Petropower And Soviet Expansion And

COMMENTARY
July 1986

by Edward Jay Epstein


THE constant focus on the attitudes of
individual Soviet leaders, measured by
their public pronouncements, style, and degree of
apparent enlightenment, obscures the extent to
which Soviet foreign policy depends on an underlying
economic reality: the world price of a barrel
of oil.
To maintain over 150,000 technicians in 76
countries, constructing everything from oil refineries
and nuclear reactors to SAM anti-aircraft
missile systems, the Soviet Union must either earn
or borrow substantial amounts of foreign exchange.*
In 1985, for example, the Soviet Union
provided foreign military and economic aid estimated
at more than $20 billion (not including
the covert assistance it funneled to a score of guerrilla
movements). In 1985, it could afford to undertake
foreign activities of this magnitude because
it exported the equivalent of 1.7 billion barrels
of oil in petroleum and natural-gas products
-a quantity which made it, not Saudi Arabia, the
world's leading producer and exporter of energy.
Since the world oil price averaged just under
$30 a barrel that year, the Soviet Union, even
with these expansive undertakings, had a foreignexchange
surplus. If, on the other hand, falling oil
prices had deprived the Soviet Union of this revenue
from its energy exports, it would not even
have had sufficient foreign exchange to finance its
own food imports and to service its $20.4 billion
foreign debt.

In other words, there is a powerful relationship
between Soviet oil revenues and the foreign exchange
it has available for its global activities.
The Soviets could of course make up any shortfall
in their foreign-exchange account by borrowing
from the West, as they have done in the past. But
the seeking of Western credit on favorable terms
often requires a moderation-if only a temporary
one-in Soviet foreign designs.

THE Soviet foreign-exchange bind traces
back to the Bolshevik Revolution.
With most of its gold and foreign reserves seized
by the Allies in 1917, the Soviet Union was virtually
paralyzed. It could not obtain credits abroad
to purchase drilling bits to reopen its oil fields,
fertilizers to save its crops, or spare parts to keep
its trucks on the road. As far as its foreign activities
went, it had to resort to clandestine sales of
art and national treasure to finance its Communist
International (Comintern) apparatus and diamond
smuggling to support its diplomats. It even
permitted its intelligence service to sell secret documents-
both phony and real-to anti-Communist
exile groups throughout the 1920's.
Confronted with this desperate situation, and
the need for foreign credit, Lenin moved to scale
down and moderate the more aggressive aspects
of Soviet foreign policy. To expedite obtaining
financial credits from the West, he even suspended
the central Bolshevik principle of advancing
world revolution. When Britain threatened to cancel
trade negotiations because of Soviet aid to revolutionaries
in Afghanistan and India, Lenin agreed publicly to end propaganda aimed at the British empire. To make this new policy more credible to British intelligence, orders were subsequently sent to Soviet embassies calling off subversive
activities, in diplomatic codes which Soviet
intelligence knew the British were interceptingand
reading.

To recruit American capital to Russia, Lenin
radically revised "War Communism" to allow private
capitalism a place in the Soviet economy. Under
his "New Economic Policy" (NEP), he sent
representatives to the United States to encourage
businessmen to invest in "concessions" in the Soviet
Union from which they were promised large
profits. The offer attracted some 350 foreign com,
panies, resulting in a much-needed infusion of
equipment and technology-all financed by Western
credits-during the 1920's.

To acquire technology and equipment from
Germany, not only did Lenin cut off aid to German
revolutionary organizations, but the Kremlin
entered into a secret arrangement with the
German government allowing it to rearm in the
Soviet Union. Although prohibited by the Versailles
peace treaty from having any real military
forces, the Germans covertly organized and
trained their armored divisions and air force over
the plains of Russia. The German general staff
also manufactured in Russia vast quantities of
banned armaments, including tanks, aircraft, poison
gas, battleships, and submarines. The 150
million Reichmarks a year the Soviet Union received
from this deal-which accounted for a
third of the German military budget-financed a
substantial portion of Soviet activities abroad in
the 1920's. (The unforeseen part of this unconventional
arrangement was that many of the same
German armored divisions that trained in Kazan
in the late 1920's would return as invaders in
1941.)

