Petrostate: Putin, Power, and the New Russia

To Hitler, Russia stood for wheat and petroleum, but Hitler’s information was at least partially dated. Once under Soviet control Russia’s grain surpluses diminished rapidly. Whereas pre-revolutionary Russia had exported 9 million tons of wheat in 1913, the most the Soviets could muster prior to the Second World War was 5 million tons in 1931, and to do that they had to starve their own people.¹

But if the breadbasket of Europe was not as full as it once was, the oil wells were pumping and as attractive as ever. One of Hitler’s highest priorities was to capture the Baku fields. Although German troops did not quite reach Baku, they did attack the Grozny fields in Chechnia in the north Caucasus. Even there, however, by the time the Soviet troops were forced to retreat, the oil fields were so badly damaged that Hitler was unable to derive much benefit from them. But in the process, Hitler did manage to deny their use to the Soviets. Moreover, the Germans disrupted supply routes from Baku to the north so that the Soviets had a hard time maintaining their fuel supply. The USSR was helped to some extent by Lend-Lease oil shipments of 2.7 million tons of petroleum from the United States. Nevertheless, by the time the war ended, many Soviet oil fields had been badly damaged, so that in 1946 Soviet oil production had fallen to 22 million tons, down 30 percent from the 1940 peak of 31 million tons.²

THE VOLGA-URAL REGION

To expedite the postwar reconstruction of both the fields and the refineries, the Soviet government swallowed its pride and once again sought foreign help. They also confiscated $1 million worth of oil field equipment from Romania as a form of war reparation.³ Most of the Soviet effort was directed at reconstituting and expanding the traditional Baku area, but gradually they moved north toward the meagerly developed Volga-Ural region. Although exploration in the newer area predates the revolution, no oil was found there until 1929.⁴ Even then not much happened, and when the Second World War started annual output was not quite 2 million tons a year. Some major finds were made in the Volga-Ural’s Devonian geological level deposits during the war in 1944, but serious drilling work began only in 1955.⁵ Despite considerable drilling effort, because of the wartime damage, output in Azerbaijan in the Soviet era, especially Baku, never fully recovered. Even in 1966, the postwar peak, Soviet oil producers were unable to equal the 22.2 million tons pumped in Azerbaijan in 1940. (After the collapse of the USSR, Western companies were brought in by the government of Azerbaijan and production soon surpassed earlier output.) Fortunately as more and more new fields were discovered in the VolgaUral region, output there rose rapidly and that area soon outproduced Azerbaijan. As a result, by 1949, total output in the USSR surpassed the previous level of production (see Table 2.1).

Overall output in the Volga-Ural region continued to increase until about 1970. This included the field at Romashkino in the Tatar ASSR (Autonomous Soviet Socialist Republic). For some time this field was thought to hold the largest crude oil deposits in the world. But after 1965 the rate of increase in output per well in this region began to fall sharply.⁶ The response was to seek some way to enhance “secondary recovery.” As in many other parts of the world, the initial solution was to inject water into the wells to restore the pressure needed to facilitate the extraction of petroleum. But water injection was only partially successful. Occasionally it made matters worse. For a time the extra water worked and increased the petroleum yield from the well, but the Russians typically injected too much water; as a result, it often became more difficult than necessary to extract the petroleum the water was intended to flush out. Special pumps were required, and before long the workers often found themselves pumping out more water than oil.

While Soviet petroleum engineering was often very effective, there were other more advanced procedures that could have been used; but because Soviet authorities restricted contact between their technicians and foreign specialists, many production methods used in the West were not familiar or were unavailable to Soviet petroleum technicians. Moreover, even when such knowledge was available, the Ministry of the Petroleum Industry lacked the authorization to import the necessary equipment. The purchase of foreign equipment had to be approved by Gosplan, the Central Planning Agency, and foreign currency for the purchase had to be set aside by the Ministry of Foreign Trade and the Ministry of Finance. Even then, because Soviet authorities did their best to prevent onsite visits by foreign specialists, the manufacturers of that equipment could not always demonstrate how to use it properly. Thus much of what the USSR imported at the time served no useful purpose. Moreover, during the Cold War, U.S. authorities did all they could to embargo the export of advanced equipment and technology that the Soviets needed for enhanced recovery.

