Political Economics Prof

Tag: Russia

Saudi Arabia, Oil and Geopolitics

Saudi Oil Minister

Introduction: The Fall in Oil Prices in 2015

Crude oil prices temporarily rose because Saudi Arabia signaled that it
would cooperate with OPEC and non-OPEC producers to “stabilize” oil
prices. Nothing specific was
mentioned. At the current price and for
political reasons, it is unlikely Saudi Arabia and its Persian Gulf allies will
cut production or negotiate joint production cuts with other large
producers. The comments are probably an
indication that Saudi Arabia might be part of a global reduction in crude oil
production if prices go much lower and the political situation in Syria changes.

Until recently, Saudi Arabia was seeing the results it
wanted. Some are economic, having to do
with the current and future price and production of oil. The economic targets were shale production in
the U.S and tar sands production in Canada.
The geopolitical targets were Iran and Russia. But unexpected economic and geopolitical
changes have increased the cost to the Saudis of continuing their
policies. Low prices will continue
longer than the Saudis expected. At the
same time, geopolitical changes have made it more unlikely that Saudi Arabia can
change its strategy or negotiate a favorable change in the global oil industry.

Economic Goals

Until 2014, increased production in the U.S. and Canada was
matched by increased demand by China and other developing countries. Prices remained at record high levels, over $100/barrel. But a continued increase in U.S. shale production combined
with slower growth in Chinese and global demand in 2014 led to surplus
production and rising inventories. Since
both global supply and global demand are inelastic, a small percentage increase
in global supply relative to global demand led to a decrease in exports and a
large decrease in price. Thus far, about
45%.

The fall in the price of oil is part of a bigger picture,
the fall in the price of virtually all globally-traded energy products,
minerals, metals and agricultural products.
Strong growth in global demand before and after the last recession, led
by China, encouraged countries and companies to expand capacity and production
in almost all commodity industries. A
slowing of global growth resulted in excess supply and large decreases in world
prices. This implies that the pricing and supply problems of the global oil industry is not just caused industry variables but is part of a larger global trend of slowing manufacturing and exports.

Oil production in many countries cannot be reduced for
domestic political reasons. In some countries, the state owns or controls oil production and relies on oil export income for government revenue, earning hard currency to service rising foreign debt and maintaining employment and politically-necessary welfare programs and subsidies. In countries like the United States, where oil production is done by private companies, producers try to maintain output as long as price is above marginal production costs, thus contributing to covering ongoing financial costs
(interest and principal payments on increased levels of debt) and avoiding penalties for shutting down output of producing wells.

Saudi Arabia and its allies knew if they cut back production
and the price of oil rose, other countries and companies would expand
production. American shale production
would continue to increase if the domestic price (WTI, a few dollars below
Brent, the world benchmark price) stayed above $60/barrel. At the current price range of $40-$45/barrel,
some American production has been shut down and most drillers are
losing money. But total production has not gone down as far or a fast as the Saudis expected. One reason is that many of the drillers hedged the price of some of the oil they sold when the price began to fall. Another is that production costs are falling, partly due to new drilling technology. Their average selling price is high enough to cover lower marginal drilling and ongoing financial costs. Some are even making a profit.

The only question is how
long will it take for some American shale companies to go bankrupt and the rest
to decrease production further.
Apparently it is taking longer than the Saudis expected. American
shale producers have cut costs of production, squeezed suppliers, and become
much more efficient, reducing their marginal cost break-even price. But a high percent of operating revenue is going to debt repayments. A few highly leveraged producers have gone bankrupt. Production assets are being sold to other companies.

Oil producers are still losing money, their bankers
are getting nervous but total production has only decreased about ½ million
barrels/day. If oil prices don’t rise to around $60/barrel before the middle of next year, the decrease in production will accelerate.

Many of the hedges come off this quarter and the first quarter of 2016. We should see increased financial pressure on drillers in the second quarter of 2016. The Saudis can wait that long to see how quickly the financial position of American producers deteriorate and if declines in production accelerate.

Russia has also reduced its cost/barrel and break-even price by applying new technology, better organization and apparently lower taxes and fees on oil production.

Saudi Arabia has actually increased production after
completing a $100 billion modernization and expansion of their oil
infrastructure. The increased production
and processing was for increased domestic consumption and more refining. Exports have remained
constant. In the future, more of Saudi oil exports will be refined products and petrochemicals rather than crude oil. This put them on a collision course with U.S. refineries, who have dramatically increased exports of refined petroleum products.

Saudi Arabia has been
fighting hard for market share. They
have taken market share away from Russia in China by offering larger discounts
off list prices. They have also increased
sales to Europe by also offering lower prices.
This is one of the benefits of being the world’s lowest cost producer
and having a $700 billion sovereign wealth fund. But the government is running a huge deficit relative to GDP. At some point, the combination of lower oil revenue, large government deficits, the proxy and air war in Yemen, supporting Sunni militias in Syria, and the need for newer military equipment may force the Saudi government to reconsider its geopolitical strategy. And, as discussed below, a change in American policy in the Middle East might be another reason for changing its oil strategy.

A major goal of Saudi Arabia’s low-price strategy was to reduce global investment in oil exploration and production capacity. This seems to be working. A year of low prices has led to the
cancellation of many oil capital projects to maintain production in old fields
and open up new fields in other countries.
So far, industry analysts think about $200 billion of capital projects
have already been cancelled or delayed. Many U.S. shale drilling rigs have been taken out of production.  This means
less global oil production in the future, higher prices and a stronger long-term
position for Saudi Arabia. And possibly for the United States. When WTI crude prices go above $60/barrel, or possibly lower with the continuing reduction in production costs, U.S. shale production will start expanding and new drilling will raise production above the recent level of 9.2 million barrels/day.

Geopolitics and Religion:
Saudi Arabia, Iran and Russia

Saudi Arabia and Russia are the world’s two largest
exporters of oil. Between them and with Saudi
Arabia’s allies, they could jointly reduce exports and raise world prices. As long as the world price stayed below $60/barrel, most U.S. shale producers would continue to lose money and probably be
forced to reduce production further.
This would also reduce the economic pressure in Russia, which is in
recession. Russia would probably run a larger trade surplus and earn more hard currency to support domestic debt and reduce the government’s deficit. Russia might also decide to match Saudi discounts. Europe still depends on
Russia for most of its imported oil and natural gas. If Russia can maintain its dominant position in Europe, the end result might be the lifting of European sanctions and more Russian interference in Ukraine.

But geopolitics has intervened. Iran, subject to punishing economic
sanctions, agreed to delay its nuclear weapons program in exchange for the
lifting of the sanctions. This resulted in tens of
billions of dollars becoming unfrozen and Iran could increase oil production and
exports. Iran has said it will use some
of the money to modernize and expand its oil industry, increase exports by ½
million barrels/day almost immediately and continue to increase production and
exports in the future. This negates the
Saudi’s strategy of reducing global production by pressuring American shale
producers.

There is no way that Saudi Arabia will do a deal with Iran. They are bitter enemies. Besides rivals for control of the Persian
Gulf, Iran is the leading Shia country in the Middle East and Saudi Arabia is
the dominant Sunni country. They are
fighting a war by proxy in Yemen.