By the late 1920's, Soviet oil production from
the Baku fields had been largely restored, and exports
of oil, as well as of timber and agricultural
commodities, had largely alleviated the foreignexchange
crisis. Its trade relations with the West
normalized, the Soviet Union could afford a more
expansive foreign policy. It resumed-and escalated-
covert support of subversive groups in
India, Afghanistan, and elsewhere; confiscated,
without compensation, almost all the foreign concessions
it had awarded; and dismantled most of
the German military apparatus on its territory
(though pilot training continued until 1932).
The onset of the great depression, which extinguished
most of the markets for Soviet exports in
Europe and America, ended this brief period.
During the 1930's Stalin not only abandoned the
rhetoric of world revolution under the slogan "Socialism
in One Country," but adopted a policy of
accommodation toward, if not outright appeasement
of, potential enemies. When the Japanese invasion
of Manchuria in 1931 threatened the Sovietowned
Chinese Eastern railroad, Stalin, rather
than resisting, sold the railroad to the Japanese
puppet state of Manchukuo and arranged a nonaggression
pact with Japan. In 1932 alone, the
Soviet Union signed nonaggression treaties with
Poland, Finland, Estonia, Latvia, and France. (Subsequently
it invaded all these nations, except for
France, and annexed part or all of their territory.)

In 1933, in return for American recognition,
Stalin pledged that the Soviet Union, directly or
indirectly, would refrain from any subversive acts
against "the political or social order of the whole
or any part of the United States." Despite Hitler's
stated goal of destroying the Comintern, Stalin
concluded a nonaggression treaty with Nazi Germany
in 1939, and proceeded to profit handsomely
for the next two years from surcharges on goods
transshipped across Russia to evade the Allied
blockade. Then, after being attacked by Germany,
Stalin allied himself with the United States and
England. In return for massive lend-lease shipments
from the United States, Stalin agreed to
dissolve the Comintern itself-which, since Lenin,
had embodied the aim of overthrowing capitalism.

AFTER the war, with its economy in a
shambles, the Soviet Union itself desperately
needed foreign help. Although the Allies
did not accede to Stalin's demand for massive
reparations from Germany and Japan, he expropriated
from Eastern Europe and Manchuria vast
quantities of capital goods-including entire factories,
railroads, and shipyards. Until Stalin's
death in 1953, not only did the Soviet Union furnish
virtually no substantial foreign aid to non-
Communist nations, but it effectively extorted aid
from its allies through distorted barter arrangements.
Stalin's successors, confronted with increasing
unrest in Eastern Europe in the mid-50's, could
not divert substantial resources to overseas adventures.
In 1954 they even found it necessary to cut
off further economic credits to Communist China.
Indeed, much of the subsequent tension with
China proceeded from the Soviet Union's decision
to use its scarce foreign exchange to strengthen
itself at the expense of its Communist allies during
this period.

In the late 1950's, Khrushchev attempted to
change the direction of foreign aid by supplying
Eastern Europe with increased quantities of oil
and gas from newly-developed fields in the Ural
Mountains. He also initiated a number of dramatic
foreign-aid enterprises designed to compete
directly with the West. The most notable of these
projects was the construction of the Aswan Dam
in Egypt.

Khrushchev's pledge to undertake this project
in 1958 flowed not from any ongoing foreign-aid
program-the Soviets had not then even created
an administration for disbursing economic aidbut
from a unique opportunity to gain entry into
the Middle East. In 1956, after the United States
and Britain abruptly withdrew their offer to
build the Aswan Dam, Egypt nationalized the
Suez Canal and, by doing so, precipitated a brief
war with England and France. With anti-Western
feelings running at fever pitch, Khrushchev stepped
into the vacuum, and offered the Egyptian government
what it vitally needed to restore its credibility:
financing for the dam. The Soviets, after
two years of hard negotiations, were willing to
lend the Egyptians only about one-quarter of the
amount necessary to build the dam. The loan was
presumably to be paid back through the cotton
and other agricultural products that the Soviets
were already importing from Egypt. (As it turned
out, however, the Egyptian goods were insufficient
to repay the loan and, not without irony, the large
shortfall was made up from surplus American
wheat Egypt received from the United States in
the 1960's.) Despite the public-relations coup involved
in building the dam, Khrushchev at the
time of his removal in 1964 came under criticism
for his decision to provide these much-needed resources
to a non-Communist country.