WEST SIBERIA

When output per well in the Volga-Ural region also began to fall, the slack was taken up by the opening of new areas in West Siberia. In contrast to the long period from 1929, when the first oil was struck, until the late 1940s, when production in the Volga-Ural region finally began to reach a meaningful level, the lag between discovery and production in West Siberia was much shorter. Although exploration for liquid energy in the region began before the Second World War, the first find occurred by accident in West Siberia in September 1953.⁷ A drilling team was delayed while sailing up the Ob River near the town of Berezov. On the spur of the moment they drilled a test well and found gas in what became the Berezovskoe gas field. It was seven more years, in 1960, however, before the first oil was discovered in a Jurassic zone near Shaim on the River Konda, a tributary of the Ob and Irtysh. The “super-giant” field in a Cretacean level at Samotlor, about 500 miles to the east, was discovered in 1965, and the first commercial-scale well was completed in April 1968.⁸ Whereas it took almost twenty years for the Volga-Ural fields to move from discovery to delivery to consumer, it took only eight years in the West Siberian Tiumen region. By 1970 production had reached 31 million tons; by 1975 it was 145 million tons; and in 1977, about 210 million tons.⁹

Notice the pattern here. The output in West Siberia seemed to compensate for the drop in productivity in the Volga-Ural fields in the late 1960s and early 1970s, just as the output in the Volga-Ural regions, coming on line in the late 1940s and early 1950s, offset the declining output of Baku. So far, each time output in one major region slackened, the Soviets found a new region. It would be nice if Russian oil operators could continue in this leapfrog manner. The American geologist John Grace doubts that will happen, since most of the giant fields in Russia, at least those that are easily reachable in terms of production and transportation costs, have already been discovered. But this type of solution to their production problem also had a negative side. It postponed the time when the Soviets would have to face the need to use their resources more efficiently. This is important because outside analysts began to warn as early as 1977 that the Soviets would shortly run out of new fields to develop. In an April 1977 open report that made big headlines in the United States, the CIA predicted that without a substitute for water injection technology, Russia’s annual output would drop sharply in the Volga-Ural region. As the CIA saw it, by 1985 Russian oil output would fall off so sharply that the USSR would no longer have enough petroleum to export. In fact, it predicted that by the mid-1980s, the USSR and its East European allies would be forced to import 3.5 to 4.5 million barrels a day (175–225 million tons). As we shall see, the CIA’s predictions were wrong; none of that happened.

THE SOVIET PLANNING, PRODUCTION, AND INNOVATION SYSTEM

The Soviet planning and incentive system and the special peculiarities that affected the Soviet raw materials and petroleum industries all but guaranteed that the Soviets would have difficulty solving their efficiency and productivity problems. In fairness, it should be pointed out that an inability to manage innovation effectively was not an affliction brought on solely by the Russian Revolution. The revolution seems to have compounded the problem, but even before 1917, we saw when discussing drilling technology in Baku in the nineteenth and early twentieth centuries, Russia’s existing methods lagged behind developments in the West. Invariably it was necessary either to import more advanced technology or bring in foreigners to run actual concessions.¹⁰ Such lags were not necessarily characteristic of all pre-revolutionary and pre–Five Year Plan technology, but they were widespread enough to cause suspicion that something deeper than a poor incentive system was at fault. There are a number of explanations: Russia was too remote to be affected by the West European Renaissance, Napoleon never stayed in Russia long enough to bring with him the reforms of the French Revolution and their emphasis on scientific enlightenment and rationality, widespread literacy was lacking until midway into the twentieth century, and the oppressive legacy of authoritarian and rigid governments before and after the revolution discouraged initiative. A mixture of all these factors probably contributed to the problem. Whatever the exact explanation, there is no doubt that Russian culture and history combined with the Soviet system of central planning and a lack of economic incentives stifled creative thinking, at least in the economic and technology spheres.

The Soviet development of the turbo-drill illustrates how shortcomings in the Soviet process of producing, planning, and innovation affected the development of the Soviet petroleum industry. In a perceptive analysis, Robert Campbell of Indiana University explains why the innovation-shy Soviet petroleum engineers were nonetheless prodded into developing this unique process which could utilize lower quality steel pipe.¹¹ To drill effectively using rotary drilling, the driller must have good-quality pipe that can withstand increasing tension and pressure as the drilling goes deeper. With poor-quality steel pipe, breakdowns, cracked pipe, and tool-joint failures are endemic.¹² This means not only an increased need for replacement pipe but lost time spent on repairs and lifting and lowering the portions of the pipe string that remained intact. With the type of pipe available to the Soviets at the time, they could drill down only 2,000 meters.¹³ In 1950 that was the depth of almost 90 percent of Soviet wells. Though inefficient, it was adequate for the drillers in the Baku region. The Soviets were able to satisfy their needs, albeit with a good deal of waste.

While shallow wells may have been suitable for Baku, they were of no use in the producing fields in the Volga-Urals region where oil and gas deposits were much deeper. Furthermore, the use of the traditional rotary drill process with low-tensile-strength pipe meant that the drillers could reach the 2,000 meter depth only when the ground was soft and the rock not too hard. But as Campbell pointed out, Soviet drill pipe at best was made from what in the United States is considered unsatisfactory grade D and some higher grade E steel.¹⁴ In the United States, drillers restricted themselves to the use of grade E steel and pipe or even higher grades.

