BY DOUGLAS OLLIVANT
Russian President Vladimir Putin has been acting with supreme confidence and relative impunity in Ukraine, but one looming vulnerability is bound to be making him nervous: the price of oil. It’s the key to regime stability, and in both the near term and the run-up to the 2018 elections, it’s going to dictate Putin’s political fortunes.
In the past six months, the price of oil has dropped more than 50 percent from slightly above $100 per barrel to the mid-$40 range, with a small recent rebound. Analysts are split on whether this decline is temporary, but no one is predicting a rapid return to the sustained high prices that had buoyed Russia’s economy since the end of the Yeltsin period. While EU antitrust actions against Gazprom and other sanctions on the Russian energy sector exacerbate Russia’s current position, the key fundamental is the global price of oil per barrel and the centrality of oil to the Russian economy. Everyone understands that Putin can’t snap his fingers and diversify the economy; it’s all about distribution of shrinking rents. It is lost on no one that the collapse of oil undermined Mikhail Gorbachev’s government in 1986.It is lost on no one that the collapse of oil undermined Mikhail Gorbachev’s government in 1986.
In the West, there has been a standard assumption that Putin knows he alone can’t bump the price of Brent crude. But he has surprised us before. After all, who foresaw that he’d invade Ukraine or Georgia?
Pressure caused by cratering oil prices may make Putin act in ways that the West may not expect. Around half of the Russian government’s revenue comes from the oil and natural gas economy. The Russian 2015-2017 draft budget is based on a $100-per-barrel price for a $400 billion-per-year budget. But oil has been trading between $45 and $65 for the last several months, and some believe it could dip into the mid-$20 range. Meanwhile, the ruble lost half its value against the dollar in 2014, and inflation in Russia has ballooned to 17 percent. The economy is projected to precipitously shrink by 3 to 8 percent in 2015.
In response, Russia began slashing social spending in the late fall of 2014 — just at a time when these services are becoming more essential than ever to lessen the impact of a contracting economy. Putin now also has less freedom of action vis-à-vis his oligarchs; he can’t let the price of oil completely destroy their fortunes. If he does, he risks infighting and loss of control.
Although Russia has very low external debt — just 15 percent of its GDP — and has, even after the interventions of the last year, some of the world’s largest foreign currency reserves, it will not be able to continue under these conditions for long. In February of this year, the Russian parliament laid out a 60-point plan to deal with budget crisis. It is an indication of the urgency with which Moscow sees the problem. However, nothing short of severe austerity measures could compensate for the oil-price decline, and Putin is not in a political or economic position to take such measures.
So what options might Putin’s advisors, told to do something about market oil prices, bring back to him? Or, worse, what might they come up with and go off and implement on their own? Here are four possible scenarios.
Sabotage the P5+1 talks
Since 2006, Russia has been a central member of the P5+1 countries’ negotiations with Iran to curtail its nuclear program. However, Russia has consistently played both sides; while Putin doesn’t want a nuclear-armed Iran, he has been more than happy to use the West’s intense interest in a settlement with Tehran for his own purposes.
Russia has supplied to Iran nuclear technology and a wide range of advanced weaponry. And Moscow recently announced that it is lifting its ban on selling Tehran the S-300 missile system, an advanced air-defense package that will blunt the West’s threat of military action. In 2014, during the Crimea crisis, Russian even directly threatened to derail the multilateral talks with Iran.
The idea that Russia could sabotage the P5+1 talks at the eleventh hour is not difficult to contemplate.
But would spiking the talks spike the price of oil? It is unclear whether the prospective success of the current negotiations is “built-in” to the current low oil prices. While ramping up production will take a few months and getting back to full export capacity would take a few years, Iran has approximately 30 million barrels of oil currently in floating storage. From this, many analysts agree that Iran could bring 400,000 barrels a day of new oil to global markets within weeks of a final agreement. Over nine months to a year, Iran could bring online an additional 1 million barrels a day. At a minimum, these new flows would delay any hypothetical recovery of oil prices for a year or more — a critical time period for Russia, which is focused on returning to economic growth in 2016.
There may even be some adventurous souls in the Kremlin who now secretly wish that the talks fail, leading to a military strike — whether by the United States or Israel or both — on Iranian nuclear infrastructure. Whereas Russia has previously been a vehement opponent of military action against Iran, that could change (if not in rhetoric, then at least in reality). Not only would the bombing of Iran’s nuclear facilities scuttle any possibility of a long-term agreement, but it would pitch the Middle East into chaos.Not only would the bombing of Iran’s nuclear facilities scuttle any possibility of a long-term agreement, but it would pitch the Middle East into chaos. And Tehran has made clear that if it comes under any military attack, it will close the Strait of Hormuz.
