Streetwise Professor

Russia has invaded Crimea-and hence has invaded Ukraine.  No Obamaesque circumlocutions about “uncontested arrivals” can gainsay that very basic fact.  The Russians have occupied a major Ukrainian air base in the peninsula, and have given an ultimatum to all Ukrainian military units to surrender their posts.

Yes.  All unopposed. So I guess that makes it OK.

But what to do about it?

First: a no brainer.  Eject Russia from the G8, and reschedule a meeting of the G7 somewhere far away from Sochi (as is scheduled for June).  But seeing as that it is the Obama administration and various EU factotums that will make the decision, no brainer is probably asking a wee bit too much.

Second: pressure FIFA to strip Russia of the 2018 World Cup.  Even though the thought of Putin blowing another $50 billion on a vanity project has some appeal.

@libertylynx suggests persuading the Saudis to turn on the taps to reduce oil prices, and hit Putin where it hurts.  (Though since Obama has seriously alienated the Saudis with his Syria policy and his dalliance with Iran, there is serious room to doubt whether the Saudis would be at all accommodating.)  Indeed, in 1986, the dramatic increase in oil production by the Saudis struck the USSR a mortal blow, and Putin’s Russia is almost as dependent on oil revenues as the Soviets.  (See Gaidar’s memoirs for a blow-by-blow account of how the collapse in oil prices gutted the USSR.  I’ve often wondered whether the Saudi action was directed against the USSR, rather than OPEC cheaters as was stated publicly, and done at the behest of the Reagan administration.)

There are some differences, though.  In ’86 KSA had about 7 million barrels of spare capacity, at a time when world consumption was on the order of 60 million barrels.  By producing to the max, the Saudis drove the price from around $23/bbl in December, 1985 to under $10/bbl in mid-1986, about a 60 percent drop.  Now Saudi spare capacity is  around 2 million bpd, when world output is around 90 million bpd.  A 2+ percent increase in Saudi output would result in at most a 20 percent price decline.  (Note that other producers would cut back, so that world output would go up by less than 2 percent even if the Saudis produced to their capacity.) Certainly enough to hit Putin hard, but not enough to create the existential crisis that the Soviets faced in the 80s.  But every little bit helps.

Insofar as gas is concerned, the Europeans could cushion the blow of sharply reducing consumption of Russian gas by increasing use of coal, which is in abundant supply in the US because the shale gas boom has displaced large quantities of coal in electricity generation.  But I doubt Europe has the stomach for that, and it could not get along without Russian gas altogether.

This leaves one last thing: crying havoc, and letting loose the accountants of war, a policy I advocated in August, 2008.  There is nothing that would make Putin and his coterie of thieves and thugs freak out more than putting their billions in loot stashed in the West at risk.

The fall of the Yanukovych regime provides a perfect cover for such an operation.  An aggressive search for the boodle of Yanukovych and his spawn would no doubt serendipitously uncover other illicit loot from the FSU: after all, a Hermitage Capital investigation traced connections between Yanukovych-linked companies and the fraud that the martyred Sergei Magnitsky uncovered.

This suggests a potentially fruitful asymmetric attack on Putin.  Loudly and publicly announce a thorough investigation of Yanukovych monies in the West.  Through back channels, tell Putin that unless he backs off-way off, like back to Rostov-on-Don off-that any dirty Russian money (and is there any other kind in Western banks-hell, even Putin pretty much agrees with this) that just so happens to be discovered during the investigation of Yanukovych will go to covering the US national debt.  Then go ahead and investigate anyways, and keep track of the moneys uncovered, for potential use at a later date.

Alas, even though this is a bloodless alternative (though it would drain the blood from Putin’s already pale, Botox-injected face), I seriously doubt Obama has the stomach for it.  In part because he knows Putin would lose his sh*t, and he doesn’t want to deal with that.