Why did the Soviet Union, as the world’s largest producer of steel, not produce higher quality steel? As long as the Soviet system placed stress on quantity rather than quality of production, the Soviet manager had little or no incentive to produce the higher grade steel. His pay depended not on producing high quality but on producing as much quantity as possible, usually measured by the weight of the steel.¹⁵ Generally, the Soviet manager was not concerned about whether his product was sought after in the marketplace. It was usually enough that his product was produced and transferred from the factory floor. Once that happened and a factory achieved its physical output plan targets, the workforce would then share in the enterprise bonuses.

To ensure that such bonuses would be forthcoming, the factory manager devoted virtually his whole effort to searching for ways to increase production. Over time, Soviet managers developed a fine-honed sense of just how this should be done. Those who did not succeed were discarded along the way. Soviet economists soon discovered, however, that a single-minded devotion to quantity led managers not only to ignore quality and variety but to dispense with them. Every time, for example, a machine was shut down to change size or to improve the process, less time was available for production. Occasionally a change in process might lead to faster or improved production, but there was always the possibility that the innovation would not succeed and production would not increase. By contrast, there was always the certainty that in switching production models, production would be curtailed at least temporarily. Because few managers were willing to take such risks, quality improvement inevitably suffered. In the Soviet system, innovation was disruptive and therefore to be avoided.¹⁶

For the oil drillers, this meant that the steel manufacturers they depended on had no incentive to produce or even contemplate producing the higher grade qualities of steel.¹⁷ In his colorful way, Nikita Khrushchev put it vividly when he complained: “The production of steel is like a well-traveled road with deep ruts; here even blind horses will not turn off, because the wheels will break. Similarly, some officials have put on steel blinkers; they do everything as they were taught in their day. A material appears which is superior to steel that is cheaper, but they keep on shouting ‘steel, steel, steel!’ “¹⁸ While this attack was delivered in the context of criticism of the planners’ inability to switch to new, more sophisticated and innovative industries like electronics, computers, and chemicals, Khrushchev’s complaint was equally valid when addressed to the need for qualitative improvements within the steel industry itself.

The planning system was equally ill-suited for locating new deposits. Since planning targets were usually spelled out in terms of some physical measure, for those in agencies like the Ministry of Geology whose work involved drilling, the most reasonable index seemed to be the number of meters drilled. Supposedly the more meters drilled, the better the performance. But Soviet geologists soon discovered that the deeper they drilled the longer it took them and the less drilling they did.¹⁹ As a result, the geologists quickly developed the practice of drilling shallow holes. As an article in Pravda pointed out, “Deep drilling means reducing the speed of the work and reducing the group’s bonuses.”²⁰ A description of the area sounded more like a smallpox rather than a mining report. “In some places, the land is becoming increasingly pitted with shallow, exploratory holes drilled in incessant pursuit of a larger number of total meters drilled.” It was not surprising, therefore, that “there are geological expeditions in the Republic of Kazakhstan that have not discovered a valuable deposit for many years, but are counted among the successful expeditions, because they fulfill their assignment in terms of meters. The groups that conscientiously ‘turn up’ deposits are often financial losers.”

Moreover, even if the drillers from the Ministry of Geology found a field, they bore no responsibility for determining its size. Consequently, the actual producing ministries also had to maintain their own drilling units. In some instances there were two and on occasion as many as three separate drilling agencies duplicating one another’s work.²¹ Undoubtedly it would have been much more efficient to base the drilling team’s compensation on the amount of raw materials actually recovered, but this was resisted by the planning agencies and the Ministry of Geology, which feared such a shift would disrupt its planning procedures. As often happened, they had confused the means— that is, how many meters are drilled—with the end, how much oil was found. Another way the Soviet planning system created institutional blockages to a more efficient utilization of mineral deposits was that responsibility for production and drilling was usually divided up among several large ministries or state committees such as the Ministry of the Chemical Industry, the Ministry of the Gas Industry, and the Ministry of the Petroleum Industry.

Unfortunately, nature did not always break itself up into the same neat and precisely defined categories. This also helps to explain why so much natural gas was burned off, that is, flared. Virtually none of the flaring was done by enterprises within the Ministry of the Gas Industry. Most of it was done by drilling units working within the Ministry of the Petroleum Industry. They produced the gas as a by-product in extracting petroleum, which, after all, was their main concern.²² Therefore, the plan fulfillment efforts of the Ministry of the Petroleum Industry set out in tons of petroleum produced were little affected by what happened to the by-product, natural gas (a by-product of petroleum extraction). Since Petroleum Ministry officials received no credit for producing gas, they did not concern themselves with building gas pipelines to move the gas to market. Why should they bother? To rid themselves of the nuisance, more often than not they simply flared it.

