Geopolitics of Energy
Updated: Feb 14
The fall of the Soviet regime can be traced to two key moments of disruption in Eastern Europe. The first wave occurred in the aftermath of World War II, when Soviet-style communism was imposed on the countries of Eastern Europe, leading to popular uprisings, protests, and underground movements that sought greater freedom and independence. The second wave of resistance emerged in the 1980s, amid growing discontent with the communist regimes in the region. This wave was marked by the rise of popular resistance movements, such as the Solidarity movement in Poland and the Monday demonstrations in East Germany, as well as the emergence of new opposition groups that aimed to challenge the status quo and push for greater political freedoms.
Eastern Europe’s Roaring of Liberty Against the Soviet Regime
The first wave of resistance in Eastern Europe can be attributed to the fallout from Khrushchev's secret speech, while the second wave had several contributing factors, including Pope John Paul II's visit to Poland in June 1979. The Pope's visit was seen as a symbol of resistance to Soviet-style communism, inspiring the Polish people to demand greater political and religious freedoms and representing a direct challenge to the Soviet regime. This helped to fuel resistance movements in other Eastern European countries, such as the Solidarity movement in Poland, led by Lech Wałęsa. Initially formed to defend workers' rights, the movement quickly evolved into a broader resistance effort that challenged the entire communist system, mobilizing large numbers of people through strikes and protests.
In Hungary, the Hungarian Democratic Forum, established in 1987, played a key role in the country's transition to democracy. The party advocated for greater political and economic freedoms and helped to mobilize the Hungarian people in their demand for change. The human rights movement, Charter 77, was founded in Czechoslovakia in 1977 and was one of the first resistance movements in Eastern Europe, seeking to defend basic human rights and challenge the communist regime.
The reburial of Imre Nagy and other prominent figures of the 1956 Hungarian Revolution on June 16, 1989 in Heroes' Square, Budapest: Source
In East Germany, a growing opposition movement emerged in the late 1980s, challenging the communist regime and demanding greater political freedoms. The Monday demonstrations in Leipzig, which brought tens of thousands of people into the streets to protest the government, were a notable event. The Velvet Revolution in Czechoslovakia in 1989 was a peaceful political revolution characterized by mass protests and the non-violent overthrow of the communist regime, led by Vaclav Havel. The revolution helped to establish a democratic government in the country.
Another possible factor was the failed invasion of Afghanistan by the Soviet Union between 1979 and 1989, as well as the breakdown of the Sino-Soviet alliance. In 1983, the Reagan administration established Project Socrates, a classified U.S. Defense Intelligence Agency program directed by physicist Michael C. Sekora, with the aim of examining the reasons for the U.S.'s inability to maintain its economic competitiveness and finding ways to rectify the situation.
The Finale and Triumph of Market Economy over the Marxism
However, the critical factor that contributed to the collapse of the Soviet regime was its policy of prioritizing arms accumulation over economic development and market mechanisms. This was driven by various factors, including geopolitical rivalry with the West, the need to maintain a strong military to support global ambitions, and a belief in the superiority of central planning and state control over market-based economic systems. The Soviet Union invested heavily in its military and defense industries, neglecting its consumer goods and agricultural sectors, leading to shortages of consumer goods, long lines for basic necessities, and widespread discontent among the Soviet people. Additionally, the government's reliance on central planning and state control stifled innovation and economic growth, and led to widespread inefficiencies and corruption. As a result, the Soviet economy was unable to keep pace with the economies of the West and began to stagnate, albeit with attempts of reforms by Gorbachev.
