Russia is far more than a “gas station masquerading as a country”, as some of the more excitable voices from the hawkish wing of American politics would have it. On a purchasing power-adjusted basis, Russia has been and remains one of the world’s largest economies. That simply doesn’t happen only by virtue of pumping stuff out of the ground. The non-energy portions of Russia’s economy might not be world-beating in their efficiency or export-prowess, but they exist and are sizable.

At the same time, energy is, quite obviously, extremely important for the overall health of the Russian economy. In particular, energy is positively vital for the stability of government finances. The Russian government levies some of the highest energy taxes in the world – taxes which allow it to re-distribute a healthy portion of energy revenues to the population in the form of welfare spending and pensions. From a macroeconomic perspective, the hard currency that Russia earns from selling hydrocarbons on world markets is crucial to maintaining stability and to amassing a large base of foreign currency reserves.

The Russian government has been gradually expanding its role in the energy sector over the course of the past decade. Rosneft has been particularly aggressive in its expansion efforts, snapping up the assets of the former TNK-BP in mid-2013 at a huge premium. Meanwhile, in late 2014, the state also seized control of Bashneft, further eroding the formerly-dominant role of privately owned producers.

So how is the energy sector faring amidst this gradual expansion of state control? How has it weathered the recent rout in commodity prices?

I aggregated the financial statements of Rosneft and Bashneft to try to gain a picture of the broader health of the state oil sector. While these two companies are very different entities in size, scale and corporate history, the Russian state now calls the shots for both and stands to greatly profit (or lose) depending on their performance.

What jumps out from the financial statements? Several things. First of all, the industry’s operating margins have gotten gradually squeezed over the past several years, having declined by a bit more than 3% since 2011.

This was partially the result of significant long-term changes in operating expenditures: the infrastructure that oil companies need to build in order to extract oil has been getting gradually more expensive. However, Russian companies are better situated than most to weather this storm since their costs are denominated in (depreciating) rubles while the actual revenue they earn selling oil is denominated in (appreciating dollars). And considering the scale of the rout across the energy sector within the US, a 3% loss in margins actually appears to be rather modest.

It is also important to note that the weakened performance of Russian oil companies is not a question of taxes: although tax burdens across the industry ticked up in 2012-14, by 2015 they were actual marginally below their 2011 level. Recent coverage has suggested that Russia might tax the industry to death in the not-so-distant future, but there doesn’t appear to have been any appreciable change over the past five years.

Perhaps surprisingly, capital expenditures (which, due to their usefulness as a cover for contract featherbedding, have been a positively enormous problem for Gazprom and for many other state-owned firms) were broadly kept under control. While they grew appreciably at Bashneft, over the past four years Rosneft’s management managed to actually reduce its capex as a share of revenue from around 14.5% to 11.5%. That broadly fits with trends visible in the rest of the industry, where increasingly cash-strapped firms are scrapping investment programmes formulated when oil was close to $100 a barrel.

But was this purely an improvement in managerial effectiveness? Or was there another factor incentivizing the conservation of cash?

Leveraged up

Well, one of the most alarming trends across the sector is the extremely rapid growth in leverage. As recently as 2011, debt in the oil sector was only slightly larger than recorded Ebitda and annual spending on debt service was a little more than 2% of operating income. Indeed, in 2012 Rosneft and Bashneft had negative net financing costs: they actually earned more from their investments than they had to pay in debt service costs.

This sort of conservative capital structure was broadly in line with the experience of comparable energy companies in other countries, which tend to avoid taking on much debt because of the enormous volatility in their cash flows. ExxonMobil, for example, has a capital structure that is almost entirely equity-based, which allows it to survive the inevitable ebbs and flows of commodity prices.

By 2015, however, the level of debt at the Russian firms had more than doubled and debt service costs collectively consumed almost 30% of operating income. Debt had thus grown significantly in both volume and in cost. All things considered, it seems far more likely that the urgent need to service a growing debt burden, more than any sudden improvements in efficiency, explain the reduction in capital expenditures and the more abstemious level of spending on exploration (which, in relative terms, fell by roughly 50%).

As in other areas of the Russian economy, the problems in the energy sector do not appear to be critical. Taking a step back and looking at the underlying financials, there is little doubt that the sector as currently constituted can continue to operate over the short and medium terms. In 2015, cash from operations was more than sufficient to service the sector’s short-term borrowings and to begin a (modest) paydown on the accumulated long-term debt balance. And that was before the conclusion of several recent deals, such as the agreement to sell stakes in several Siberian oilfields to a consortium of Indian energy companies, that will generate even more cash for debt paydown.

But the long-term trends ought to be highly disconcerting to the powers that be. Net margins (eg. the profits that flow to the state via its equity holdings) are sharply lower now than in 2011. Given the structural shift towards more leverage and the steady, gradual erosion in the industry’s operating margins, they don’t seem likely to improve in the near future. That doesn’t mean the sky is falling in (the industry is still profitable, and, unlike the financial sector, hasn’t needed much in the way of government assistance), but it does suggest that there are no easy solutions for the Russian state’s increasingly tight budgetary situation.

The squeeze on the energy sector is real – and doesn’t look like it’s going away. 

Mark Adomanis is a Wharton MBA by day, Russia analyst by night. Follow him on @MarkAdomanis