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Russia Comes to California

Does Russia outperform California when it comes to relying on market forces?

January 29, 2001

Does Russia outperform California when it comes to relying on market forces?

Of course, President Bush’s was a political decision, as California Republicans had privately advised of the dangers of appearing indifferent to the state’s problems. This was all the more important since the major power generators are located in Mr. Bush’s homestate of Texas. Thus, when California’s Democrat Governor Gray Davis turned up the heat and accused out of state power-generating companies of price gouging and profiting from California’s woes, Mr. Bush relented.

This seems to stand in sharp contrast to Russia’s energy policy. After all, stories about Russia turning the tap off on its gas or oil supplies to the Ukraine, Belarus, Moldova, or other former Soviet republics are an almost daily occurrence. But a closer look reveals that this first impression tells only part of the story.

In the days of the Soviet Union, Moscow mostly used a big stick — in the form of its armored divisions — to keep its Warsaw Pact allies loyal. But there was also a small carrot for Eastern Europe. Russia’s natural resources — especially oil and natural gas — were sold at prices that were well below world market prices in the 1970s.

And, equally important, within the Soviet Empire, those prices didn’t fluctuate as wildly and unexpectedly as they did in the West.

Those days are now gone. Russia’s natural gas monopoly, Gazprom, and a handful of oil exporters still sell oil and gas to parts of their old Eastern European empire as well as former Soviet Republics — but strictly at market prices.

They also demand payment in dollars, not barter-style goods and services as was the case in the Soviet era. And when the money is not forthcoming, the spigot simply goes off. For example, the Russian energy distributor, Itera, cut gas supplies to Ukraine power plants in January, claiming it was owed $64.2 million in back pay.

But despite these incidents, Russia generally continues to sell gas to Ukraine. Why? The answer may be found in a recently signed military cooperation agreement. The new pact will bolster defense links between the two countries and establish a joint Navy unit in the Black Sea. Russia will gain the right to take part in any multinational military exercises in Ukraine.

The bear hug between Russia and Ukraine is a foreign policy debacle for Western Europe and the United States. The strategic importance of Ukraine is hard to overestimate.

It is the largest nation in Eastern Europe, and has a population of over 50 million — larger than Poland’s 38 million. As long as Ukraine — at least in principle — remains a Western ally, Russia could never aspire to a dominant role in Eastern Europe. Now, howver, the Ukraine is firmly in Russian hands.

Here lies the difference between the Ukraine’s energy creditors and those of California. Ultimately, the power crisis now gripping California will be resolved simply because there are open markets, and the state is able to conduct blind auctions to buy power from supplies around the country. In Eastern Europe, Russia has a near-monopoly on energy supplies. The reorientation of ex-Soviet republics toward the Russian sphere of influence is an early warning of how monopoly power can be wielded.

California will live or die by economic means. In the Ukraine, the opposite is the case. The Ukraine economy probably has no business being in energy-intensive industries, if it can’t pay for its oil and gas. But because it has not been willing to reform, and introduce market forces to the equation, it dies by the political sword, and — so to speak — returns to the colonial status vis-a-vis its former master.