To make the situation even more bitter, if possible, there
is Syria. The Syrian government is Shia,
supported by Iran, and Iran’s and Syria’s client, Hezbollah. Both Iran and Hezbollah have sent troops and
military aid to the Syrian government, whose main opponents are Sunni, including al-Qaeda
and Islamic State.

The Syrian government has long been a client state of Russia. Vladimir Putin has decided to give military
aid and air power support to Syria. After Turkey shot down a Russian bomber, Russia increased the military technology, and probably the number of Russians, it based in Syria. It
is highly unlikely there will be a political settlement in Syria, where Shias are
in the minority, that would be acceptable to the Syrian president, Russia, Iran, Saudi Arabia and the Sunni opposition groups.

Russia has also signed economic and technical agreements
with Iran. Any chance that Russia and
Saudi Arabia would cooperate to reduce global oil production in the near future has disappeared.

The United States and Saudi Arabia

One reason that Russia has initiated more contacts with
Iran, and supported Iran’s goals in Syria, is that it appears the Obama
administration has been slowly moving away from the alliance with Saudi Arabia
and towards some sort of détente with Iran.
Washington worked hard to come to an agreement with Iran, despite past
animosity. Also, American support of
Saudi Arabia’s bombing campaign of Shias in Yemen has been almost invisible.

The United States (and Russia) have learned some bitter
lessons about the limits of military power in Afghanistan and the Middle
East. Maybe it is time to review
America’s reliance on Saudi Arabia as an ally.
Think of the history:

Going as far back as Franklin Roosevelt, the U.S. and the
House of Saud agreed that Saudi Arabia and American oil companies would supply
America and its allies with oil at low prices in exchange for American
protection of Saudi Arabia and its oil fields. Since then:

Saudi Arabia has nationalized its oil fields and kicked out
American oil companies (and their alien influence).

Saudi Arabia has twice cut off oil exports to the United
States.

OPEC, dominated by Saudi Arabia and its allies, increased
the price of crude oil by a factor of 10 ($3/barrel to over $30/barrel) between
1973 and 1979.

The Saudi government supports a fundamentalist version of
Sunni Islam (Wahhabi) and spends money to spread its version of Islam throughout
the Muslim world.

Wahhabi Islam is the theological justification for al-Qaeda
and its offshoot, Islamic State.
Al-Qaeda was originally begun by Saudi Arabia and America as a weapon to
fight the Russians in Afghanistan. After
the Russians left, did America think that al-Qaeda would disband? Did American leaders think that al-Qaeda
wouldn’t go after secular Muslim states and not remember that Islam has been
fighting against Christian states for over 1,300 years?

15 of the 19 terrorists involved in the 9/11 attacks were
Saudis.   None of the subsequent terrorist
plots or bombings in the U.S. or Europe were by Shias.

Saudi Arabia remains one of the most repressive countries in
the world, complete with religious police.

America no longer needs Saudi oil. The U.S. imports only 400,000 barrels per day
of Saudi oil, only because Saudi Arabia sends the oil to American refineries it
partly owns.

America’s protection of Saudi Arabia and its oil fields has come at a high price. The United
States committed most of its front-line military to defeat Iraq when Iraq invaded
Kuwait and threatened nearby Saudi oil fields.
Subsequent military involvement in the Middle East has strained American
military resources and diverted resources from Afghanistan. One result has been
the hollowing out of NATO, which could have serious consequences for America’s
position in Europe. Eastern European
leaders, eager in the past to join NATO for protection from Russia, have
expressed doubts about how much military and political support they could
expect from NATO in light of increased Russian pressure. America’s almost total lack of support for
the pro-West Ukrainian government has made Eastern European governments more
nervous and, in some states, led them to reconsider their relationship with
Russia. A few have called for ending
economic sanctions against Russia.

Conclusion: Implications for U.S. Foreign Policy

The problem with being a global power is that all political
and military actions in one part of the world have repercussions in other parts of the world and unintended
consequences like blowback in the future. This calls for a subtle and flexible set of
foreign policies. Adapting to changing
circumstances and recognizing sometimes there are limited options is
crucial. Relying on an outdated set of
circumstances for an alliance with a rigid Saudi Arabian government limits
American options in the Middle East.
American foreign policy makers should question the wisdom of basing
decisions in the Middle East on the geopolitical interests of a repressive
government with no important allies in the region.

UPDATE (January 17, 2016)

By executing a Shiite cleric, the Saudis are
playing a devious and dangerous game.
Saudi Arabia sees Shiite Iran as their main geopolitical threat and is
very nervous about the treaty between Iran and the major powers. By inflaming relations between Shia and Sunni
countries, the Saudis are making it more difficult for the U.S. to follow up on
the lifting of economic sanctions against Iran.
The Saudis do not want any détente between the U.S. and Iran, which
implies a more flexible U.S. relationship with Saudi Arabia. By executing the imam, the Saudis also hope
it is more likely that the Iranian hard-liners, who also don’t like the treaty,
will defeat the moderates in the current government in the upcoming elections.
If they denounce or reject the treaty, the U.S. is once more dependent
on Saudi Arabia as the foundation for its Middle East policy. Iran will then be forced to strengthen its
ties to Russia and China.

At the same time, the Saudis continue to flood
the global oil market, leading to even lower prices. The main target of this strategy is the U.S.
shale oil industry. The Saudis hope to
force the industry to drastically cut production because of heavy financial
losses. So far this hasn’t happened but
virtually the entire industry is losing money (negative cash flow). On the positive side for the Saudis, the U.S.
and global oil industry is cutting investment, implying less
production capacity in the near future. Lower prices is leading to investment by the U.S. shale producers in new technology to reduce extraction costs.

The Saudis seem to believe that the United
States government can mentally separate the Saudi’s geopolitical strategy from
the Saudi’s oil strategy. They may be
right.

Saudi Arabia had a sovereign wealth fund of about $700 billion at the beginning of 2014. Their government deficit is running at around $100 billion per year. Cost reductions are politically dangerous because over 80% of Saudis, directly or indirectly, receive their income from the government. The government runs large social welfare programs and subsidizes the cost of food, fuel and electricity. Over 80% of the country’s export revenue and government revenue come from oil exports. I would guess that the Saudi government will start to reconsider their oil export strategy sometime in the fourth quarter of this year.



November 25, 2015
Energy and Geopolitics II: The World ex-United States

Middle East Oil Wells

OVERVIEW

Outside of the United States and Canada, most of the world’s
oil and natural gas is owned and produced by governments or
government-dominated companies with minority shareholders. Two examples of the
latter, public companies with stockholders, are Petrobras in Brazil and Gazprom
in Russia. But government officials,
especially the president, control management and make the important decisions.

Production and investment decisions are not made based on
financial criteria alone. Often,
internal political or foreign geopolitical factors are more important. Many countries’ economies and government budgets depend critically on oil and natual gas revenue from exports. Maintaining internal peace and welfare programs are more important than rational economic considerations.

What this means is that production and distribution
decisions in these countries are made using different criteria than by private
companies in the United States and Canada. Producing and exporting oil and natural gas are mostly political
decisions. Petrostates like Russia, Brazil, Venezuela, Nigeria,
Algeria and other countries in the Middle East and Africa have not used their
oil and gas revenue to industrialize or diversify their economies. Generating revenue for government, not profits for investment, is the main
concern of these countries.

