Raising the Costs to President Putin The Energy Editorial, April 2014
-by building dissonance within. Some like to remember fondly the call by Ronald Reagan for Gorbachev “to tear down this wall”. The United States “Won the Cold War” said George Bush Senior in his State of the Union Address. We need to step back and recognize with some humility that the Soviet Union fell largely of its own weight rather than as a result of external pressure. Again today Russia is economically weak. It has become an exporter of raw materials, its industrial sector is weak, and its revenues are already falling. Conditions now offer the opportunity to aggravate Russia’s economic frailty – let’s focus on that.
It had become clear that the Soviet command economy of the 60s and 70s was not working: corruption was rampant, productivity was low, Gosplan targets were met by cooking the numbers, and the economy was in serious need of reform. Yuri Andropov (head of KGB) knew it and had set up an economic unit in the KGB to assess the damage and the competition - mostly from the US.
But Russia was suffering something else. Its misguided foray into Afghanistan had cost it a fortune in blood and treasury and it was still trying to recover well into the 80s when the Soviet economy got hit by another exogenous surprise. The Saudi netback policy for recovering its oil market share caused the price of oil to tank in 1986, just when Russia was at its weakest. Russian oil export revenues fell to an all-time low and the best efforts of the economic reformers were not as strong as the centrifugal forces at work in the USSR. The rest is history.
Today, Russia has volunteered to take on the additional expenditures inherent in consolidating its occupation of Crimea - if it stops there. Russian speaking Crimean’s who welcomed the Russian action are going to be looking to Moscow for their just rewards. Crimean’s who might be less content with developments - Tatars and others - may require some expensive buying off or even more expensive oppression.
Meanwhile at home, because President Putin has refused to lower above ground risk in the Russian oil and gas sector, production of both have stagnated and will soon fall. In oil markets, which could be exacerbated by the arrival in markets of increasing volumes of shale oil in the US and new oil from Provinces with bright production futures - there is the risk of softer prices for both - especially if Iran’s ambit to weaken sanctions is any more successful than it already is.
In gas markets, President Putin is the most vulnerable. It is from gas revenues that the President fills his war chest. Gazprom pays no taxes to the state and the high rent from selling gas to Europe at oil-linked prices from legacy production capacity has flowed to the Kremlin fueling his geopolitical strategies. These funding sources are falling fast because European gas demand is off, because Europe is diversifying away from Russian gas since Russia shattered its reputation as a reliable supplier and because oil-linked contracts are being replaced at lower spot-related prices.
The West should not stand idly by and watch Russia reabsorb more of its “Near Abroad”. But it should recognize that its tools are limited and its punishment largely symbolic. Reinforcing the growing economic pressure on Putin and imposing pariah status on Russia may be the most the West can do without unduly damaging itself.