It’s not a high-probability event, but it would — perversely — throw a significant lifeline to the Russian regime through a rapid, sustained increase in the price of oil.
Destabilize several smaller oil producers or export routes
This type of destabilization is both difficult to do and would have to be done at some scale. World oil markets barely blipped when Libya’s oil production went from 1.5 million barrels per day before its civil war to just 500,000 barrels per day currently. Hence, experts believe that somewhere in the neighborhood of 2 million to 3 million barrels per day would have to come off the market to significantly impact prices.
However, this avenue is made easier by the level of instability in many small oil-producing states. The shortlist includes Venezuela, Iraq, Nigeria, Algeria, Azerbaijan, Kazakhstan, and arguably Mexico. Were Russia to provide deniable support to various insurgent movements in these countries, it could have the desired effect.
Alternatively, Russia could exert pressure on transit states, limiting or suspending oil exports. The 100,000 barrel-per-day Baku-Supsa pipeline and the 1 million barrel-per-day Baku-Ceyhan pipeline across Georgia are both potential targets. Of course, Russia has extensive experience intervening directly and indirectly in Georgia. It’s not hard to imagine that Moscow could pressure Tbilisi to close pipelines for “repairs” or directly interrupt the flow of oil through sabotage.
Destabilize a major oil producer
Saudi Arabia is the locus of OPEC decision-making. Russia has been a free rider on the OPEC cartel since the 1970s, enjoying a high price of oil made possible by production limitations that are not binding on Russia. Now, however, OPEC has made the decision that production cuts can no longer sustain prices, hence OPEC is no longer inadvertently supporting Russian interests. What could Putin do to cause a drop in Saudi production? The Saudis have a series of vulnerabilities: in the south from Yemen, indigenously from its Shiite minority, and from general discontent among its own youth.
Were Russia to decide that reducing Saudi production was a necessary “defensive” measure, some of these groups could be covertly equipped to challenge Saudi security and stability. Recently, the Yemeni foreign minister alleged that civilian Russian cargo planes were already supplying the Shiite Houthi rebels with arms. Let’s not forget that Moscow is good at this game: It has extensive experience arming insurgents in Ukraine, Nagorno-Karabakh, South Ossetia, and Abkhazia.
And the Kremlin is not above getting in bed with erstwhile enemies, either. The Islamic State targets the overthrow of the Saudi monarchy; should the survival of the Russian regime start to be threatened, even extreme options like Russian covert support for jihadis could be on the table.
False-flag operation
Some 17 million barrels of oil transit the Strait of Hormuz daily, making it the biggest choke point in the world’s oil supply. The strait is narrow — it has only two shipping lanes, and at a little less than two miles wide, it would be relatively easy to disrupt. Any threat of conflict would greatly reduce the flow that passes through it. Closure of the strait would instantly remove 20 percent of the world’s oil from the market, causing an immediate supply shock similar to that of 1973.
This would be among the most delicate of possible operations to execute. But as Putin has repeatedly demonstrated, he is willing to take great risks to reshape global affairs.
It could be done, however, with a small team of former Russian intelligence agents in small boats, similar to those Iran used to lay mines in the strait during the Iran-Iraq War in the late 1980s. Alternatively, Putin could use a Russian Kilo-class diesel-electric submarine (identical to the three such submarines in the Iranian Navy) to place mines (identical to those that currently constitute half of Iran’s stockpile) in the shipping lanes. The moment a mine were detected, let alone struck a tanker, global oil prices would certainly spike, with blame placed on Tehran. And the P5+1 talks would be scuttled as a bonus.
Such a false-flag operation would be difficult to initially identify, given past Iranian threats. Many times throughout the many years of the P5+1 negotiations, Iran has announced it has plans to close the Strait of Hormuz if its “interests are threatened.” Further, the West would be on hair-trigger alert and could easily react hastily to any suggestion of actions by Iran in the strait, potentially drawing Saudi Arabia and the United States into an inadvertent military confrontation with Iran.
Any and all of these options mooted above may be low-probability events. But Western leaders must re-examine some core assumptions about Russian behavior and start thinking proactively about what Putin might do next. Further declines in his inability to distribute oil rents present an existential challenge to his regime. It would be naive to believe that he — and his advisors — are not casting about for options to address this challenge.
By enlarging our strategic imagination, we will be less likely to be surprised by the unexpected and will be better prepared to deter potential actions before they occur or respond to them if they do.
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