Current Thoughts About Oil and Gas

Vladimir Putin, the President of the Russian Federation, might well be about to make a huge mistake regarding the supply of oil and gas, his country’s main export. A brief lesson from history could save Russia a lot of money by avoiding this error.

I once saw a car bumper sticker that said, “If you think education is expensive, try ignorance.” Education through studying is an obvious way to learn things and avoid making mistakes. And who wants to make mistakes, especially when doing so might turn out to be expensive?

Although many may no longer think so, an example of a very useful education is studying history. When we study history, it is almost as if we are looking at a free laboratory experiment that someone else ran in the past. We can examine the circumstances in which various events occurred, observe the actions and motivations of the people and the personalities involved, and finally, see the results after all the events have played out. As a result, we can learn a lot from examining these different viewpoints.

For example, there is the current situation concerning Russian oil and gas supply to Western Europe. Certain Western countries, especially Germany, Italy, and Hungary, to name but three, have become highly and overly dependent on these supplies from the East. In 2021, Germany received 32% of its gas from Russia. Experts in the field say that it would be very difficult for it to move with any speed to any other comparable source of supply. German industry, particularly the chemical industry, relies heavily upon these imports, and Russian gas is also widely used for domestic heating. All of which makes Germany and these other countries reluctant to come down too hard against Russia, even in the face of the latter’s invasion of Ukraine with all its attendant horrors.

And so, although they have gone along with the general raft of Western sanctions against Russia, there is sometimes a feeling that their hearts are not really in it. This appeared to be the case for a while, but maybe things are changing? With each Russian missile that hits a theatre, school, or shopping mall, the need to stand up against this aggression has become clearer in the West. And yet, at the same time, what can these vulnerable countries do about their reliance on this Russian gas? If they apply the sanctions fully, are they not risking that Russia will turn on them, jeopardising their own economies?

I suppose the first lesson to be learned from this particular glimpse of history is to never again become so dependent upon any one source for vital supplies, especially so when the country in question has a habit of both invading its neighbors (Georgia in 2008 and Ukraine in both 2014 and 2022) and also threatening to do so (Estonia, Latvia, and Lithuania at various times in recent years). In a way, this has just reinforced the lessons learned during the recent COVID-19 pandemic, where huge supply chain problems showed the imprudence of not having alternative sources of supplies.

Looking at this situation, some have commented that Russia has Germany over an oil barrel, so to speak. “Don’t upset us too much, Meine Herren, or we might shut down your essential gas supplies.” In fact, it has been suggested by some that this might be going to occur this very week. The Nord Stream 1 gas supply pipeline is currently shut down for annual maintenance, which normally happens for a few days each year. But will Russia resume supplies on July 21st, as previously scheduled, or will various “technical problems” get in the way? We shall see.

So far, the Russians have not been shy about letting the West know that the possibility of a total shutdown exists. In April 2022, Vladimir Putin stated that “unfriendly” foreign countries must jump through various hoops of his choosing. In that case, these countries were informed to start paying for gas in roubles, or Russia would cut off their supplies. This is a case of letting his customers know whom he thinks is in charge, although thus far, the Germans have not been cut off, even though they refused to start using the Russian currency.

However, there are other facets to this “essential gas supply” question. It will be helpful to take a step backward and look at the other issues in play. Let us go back to the 1970s and examine the 1973 Oil Crisis. The background was similar to the one we see now with Russia and Europe. Back then the West relied upon OPEC (basically Saudi Arabia and the other Middle Eastern States) to supply them with lots of cheap oil which helped to keep their industry running and all their cars on the roads. When several Western countries supported Israel against Syria and Egypt in the October 1973 Yom Kippur War, the Saudis and their OPEC partners took revenge by putting an embargo on oil exports to these countries. The initial nations targeted were Canada, Japan, the Netherlands, the United Kingdom, and the United States. The embargo also extended to Portugal, Rhodesia (modern Zimbabwe), and South Africa. By the end of the embargo in March 1974, the oil price had risen nearly 400%, from around US$3 per barrel to nearly $12 per barrel on the global markets.

In the short-term, price rises of this magnitude had an enormous and catastrophic effect on the economies affected. Drivers who had never had to queue up for petrol in their lives now found that they were not only queueing but were not even guaranteed to find any supplies remaining when they finally arrived at the pumps. That 400% rise in such an important commodity as petrol meant that it was as if OPEC had imposed a huge unavoidable tax on the Western consumer. If people’s money had to be spent on petrol, then it was no longer available to be spent on other things. So, there was inflation in petrol prices which then led to a knock-on effect on the price of almost everything else. This was accompanied by a drop in consumer spending on many other items, leading to some businesses facing a series of severe crises.