Whatever its net assessment of Khrushchev's
grand ventures abroad, the new Soviet leadership
moved to downgrade foreign aid to the role of
stimulating markets for Soviet exports (especially
weapons). This lower profile also fit in with the
theme of detente in the late 1960's. Under Brezhnev,
the Soviets again sought to import large
amounts of capital from the West on favorable
terms in order to develop their oil, gas, and petrochemical
industries. To this end, Armand Hammer
of Occidental Petroleum (who had been dealing
with the Soviet Union since the time of Lenin)
persuaded President Nixon to inform the
U.S. Export-Import bank that it was in the "national
interest" to finance a Soviet pipeline and
storage facilities to transport gas between the Ural
Mountains and the Black Sea. Consequently, the
bank provided the Soviet government with a
$182-million low-interest loan-the largest credit
ever granted to a Communist country. Less successfully,
Hammer also attempted to arrange for
the Soviet Union a $4-billion loan from Japan,
which was to be used to build a trans-Siberian
pipeline. Although it was suggested that the Soviets
might even return four islands to Japanese
sovereignty to sweeten the deal, it never went
through.
The magnitude-and direction-of Soviet foreign
aid changed dramatically in the 1970's. From
1953 until 1973, the combined military and economic
aid to non-Communist countries supplied
by the Soviet Union, which was almost entirely
in the form of loans, averaged just under $1 billion
a year. In 1974, it leaped to $7 billion; by
1979, it had exceeded $10 billion; and by 1982,
it had reached nearly $20 billion. At the same
time, the subsidies that the Soviets supplied to
the Communist bloc, much of which were readvanced
as foreign aid to further Soviet objectives,
increased more than tenfold.
This quantum leap in foreign aid was accompanied
by a commensurate increase in the willingness
of the Soviet Union to confront the West.
In Asia, it moved into Afghanistan, funded Vietnam's
military domination of Cambodia and
Laos, and took over the huge naval and air base
at Cam Ranh Bay. In Africa, it provided the military
wherewithal to establish and entrench client
regimes in Angola, Mozambique, and Ethiopia.
In the Middle East, it turned the pro-Soviet government
in Syria into a formidable regional
power, supported Libyan incursions into Chad
and Sudan, and became the dominant supplier
of weapons for Iran, Iraq, South Yemen, and
Algeria. In Latin America, in addition to its continued
subsidization of Cuba, it undertook to support
anti-American regimes in Nicaragua and
Grenada. It even quietly resumed economic aid
to China-after a twenty-year hiatus.

This new phase in Soviet expansion was made
possible economically in the winter of 1973 by
the explosion of world oil prices.

ALTHOUGH Russia has been a major producer
of oil since czarist times, its
earnings from exports were limited until the early
1970's by a combination of high transportation
costs and low world prices. In the 1960's, with oil
fetching less than $2 a barrel on the world market,
the only real export market was the Communist
bloc; and even here, for the most part, the oil
was delivered as part of long-term credits that the
Soviets had extended to their allies.
Since the Soviets believed, with some justification,
that oil prices were being artificially depressed
by a cartel of Western oil companies, they
attempted to break this control of marketing and
refining by offering their own surplus crude at
bargain prices to government-owned oil companies
in India and Italy-and, in the case of
India, by building a refinery to process it. But
this strategy, aimed at disrupting the market, only
caused the cartel to push the world price even
lower. Despite falling prices, the Soviet Union
developed new fields in the Urals and Siberia in
the 1960's that more than trebled its oil production.
By October 1973, it had become the world's
largest producer-surpassing both Saudi Arabia
and the United States.