For many countries, exporting oil or natural gas (and other
commodities) is the major source of hard currency revenue and government
income. Domestic spending, importing
consumer goods, government social welfare and subsidy programs, foreign policy
and even internal stability and corruption depend on commodity export
earnings. As does servicing foreign
borrowing, which has grown rapidly in the last six years.

With much greater potential supply of oil and natural gas
because of new discoveries and innovative production technology, and growing
substitutes, no one country or small group of countries will be able to control global
supply or price.

Among the fossil fuels, the long run outlook (20 years) of
natural gas appears to be the best. Even
without the fall in natural gas prices, the global trend away from coal to gas to generate power will likely
continue and increase demand for gas. In Asia, however, both coal and natural gas production are increasing because of the huge increase in the demand for electricity.

Massive increases in profitable
reserves and technological changes in production and distribution will
permanently bring down prices of natural gas in high-cost areas like Asia and
Europe. LNG, more tankers and interconnect pipelines will make the global
gas market more integrated, more like the global oil market.

Three new potential major producers of natural gas are
Argentina, Bangladesh and Egypt. Qatar
and Australia have completed and can expand large new LNG complexes. Some of Qatar’s new gas revenue is supporting Sunni fundamentalist
groups in Syria and Iraq.

Substitutes for oil and gas should be cost competitive in
the near future. Solar, especially
decentralized solar on buildings, will continue to grow rapidly as the
technology improves and the costs keep coming down. Adoption of solar
will accelerate if battery storage costs come down and countries don’t have to
build or expand electricity plants and grids.
Solar panel costs are falling rapidly and Elon Musk says his new lithium
battery plant in Nevada will reduce storage costs by 30%. Wind turbine currently depends on subsidies
but there is some new technology that may eliminate the gigantic windmills
(375 feet high) and lower costs.

Many countries are looking at nuclear
again because of major advancements in technology and safety. There are currently 437 nuclear power reactors operating worldwide. 60 more are under construction, another 165 are planned, and 331 more are proposed. The number of nuclear power plants in the world could easily double in the next two decades. China alone plans to build 46 new ones by 2020. Japan, which paid $270 billion to import fossil fuels (mostly natural gas) in 2013, currently plans to start up 15 shut-down nuclear power plants. On the other hand, Germany is shutting down the last of its 17 nuclear power plants, substituting solar and wind (interruptible) backed by gas.

Other sources of energy beyond the use of fossil fuels are
being researched and developed in laboratories.

The key is how long oil and gas prices stay at current
levels and what the new equilibrium prices will be. This is not just
an economic question. Domestic policies,
like China’s and America’s policies to reduce carbon emissions from coal, and
geopolitics will play key roles. Also,
there will be major shifts in where oil and gas are produced, who exports, new
technology and the expanding importance of substitutes.

THE EASTERN MEDITERRANEAN

Huge new natural gas fields have been discovered in the
eastern Mediterranean. The largest so
far are in the coastal waters of Israel, Gaza, Egypt and Cyprus. The fields may extend north to Greece, Lebanon
and Syria. Israel, now self-sufficient
in natural gas, could supply Palestine and Jordan. Pipelines could be built
from Israel, Gaza and Egypt to Cyprus and then another set to Greece, which
would connect into the proposed integrated pipeline systems of central Europe
and, through Austria, to the rest of Europe. Or a pipeline could be built to connect with the large pipeline running through Turkey to Europe. South-Central European countries could eliminate their almost complete
dependence on Russian natural gas and threaten “reverse flow” to Ukraine. Egypt already has an LNG plant and other
producers could construct them, expanding their geographical market for their
gas.

If this occurred, it would be a tremendous economic boon to
all the countries involved. So what’s
the problem? Geopolitics. There are countries involved that don’t like
each other. To say the least. Besides Israel and Gaza, Cyprus is divided
into Turkish and Greek areas. Would the
economic benefits be great enough to overcome political rivalries, many based
on long-standing hatred and conflict?

RUSSIA AND EUROPE

Russia is Europe’s largest external source of oil and
natural gas. Europe is Russia’s largest
customer for both. But the conflict in
Ukraine has changed the geopolitics. Russia
may pay a very high economic price for its intervention in Ukraine.

It is also one reason that I don’t think Russia will invade
and conquer the whole country, as Putin has threaten to do. Or even increase destabilization pressure. Europe would expand sanctions, look to new
sources of energy and accelerate programs to import less Russian oil and
gas.

While these policies will probably have little short-run
effect on the volume of Russian exports of oil and gas to Europe, a longer-run
combination of lower prices and less volume would have serious economic
consequences for the Russian economy.
Since Putin’s and his successors’ political popularity in Russia partly
depends on continuing the high rates of economic growth and standards of living
made possible by increased revenue from energy and commodity exports, pursuing
an aggressive or confrontational policy against Ukraine and Europe could have
serious domestic consequences for the current and future Russian governments.

Under U.S. pressure, Europe has imposed some economic
sanctions on Russia, the most effective being that Russian companies cannot
access European financial markets. As
loans come due, the companies, many of which are government owned or
controlled, have to borrow hard currency from the Russian government. Russia’s foreign reserves of hard currency
are shrinking. Over half are committed
to future retirement costs, although the fund can be raided.

New internal capital to modernize old fields and develop new
fields is not available. Global bond
markets are closed. Russia’s response
has been to relax rules limiting foreign investment in Russian oil and gas.

In addition, Europe is beginning to institute actions that
will reduce its dependence on Russian oil and natural gas, which means lower
export earnings for Russia regardless of the change in energy prices.

Europe has large natural gas reserves but will not develop
them quickly because of political opposition, lack of infrastructure and more
difficult drilling geology than the U.S.

RUSSIA AND CHINA

China imports more oil than does the United States. Before the tariff batlle, China was importing more U.S. crude oil.  China is about to become a major importer of natural gas as it substitutes gas for domestic coal production.  So China has joined the United States as a large market on the demand side.

Russia is now China’s largest supplier of oil.

Russia’s president Vladimir Putin has his own “pivot towards
Asia.” Russia’s main market for oil and
natural gas is Europe. With the
expectation that sales will be lower in the future and that older fields are
declining in production, Putin has turned to China for capital investment and
as a major export market. China plans on
substituting natural gas (and other energy sources) for its dependence on coal
(cough, cough). Russia has a huge new
field in eastern Siberia it wants to develop.
The cost is somewhere between $55 billion and $100 billion. Russia doesn’t have the capital and can’t
raise it in western financial markets because of the economic sanctions. So, apparently, the deal is that China
supplies part of the capital and agrees to take the production for the next 30
years. Although secret, apparently at a
low price. Russia originally announced
that sales to China would bring in $400 billion over the 30 years but that was
before the large drop in the price of natural gas, especially in Asia, and the
reality that there will be a lot more natural gas available from other sources.

Russia is now encouraging China and other Asian countries to
invest in Siberian oil and gas. Knowing
that Russia has used oil and gas exports as a geopolitical weapon against
Ukraine, Europe, Georgia, Serbia and Armenia, potential investors in China,
Japan and South Korea have to be worried about the political consequences of
becoming too dependent on Russian oil and gas.
And having their investments expropriated by future Russian government.