The communiqué issued by OPEC on December 9, 1985 marked a significant turning point in the history of the organization and the global oil market. The decision by Saudi Arabia, in which some scholar may see US's influence, to increase its oil output and flood the market with additional oil led to a reevaluation of OPEC's role in the oil market. Instead of trying to control prices through production quotas, OPEC began to focus on maintaining market stability and ensuring a stable supply of oil. The events of 1985 demonstrated the limits of OPEC's ability to control prices and highlighted the importance of market forces in determining oil prices. The increased competition in the oil market, combined with the economic problems faced by the Soviet Union, which was heavily dependent on oil exports, ultimately led to the collapse of the Soviet economy and marked the end of the Soviet Union. The events of 1985 marked a redefinition of OPEC's role in the oil market and a recognition of the importance of market-based mechanisms for determining oil prices.
Nonetheless, the decline in oil prices during the 1980s was a crucial factor that exacerbated the economic woes faced by the Soviet Union. The Soviet economy was heavily reliant on oil exports and the slump in oil prices had a significant impact on the Soviet budget. During the 1970s, oil prices had risen dramatically, leading to significant benefits for the Soviet Union, which was blessed with ample oil reserves. However, the global oil market changed in the 1980s, resulting in a fall in oil prices. This had a profound effect on the Soviet economy, as the drop in oil revenues made it difficult for the Soviet government to finance its various economic and military initiatives. The decline in oil prices was just one aspect of the growing economic problems faced by the Soviet Union, which also included a fall in Soviet agricultural output, declining industrial productivity, and a rising budget deficit. Despite attempts by the Soviet government to address these economic problems through reforms, they proved ineffective in reversing the downturn of the Soviet economy. These economic problems ultimately contributed to the downfall of the Soviet regime and the dissolution of the Soviet Union.
Setting aside other factors, let us examine the geopolitical aspect of energy in detail to understand the current implications of Russia's invasion in Ukraine and the energy market's dynamics and the potential for intervention and sanctions by the US and Western allies.
Disinformation or Intelligence?
Three days ago, Saymour Hersh, in a post to Substack, claimed that the sabotage of the Nord Stream 2 pipeline was carried out by a collaboration between the US Navy, the CIA, and the Norwegian Navy, under the direct order of President Biden. Hersh's report relied on an anonymous source who stated that, in June 2022, US Navy divers placed C4 explosive charges at strategic locations along the pipelines, under the guise of a multinational wargame simulation. According to the source, the charges were remotely detonated three months later, upon receiving a signal from a sonar buoy dropped by a Norwegian P-8 surveillance plane.
Hersh is an investigative journalist who has won numerous awards for his reporting, including the Pulitzer Prize. He is renowned for his in-depth reporting on political and military scandals, such as the My Lai massacre in Vietnam and the Abu Ghraib prison abuse scandal in Iraq. Hence, his reports carry a significant weight, and the sabotage of the pipeline is no exception. However, Hersh's report, which relied on an anonymous source, has been met with skepticism. Oliver Alexander, in a response on Substack, pointed out several problems with Hersh's claims. Firstly, the practice of mine clearing has been a routine component of the BALTOPS exercises, casting doubt on the notion that it was used as cover for the alleged operation. Secondly, the supposed highly secretive operation would have required significant changes to the parameters of the BALTOPS exercise, which would have had to have been planned far in advance, raising questions about the feasibility of keeping the operation covert. Additionally, Hersh's description of the Norwegian navy finding the "right spot" to sabotage the pipeline has been challenged, as the three explosions took place at distances of 6.17km and 80km apart. Lastly, Hersh's assertion that the US needed to "camouflage" the explosives by adapting their salinity to that of the water has been dismissed as weak evidence.
Payoff matrix, our assessment
When examining potential actors in the sabotage of the Nord Stream 2 pipeline, Russia is at the top of the list, followed by the United States and Germany, based on ability, motivation, resources, risk calculation, and cost-benefit ratio. If Russia was responsible for the sabotage, it could reap several benefits. Firstly, it could undermine Europe's energy security by disrupting the flow of natural gas, thereby increasing Europe's dependence on Russia for energy. Secondly, the damage to the pipeline could delay its completion and increase costs, potentially damaging Russia's competitors in the European energy market. Thirdly, the incident could serve to strengthen Russia's negotiating position with European countries by offering alternative sources of energy. Finally, if the US were suspected of being behind the sabotage, it could further damage US-Germany relations and potentially discredit the US in the eyes of some European countries. However, both the Norwegian and Danish investigations have found no evidence of Russian involvement, and the White House has firmly rejected Hersh's allegations.