The Soviet pricing problem was solved by the
wave of oil shocks, beginning in 1973, that collapsed
the Western cartel and panicked the market.
The first crack in the cartel's solid front
actually had come two years earlier in Libyawhich
had granted a concession to Armand Hammer's
Occidental Petroleum, an independent marketer
of oil, well outside the cartel's purview. In
the negotiations over Libya's share, Hammer
agreed to Qaddafi's terms. The Persian Gulf nations,
led by Iran, then demanded that the cartel
match these terms; this gradually ratcheted up the
price to $2.18 a barrel, and weakened the cartel's
control over the marketplace.
Then, in October 1973, came the first real
shock: the Egyptian and Syrian attack on Israel.
The Yom Kippur War was accompanied by the
declaration of an embargo by Saudi Arabia and
four other Arab producers on the delivery of oil
to the United States and other Western nations,
which sent prices spiraling upward to $16 a barrel
by the end of the year. In the turmoil that followed,
the OPEC oil producers effectively nationalized
the concessions that had been controlled
by the Western cartel and, auctioning off their oil
to the highest bidder, turned the oil market into a
free-for-all.
The next oil shock came in Iran in 1977, when
riots against the Shah closed down that country's
oil fields, and prices soared to $30 a barrel. And
when in 1980 Iraq invaded Iran, causing another
round of frantic buying as Japan and Europe
sought to stockpile oil, prices were driven up to
$40 a barrel.
Whether by design or willy nilly, the Soviet Union
played a role in the events which had precipitated
the 2000-percent rise in the value of its
chief export. The policy of undermining the
Western cartel, which the Soviet Union had begun
a decade earlier in India (if not Suez), was
brought to a successful realization by its client
state in the Middle East, Libya. As U.S. intelligence
learned from its intercepts of the traffic in
messages between Tripoli and Moscow during
Libyan negotiations with Armand Hammer, the
Soviet Union was not uninvolved in the outcome.
After the Western cartel's control over prices was
weakened, the Soviet Union provided Egypt with
the mobile surface-to-air missiles, anti-tank weapons,
and canal-bridging equipment that made the
Yom Kippur War possible. The Soviet Union also
later furnished Iraq with the armaments to invade
Iran.
The windfall the Soviet Union received from
these oil shocks was immense. It came at a time
when the new oil fields in Siberia were coming
on stream and raising Soviet oil production from
three billion to four-and-one-half-billion barrels a
year. By the early 1980's these fields were also producing
the equivalent of another billion barrels
of oil a year in natural gas. This meant that each
one-dollar increase in the price of oil and natural
gas-which is loosely pegged to oil-raised the
value of the Soviet energy product by some $5.5
billion a year. The oil shocks of the 1970's, which
by 1981 had escalated the world price by $37 dollars
a barrel, were producing a theoretical profit
to the Soviet economy of over $200 billion a year.
Such a bonanza would add roughly 10 percent
to the Soviet gross national product.
I N TERMS of geopolitical benefits, the inflated
oil prices radically improved
the Soviet Union's global standing. To begin
with, they completely changed its terms of trade
with the West. Up until the oil shocks, the Soviet
Union had no major product to export to the
West, except gold-whose production was limited.
Its other exports were mainly luxury goods like
caviar, furs, crab meat, and diamonds, which
could be dispensed with or embargoed. After
1974, with European nations frenziedly bidding
for oil to build their stockpiles, the Soviet Union
began increasing its shipments of heating oil and
diesel fuel to Europe from its Baltic refineries.
By the early 1980's, its annual energy exports to
the West rose to over half-a-billion barrelswhich
included crude as well as gas product-
and generated nearly $25 billion in hard
currency. This accounted for 80 percent of the
Soviet Union's total income. In all, in the decade
since the first oil shock, it has been estimated that
the Soviet Union has gained over $300 billion in
foreign exchange.
This huge transfer payment from West to East,
unprecedented in its magnitude, greatly widened
the scope of Soviet foreign policy. It not only allowed
the Soviet Union to undertake global adventures
on a scale that previously would have
been inconceivable; it freed Moscow, for the first
time since the Revolution, from dependency on
non-Communist governments for credit on favorable
terms. Moreover, it financed the massive purchase
of grains from the West to ameliorate living
conditions in the Soviet Union.
Secondly, after the price explosion the Soviet
Union gained enormous leverage over its Communist
allies through the export of energy. By
1980, it was exporting some 1.3 billion barrels of
oil (or its equivalent) a year to Eastern Europe,