THE CIA’S PREDICTION OF A SHARP DROP IN PETROLEUM PRODUCTION

Given so many counterproductive and illogical practices, it is easy to see how CIA analysts could conclude that despite the Soviet Union’s large land mass, Soviet petroleum output would drop sharply. Since the oil field operators would most likely continue to flood more and more of their best oil wells, it seemed inevitable that before long the USSR was bound to become a net petroleum importer. Moreover, were production to continue to fall as the CIA predicted, the USSR was sure to find itself with problems that extended far beyond the Ministry of Petroleum. Petroleum was virtually their only hard currency export, and if they could not export it they would not be able to earn the hard currency they needed to pay for imports. Were that to happen, they would be unable to fund the $6.5–8 billion a year they periodically spent on meat and grain imports.²³ As it was, even with the petroleum exports they frequently ended up with a trade deficit.²⁴ In 1975 and again in 1981, for example, the Soviet trade deficit exceeded $4 billion. It would have become even higher if the Soviets had been unable to respond by increasing their petroleum exports.²⁵

RUSSIAN PETROLEUM AS DIPLOMATIC WEAPON

The CIA rightly concerned itself with the Soviet Union’s ability to export petroleum. The earlier surge in Soviet petroleum output and the corresponding increase in exports in the 1960s and 1970s provided Soviet leaders with a particularly effective economic and foreign policy weapon. It opened doors in the third world for Soviet ideology and diplomatic initiatives that otherwise might have remained closed or just half open. Countries in the struggling regions of Asia, Africa, and Latin America in that era generally welcomed the radical rhetoric propagated by the USSR but often hesitated to turn their backs completely on their former colonial masters for fear of economic reprisals and export embargoes. In particular, radical leaders in the third world feared that if they became too tied to the Soviet Union or went so far as to nationalize the Western oil companies’ distribution network as did Cuba and Ceylon (renamed Sri Lanka in 1972), the United States would arrange with the so-called Seven Sisters capitalist oil companies to embargo the delivery of the petroleum essential to running their economies.²⁶

First organized in 1928, the original Seven Sisters consisted of Royal Dutch Shell, Standard Oil of New Jersey (today’s Exxon), and the Anglo Persian Oil Company (today’s BP). After the breakup of Standard Oil, the original three members were expanded to include Standard Oil of California (today’s Chevron), Standard Oil of New York (Socony Vaccum and later Mobil Oil, now part of Exxon), the Texas Company (what became Texaco and then Chevron), and what was once Gulf Oil (now also Chevron). In contrast to today’s world where we worry about energy shortages, the reason the Seven Sisters joined together was to deal with an overabundance of petroleum on the market and the price cutting that resulted. Their purpose was to form a cartel and limit production and price cutting, and in the 1950s one of their main concerns was how to deal with the Soviet practice of price cutting. They also used their control of petroleum exports to punish third world countries that nationalized properties owned by Western investors or otherwise impinged on Western prerogatives.²⁷

Man does not live by bread or oil alone, but the leaders in the third world quickly discovered that it helps to have a little of both. Once the USSR began offering to underwrite the growing ranks of rebellious colonies with Soviet petroleum, this reduced the retaliatory powers of the mother countries and the Western oil cartels, which often as not did their bidding. Even when there was no formal embargo on petroleum sales, such offers from Soviet officials were very much appreciated because most of these former colonies lacked sufficient hard (convertible) currency for their needed purchases in the traditional energy markets. The Soviets in almost all cases were happy to sell oil at a lower price (sometimes less than a dollar a barrel) or lend or barter their oil without insisting on hard currency payments as a way to gain influence. This was an important form of economic support for the East European Communist and other Council of Mutual Economic Assistance countries (CMEA but more commonly referred to as COMECON) as well as Cuba and most of the former African and Asian colonies including India, Ceylon, Pakistan, Guinea, and Ghana.²⁸

Since the Soviet Ministry of Petroleum was an instrument of the state, there was little resistance within the Soviet Union to using the country’s petroleum this way. The first priority was to provide for domestic needs. The next was to use petroleum exports to generate the money needed to pay for the Soviet Union’s and Eastern Europe’s hard currency imports from the capitalist world. Anything extra available for export could then be used to promote the state’s political goals. Unlike a private petroleum company, the Ministry of Petroleum did not feel constrained by normal corporate profit and loss considerations. To say the least, profit maximization was not an overriding objective. In fact, it usually played no role at all. Moreover, just as in the Czarist era, the richer countries in the outside world, and especially the Seven Sisters, were not particularly welcoming to exports of Soviet petroleum. Both Western governments and businesses remained unforgiving about the nationalization of the Baku oil fields. For example, until 1971 the British went so far as to prohibit oil dealers, including a network of as many as 400 Soviet-owned service stations located in the United Kingdom, from importing Soviet crude oil.²⁹ The Soviet response was to arrange for their English subsidiary to import crude oil instead from Finland, which was strange, since Finland is not often thought of as a petroleum powerhouse. In fact, Finland imported more than three-quarters of its petroleum from the USSR. Admittedly this was a pain in the neck and added an extra step for the Soviet Ministry of Foreign Trade officials in charge of their British subsidiary. But it also shows how difficult it was to exclude Soviet petroleum exports from world markets.