The Energy as a Weapon
Despite the lack of concrete evidence pointing to a culprit behind the sabotage of the Nord Stream 2 pipeline, Hersh's report sheds light on the broader issue of Russia's invasion of Ukraine. In spite of the ongoing war, Russia continues to supply natural gas to its European clients through Ukraine. This dependency is critical for households and district heating in Ukraine, with roughly 80% of households relying on centralized gas supply for heating.
The vulnerability created by this reliance on gas for heating is significant. Bypassing Ukraine through the operation of Nord Stream 2 and shutting down Ukrainian pipelines could potentially create a humanitarian risk during cold winter months and negatively impact Ukraine's income as a transit hub for Russian gas.
Previous disruptions in Russian gas supply to Ukraine in 2006 and 2009 highlighted Europe's vulnerability to Russia's use of energy as a weapon and the need for alternative supply routes. These disruptions also motivated both Russia and Ukraine to reduce their reliance on each other. The commercial launch of the Nord Stream 1 and Turk Stream pipelines significantly reduced Ukraine's role in Russian gas exports to Europe. The Nord Stream 2 pipeline, if not sabotaged, which Gazprom expected to launch in early 2022, would have further reduced Ukraine's share of Russia-Europe gas transit.
However, by 2015, Ukraine had secured alternative supplies from Hungary, Slovakia, and Poland, and had ceased its imports of Russian gas. The country's efforts to reduce its dependence on Russia serve as a reminder of the need for diverse and secure energy sources.
The Battle of Oil Market
While gas can play a major role in regional geopolitics across European countries, its revenue for Russia pales in comparison to oil revenue. Oil shipment, which includes tankers and suppliers from around the world, has a global impact. The fluctuation of oil prices directly affects each country's inflation and, in turn, its economy.
The events of last year, when Russia's invasion of Ukraine sent oil prices skyrocketing, had far-reaching consequences. The price per barrel of oil rose from USD 83 to almost USD 115, leading to a jump in US inflation to above 9 percent and prompting the Federal Reserve to raise its policy interest rate above 4 percent. In response, President Biden announced the release of the US Strategic Petroleum Reserve (SPR), established in the 1970s to combat oil shocks, in an effort to ease the upward pressure on oil prices. At the same time, Biden set out on a trip to meet Saudi Arabia's Crown Prince Mohammed Bin Salman (MBS) in the country.
On October 5, last year, OPEC+ oil ministers reached a historic agreement in Vienna, committing to a production cut of 2 million barrels per day, starting in November. Biden administration's top energy envoy, Amos Hochstein, played a pivotal role in lobbying for to vote against cutting oil production agreement. He, alongside senior national security official Brett McGurk and special envoy to Yemen Tim Lenderking, visited Jeddah in September to continue discussions on energy and security issues following Biden's high-profile trip to Saudi Arabia in July. The extent of the administration's efforts to secure the agreement has been previously underreported.
SPR Intervention in 2022, source: 1, 2, 3, 4
But once the SPR was successfully deployed and oil prices around the world fell, prompting Saudi Arabia to signal an increase in oil output in November. Although there is currently no change in production from Saudi Arabia or OPEC, oil prices have remained in the range of USD 76 to 80 per barrel. The US has since begun refilling the SPR, which could result in an accounting profit of over USD 4 billion, equivalent to an extra 60 million barrels of oil.