Cuba, and Vietnam, worth over $40 billion at
prevailing world prices. To be sure, the Soviet
Union charged its allies only a fraction of the
free-market price, which averaged for most of the
Communist bloc approximately one-third of the
$40-a-barrel price. The difference, which came to
over $30 billion, amounted to an annual Soviet
subsidy for its allies.
Communist nations are free to resell this oil at
world prices, though Moscow presumably expects
its allies to use the proceeds for activities that
dovetail with its own strategic purposes. Cuba,
for example, was allotted 88 million barrels of
crude in 1980 which, at $40 a barrel, was worth
over $3.5 billion dollars a year (for which it paid
in sugar-at a very nominal rate). Cuba resold
part of the oil in the free market, earning over
$800 million in hard currency which it employed
in part to finance guerrilla movements in Latin
America and to provide its own foreign aid to
Nicaragua and Grenada.
In the case of East European countries that
needed the low-cost fuel to keep their own economies
from collapsing, the subsidy heavily increased
their dependence on the Soviet Union.
Poland, for example, was threatened by the Soviet
Union in 1981 with a cutoff in its allotment
of 105 million barrels a year if it did not crack
down on the Solidarity movement. Polish leaders,
understanding that the nation would be bankrupt
without this Soviet assistance, acceded to the
demand.
Even Yugoslavia, which prides itself on its political
independence, relied throughout the
early 1980's on receiving from the Soviet Union
just under 100 million barrels of oil a year (although,
in its public accounting, it disguised
some two-thirds of this oil as Middle East imports).
The value of this annual subsidy, which
was worth upward of $3 billion in 1981, had at
least to be taken into consideration in any action
that seriously went against the interests of the
Soviet Union. In this context, it is not particularly
surprising that Yugoslavia publicly supported
the Soviet Union on almost all its foreignpolicy
initiatives in the 1980's.
Thus the higher oil prices rose, the more potentially
costly it became not only for the bloc
countries but even for neutral nations to oppose
Soviet policy.
THE Soviet Union also gained from inflated
oil prices a rich market for arms
sales, its second largest export. Throughout the
70's and early 80's, Saudi Arabia and other Arab
oil producers actually gave the Soviet Union 50
to 60 million barrels of oil a year to pay for shipments
of armaments to Syria. In separate oil-forarms
barter deals, Iraq, Iran, and Libya provided
another 50 million barrels a year. (North Korea
and other Soviet allies received an additional 60
million barrels a year from Iran.) When the price
of oil then escalated, partly because of the wars
being waged with these weapons, the Soviet Union
received a windfall from selling its Middle East
oil on the world market.
This meant, in effect, that the Soviet Union
was being subsidized by Saudi Arabia and other
Middle East nations for stationing military advisers
and prepositioning planes, tanks, and missiles
in the Levant. Between 1979 and 1983, according
to CIA estimates, the Soviet Union sold
oil producers over $27 billion worth of arms (with
$9.2 billion worth going to Syria, $7.2 billion
worth to Iraq, $5.8 billion to Libya, and $2.7 billion
to North and South Yemen). During these
years, arms shipments paid for by oil producers
accounted in value for over 12 percent of total
Soviet exports.
Finally, the demand for oil helped the Soviet
Union acquire Western technology on a scale not
seen since the days of lend-lease. Contrary to prevailing
myths in the media, the vast preponderance
of technology transfers from West to East
proceeded not from espionage or theft but from
openly-arrived at deals with some of the largest
corporations in the West.
During the 1970's, for example, the Bechtel
Corporation installed in the Soviet Union the
pipelines, compressors, and processing facilities
that greatly enhanced its capabilities for exporting
petrochemicals. Similarly, Caterpillar delivered
to the Soviets highly-specialized pipelaying equipment
(which could also be used for missile handling).
The Soviet offer to deliver 70 billion cubic
meters a year of Siberian natural gas to Western
Europe (the equivalent of 2 million barrels of oil
a day) induced English, French, Italian, and
West German corporations, with the full backing
of their governments, to sell the Soviet Union
the turbines, control mechanisms, alloyed steel,
drilling bits, and earthmoving equipment necessary
to construct the transcontinental pipeline.
The technology for entire industrial centers was
transferred to the Soviet Union by European and
American contractors during the 1970's. As the
price of oil soared during the decade, the value
of Soviet machinery imports from the West increased
by 1000 percent, reaching $9 billion in
1983.
This inflow of capital goods and technology
was indeed counted on by Gorbachev to modernize