But here’s the thing.  There’s really not much reason to be intimated by Putin’s bluster–outside the FSU, anyways.  Russia has economic feet of clay.  Militarily it is a pretend power, fit to intimidate other decrepit post-Soviet militaries in smaller states on its borders, but sadly outmatched against a real power.  So call his bluff. Guarantee full employment for forensic accountants.

Then buy ear protection to guard against the shrieks emanating from points east and north, grab some popcorn, and sit back and enjoy the show.

I have repeatedly called the administration’s policies in Syria and vis a vis Russia “feckless.”  This was intended to be a damning insult.  But it just isn’t insulting enough.

Why do I say that?  The White House told CNN that the Russian takeover of Ukraine isn’t an invasion.  Get this: It’s an “uncontested arrival.”

You know, just like the Rhineland, the Anschluss,  the Sudetenland, Estonia, Latvia, Lithuania, etc.

Only Orwell can do justice to such a monstrous formulation:

“Political language is designed to make lies sound truthful and murder respectable, and to give an appearance of solidity to pure wind. ”

This administration will stop at nothing to avoid confronting Putin in any way, shape, or form.

Reading such Orwellian formulations as “uncontested arrival,” Putin will conclude that the US will not even put a speed bump in his path, which will only encourage him.  In Ukraine, definitely.  But maybe not just there.  He also itches to settle the Baltics’ hash.

This is very dangerous.  Eventually political pressure or a Jimmy Carter circa December, 1979-like realization will compel Obama to do something, as much as he rebels against the very idea.  This is exactly the way things can spin out of control.  Far better to be stalwart upfront, then reactive later on.

But hey.  Who am I to harsh The One’s happy hour?

Putin dramatically escalated the situation in Crimea over the last 24 hours, sending in troops to occupy airports, blockading roads, surrounding Ukrainian border posts, and cutting off phone and internet communications.

Russia denies its troops are involved.  What, is this the Immaculate Occupation?  Or are these aliens that descended on Crimea?  (One story is that these are actually Russian private contractors, rather than military troops.  But they are still taking the Tsar’s ruble.  That’s all that matters.)

And I am sure you will be shocked, but the US response is feckless.

The White House drew another line.  I kid you not:

“We are watching to see … whether or not Russia is doing anything that might be crossing the line in any way,” White House press secretary Jay Carney told reporters Friday. “We made clear that the U.S. supports the territorial integrity of Ukraine and the sovereignty of Ukraine. We have made clear to Russia that we believe it would be a grave mistake to intervene in any way. We obviously have and will continue to have direct communication with Russian government officials.”

Again with the lines.  Now Putin knows we’ll do nothing.

Later, Carney even refused to name Russia: he said an “outside country” had occupied parts of Crimea.  Maybe it was Albania. Or Andorra.

Kerry had his 1000th conversation with Lavrov: the first 999 were so productive! Just ask the Syrians.

He tweeted afterwards that he told Lavrov that “territorial integrity and economic stability are in everyone’s interest.” Lavrov-and Putin-quite obviously disagree, if they are the ones violating territorial integrity, and have the track record to prove it.

Later Samantha Power said that the US was gravely concerned.  Gravely is about right, because our credibility is being buried day after day.  Obama then appeared, and read a brief statement.  He didn’t even make it to “gravely”: he is just “deeply” concerned.  He said that Russia faced unspecified costs, and like Kerry, presumed to lecture Putin on what was in Russia’s interests, even though Russia’s actions clearly indicate it takes a very different view of those interests.

In my opinion, Putin is pushing to see how far he can go.  He is getting no pushback, so he will continue to push more.  Obama certainly shows no appetite to push back.

And speaking of appetite, there’s a Russian proverb that the appetite comes with the eating.  He has taken a big bite out of the Crimea, and as of yet, there is nothing to stop him for coming back for seconds and thirds.  Certainly not the US, and certainly not Europe (especially Germany).

As I said throughout.  Ukrainians are on their own.  The feckless West will do nothing of substance to drag Putin away from the table, and he will feast on Ukraine piece by piece in the coming weeks and months.

