The Economic War

Cutting off Europe's gas supply is Putin's last throw of the dice

The Nord Stream 1 gas recieving station in Germany which now sits idle after Russia cut off supplies (Photo by Jens Büttner/picture alliance via Getty Images)

On any given day in this war there is a lot going on: routine Russian missile attacks against towns and cities; new strikes by Ukrainian artillery against Russian assets; vast movements of war materiel by road, rail, and air; air defences trying to take out drones, helicopters and fixed wing aircraft; and probing attacks on the ground from both sides, some that do little more than test the other’s defences though others shift the front lines. These front lines stretch right across the east and south of the country, with separate operational dynamics in Kharkiv, Kramatorsk, Donetsk, Zaporizhzhya, and Kherson. Crimea is increasingly drawn in the action, and naval activities in the Black Sea continue.

Naturally we can get fixated on one aspect of this war. This last week we have been trying to work out what is happening with the Ukrainian offensive in the south. At other times the main preoccupation has been with mounting evidence of war crimes or exporting grain. Even as we wait for more news about the current battles there have been alarming developments in and around the nuclear power plant at Zaporizhzhya, where Russia is engaged in one of its dangerous games of brinkmanship, seeing if it can extract some benefit from a dangerous situation before – hopefully - it pulls back.

Away from the fighting the most important moves are in the economic sphere, especially in the energy markets. These moves are geared to influencing the military situation although their more important consequences may end up over the long-term being away from the war, reflected in the stresses and strains imposed on the global economy. As for influencing the course of the battles in the short-term, which is what is intended, their effects may be limited.

Western Economic Warfare

Making sense of the economic dimensions to this war can be even trickier than making sense of the military dimensions. This is not only because of the difficulties of working out what is going on but also what matters. In the economic as in the military spheres it is one thing to establish who the various measures are hurting and the damage they might cause, but quite another to assess how they might affect the conflict.

Economic sanctions as a form of coercion have a mixed record. At their most demanding they involve one state, or group of states, restricting trade and denying finance to another to persuade it to abandon some policy that is deemed threatening to international order or to cherished norms. After the end of the Cold War sanctions became a favoured response by Western states to crises, not least because they then dominated the international financial and trading systems.  Costs could be imposed on others with few negative consequences.

Historically sanctions have been promoted as a a non-violent alternative, or supplement, to military action. Their practical effects, however, could be severe, leading to shortages of food and medical supplies, and so cause suffering among the enemy population. In circumstances of total war, when civilians were viewed as legitimate targets, this humanitarian impact was accepted and there were hopes that if sufficiently intense might even prompt food riots and revolutions to overthrow the ruling elite in enemy states. (Recall the Bolshevik slogan of ‘Bread, Peace, and Land’ in the 1917 Russian revolution). With limited wars, inflicting such suffering is more problematic. Populations ruled by dictators appear more as innocent victims than perpetrators. Also dictators have means of suppressing mass unrest and look after their own comforts. Indeed because target regimes can control both smuggling and rationing they can use sanctions to strengthen their positions, blaming hardships on their external enemies.

The experience with Iraq, which was under sanctions from 1990 to 2003, served as a salutary reminder that blame for miserable economic conditions, along with high levels of infant mortality, could be passed from the government, however culpable, to the responsible great powers. Even when it was clear that the sanctions were achieving little and were probably counter-productive it was difficult to ease or remove them without some concessions from the target government. Before those directed against Iraq were lifted after the overthrow of Saddam Hussein in 2003, there was talk of a new approach of ‘smart’ sanctions that would be much more directed towards the guilty parties in the offending parties, as an advance on the ‘dumb’ sanctions that hurt all society in an indiscriminate way. This approach was embraced by the Obama Administration and applied during the original 2014 Ukraine crisis.

As with a lot of the sanctions imposed in recent decades one objective in 2014 was simply to make a point, as much for domestic and allied audiences, of strong objections to Russia’s behaviour and solidarity with its victims. Sanctions, even if lame in their effects, are at least one step up from total indifference though well short of direct military intervention. They provide an opportunity for those orchestrating the effort to show some leadership and make general statements about their grave concerns and determination to see whatever transgressions prompted the action in the first place reversed.