Such efforts to keep Soviet petroleum out of world markets was largely a result of the Seven Sisters’ neither needing nor desiring to buy any petroleum from the Soviet Union. These companies regarded the Soviet Union as a spoiler and a disruptive influence—often accusing Soiuznefteexport, the Soviet Foreign Trade Organization responsible for exporting the country’s petroleum, of dumping its products to force down the Sisters’ petroleum prices and profits. Because there was pressure to keep them out of world markets, for some time Soviet petroleum export officials were relegated to dealing with impecunious and marginal consumers or working out under-the-table transactions.

As world energy demand grew, however, attempts to exclude the Soviet Union from the capitalist world’s petroleum markets became harder. Even more important, by the mid-1970s it made increasingly less sense. The first serious Soviet challenge to important Seven Sisters markets occurred in 1960. ENI, an Italian energy company headed by Enrico Mattei, had been attempting to break into the Sisters’ club. In 1957, he signed a contract with Iran to buy petroleum from that country at concessionary prices that were higher than those that had been offered Iran by the Seven Sisters.³⁰ At the same time he offered to sell potential customers that Iranian petroleum at a cut-rate price. Increasing the pressure, Mattei broke ranks again in 1960 by arranging for yet another out-of-order petroleum purchase, this time a cut-rate purchase from Soiuznefeexport. As he did with Iranian petroleum, he sought to sell this petroleum to Seven Sisters customers in Europe by undercutting the prevailing Seven Sisters price. This was considered a direct challenge to the ability of the Seven Sisters to control prices and a serious destabilizing threat. In some quarters, the inability of the Seven Sisters to prevent low-priced Soviet petroleum from breeching their monopoly control was viewed as the end of the Seven Sisters monopoly.

But Soviet petroleum exports served as an equal opportunity spoiler. They not only undermined the Seven Sisters and their price control efforts but they also undercut the efforts of the Organization of Petroleum Exporting Countries (OPEC) member countries that were trying to do the same thing. Created in September 1960, OPEC was set up to prevent private oil companies from cutting the price of the petroleum they purchased from Saudi Arabia, Kuwait, Iraq, Iran, and Venezuela. These original members of OPEC attempted to do this by regulating how much petroleum each of these countries could produce and by doing so reduce worldwide supplies.

But while most of the world’s major petroleum exporters were curbing their production and exports, the Soviets were expanding theirs. By 1975, they had become the world’s largest producer of petroleum, overtaking the United States, which had maintained that distinction continuously since 1902 when it outproduced the largest producer at that time, Czarist Russia.

By refusing to go along with OPEC, the Soviets increased their political leverage as well as their earning power. For that reason, the 1973 OPEC oil embargo imposed on the United States and several European countries provided the Soviet Union with a golden opportunity. The tightening of petroleum markets that resulted from that OPEC embargo more or less brought an end to the USSR’s bad boy image. The Soviet Union may have been a rogue, but OPEC members were no better, and in 1973, at least, were much worse. Thus after 1973, energy consumers around the world came face to face with the realization that reliance on energy supplies from the Middle East involved enormous risks. How much more risky could reliance on the USSR be?

As their industrial output continued to grow, Soviet leaders also sought to export some of their growing output of natural gas. At the same time, after 1973, whatever resistance potential customers may have had to buying petroleum and gas from the Soviet Union all but disappeared. Chastened by the 1973 Arab embargo, customers in Western Europe in particular began to search for ways to reduce their dependence on the now uncertain imports from the Middle East. The Germans were especially eager to gain access to other sources, and the Soviets could ship them natural gas—a cleaner fuel than oil—via an overland pipeline. Most of all, it was reassuring that petroleum and gas from the USSR would be unaffected by OPEC embargoes or sea blockades. To top it off, because of their outsider status, the Soviets were usually willing to undercut market prices.

In time, major net importers of energy such as the United States, Western Europe, China, and India came to realize that it was in their interest to encourage as much energy production in the world from as many different producers as possible. This obviously included Russia— the more supplies there were the better. This was particularly important for consumers of petroleum. If one supplier decided to withhold deliveries of its petroleum, importers could readily substitute with petroleum from another supplier. That reduced—but did not eliminate—the chance of a political embargo by an OPEC-type organization against a single consumer or group of consumers. But those who initiated such an embargo had to win support from like-minded exporters and even then there were bound to be some exporters such as Russia that would refuse to join in. There is always the danger that those exporters would use the opportunity to poach on others’ customers and sign up new sales.