Update: Obama does have his priorities.  He rushed off after his perfunctory statement (taking no questions), so he could give a speech at the DNC.  Obama: leading his party from the front; leading the world from behind.  Way behind.

The Russian Ministry of Foreign Affairs’ Twitter timeline has to be read to be believed.  Some words that come to mind: chutzpah, irony, projection.   Some samples: “Russia advises everyone to give up provocative statements on Ukraine.”  “Russia calls on Ukraine to avoid religion based conflicts.” (Recall the earlier MFA statement about violations of Orthodoxy-meaning that the MFA was injecting religion.) “Lavrov urged OSCE to condemn growing nationalist sentiment in Ukraine.”  “Russia urges West to realize responsibility for #Ukraine’s failed peace deal.”  (The latter tweet is directed to the German, French, and Polish foreign ministries.)

The world petroleum market is undergoing substantial organizational changes, with private oil companies become progressively less vertically integrated and increasingly focused on the upstream.  The latest indicator of this trend is that Chevron is investigating the possibility of divesting its midstream operation.  This follows hard on the heels of the sale of Shell’s midstream and downstream operations in Australia to Vitol (bonus SWP quotes in the linked Reuters article).

This represents an interesting case study in transactions cost/Coasian economics.  In particular, the development of vibrant spot and forward markets for crude oil and petroleum products, and the growth and development of specialized trading firms (like Vitol, Trafigura, and Glencore) have reduced the costs of transacting on the market via the price system relative to the costs of conducting transactions within integrated firms.  Given the existence of thick, liquid, and active spot markets, and the development of logistical expertise by trading firms, assets at a particular stage of the value chain are less subject to holdup by owners of assets at adjacent links of the chain.  For instance, the existence of highly competitive spot markets for crude means that a refinery is  not locked into a small number of upstream suppliers, and thus need not be integrated with a source of crude supply to avoid contractual hazards.  The existence of active product markets has a similar effect.

It is interesting to note that much of the recent disintegration is occurring in smaller markets, and emerging markets, where contracting hazards have historically been particularly acute.  But this is precisely where the trading firms (notably Trafigura and Vitol) have stepped in and acquired assets from oil majors.

This evolution allows the majors to free up capital that they can employ in higher returning-and massively expensive-upstream exploration, development, and production activities.

I said that this was an illustration of transactions cost/Coasian economics in action.  As in most things economic, Adam Smith should really get the credit.  He noted that the division of labor (i.e., specialization) is limited by the extent of the market: Stigler used this insight to explain vertical integration.  The past thirty years have seen the development of a very extensive and vibrant market for oil and refined products (with Marc Rich deserving much of the credit for starting the process).  This spot market facilitates specialization, with the petroleum markets being increasingly characterized by firms that specialize in upstream, midstream, or downstream activities.

Interestingly, this development creates political and regulatory battles, as specialized firms at different segments of the value chain use political and regulatory means to capture a bigger share of the value of a barrel (pace the new battle over US crude oil exports).

Markets in action are a beautiful thing to behold.  Politics not so much.

The situation in Ukraine continues to be fraught.  The Rada is quite predictably having difficulties forming a government, even though every moment without one delays the country’s ability to deal with a looming economic crisis.  Many in the Euromaidan movement are deeply suspicious that what will emerge from the legislative haggling will be a case of Meet the New Boss, Same as the Old Boss.  Pro-Ukrainian Tatars scuffled and then routed a group of pro-Russian demonstrators in front of the Crimean parliament.

In other words, the typical chaos of a revolution.

Though Putin remains silent, other Russian rhetoric is vituperative and hysterical.  Most notably, the Foreign Ministry-you know, the entity that is supposed to be where suave diplomats craft high sounding language-more resembles  an agitprop outlet.  You really have to read the whole thing to get the full effect.

