively fund and develop key ports along its strategic water bodies. But it will not be easy.
The History of Russian Shipyards
Russian shipbuilding began in earnest during Peter the Great's reign from 1682 to 1725, bringing about rapid development in Russia's navy. With the Russian Empire internally secure, Peter wanted to ensure his country's dominance by expanding its influence abroad, mainly through building a navy. However, later monarchs failed to keep the navy competitive, and with the advent of ironclads the maritime force was soon entirely left behind. Russia at first tried purchasing these steam-powered and armored vessels from foreign shipyards, and it was not until 1864 that the country built ironclads of its own. Eventually, the Russian navy was built entirely in shipyards in St. Petersburg on the Baltic Sea, in Vladivostok in the east, and on the Black Sea.
During the early days of the Soviet Union, when the Russian navy was still reeling from the defeats of the Russo-Japanese War, World War I and the widespread destruction that occurred during the civil war, Josef Stalin sought to greatly expand it by focusing on smaller vessels, primarily submarines, battleships and battle cruisers that could be constructed quickly. Unlike many navies of the era, Stalin viewed aircraft carriers and other larger vessels as a low priority: They were an offensive platform ill-suited for Russia's defensive military posture. Stalin saw the growing importance of naval power in the north, and, sensitive to Scandinavian blockade, in 1933 Stalin completed the construction of the Baltic-White Sea Canal, which could easily transport smaller vessels, and quickly expanded capacity at Murmansk shipyard in the northwest. All the while, military priorities outweighed the merchant fleet.
Stalin's secretive naval strategy left the shipyard industry in disarray following his death, leaving Nikita Khrushchev and Adm. Sergei Gorshkov to complete the task. By focusing on shipyard repair, advanced designs and industrial espionage, the Soviet Union would build some of the most advanced submarines and small surface ships in the world. Despite this, Leonid Brezhnev's subsequent buildup plan rapidly and entirely outstripped shipyard capacity, reducing commercial shipbuilding and forcing the Soviet navy to accept whatever they were sent, usually vessels that did not even pass sea trials. The Soviet Union never did develop a comprehensive aircraft carrier program, and after a period of economic and military stagnation, Russia was only beginning a modernization plan when the union fell in 1991.
In the 1990s, the Russian Federation lost the vast majority of its naval capabilities; the Baltic Fleet specifically was reduced by 85 percent. Moreover, at that point, Russian shipyards had had little to no experience in commercial shipbuilding for the past 70 years. Of course, in the economic chaos of the 1990s following the Soviet Union's collapse, several Russian shipyards received international financial support to dismantle nuclear platforms. Still, the navy needed more resources.
Bolstering the shipyard industry became a policy priority. A comprehensive, targeted civil shipyard development plan finally surfaced in October 2006 when the government approved a set of federal projects that included developing hydrocarbon rigs and Arctic transports as well as offshore wind stations, Arctic fishing trawlers, and heliports to facilitate transporting supplies to remote areas. The program attracted only a limited amount of private financing: Today, of the 1.6 billion rubles (roughly $20 million) invested, 0.84 billion rubles came from the Russian government, and federal contributions have grown larger and larger since 2011. These projects notwithstanding, many shipyards will likely continue to rely on military orders for revenue.
As it started pouring money into new ships, the government in 2007 also created a state-owned enterprise to manage Russia's various shipyards: The United Shipbuilding Corporation (USC) now handles over 80 percent of shipbuilding demand. Furthermore, Moscow released plans to remedy a lack of technical expertise by trying to retain highly educated potential workers. Russian graduates usually seek employment outside of Russia, which makes recruitment difficult. Ultimately, the government may require graduates to remain in Russia for a set period. But such a policy would only hurt an already beleaguered academic research institution base.
Finally in 2008, strategic guidance, often referred to as the "Strategic Investment Law," was created to stipulate how foreign entities could invest and participate in the development of the Russian economy in sectors such as military technology. Initially, the guidance was not an issue because exports to China and India were strong. However, Chinese acquisitions of Russian hardware have fallen. The law was simply meant to prevent foreign companies from controlling ownership of strategic sectors and firms.
Despite these policies, and the fact that it benefits from over a quarter of the funding in the State Arms Program 2011–2020, the prognosis for growth in the shipyard industry is not good. Cutbacks following the oil price crash have hurt the navy's procurement plan. Obstacles also emerged once Ukraine’s shipyards stopped servicing Russian orders following the annexation of Crimea. This will force state-owned USC to build up its own capacity or find alternative foreign components, the former being the priority. And although Russia has put in place measures to stimulate the commercial shipbuilding sector as well, they have had little effect outside of shipping for the energy sector.