I was studying economics at the time, and I recall one of our lecturers giving his verdict on this chaos. “It’s simple,” he said. “The Arabs have learned economics!” By which he meant that in 1973, the Arabs were in a monopoly position regarding the supply of oil, a product which was much in demand. Therefore, leaving aside the desire to have revenge upon Israel and its supporters, on purely economic terms, they were selling oil, and they were the only ones with a large supply of it. Hence, instead of charging $3 a barrel, why not make four times as much income by charging $12 a barrel. The market would pay up. Grudgingly, perhaps, but it would pay up because it could not do without that oil.Western demand at the time was what economists call “price-inelastic,” meaning the oil demand would not change very much, regardless of the price being charged. People had to have it!

That was the situation in 1973, and yet, had the Arabs really learned economics that well? In the short term, they were raking it in, to be sure, yet economic actions lead to economic consequences. The West was faced with this question, “What should we do about this expensive Arab oil?” And the answer was not long in coming.

It consisted of the following thought process. “We in the West need to find alternative sources of oil. When oil was cheap, there was no incentive to do so. Still, now we have seen that oil can be used as a weapon against us, so we no longer want to be at the mercy of this monopoly, or indeed, any monopoly. And this new higher price is killing us, so we need to find other sources of supply. And now that the price is so high, it will be worthwhile to drill and explore for oil in more remote and less accessible places. This is what took place over the next few years, with oil drilling expanding in places like Alaska, Norway, and the North Sea off the coast of Scotland. And also in the cold frozen wastes of a country whose name back then was the Soviet Union.

Another thing that happened was that the West took steps to reduce oil consumption. Admittedly, just like the search for new oil, this took time. Still, the car and airplane industries began to focus on producing models that consumed less petrol. People began to insulate their homes so that their heating would be more efficient.

Thus, the response of the West was to increase their oil supply and reduce their demand for it. In seeking to exploit their monopoly position in the short term, the Arabs ended up undermining this same position in the long term. It is a fact that people will gradually adapt to such situations. They may not have wanted to, but in this case, “necessity was the mother of invention.” And we could also say that it was the mother of additional exploration.

Having looked at this historical lesson from almost 50 years ago, it is now time to return to the question of Russia’s oil exports to the West. Russia could put an embargo on them tomorrow, producing short-term chaos, especially in Germany and throughout the European Union. But the West would respond, and measures would be taken to restore supplies somehow. I am sure other countries would gradually be able to make up the shortfall in a latter-day oil and gas version of the Berlin Airlift. There are many oil-producing countries in the world these days, unlike during the 1970s. For example, European countries are seeking fresh sources of supply in the Caspian Sea area, where deals are being negotiated with Azerbaijan and Kazakhstan, both formerly parts of the Soviet Union.

Refusing to supply the West would also cost Russia a lot of money as well. It is estimated that 60% of Russia’s oil and gas exports go to Europe, per the Organisation of Economic Co-operation and Development (OECD). This works out to something like $500 million a day. This is what is helping to fund Russia’s war against Ukraine, so it would be a surprising move if Russia were to forego this money for very long. In fact, if we look at the problem the other way round, it ought to be Europe that puts an embargo on Russian oil imports.

It is strange indeed that the governments of Europe are supplying Ukraine with weapons on the one hand and are still supplying Russia with the financial means of fighting on the other. But that is what they are still doing, to Russia’s advantage. How foolish it would be for Vladimir Putin to cut off the West from his oil and gas. Surely, he would produce chaos in the short term, but Germany and the others are resourceful. They would eventually find a way to get around this problem. But in the long term, he would be throwing away the income derived from his country’s major export. Having been thrown into chaos, no country in the West would ever allow itself to become so reliant on a country that turned the taps off at a moment’s notice.

To conclude, in the case of Germany, it might have a real problem concerning its imports of Russian oil and gas. However, with a little perspective gained from a study of both economics and relevant history, the problem, while still potentially there in the short term, should cease to be one in the long term. In the case of Russia, it needs to tread carefully. Russia appears to be in a strong position regarding its oil but making the wrong move could see it throwing this strong position away.

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