US Inflation and Fed Funds Effective Rate in 2022
Despite basing its 2023 budget on a USD 70.10 Urals price per barrel, Russia saw its average price drop 42% to USD 49.48 a barrel in January and has stopped disclosing net capital outflow data which is expected to shrink 58.2% as exports fall, however, the central bank reported a surplus in the financial account of the balance of payments due to a decrease in liabilities to non-residents and growth in the country's foreign assets. Russia's gas revenue will also fall at least 23% this year. Russia took the decision to reduce its oil output without consulting the OPEC+ group, which includes Saudi Arabia and has decided to cut output by 2 million barrels per day since October, however, the reduction in global oil supply comes at a crucial time as the IEA expects a global demand surge of 1.9 million barrels per day, with China accounting for almost half of the increase.
Global Oil Market Share: source
The global oil trade is becoming increasingly divided along geopolitical lines as Russia, in response to Western sanctions, turns to non-Western logistics and finance to sell its crude through gray networks that operate outside the control of Western intermediaries. The growth of this trade has allowed Russia to put more of its export machine outside Western control and has made pricing less transparent. The gray market, which is supported by a novel cast of traders, a vast tanker fleet, and new sources of finance, is captured by intermediaries who offer a conduit for funnelling money to offshore accounts that the Kremlin can likely influence. However, this sanctions-dodging will have negative consequences for the rest of the world, including further splitting the oil trade along geopolitical lines, and making oil trading riskier, as a growing portion of petroleum is being transported by firms with no reputation, on ageing ships, which may cause accidents for which insurers may be unwilling or unable to cover.
Global oil has tight demand and supply's price elasticity in the short run (upper right), Russian oil demand is different due to sanctions (upper left). Source Janis Kluge's tweet and Research Gate
Russia's military tactics in four phases: source
Russia is increasingly reminiscent of its Soviet predecessor. Volodymyr Dacenko, a former member of the reform team of the SC "Ukroboronprom" and a Forbes Ukraine columnist from 2019 to 2021, has outlined Russia's military tactics last year in line with our analysis, dividing its operational phase into four stages: 1) a blitzkrieg in the first weeks of the conflict, 2) a tank breakthrough (April to May 2022), 3) a probe of the defense (summer to autumn 2022), and 4) an infantry assault (winter 2022). These shifts in military tactics reflect the fluctuations on the battlefield, but also reveal a lack of a clear grand strategic objective for Russia. It is not clear what the end goal of this war is in Putin's mind. If the goal was to swiftly achieve the coup de grâce of Zelensky's administration and install a Russia-friendly regime in Ukraine, this outcome does not seem to be imminent. The next round of major Russian offensives has thus far not been very effective, amidst several Western deterrent mechanisms.
In contrast to China, Russia only joined the World Trade Organization (WTO) in 2012. Despite having played a role in the creation of the Bretton Woods institutions such as the International Monetary Fund (IMF) and the World Bank after World War II, the Soviet Union chose not to join these organizations. Instead, the Soviet economy relied on a militaristic approach and engaged in barter trade with former Soviet Union and Eastern European communist states. Yugoslavia, in particular, served as a distinctive trading hub between the communist bloc and the Western bloc, utilizing companies like Genex Group (or General Export) which, at its peak, had a trading volume of up to USD 4 billion. The Soviet Union was a major trading partner for Yugoslavia and the two countries enjoyed close political and economic ties, with the Soviet Union being a significant source of trade and investment for Yugoslavia. Soviet imports from Yugoslavia included machinery, electronics, and textiles, while Yugoslav imports from the Soviet Union included raw materials and energy products.
Today, both Yugoslavia and the Soviet Union are no more, Russia faces embargo and sanctions that have isolated it, relying heavily on its energy gray market as its sole source of hard currency income. This bears a striking resemblance to the situation the Soviet Union faced. Putin's latest major military operation may be seen as his final gamble, as well as his gamble on market force. If successful, he aims to rewrite the global order with "multipolarity" by establishing Ukraine as a puppet state. However, if he were to fail, a new global order may still emerge, albeit potentially accompanied by Russia's disintegration. We see an imminence in the latter.