But while buying petroleum and natural gas from Russia has its advantages, there can also be serious risks, especially for consumers of Russia’s natural gas. Because pipelines needed to supply natural gas are very expensive to construct, no one can afford to build a second standby pipeline from some other supplier as a reserve for emergencies. Thus even though the European pipeline network links up three major sources of supply—Russia, the North Sea, and Algeria—consumers of natural gas tend to become dependent on a single dominant supply source. This makes them vulnerable to the whims of that supplier. While LNG (liquefied natural gas), which can be delivered by seagoing tankers, could serve as a backup, it too requires billions of dollars in investment, not only for the special tankers that transport it but also for the expensive processing plants at the export site that freeze it and the plants at the import destination that return it to gaseous form. As a result, no one is willing or able to sell or buy LNG without an expensive infrastructure already in place, which explains why it is so hard to create a spot market for LNG, a market where buyers and sellers can agree to a sale at the last minute on the spot. As a result, unlike petroleum imports, which can be sent by tanker from any number of petroleum producers, if something happens to that natural gas pipeline, there are rarely any alternative natural gas supplies available to pipe in as a substitute.

President Ronald Reagan understood the political implications of all this and decided to do what he could to prevent the USSR from building a gas pipeline to Western Europe. He worried that if the Europeans became increasingly dependent on such supplies, as strong economically as Western Europe might be, they would soon find themselves vulnerable to Soviet political pressure. Reagan worried that as West European households and industries began to rely on Soviet natural gas, they would likely begin to think twice about countering Soviet political demands.

In an effort to deny the USSR such a weapon, Reagan launched an intense effort to prevent the pipeline’s construction. In 1984, he asked his friend, British Prime Minister Margaret Thatcher, to prevent the English firm, John Brown Engineering, from selling the Soviets the compressors they needed to move the gas through the pipeline from the super giant Urengoi natural gas field in West Siberia to Germany. Similar pressure was put on General Electric, another manufacturer of turbines and compressors. These efforts failed, however, and the pipeline was eventually completed.

Once the pipeline was completed in 1985, consumers in Western Europe became quite comfortable importing Russian natural gas and using it in their homes and factories. While cold weather caused occasional delivery problems, the Cold War never did. As a good salesman, Viktor Chernomyrdin, when he was Minister of the Soviet Gas Industry, always insisted that he would never think of cutting off the flow of gas for political reasons. He continued to issue such assurances when the Ministry, in August 1989, was transformed into a hybrid state corporate entity which he called Gazprom. He abandoned the title of minister and called himself the CEO of the now newly created joint stock corporation. The promise that the ministry and then Gazprom would honor its contracts has been echoed by numerous other senior government officials including Chernomyrdin’s immediate successor, Rem Vyakhirev, who as CEO, sold much of the company’s stock to nonstate entities in November 1992. Others frequently made the same claim. For example, in 2006, Igor Shuvalov, President Vladimir Putin’s economic adviser insisted that “Europe will never have a more reliable supplier than Russia.”³¹ Or listen to Putin himself. At the Balkan Energy Cooperative Summit in Zagreb in June 2007, he insisted that “for four decades now, despite the serious and truly global changes in the world, Russia has never broken a single one of its contractual commitments.”

Such assertions, however, overlook the fact that the Soviet Union in its day and Russia after 1991 have frequently terminated the shipment of energy supplies when a customer chose to oppose Soviet or Russian political or economic objectives. Yugoslavia under Tito, Israel in 1956, Finland in 1958, China in 1959, Latvia in 1990, Lithuania in 1990 and 2006, and Estonia in 2007 had their petroleum deliveries cut off. Later, Putin’s regime halted or reduced the flow of natural gas supplies to Ukraine, Belarus, Georgia, Moldova, and even Bosnia. What passes as “the rule of law” in other societies became “the law of the rulers” under Putin. A contract commitment with state-controlled enterprises in Russia has never been a guarantee of performance nor a deterrent to arbitrary behavior by Russian entities. That was true in the Soviet era and it again became common under Putin. Concessions made at a time when Russia is weak and prices are low are invariably invalidated once prices rise again and Russia regains its strength. Put simply, higher prices increase Russia’s bargaining power. Precedent is no guarantee that the Russians will not some day mend their ways, but it does suggest that President Reagan had legitimate concerns.

WILLIAM CASEY: DID HE PRECIPITATE THE COLLAPSE OF THE USSR?

Recognizing how important petroleum and natural gas production and delivery were to the Soviet Union’s domestic and foreign well-being and influence, William Casey, appointed by President Reagan in 1981 to head the CIA, decided that the best way to undermine the USSR was to undertake an effort to cripple its energy sector. Given that four years earlier the CIA had predicted there would be a sharp drop in production, which would turn Russia from an oil exporter to an oil importer, it should be relatively easy to expedite that drop in oil production.

Fortunately for the USSR, neither it nor Russia became net importers—far from it. So was the CIA wrong? Production did peak in 1987 at 625 million tons and it did fall to 571 million tons in 1990 (see Table 2.1). Yet according to the CIA, the USSR and Eastern Europe should have been importing 175 to 225 million tons by then. But that did not happen. The USSR remained a major petroleum exporter until it disintegrated. After that, production in Russia itself did indeed fall sharply in the mid-1990s, but as we shall see in Chapter 4, this was because petroleum prices were low and taxes were high so the new private owners concluded they could make more money by stripping assets than by producing petroleum. These were not the reasons anticipated by the CIA.