Soviet industry. And so long as the price of
oil moved upward, this transfer of capital from
the West to the East could reasonably be expected
to continue. On this score, there is no economic
symmetry between the United States and the
Soviet Union. Whereas rising oil prices decrease
the GNP of the United States, Japan, and Western
Europe, since they are net importers, they
increase the GNP of the Soviet Union, since it is
a net exporter. (According to a 1983 Treasury
Department analysis, every $7 increase in the
price of a barrel of oil decreased the GNP of 26
industrial nations of the OECD by approximately
1 percent while increasing the GNP of the Soviet
Union by roughly .5 percent.)
I N 1983, oil prices began falling, as
European nations reduced the stockpiles
they had built up at the start of the Iraq-
Iran war. At about the same time, Soviet crudeoil
production peaked at 12.5 million barrels a
day and gradually began declining. Then the
price abruptly collapsed, falling from $30 a barrel
in mid-December 1985 to $15 a barrel in February
of this year. Soviet oil production meanwhile
had fallen to 11.5 million barrels a day.
To make matters worse, the Soviet pipeline was
delivering less than half the expected 70 billion
meters of natural gas a year to Western Europe;
and the price, which was pegged by a complicated
formula to the free-market price of crude
oil, was scarcely half of what the Soviets had expected
in 1981. This decline was made more disastrous
for the Soviets because they were paid for
their exported oil in dollars, which had declined
by more than 33 percent against European currencies
(and the Soviets had to trade these dollars
in for Deutschmarks to pay for a large share of
their machinery imports from Germany).*
Thus the halving of prices amounted to a new
oil shock, which reversed the flow of wealth from
East to West. It quickly eroded the advantages of
being a petropower. With oil exports accounting
for 80 percent of its foreign exchange, the Soviets
had to reckon with the fact that for every decline
of a dollar in the price of oil, they would lose a
billion dollars a year in hard currencies. The $15
decline thus meant that the Soviet Union would
earn $15 billion less in foreign exchange in 1986.
Its terms of trade would, at these lower prices,
quickly deteriorate. Since its commitments to buy
machinery and wheat from the West could not be
* When, in March 1986, oil fell to $10 a barrel, the Soviets
received unexpected-and possibly unintended-help
from Vice President George Bush. After he suggested that
the United States might encourage Saudi Arabia to cut back
on its oil production, oil prices rallied back to the $15 level.
cut back so quickly, it had no choice but to increase
drastically its debt to the West.
Falling prices also greatly reduced the dependence
of the Soviet Union's allies-and neutral
countries-on Soviet fixed-price exports. The
price drop caused considerable problems as well
for Communist-bloc nations that funded their
foreign activities by reselling their Soviet oil allotment.
Cuba, for example, finding the resale
value of its Soviet oil sharply eroded, had to postpone
payment on its foreign debt this April. Soviet
relations with allies would become progressively
more difficult if the world price were to
drop below the Soviets' fixed price-as it did in
the 1950's. The Soviet oil allotment would then
become a tax rather than a subsidy for the
allies.
Moreover, the Arab oil producers who buy most
of the Soviet weapons are themselves vulnerable
to falling prices. Even Saudi Arabia is running
such a huge deficit this year that it has delayed
announcing its 1986 budget. And if these producers
can no longer afford to purchase weapons, the
Soviet Union's ability to earn foreign exchange
will be further reduced. Under those circumstances,
the Soviet Union would have to reassess
the value of maintaining unsubsidized military establishments
in Libya and Syria.
Finally, in the Soviet Union itself, despite all the
raised expectations of a reformed economy, lower
oil prices would greatly constrict the import of
Western capital and technology. As a May 15 Defense
Department memorandum entitled "Effect
of Declining Oil Prices on the USSR" noted: "The
drop in oil prices has created a critical problem for
the Soviets in their hard-currency account.... The
USSR will confront intractable economic choices
and its ability to purchase grain, technology, and
computers will be severely affected. To pursue
economic modernization the Soviets need to obtain
turn-key plans, and after Chernobyl they may
need large amounts of food and milk. Their loss
of hard currency, therefore, poses a grave dilemma."
For the past decade, the success of the Soviet
Union in maintaining-and expanding-its empire
has rested largely on the wealth generated
by its petroleum exports. It follows that keeping
prices down is in the political (as well as the
economic) interest of the West.

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