There is another complication. China is rapidly extending its influence into
the old Soviet republics in central Asia.
China has offered economic aid, including railroads and natural gas
pipelines connecting China and central Asian republics. One of the world’s largest natural gas fields
is in Turkmenistan; this is where Russia gets some of the natural gas it sells
to Europe. There are other possible gas fields. All of this creates the potential for
geopolitical rivalry between Russia and China in the area.

China also borders Kazakhstan, another former Soviet
republic. Kazakhstan is a large oil
producer and has the potential to produce more.
Russia sees Kazakhstan as in its sphere of influence. The president of Kazakhstan was the Communist
boss of the republic when it broke away in 1991. The Chinese, however, have made a number of
proposals that would divert some of Kazakhstan’s oil to China. Russia is not happy about this prospect.

In the long run, this policy could create
serious geopolitical problems for Russia. Supplying China with cheap
oil and gas while China expands its influence in Central Asia and renews its
claims (legitimate) on eastern Siberia is a dangerous policy. But that
will someone else’s problems, not Putin.

OPEC

OPEC has been ineffectual as an oil cartel, probably since 1985 when Saudi Arabia cut production with disastrous results. Iraq has invaded both Iran and Kuwait to grab large oil fields. Saudi Arabia and Iran are deadly enemies and compete to dominate the Persian Gulf region (and Islam). Many of the oil exporting states have seen civil wars and declining production. OPEC’s exports and net exports have been declining while global production is rising.

OPEC’s control has also been eroded by the growth and development of oil production in non-OPEC countries, even before shale. What shale does is greatly increase potential global oil production in non-OPEC countries if prices rise. Maybe even more important, shale oil greatly increases oil reserves outside of OPEC countries. Before shale, a high percent of the proven reserves in the world were in OPEC countries, mostly in the Middle East. This implied that OPEC’s market power would last a long time. No longer.

NAFTA

NAFTA (The U.S., Canada and Mexico) is the new OPEC. Almost all of the net increase in global oil
production since 2007 has come from NAFTA countries. Future increases in oil production will come
mostly from American and Canadian fracking, and deep-water rigs in the Gulf of
Mexico.

NAFTA is the new OPEC also in the sense that the American
and Canada companies, using fracking technology, can react quicker to changes
in global supply and demand, and subsequent price changes. New technology, better management and organization, and large cost reductions because of low prices have reduced the break-even cost of shale oil and gas.

The best oil fields in the United States have marginal costs
of pumping out and distributing oil about equal to all but the lowest cost fields in the Middle
East. Because of fracking technology, fixed
cost/barrel to modernize and expand existing fields is probably higher in most of the
Middle East and the rest of the world than expanding or opening new fields in the United States.

The geopolitical implication of all this is the United
States could cut off all oil imports from the Middle East and quickly substitute
NAFTA oil, mostly American. There are
major geopolitical implications if the United States has oil security, doesn’t
need Middle East oil and becomes a major exporter of petroleum and natural gas. Maybe the Iranian agreement, over strenuous
Israeli and Saudi objections, is an indication of the changing, more flexible
geopolitical policies of the U.S. in the Middle East.

SUMMARY

Global demand for energy will continue to increase in the foreseeable future. Global production of all sources of energy, including coal production in Asia, will increase. New technology on both the demand side (electric vehicles and autonomous driving) and supply side (fracking, LNG) will change the economics of energy. This will have geopolitical consequences. Middle East oil will become relatively less important. U.S. exports of oil and natual gas might have geopolitical effects. Development and sales of new technology such as solar and wind, may, in the long run, become more important than fossil fuel extraction.

======================================================

This is a summary of prior posts plus new information and conclusions. The latest related post was on Russia and the Geopolitics of Energy.

For an excellent history of the rise of OPEC, see Daniel Yergin, The Prize.

For an excellent, detailed article on Gazprom, see http://oilprice.com/Energy/Energy-General/How-Russias-Energy-Giant-Imploded.html. Gazprom has a virtual monopoly on Russian natural gas production and exports. Its management has very close ties with the Russian government. Putin has used Gazprom to implement both internal and foreign policy objectives. Gazprom owns a TV network and a major bank. Some of its profits were diverted to pay for the incredibly expensive Olympic Winter Games, with billions of dollars ending up in the pockets of oligarchs and government officials. Overseas, Gazprom has cut off or threatened to cut off gas supplies to Europe, Ukraine, Georgia, Armenia, the Baltic States, Slovakia and Serbia on orders from the Kremlin. In each case, Gazprom was used as a blunt geopolitical weapon to change another country’s democratic or anti-Russian politics.

September 12, 2015
Ukraine and Russia

Russian T-72 Tank Seen in Ukraine

HISTORICAL BACKGROUND

Most of what is now Ukraine
came under Russian control in the 1700s, due to the expansionist policies of
Catherine the Great. Part of western
Ukraine (Galicia) was a province of the Austro-Hungarian Empire.

With the collapse of the
Romanov regime in 1917 and Austria-Hungary in 1918, Ukrainians attempted to
establish an independent republic.
During the Russian Civil War, Ukrainian nationalist groups fought on the
side of the Communist Red Army because they knew that if the monarchy were
reestablished, Ukraine would be forced back into the Russian Empire. Their hopes for independence were crushed as
the triumphant Communist regime absorbed Ukraine into the Soviet Union.

Ukrainians suffered under the
Stalinist regime. Because the Ukraine
was the “bread basket” of the Soviet Union, grain and other crops were
systematically confiscated by the Communist government to feed industrial
workers at subsidized cost and exported to earn foreign currency. Bad weather plus confiscations in 1932-33 led
to millions of Ukrainians starving to death.

During World War II, some
Ukrainians fought with the Nazis, hoping to be free of Russian rule. After the war, Ukraine was treated harshly as
punishment. All Tatars in the Crimea were
deported to the interior of Russia; over half died.

RECENT CONFLICT BETWEEN UKRAINE AND RUSSIA

From 1991 until 2004, Ukraine
was ruled by former Communist bosses and their protégés. Little changed politically or economically. Some state assets were privatized, creating a
small group of oligarchs with ties to government officials. Corruption was rampant. Old industries were not modernized. Production and exports were still mostly
oriented to supplying Russia with food, industrial materials like pipe and
weapons. There was little economic growth or development.

Fed up with the lack of
progress, corruption, and economic stagnation, Ukrainians took to the streets in
2004 to protest the regime of President Viktor Yanukovych. The “Orange Revolution” was one of a number
of popular protest movements against authoritarian regimes on the Russian
periphery. President Yanukovych was
replaced by a democratic government.
Unfortunately, the President and the Prime Minister became bitter
enemies. The pro-Russian party of former
President Yanukovych had a strong position in parliament. The government appeared paralyzed and didn’t
institute the reforms demanded by the “Orange Revolution” protesters. Aided by Putin’s campaign managers and Russian money, Viktor Yanukovych was elected President again
in 2010.

Unlike the peaceful “Orange
Revolution” of 2004, the 2013-2014 demonstrations protesting the pro-Russian
policies of President Yanukovych led to the use of violence against the
demonstrators. This time the removal of
Yanukovych led to an armed rebellion against the new government by Russian separatists in the eastern
provinces (Yanuokovych’s political base), a Russian takeover of the Crimea and
a shooting war with Russia over control of Ukraine’s eastern provinces.