As a source of coercion, however, there is no evidence that smart sanctions are any more effective than their dumber cousins. The named individuals are inconvenienced but not to the point where they are motivated to attempt to put serious political pressure on the targeted regime, even on the unlikely assumption that the regime might respond to such pressure. This is not to say that sanctions invariably fail. They were one factor wearing down the Apartheid regime in South Africa. In Libya, they changed the Gaddafi regime’s attitude to support for terrorism and nuclear proliferation in 2003. They helped create the conditions for a nuclear deal with Iran in 2015. Though this was then abandoned by Trump, Teheran’s desire to be free from constraints is one reason why a new deal might be put together under Biden. But they succeed because they can aggravate other problems that the target is facing or else, coercively, by persuading the target that they can be avoided or eased by meeting sspecific demands.

Though the West warned of sanctions to come if Ukraine was invaded, this prospect had little impact on Russian decision-making. As the ‘special military operation’ was expected to be over quickly Moscow doubted that anything imposed would be more than symbolic, perhaps extra restrictions on named individuals but nothing that would do long-term harm to the Russian economy. Then, to Moscow’s irritation, as it became apparent that Ukraine would not be rolled over quickly and that the Russian invasion was being accompanied by great brutality, Western sanctions were stepped up correspondingly, moving beyond freezing the assets of oligarchs to cutting off Russia from much, though not at all, of the international economy. Eventually because the steep rise in oil and gas prices suggested that -  if anything - the war might end up boosting Russian finances there were moves to cut back on Europe’s dependence on Russia as a key energy supplier (on which more below).

The Russian economy has not ground to a stuttering halt. Moscow can prevent any adverse Security Council resolutions that would make sanctions mandatory for all member states using its veto, and the West is no longer quite so dominant in international trade and finance. China and India have not been prepared to endorse the sanctions, although neither has done much to break them either. Putin has taken care to spare people in the key cities of Moscow and St Petersburg the worst effects of shortages. The oligarchs play only a marginal role in Russian policy-making, and they have not banged down the Kremlin doors to demand an end to the war. Energy exports finance the war, and the rouble remains strong, albeit because the flow of exports has not been matched by a corresponding flow of imports.

Over the longer-term the consequences for the Russian economy, already in the second tier in the global hierarchy, may be awful because of the exodus of many international companies, a lack of new inward investment and limited access to Western technology, as well as a loss of markets for its oil and gas. In the short-term, there is one area where the sanctions are making a difference to the war effort, and that is in defence production. All manufacturing in Russia has been badly affected by the lack of vital components and this means that it is becoming harder to produce new equipment and fix damaged systems. This is giving the Russian commanders quite a headache as their forces use up equipment much faster than they can be replenished, including in areas, such as artillery, where it must have assumed ample supplies.

Russian Economic Warfare

If anything economic measures have come to play a larger role in Russian strategy.

Following the break-up of the Soviet Union, Russia sought to use the trade and energy dependence of its newly independent neighbours to influence their domestic and foreign policies. This became a routine form of political pressure and was extended to other countries that were following adverse policies.

In all of this the energy sector was of special importance. Putin’s success as President was founded on a recovery in oil and gas prices (just as Gorbachev’s failure had been aggravated by their fall). It was energy exports that made possible a much improved standard of living for the Russian people and investment in military capabilities. Abundant reserves of hydrocarbons encouraged the idea that this was Russia’s distinguishing feature as a modern great power. The idea that Russia was an ‘energy superpower’ pre-dates Putin’s presidency but for many of those around him it soon appeared as an obvious ‘big idea’. Energy was therefore identified as a source of both prosperity and influence. The two could work together so long as Russia could use its position in the market to build up dependencies so that its customers came to rely on it for supplies and avoided actions that might lead to its disruption by upsetting Moscow. This approach was most evident with Germany, despite warnings from Germany’s allies that it was creating a foreign policy vulnerability that Russia could exploit.

This strategy worked best when the prices were high and the pressure was subtle. But there was always a tension between the commercial and political aspects of energy policy. This has been aggravated by Putin’s instinctive response to any challenge from another state, which is to look at once for the pressure points. With his neighbours this often meant putting up tariffs on their exports of goods into Russia, withholding supplies of some commodity, shutting off their gas supplies or putting up prices to exorbitant rates. One reason for the current mess is that this was the approach adopted in 2013 when the Ukrainian president, Viktor Yanukovych, as pro-Russian as they come, faced a full economic squeeze on his government to stop him signing an association agreement with the EU (not even NATO) and instead join Putin’s own project for a Eurasian Union. The economic pressure worked – so well and so conspicuously that when Yanukovych complied this prompted massive demonstrations in Kyiv leading to Yanukovych’s flight and the arrival of a new government in Kyiv deemed from the start by Putin to be hostile to Russia and so to be undermined at every turn.