The CIA prediction was far off the mark. In fact, in 2006 Russia again became the world’s largest producer of petroleum. Nonetheless, the production and central planning problems on which the CIA based its 1977 analysis were real. The Soviets continued to inject too much water into the oil fields and the bureaucratic and central planning practices that characterized the Soviet economic system resulted in enormous waste and lost opportunities.

While the CIA devoted considerable effort to research and analysis of the problems that confronted the Soviet petroleum industry and its exports, once William Casey took over as the head of the CIA, he began to tackle the issue more aggressively. Some, including Peter Schweizer of the Hoover Institute and Yegor Gaidar, former Acting Prime Minister of Russia in the early years of Boris Yeltsin’s presidency, have advanced the view that Casey sought to cripple the Soviet petroleum industry’s export-earning capabilities to prevent it from generating the hard currency Russia so desperately needed to pay for its food and technology imports.³²

Schweizer goes so far as to argue that the CIA under William Casey launched a complicated scheme that ultimately led to the collapse of the Soviet Union. As Schweizer tells the story, CIA chief Casey received authorization from his boss, President Reagan, to work with Saudi Arabia to weaken the Soviet petroleum industry. This was typical of Casey’s out-of-the-box thinking. As he saw it, Casey reasoned that the Saudis would cooperate because they were angered by the Soviet invasion of Afghanistan, a brother Islamic country. Saudi Arabia at the time actively supported the Afghan guerillas fighting the Soviet occupiers. Before long the Soviet Union found itself bogged down there. Casey also sought to weaken the USSR at home.

From his own background in international finance Casey understood that the Soviet Union depended heavily on petroleum exports to pay its international bills. This included not only payment for massive imports of grain (by the late 1970s, the Soviet Union had become the world’s largest importer of grain) but for imported factories (for example, large chemical plants) and technology that the USSR was unable to produce itself. These imports were also important in providing the Soviet Union with the wherewithal needed for its military-industrial complex. According to Schweizer, Casey thought that if he could somehow shrink the value of the USSR’s petroleum exports, that shrinkage would force the Soviets to curtail their involvement not only in Afghanistan but elsewhere in the world. All of this suggests, however, that Casey was unconvinced by the earlier CIA predictions that Soviet oil output would fall. If those earlier conclusions had been right, the Soviet hard currency earnings would have been reduced without any need to seek Saudi help and, short of money, the Soviet Union would have been forced to withdraw from Afghanistan. A drop in hard currency export earnings would also have hurt industrial investment within the USSR itself. Except for the revenue earned from petroleum and to a lesser extent natural gas exports, the Soviets had virtually no other way to pay their external bills. Consequently, Casey sought ways to reduce the USSR’s earnings from its petroleum exports. While he might not precipitate the Soviet Union’s collapse, at least he could weaken its structure.

To implement this ingenious scheme, Casey sought out the Saudi leadership in 1985 and, according to Schweizer, urged them to increase their output and export of crude oil. By expanding world supply they would precipitate a drop in world oil prices. Casey argued that this would not only help the U.S. economy but would seriously hamstring the Soviet economy and presumably force the Soviets to curb their adventures in Afghanistan.

What was the exact cause and what was the effect even now is not known precisely. As reflected in Table 2.1, Saudi output fell to a sixteen-year low in 1985 after hitting an all-time high in 1980. Then after King Fahd’s visit to Washington to see President Reagan in February 1985, the Saudis did pump more oil.³³ Output in 1986 rose 45 percent over 1985 (see Table 2.1).³⁴ But perhaps equally if not more important, increased petroleum pumped from the North Sea and West Siberia hit the market at the same time. As anticipated, average prices in 1986 fell to half of what they had been the year before, to $25.63 a barrel (see Table 2.1). By 1988, average prices dropped even further to $24.71.

We could only guess at the time what the impact of the fall in prices was on the Kremlin leadership. With the benefit of hindsight, Casey appears to have anticipated correctly. Relying on Politburo archives, Yegor Gaidar reports that Soviet leaders were in near panic. The drop in prices, he says, cost Russia $20 billion a year.³⁵ Their financial condition was evidently much worse than we on the outside knew. It was widely believed that even if oil prices were to fall, the Soviets could use their large stocks of gold to pay their bills. But Yegor Gaidar now reveals that by early 1986, they had only $7.6 billion left, not the $36 billion in gold that most outside observers at the time assumed. Most of their gold had already been sold to pay for earlier grain imports. In 1963, for example, Khrushchev spent one-third of the country’s gold to import 12 million tons of grain.³⁶ Once oil prices started to fall, not only did each barrel of petroleum exported earn fewer dollars but the drop in export earnings also forced the Soviets to reduce their industrial imports and the investment they needed to sustain oil production.³⁷ This in turn affected morale already shaken by the turmoil precipitated by Gorbachev’s 1985 perestroika campaign. As a result, crude oil output began to drop sharply. By 1990, crude oil output was down about 10 percent (see Table 2.1), which meant a further reduction in imports and the need to borrow even more money from foreign banks and governments.