NATURAL GAS AS A GEOPOLITICAL WEAPON: UKRAINIAN DEMAND FOR RUSSIAN NATURAL GAS

Before the conflicts began,
Ukraine depended on Russia for about two-thirds of its natural gas, about 30
billion cubic meters a year. The cost
was around $10 billion minus transit fees, a major cost for a small economy of around $200-$250 billion. Demand has
decreased because of the loss of territory and a severe recession, down to probably
around 20-25 billion cubic meters. But
Russia has increased the price and threatened to continue the current shut-off
of gas through the winter. Ukraine agreed to pay arrears for past purchases and pay COD for future purchases. Russia agreed to supply gas for six
months.

The money for these purchases
and other debts will come from a $17 billion loan from the IMF. In addition to paying for Russian gas and
oil, a $3 billion Russian loan will come due in 2015.

Ukraine is trying a number of
strategies to reduce its dependence on Russian natural gas. One is conservation. Ukraine, despite being poor, has one of the
highest natural gas per capita usage rate in the world. A major reason is that the cost to consumers
and industry is heavily subsidized; the retail cost is about 25% of the
wholesale cost Ukraine pays to Russia.
Raising the internal price under current conditions will be politically
unpopular and maybe impossible.

Ukraine has tried to receive
natural gas from neighboring countries by “reverse flow” of Russian gas
delivered through Ukrainian pipelines.
Russia has successfully pressured at least two of the four countries
(Slovakia and Hungary) not to do this.

In the future, Ukraine may be
able to develop large shale gas fields which may be an extension of shale gas fields in adjoining eastern Poland.
Ukraine also intends to build a short pipeline to Poland. Gas will come from an LNG plant Poland is
building and other non-Russian sources through interconnect pipelines.

RUSSIAN GAS PIPELINES THROUGH UKRAINE

Worried that Ukraine could
shut off deliveries to Europe, Russia’s strategy has been to bypass the Ukraine
pipeline network. The Nord Stream
pipeline in the North Sea reduced the percent of Russian natural gas exported
to Europe through Ukraine from 80 percent to 50 percent. It brings gas directly to Germany, its
largest EU customer.

The proposed South Stream
pipeline through the Black Sea to Bulgaria would have enough capacity to
eliminate Ukraine as a transit point for Russian gas. As a political reaction to Russia’s military
actions, the European Union pressured Bulgaria to suspend participation in
building the pipeline and terminal. The
South Stream pipeline currently is on hold.
The interim Bulgarian government before the recent elections signed an
agreement to be part of a competing pipeline consortium that brings Azerbaijan
natural gas overland through Turkey and Greece to Bulgaria. A European Union committee is discussing building interconnect pipelines through Central Europe (heavily dependent on Russian gas coming through Ukraine) to Austria.

UKRAINE’S ECONOMY

Even before the conflict with
Russia, the Ukrainian economy had not progressed. In 1991, the economies of Poland and Ukraine
were about the same size. Since then,
Poland’s economy has tripled in size while Ukraine’s economy before the current
conflict was about the same size as in 1991.
The differences may be somewhat smaller since much of the Ukraine
economy, maybe as much as 40%, is underground.

The continuing war in the
east and the loss of the Crimea has devastated Ukraine’s already weak
economy. The eastern provinces contain
the bulk of the Ukraine’s manufacturing capacity and coal mines. Russian has imposed sanctions on some
Ukrainian exports. Ukraine’s economy is
expected to shrink by 8% this year and again next year. If fighting continues, this is probably too low an estimated.

Ukraine’s foreign-exchange
reserves are falling rapidly. International
loans from the IMF and aid from the European Union have only bought time for
Ukraine. It seems impossible that
Ukraine can meet its debt obligations without new loans and aid. Two months ago, the IMF said that Ukraine
will need an additional $19 billion if the fighting continues. Even with new loans, it is likely that
Ukraine will have to default or renegotiate its external debt. Part of its external debt is owned by Russia.

POLITICAL CONSEQUENCES TO UKRAINE AND RUSSIA

Ukraine
is the most important application of the Russian foreign policy doctrine of
recovering lost territories and forming the old Soviet Union (actually, the old
Russian Empire since Communism is no longer the official ideology). Putin’s power and domestic support crucially depends
on this strategy succeeding. After a massive and emotional propaganda campaign, there is no
way the current Russian government of Vladimir Putin can allow Ukraine to
retake its lost eastern territory or the Crimea. When it appeared that the Ukrainian army
might defeat the separatist rebels, Russia sent in Russian special forces and
heavy weapons.

What has
Russia gained and lost by seizing Crimea, supporting the eastern rebels and
sending Russian military forces and weapons into Ukraine? Russia has
gained direct Influence or control over 15-20% of Ukraine’s population, which
was Russian or pro-Russian before the invasions. There is little economic advantage; the
eastern provinces the separatists control are a depressed area with old
industries and uncompetitive coal mines. Many of the companies have shut down because of the fighting or management fleeing the area.

Both Ukrainian and Russian
refugees will continue to leave the area controlled by the separatists. As of the end of October, the United Nations estimates that about one million people have left, out of a pre-war population of 4.5 million. Other estimates are higher. About half have gone to Russia and half to other parts of Ukraine. Refugees tend to be the young and better educated. Russia will need to heavily
subsidize the region just to restore devastation and basic services. Already eight large convoys from Russia have carried food (and probably military goods) to the separatist-controlled areas of Ukraine.

This will
leave a Ukraine of about 35 million people that just voted 92% to be
anti-Russian and pro-Europe. Russia has given Ukraine nationalists a
permanent issue. It also eliminates part of the economic and political
power base of the pro-Russian oligarchs.
Most of the oligarchs, including the President, are now firmly
pro-Europe.

In the
long run, Russian intervention may eliminate a 300 mile buffer zone from NATO
forces and puts a large anti-Russian country right on its borders. But without internal reforms and with Russian
troops on its eastern and southern (Black Sea) territory, Ukraine will continue
to be weak economically and militarily.

In retaliation to economic sanctions, Russia has banned about $9 billion of imports, mostly food. Foreign food products are disappearing from Russian stores. Russian substitutes either don’t exist or are of poorer quality. This is the first sign that the Russian people, at least the urban middle class, are beginning to pay a price for Russia’s intervention in Ukraine. Greater economic pain will follow.

====================================================================

For background, see an earlier blog:

https://politicaleconomicsprof.com/2014/06/ukraine-background-to-current-crisis.html

For earlier analysis, see:

https://politicaleconomicsprof.com/2014/03/the-crimea-russia-and-us-options.html

November 15, 2014
Ukraine – Background Outline, Scenarios, and Comments

Petro Poroshenko

“You don’t
understand, George, that Ukraine is not even a state.”

Vladimir Putin to
George W. Bush, April 2008

FACT SHEET

Size of country – largest totally in Europe (size of Texas)

            Borders
seven countries (see map), mostly Russia and Belarus

            Russia or
pro-Russian countries and regions (Moldova) on three sides

Ethnic – 77%
Ukrainian

            17% Russian
speaking (about 9-10 million people)

                        Mostly
in eastern provinces, Odessa and Crimea.