Now Russia’s energy weapon is facing its greatest test. In one respect it is its best defence against Western sanctions, enabling it to finance its war and sustain standards of living. In another it is its best means of offence - Putin’s best hope of coercing Ukraine’s Western supporters so that they abandon Kyiv and come grovelling for a peace that will see gas supplies resumed at their pre-war rate.  This coercion began before the war with a cutback in supplies intended to remind Europeans where their true interests lay. Once the war began the issue of Europe’s energy dependency was inevitably thrown into sharp relief. In Berlin, most shocked by the turn of events, it was appreciated at once that Germany, with its European partners, had to get out of this dependence, but at first that was seen as at best a medium-term project because of the likely economic disruption.

The calculations soon changed. First there was pressure to deny Russia the defensive benefits of energy supplies, by limiting the amounts it could gain by cashing in on the high prices its own policies it had helped to create. Figures on Russian earnings from selling gas to Europe were embarrassing, especially when compared with the amounts being spent on providing economic and military assistance to Ukraine (by far the main economic loser). Second, there was a need to blunt Russia’s energy offensive. This was done by filling up available shortage capacity during the summer months, and diversifying to other sources such as Liquified Natural Gas (LNG), although the price of that has inevitably gone shooting up, and encouraging greater energy efficiency. Berlin has even taken the first tentative steps to delay decommissioning all its nuclear power stations.

Until late August this approach seemed to be working. Oil prices had come down, in part it has to be said because of the prospect of a global recession. Despite gas flows at only 20 percent of their pre-war levels those prices were also starting to fall. At the start of this month the G7 Finance Ministers agreed a complex scheme – a form of buyer’s cartel - to try to cap the price of Russian oil, demonstrating that they might be able to move back on to the offensive in the economic war.

The response soon came. On 2 September the Russian energy company Gazprom announced problems with the NordStream 1 pipeline which required that it shut down completely. Initially this was for a few days; now it is indefinite. Initially supplies would resume as soon as the fault as rectified; now resumption depends on an end to sanctions. All this has been accompanied by dire warnings from Russian propagandists about how Europe will freeze this winter and face economic collapse – all because of Ukraine.

This is in some ways Putin’s last throw of the dice. If this move does not work he has few options left. It is a gamble in two respects. First it marks the end of Russia’s dominant role in the European energy market. It has demonstrated that it is an unreliable supplier. Supplies not being sent to Europe cannot be easily diverted elsewhere. It takes time to build new pipelines to new markets, for example in Asia. Second, this dramatic loss of market share is only worth the effort if it has the desired political effects and leads to Europe abandoning Ukraine. But the totality of Russian actions over the past six months, from the bombardment of cities to the grisly crimes in occupied areas, to the recklessness at the Zaporizhzhya nuclear power plant, to the fake news and impossible diplomatic demands, means that European governments, even those who most anxious for this crisis to be over, do not see a way to do so until Putin backs down. Until he does so there is no route to European stability. Putin keeps on insisting that NATO is at war with Russia. Militarily this has never been the case but economically he has made it so.

So with great difficulty, and much pain, Europe will cope. We have already seen a massive package from Berlin to help energy consumers over the coming winter months and one is expected soon from London.  Of course attitudes could shift if it really did seem as if the war was stuck in a stalemate and could drag on endlessly. Then diplomatic efforts to find a way out would intensify. But for now, instead of abandoning Kyiv, Western countries, and especially the US, appear to have come to the view that the best course is to help Ukraine win, or at least convince Moscow that its military position is untenable.

The Ukrainian offensive has been making steady if not spectacular progress. Russia’s position continues to deteriorate as Ukraine methodically takes out ammunition dumps, command posts, air defence systems, and vital bridges. This threatens Russians forces with dwindling supplies and even entrapment. Russian propagandists are starting to go quiet after claiming on a daily basis that this offensive was a catastrophic failure.

If Moscow was truly confident that it could hold on to its gains and possibly extend them, it would have kept the gas pipelines open, taking the revenues and giving itself a reasonable chance of holding on to lucrative markets over the long-term. It is a sign of a loss of confidence, even desperation, that as Russia is failing as a military superpower it is jeopardising its position as an energy superpower.