Russian Shipyard Priorities
Since July 2014, the nation's currency, the ruble, has been and will likely continue to deflate with minimal interference from the central bank. Russia's gross domestic product is also in distress, contracting by 2.7 percent in 2015 and projected to grow by only 0.7 percent in 2016. All of this comes in the wake of falling oil and natural gas prices, forcing the country's budget to prioritize either military or domestic spending. But it is clear that the Kremlin is looking to increase exports of large military hardware such as naval vessels. Currently 90 percent of the state export agency's defense-related contracts are "small orders" such as munitions and small arms. Russia's navy rearmament program will depend on these foreign orders to maintain certain economies of scale and to ensure revenues for the shipyards.
President Vladimir Putin also plans to redirect $3.3 billion in overseas investment into project bonds for infrastructure — ports included. Business leaders complain that the Russian government expects unusually short payback periods on their port investments, ranging from 3-5 years instead of the more standard 20-25 years. But the country's overarching financial crunch makes funding from overseas investors all the more vital.
Specifically, the government and USC have prioritized six shipyards to support military construction activities: Yantar and St. Petersburg on the Baltic Sea, Sevastopol on the Black Sea, Murmansk in the north, and Khabarovsk and Vladivostok in the east. Shipyards such as Sevmash, in the northern city of Severodvinsk, which builds most of Russia’s submarines, are not prioritized in these programs. Instead, Russia is keeping foreign investors out of these areas to make sure it retains control over the sensitive technologies produced there.
Of USC's nearly 60 shipyards, these six complexes have some unique advantages as a target for federal and foreign investment. With the exception of the contentious Sevastopol in Crimea, which has been subordinated to USC since March 2015 and was authorized in December 2015 to repair naval surface ships and submarines, the other five are all under a special legal status to boost investment and construction orders. St. Petersburg's Shipyard Cluster alone is responsible for 70 percent of all export-oriented shipbuilding in Russia and nearly 30 percent of total shipbuilding.
The remaining four shipyards can help improve personnel expertise and achieve greater scale. Murmansk and Khabarovsk are classified as "port special economic zones," which reduces the tax and customs burdens on firms established there in relevant industries. Yantar, also a "special economic zone," is under an older regime meant to boost investment as a whole in Kaliningrad. Last, since October 2015 Vladivostok has been a "free port" to incentivize businesses through streamlined registration, reduced taxes and tariffs, and simplified immigration protocols.
A Rough Road Ahead
Foreign investors may be coming in with an eye primarily to commercial ships, but the funding will boost Russia's capacity to turn out new naval vessels as well. And when it comes to military shipbuilding, these ports focus on producing platforms for the navy's Northern and Pacific fleets. The increasing importance of these two regions indicates not only where Russia’s fleet needs improvements but also future priorities and capabilities to exert influence in the Arctic and western Pacific Ocean. And while the focus on military conflicts in its western periphery will likely be detrimental to Russia's budding naval strategy in the Pacific, Moscow will still use its stretched resources for both regions.
Unfortunately for Russia, shipyards currently cannot meet the navy's demand, and the navy cannot meet the financial obligations to expand. Five vessels have already been delayed to 2016, in part to the cut off from Ukrainian-sourced engines; engines that were meant to go in 31 of 54 frigates and destroyers. Financial problems were most recently revealed in a revised naval development plan announced on Jan. 16 that cut down the amount of future aircraft carriers from four to one and delayed their launch from 2023 to 2030.
Not only that, but Russia's defense industry still needs foreign components for its technology. Putin has frequently sought to reduce this dependence by building up Russia's domestic capabilities, and his calls have gradually taken hold as the ruble deflates, raising the cost of foreign components. But to provide the necessary funding for its many projects, Russia may reduce its restrictions on exporting technology to prevent losing more military contracts to China, South Korea, India and Brazil's shipbuilding industries.
The industry's only other bright spot appears to be its lead in Arctic shipbuilding, where it is outpacing all other competitors. But even here, economic factors could be harmful. With commodity and oil prices so low, there may be less interest in Arctic energy exploration and in production or using the Northern Sea Route in global trade and shipping. Ultimately, Russia's critical navy and the shipbuilding industry that feeds it will struggle to modernize, and the Kremlin will have to prioritize the seas it needs to defend most.