            6% Other,
including Crimean Tatars

                        Also
religious divisions reflecting regional and political divisions.

Population – about 44-46 million. (minus 2.5 million in
Crimea)

            Very low
birth rate and very high death rate.

            Declining
population and labor force.

                        Very
low life expectancy among men.

                        Rapidly
aging population.

                                    Heavy
per capita alcohol consumption.

            Demographics
similar to Russia and Eastern Europe countries.

HISTORY

Ukraine was the original “Russia”

            Scandinavian
name meaning Red.

Kievan “Rus” first Russian kingdom
to convert to Christianity (Orthodox).

Turbulent, bloody history because of location and wide
plains. Tribes going west from Central
Asia, Vikings going south to trade with Constantinople, buffer zone between
Ottomans and Russians, source of slaves and mercenaries. In modern times, often part of another
country’s empire.

            Now between
Russia and European Union.

            Western
influences in the western half, especially among young.

Crimea annexed by Russia in 1783; most of the rest of current Ukraine conquered by Catherine the Great in 1795.

            Seized by
Russia after fall of Yanukovych in Febrauary 2014.

Only second time in the area’s history that Ukraine is a
separate country.

POLITICAL

Poorly governed since independence in 1991.

            Corruption,
organized crime, oligarchs, lack of political reform.

                        Corrupt
police and judicial system.

Orange Revolution in 2004 (non-violent), repeated in 2013-14
(violent).

Both times, demonstrated against
corruption, for closer ties with Europe.

Forced resignation of President
Viktor Yanukovych, pro-Russian president.

Generational split, with older generation more inclined to
be sympathetic to Russia and younger generation more pro-West.

New president Petro Poroshenko (often spelled Porochenko in Western press), signs EU associative status
treaty, first move to closer ties with Europe.

Major players:

            Viktor
Yanukovych (corrupt former president, generally

pro-Russian).

            Yulia Tymoshenko
(leader of Orange Revolution, generally pro-West).

            Petro
Poroshenko (current president, one of eight major oligarchs).

            Vladimir
Putin (ruler of Russian since 2000.
Former KGB officer).

            Oligarchs,
who seem to be supporting pro-West government and

                        opposing
Russian militias.

RULE BY OLIGARCHS

The new president, Petro Poroshenko, is one
of the oligarchs. He appointed three
oligarchs as provincial governors. Two refused,
one accepted. One who refused, Rinat
Akhmetov, is reported to be the richest man in Ukraine, with substantial
holdings in the disputed areas. A former
supporter of Yanukovych, he suggested a fourth oligarch be appointed governor
of Donetsk province. He was forced to
flee by separatist gunmen.

Akhmetov controls a personal militia. He was able to thwart pro-Russian separatists
in a key city south of Donetsk province.
North of Donetsk province, a key industrial city and province is ruled
by another oligarch, Ihor Kolomoisky. He
is strongly anti-Russian. Moving
quickly, he has used his personal wealth and power to equip Ukrainian military
forces and fund a professionally-trained provincial militia. Not surprising, a branch of his bank in
Moscow has been seized by the Russian government.

Wall Street Journal, “Ukraine’s
Secret Weapon Against Putin: A Feisty
Billionaire,” June 28-29, 2014.

ECONOMIC



Economic stagnation since independence in 1991.

At official exchange rates, Ukraine economy about $150 billion/year, about 1/3 the size of the economy of New Jersey.

Economic structure a legacy of Soviet Union.

About 1/4 of total Soviet
industrial production.



Much of industrial output still oriented towards Russia but
total exports to West now greater than to Russia.

Part of industrial area in eastern Ukraine adjacent to
Russia. Coal mines, iron ore, steel
mills, fabricated metal products like large diameter pipes, armaments for
Russia, oil refining, chemicals. Area of
pro-Russian protests.

            Economically
depressed, especially Donetsk region.

Serious pollution problems.

Most of industrial companies owned by eight oligarchs.

Breadbasket of Soviet Union.

            Provided
about 1/4 of food in Soviet Union.

Dependent on Russia for about 2/3 of natural gas supplies
and most of oil.

Russia’s export of gas and oil used
as political weapon. Gas supplies to
Ukraine cut off three times since 2006.

2010 treaty with Russia –
subsidized gas prices in exchange for extending lease for Russian fleet based
in Crimea. Treaty broken by Russia when Crimea
taken over this year. Gas prices raised
to European levels.

Gas use for heating, cooking and
industrial fuel heavily subsidized.

            Extremely
wasteful use of fossil fuels.

Four of six oil refineries owned by
Russian companies.

Ukraine has potentially large shale
gas deposits.

UKRAINIAN NATURAL GAS IMPORTS

In 2012, Ukraine consumed 53.8 billion cubic
meters (bcm) of natural gas. Domestic
production was 19.7 bcm. Total imports
from Russia were 32.4 bcm, or about 63% of total usage. For a relatively poor country, Ukraine’s gas
usage is unusually high. Total usage is
three times that of Poland and larger than France. (Source:
International Energy Agency)

Cost of imported Russian natural gas about $10 billion per year. Ukraine having trouble paying. Needs Western financial assistance.

In 2013, the European Union (EU) countries
imported $166 billion of oil and natural gas from Russia. The EU ran an $86 billion trade deficit with
Russia.

LARGER ISSUES

Integration of former Soviet satellite countries in central
Europe into economic, military and political unions of Western Europe.

            Best
opportunity for peaceful integration in over 1,000 years.

Resurgence of Russian nationalism – sees integrating Europe
as a geopolitical and military threat.

            Supported
by Belarus and some factions in Ukraine.

                        Geographical
buffer zone next to NATO countries.

            Lack of
political and economic reforms in all three countries.

            Major
campaign to modernize Russian military weapons.

Russian use of oil and natural gas as geopolitical weapons.

            May be less
effective in future.

                        Large
deposits of shale gas in Europe and Ukraine.

                        Alternative
European import sources.

Internal threats to European section of Russia.

            Declining
European population.

            Rising
Muslim and Asian population in southern and eastern areas of Russia.

                        Muslims
make up 10-15% of Russia’s population.

Potential threat of China to Eastern Siberia and Vladivostok
(Chinese territory until 1860).

Europe moving to reduce imports of Russian natural gas.

            Opportunity
for U.S. Canada and other countries to export LNG to Europe.

                        Canada
building large LNG facility in eastern Canada to export

                        natural
gas to Europe.



Russian Black Sea pipeline to bypass Ukraine on hold.

SCENARIOS

Ukrainian forces defeat pro-Russian rebels
but guerrilla war continues.

            Continued
centralized control.

                        President
appoints provincial governors.

            Russia
reduces support but continues covert operations.

  Ukraine
rebuilds military forces with outside assistance.

Continued fighting leading to new constitution that gives
substantially more autonomy to eastern provinces.

            Possible if
Russian rebellion contained and truce holds.

Reduces highly centralized
political control of country.

Continued fighting and continued Russian pressure to
destabilize eastern provinces with ultimate aim of absorbing two to five
provinces without invasion of Russian troops.

            Victory for
Russian nationalism without economic sanctions.

Russian interference has probably
strengthened desire of western 2/3 of Ukraine to move closer to EU and
eventually NATO.