Because Gorbachev and his programs were so popular in the West, there were many calls to be supportive. This gave birth to “a grand bargain” proposed by Graham Allison, dean of the Kennedy School of Government at Harvard University.³⁸ But a growing number of foreign suppliers and bankers came to realize that the USSR’s financial plight was so serious that the Soviets might not be able to repay any such loan. This in turn led them to withhold credits. This only served to increase anxiety in the Kremlin.³⁹ Yegor Gaidar recounts that as the financial situation continued to deteriorate, out of desperation Gorbachev found it necessary to contact Chancellor Helmut Kohl of Germany. He begged for immediate help, explaining that the situation in the USSR had become “catastrophic.”⁴⁰

All of this had a destabilizing impact on the USSR. By 1988, faced with intermittent bad harvests, an empty treasury, an increasingly unpopular war in Afghanistan, and a domestic economy in turmoil as it sought to free itself from some of the excesses of central planning, Gorbachev and some of the other Soviet leaders were finally forced to acknowledge that the Soviet Union had overextended itself.⁴¹ Its economic wherewithal could no longer support its imperial pretensions. That explains at least in part Gorbachev’s decision to begin the withdrawal of Soviet troops from Afghanistan on February 15, 1989. (It is hard to resist making comparisons with the United States fighting in Vietnam and Iraq.)

Admirers of CIA chief Casey credit him and his efforts with Saudi Arabia for forcing the Soviet Union’s retreat in Afghanistan and by extension for the collapse of the USSR itself two and a half years later.⁴² Undoubtedly the increase in world petroleum output and the resulting drop in price that followed seriously undermined the Soviet Union’s international financial creditworthiness and its ability to support its own and its East European satellites’ economies.⁴³

But was the cause and effect so straightforward and so simple? Prices in 1985 did indeed fall from $50 a barrel (in 2005 prices) to $24 a barrel in 1988. While the Saudis did increase production in 1984, 1985, and 1986, they actually reduced production in 1987. Belatedly in 1988 they again made an increase but to a level less than they produced in 1980 and 1981. Whatever the cause, the Soviets did evacuate Afghanistan on February 15, 1989, but only after Soviet output hit its peak. The Saudis boosted output in 1990 by 70 million tons, much more than the 50-million-ton increase in 1988. But by 1990 the war had already come to an end. If the Saudi increase in production had such an impact on USSR prices, why didn’t oil prices fall in 1980 when the Saudis were pumping two and three times as much oil as they pumped in the mid-1980s, and why did Saudi Arabia wait until the 1990s, rather than in 1985, after Casey’s intervention, to make major increases in production?

As Gaidar’s research into the minutes and correspondence of the Politburo makes clear, there is no doubt that the fall in world petroleum prices did hurt the Soviet Union.⁴⁴ But the collapse was due to more than the drop in oil prices. After 1987 there was also a drop in Soviet oil production, which also hurt earning power. The lower prices undoubtedly did contribute some to the drop in output, just as it was to do in the early and mid-1990s. But did lower prices have that much effect on the Ministry of Petroleum and its affiliates? In the Soviet era, profits and prices were not all that important as a stimulus to production. What mattered were targets set by the plan. Market incentives came into play only after privatization. Admittedly the increased use of water injection cited by the CIA in its 1977 report did hamper production, but it was not an unsolvable problem. The CIA prediction that Soviet oil production would fall and the USSR would soon become a major importer notwithstanding, we will see to the contrary in Chapter 5 that Soviet oil production did increase again—and substantially— after 1999.

While there may have been a connection between increased Saudi oil output, lower oil prices, and the Soviet Union’s collapse, the Bill Casey intrigue does not explain why the USSR did not collapse in 1980–1981 when Saudi output was at a record high, double what it was in 1986. Note even at the 1980–1981 high point of production, the USSR still produced more petroleum than Saudi Arabia. It was only in 1992 that Saudi output exceeded Russian output. Despite the elevated level of production, oil prices were actually at a record high then. It may have been that the anxiety created by the Soviet invasion of Afghanistan in 1980 had a greater impact on oil prices than the increased Saudi output. But the fact that prices did not fall until 1981 — and that the Soviet Union was unaffected, at least in the early 1980s — suggests that while Casey’s efforts to undermine the Soviet Union’s economy may have had an impact, it cannot be argued that his conspiring with the Saudis was the sole or even the most important cause of its collapse. Nonetheless, Casey’s involvement is yet another bizarre episode in this fascinating and ongoing interplay of geology, economics, ideology, politics, and greed.