Russian invasion of eastern Ukraine.

Russian annexation of two eastern
provinces, adding 5-6 million people to European Russia.

Harsher economic sanctions. Serious impact on Russian economy.

Ukraine signs economic treaty with EU and eventually becomes
a member of EU.

            Receives
substantial financial aid.

            Outside
pressure for political reform.

Scenarios are not mutually exclusive. Some or all may happen at different times in
the future. For example, if eastern
provinces become part of Russia, the rest of Ukraine will probably ask to
become a member of NATO and EU.

COMMENTS ON SCENARIOS

Ukraine’s president has signed an associative member agreement with the EU, as he promised he would. Russian nationals’ rebellion in two eastern provinces and Russian threats eliminated prior policy alternative of trying to balance Ukrainian foreign and economic policies between Russia and the West. One consequence is that Ukraine will probably now receive about $32 billion in economic aid and loans from IMF, EU and US. IMF loans come with strings attached – Ukraine will have to reduce domestic subsidies for natural gas users and begins to reform government. I would also guess that Ukraine will have access to Western military gear and training. In longer run, good chance Ukraine will join EU and NATO.

I think there’s a good chance that current
and threatened economic sanctions will lead Russia to lessen support for pro-Russian
rebels in Ukraine, especially if Donetsk falls to the Ukrainians. Russia
still controls Crimea. There will probably be less overt but continued
covert Russian support. Putin will reduce rhetoric. Russia may continue
to threaten Ukraine with invasion.

Putin cannot appear to totally abandon the pro-Russian rebels. His seizure of
Crimea, military buildup on the border, hawkish rhetoric and military support
for the Russians in eastern Ukraine increased his popularity in Russia. He has to
appear to be continuing his support for the rebels without triggering economic
sanctions that will seriously damage the Russian economy.

Russian oil output is declining.
Russian has huge shale and deepwater oil and gas deposits but needs
Western technology to get at them. This is more important to Putin’s strategic objectives than supporting
Ukrainian rebels. In addition to keeping large European market, increased
production opens up large new markets in Asia, especially China, which intends
to triple LNG imports in the next 8-10 years. Economic and military
resurgence of Russia and Russian nationalism depends on exports of oil and
gas.

Russia will continue
to attempt to destabilize and subvert Ukrainian government but won’t invade, despite
huge military advantage. Combination of economic sanctions (including
access to Western technology needed to develop huge untapped oil and gas
fields), fall in foreign investment and tourism,
and increased capital flight would seriously hurt Russian economy.
Exports, mostly oil and gas, are about 1/4 of Russian economy and pay for
military modernization among other Putin objectives. Europe will
accelerate trend to using less Russian natural gas and oil, but will remain a
major market for Russia.

Huge potential increase in
global supply because of new technology to get at shale natural gas (and oil)
will make up for potential loss of Russian natural gas to Europe.
Eventually.   Other countries must
make massive investment in drilling, pipelines, LNG plans and LNG tankers. Needed new LNG ships will cost about $50
billion (New York Times, August 5).
Total elimination may take five to seven years but alternative sources of
supply already available.

Europe and Ukraine have their
own potentially huge deposits. Political opposition to fracking will slow
up development in France and Germany but probably not in Poland, Romania and
Ukraine, the countries with the largest potential deposits. Ukraine will
invite in Western oil countries to help develop natural gas reserves and
modernize economy. Hopefully, EU ties and foreign investments will lead
to economic growth.

If U.S. built a
pipeline network from North Dakota and Canadian shale natural gas fields to
Texas and/or east coast, and the U.S. government licenses liquified natural gas
(LNG) plants, the U.S. could export very large amounts of natural gas to Europe
at a lower price than Russia is currently charging. One new U.S. LNG
plant has been approved and seven more are pending. Canada has already started design work on an
LNG plant in eastern Canada. This could eliminate future Russian threat of
shutoff and strengthen ties of European economy to U.S. and Canada. Major
geopolitical change.

Speculative, more unlikely scenarios. 1) Ukraine voluntarily lets go of two eastern provinces. Gets rid of most of remaining Russian population and economic ties to Russia. Russian population in Ukraine less than 10%. Future firmly with West. 2) Government and judicial system becomes less corrupt and fights organized crime.

For an earlier discussion after Russia seized the Crimea, see The Crimea, Russian and U.S. Options.

ADDITIONAL INFORMATION

For a quick look at the huge disparity of the Russian and Ukrainian military forces, see

http://www.bbc.com/news/world-europe-26437359

Not in the video — Ukraine’s main battle tank, the Russian T-64, has been taken out of service in Russia because it is obsolete. Russia’s tank force includes about 550 T-90s that are comparable to the West’s best tanks. Next year, Russia says they are starting production on the T-95 which, on paper, may become the best tank in the world. It is also a step towards a fully robotic tank, which makes sense in a country with declining population. Russia’s military superiority may be irrelevant if Russia believes stronger economic sanctions will be imposed if they invade Ukraine.

By the way, U.S. design and production to replace the Abrams tank has been slowed by budget cuts and sequesters. The conservative Republicans are a danger to the national security of the country.

I would emphasize that many of the top leaders in the Ukrainian military, SBU and police started their careers, and were trained, by the Soviet Union. Also, since about 17-20% of Ukraine’s population is Russian, I would assume that a lot of police and military are unreliable. It is probably one reason some Ukrainian police and military units surrendered to Russian militia without a fight and gave the militias equipment. Poroshenko is replacing top military leaders. Then there is corruption.

Economic comparisons are harder because much of both economies are underground. Probably higher in Ukraine – one estimate by two Ukrainian economists in 2012 is that 44% of the economy is underground. Even adjusting for that, the Russian economy is about 10 times larger than Ukraine’s. Roughly, $200 billion vs. $2 trillion.

One of
the problems is that modernizing the Ukrainian economy does not necessarily
mean increasing employment. The world’s largest steel company took over
Ukraine’s largest steel complex. It spent billions modernizing the plants
and increasing capacity but reduced employment from 57,000 to 33,000. One
of the oligarch just built a fully automated steel pipe plant that created few
new jobs.

But Russia is vulnerable to economic sanctions and, in the near future, possibly declining exports of oil and natural gas. The two are related; economic sanctions would deny Russia the Western technology they need to get at huge untapped oil and natural gas deposits.

INFORMATION SOURCES

BBC News, “Ukraine Crisis Timeline”

http://www.bbc.com/news/world-middle-east-26248275

New York Times, “Ukraine Crisis in Maps”

http://www.nytimes.com/interactive/2014/02/27/world/europe/ukraine-divisions-crimea.html?_r=0

CIA World Factbook

Financial Times

Novenite (From Bulgaria, in English)

VICE – Russian Roulette (on YouTube)

  Video interviews in areas controlled by pro-Russian militias.

kvivpost.com (from Ukraine, in English)

June 29, 2014
The Crimea, Russia, and U.S. Options

Ukraine President

Russia’s
illegal invasion and annexation of the Crimea will set off a chain of events
that could strengthen U.S. power and influence, especially in Eastern Europe. Putin is gambling that President Obama and
conservative Republican leaders lack the will to energetically react to Russian
expansion. First U.S. reactions have
been weak. Unless there is a change,
Putin might be encouraged to annex other Russian-dominated areas outside
current Russian borders.

Ukraine
has tried to balance Western and Russian pressure. The popular revolt against the pro-Russian
Ukrainian Prime Minister upset the balance and precipitated the crisis.

Putin may have decided to upset the unstable status quo in Eastern Europe, starting with Ukraine and Moldova. Russia’s next step could be to annex the eastern third of Ukraine. This area includes the Donetz Basin, which
contains a Russian majority and industrial resources. If successful, Russia could then move along the
north shore of the Black Sea to Odessa and maybe to the Rumanian border. Russia
already controls the eastern third of Moldova, presenting Ukraine, especially
the Kiev region, with the possibility of being threatened or attacked from both
the east and the southwest.

The
Russians are very concerned about their long-term demographic trends. Russia’s population is declining.
Russia’s population is now about 1/2 that of the U.S. and the gap is
widening. And, in the foreseeable future, European Russians will be
outnumbered by Asians (east of the Urals) and Muslims within Russia. Adding millions of European Russians may have
played a part in the decision to annex the Crimea.

All of
this has domestic advantages for Putin. His moves are popular in Russia.
Future leaders will probably also have to be nationalistic and probably
expansionist, putting pressure on Russia’s periphery. It was naive of the U.S. to think that Russian nationalism suddenly disappeared with the Soviet Union.

An
expansionist Russian foreign policy entails huge risks.

About 40%
of the population in the Crimea is Ukrainian and Tartar. Both groups in the region have centuries-old
historical grudges against the Russians. By making a de facto control de jure, the Russians are making sure that 40% of the Crimean population will now feel
like a conquered minority and will look to Ukraine for support.

The takeover might also finally unite the pro-West political leaders in the Ukraine. Ukraine
has already signed the economic cooperation treaty with the EU that started the
crisis. Ukraine needs immediate
financial support. With loss of
territory and increased Russian pressure, Ukraine will probably ask to join
NATO if it can be guaranteed U.S. military support in weapons systems and
training. If this happens, Russia will
be faced with another enemy, along its crucial southern European border. Putin is gambling this won’t happen.

It is also likely that Putin’s land grabs will reinvigorate NATO and focus U.S. attention on European security issues.

All this will affect Poland. Poland
does not have a border with Russia, except for a short strip to
the north with the Russian enclave of Kaliningrad. Poland has long borders with Ukraine and
Belarus. Belarus – the old Russian province of Byelorussia or White
Russia – is between Poland and Russia. But Belarus is for all intents and
purposes still a province of Russia. Poland, and NATO, still has to plan
that Russia could put troops on the Polish border and attack across the
northern Polish plain. Poland will probably have to step up military spending and ask for more NATO support.

The U.S.
is putting an advanced air defense system in Eastern Europe, mostly in Poland.
One consequence will probably be to extend the system to southern Balkan
countries and step up other types of military aid to Eastern European countries
that are members of NATO or the EU.

The
Crimean takeover should drive Eastern European countries even closer to NATO
and the EU. But the U.S. has to provide substantial military support in
training and weapons. Given the sequester’s effects on the military
budget, there is some doubt this will happen.

Beside
military support to NATO, especially Eastern Europe, the U.S. has a number
of good responses, including a rapid increase in oil and especially natural gas
exports to Europe. I’m not sure Obama has the political will to overcome
opposition within the Democratic Party to the pipelines and LNG
plants to quickly approve them, although Putin has handed him a
potent new argument. Combined with developing huge untapped reserves of
natural gas in shale around the world, the Europeans would be assured that they
would not be dependent on Russian gas in a few years.

Russian
sales of oil and natural gas account for about 70% of their export
income. Combined with economic
sanctions, a fall in foreign investment, capital flight and a loss of tourism,
the Russian economy could be severely damaged.

Maybe
Western European countries will wake up and realize that Russia is still a
political and military threat. If the
U.S. does not act energetically and decisively, European countries, especially
Eastern European countries, may decide they have to accommodate Russian
aggression. The danger is greatest for
the next few years when Europe will still be dependent on Russian natural gas.

Turkey, a
long-time member of NATO, should finally be admitted into the European Union.

Another
possible consequence of Russian expansion could be America’s relationship with
China. If China sees Russia as more aggressive, this could improve
relations between China and the U.S. An extreme but interesting gambit
would be for the U.S. to support Chinese claims to resource-rich eastern
Siberia.

===================================================================

See related post, President Obama Learns Some Game Theory.

March 22, 2014
Russia and China – Contrasts

Why has the political and economic development of Russia since 1991 been so different than that of China?

Russia – political collapse of Communism and the Communist Party.

China – Communist Party keeps political control after brutally suppressing

              demonstrations in Tiananmen Square.

Russia – loses Eastern Europe and much of old Russian Empire, creating

                economic disruption and political enemies on borders.

China – keeps territorial boundaries.

Russia – slow to reform agriculture.

China – starts reforming agriculture in 1970s. Increases food production and

              income of farmers.

Russia – tries to move quickly to democracy. Ends up with disappointment

               and authoritarian government. Does not tolerate internal dissent.

China – no free elections. Does not tolerate internal dissent.

Russia – attempts quick transition to capitalism. Ends up with corrupt

               combination of government bureaucrats and oligarchs.

China – phased transition to state-directed capitalism. Creates large new

               entrepreneurial and professional middle class. Widespread

               government corruption.

Russia – attempts to attract foreign capital. Fails.

China – attempts to attract foreign capital. Succeeds.

Russia – invades Georgia and alienates foreign countries and foreign investors.

China – does not invade other countries.

Russia – defaults on most of external debt, further alienating foreign investors.

China – increases foreign debt.

Russia – uses exports of natural gas as a political weapon against Ukraine

               and Western Europe. Alienates potential European investors.

China – does not rely on exports as political weapon.

Russia – little help from Russians in other countries.

China – massive amounts of investment, technology transfer and managerial

              expertise from overseas Chinese, including Taiwan and Hong Kong.

Russia – backward banking system and underdeveloped financial markets.

China – modernizing banking system and financial markets, although much of it

              still under state control.

Russia – economy relies heavily on exporting raw materials and processed

               metals. “Oil curse.”

China – large net raw material importer. Relies on exporting manufactured

             goods and development of domestic market.

Russia – allows ruble to float with negative results.

China – fixes value of yuan. Slight appreciation because of foreign pressure.

Russia – very little importing of foreign technology.

China – large amount of foreign technology imported and diffused throughout

             economy.

Russia – little use of joint ventures to import foreign technology.

China – extensive use of joint ventures to import foreign technology.

Russia – some investment in infrastructure.

China – massive investment in infrastructure.

Russia – emigration to Israel and other industrialized societies. (One of the two

               founders of Google from Russia.)

China – immigration of overseas Chinese with capital and skills.

PROBLEMS

Russia – serious pollution and environmental degradation problems.

China – serious pollution and environmental degradation problems.

Russia – collapse of social welfare programs.

China – collapse of social welfare programs.

Russia – declining, unhealthy population. Declining life expectancy.

China – slowly increasing population. Far below replacement birthrate.

               Rapidly aging population.

Russia – moving away from dependence on raw material exports.

China – possible contradiction between economy and government.

March 30, 2011