One thing jumped out at me:

We are deeply concerned about the actions in the Ukrainian Verkhovna Rada in terms of their legitimacy. Actually referring to the “revolutionary appropriateness” only, they are stamping “decisions” and “laws”, including those aimed at deprivation of humanitarian rights of Russians and other national minorities living in Ukraine.

There are calls to prohibition the Russian language almost fully, lustration, liquidation of parties and organisations, closing of undesirable mass media, removal of restrictions for propaganda of Nao-Nazi ideology.

The course is to suppress those, who do not agree to this, in different Ukrainian regions by dictatorship and even terrorist methods.

There are threats to Orthodox sanctities.

Note the assertion that Russians are a national minority group in Ukraine.  This lays the predicate for future Russian government intervention in the country, in a  sort of Sudetenland strategy.  Also note the invocation of “Orthodox sanctities.”

This is right out of the 1830s, the age of Nicholas I, who stood for Autocracy, Orthodoxy, and Nationality.  There it is, all in one MFA statement.

Nicholas I backed his words with bayonets and sabers, notably in Poland and Bessarabia.  Today Russia rattled sabers, putting troops amounting to about one-third of the Russian Army on alert in the western part of the country.  Notably, the troops included “airborne troops and long-range military transport aircraft,” the very units that would be used to intervene in Ukraine.

I don’t believe anything is imminent.  But nor do I believe Defense Minister Shoigu’s risible statement that the alert has nothing to do with Ukraine.  Using alerts and maneuvers is a time-tested way of sending signals about capabilities and intent.  That’s what is happening here.  It is a way of showing that there are forces to back up the Foreign Ministry’s words.

Given the chaos in Ukraine, Putin has many measures short of war that he can use to influence the situation.  Economic pressure: yesterday Russia invoked health fears relating to African swine flu to threaten an embargo on Ukrainian agricultural imports.  The Russians cast doubt on the ability of the Ukrainian government to maintain safety standards in light of the ongoing chaos.  Gas.  Bribery.  Fomenting civil strife in Crimea and other areas with large populations of Russian speakers.  Fomenting conflict within the Rada (never a difficult task: given the prevalence of fisticuffs there Klitschko should feel right at home).

I anticipate that Russia will engage in a full-spectrum campaign using all of these measures to achieve the long term project of bringing Ukraine to heel.  Military action is not imminent, but the creation of the predicate for intervention and the demonstration of the ability to undertake it is clearly intended to intimidate Ukraine, and to keep it from getting too close to the west and to deter it from acting too aggressively in response to other Russian provocations.

Remember that Russia did not roll into South Ossetia or Abkhazi precipitously.  That only followed a long campaign of active measures within these regions, blood curdling rhetoric directed at the Georgian government, political operations within Georgia, and a steady campaign of military measures short of war (e.g., shooting down Georgian drones, building military roads and railroads to the border of the disputed territories).

Anticipate similar pressures here.  Ukraine is in for a long battle against an implacable foe, one who is no doubt all the more determined to avenge the humiliation suffered at the very time he expected to bask in the glory of a successful Olympics.

Russell Gold has an  interesting piece about Bakken crude, specifically, its highly volatile nature.  This volatility makes it particularly dangerous to transport, especially by rail: due to its volatility, it is prone to explode in the event of a derailment or collision.

Further illustration, as if any were needed, that oil is not all alike.  Crude is a mixture of various hydrocarbons (and impurities), and different crudes are different mixtures.  Some are very light-almost like gasoline.  Some are very heavy-almost like asphalt. Different crudes present different challenges to refine-and different dangers to produce, transport, store, and refine.

My prediction is that this will result in some technical innovation that will make crude more amenable to transportation.  Maybe some sort of processing at the rail terminals.

This also brings to mind (mine, anyways) a historical episode.  In mid-1944, the Imperial Japanese Navy was tethered to bases in Indonesia, due to the ravaging of its tanker fleet by American submarines: fuel was available in Indonesia.

And a very special kind of fuel.  Crude produced on Tarakan Island was sufficiently light that it could be burned in ship boilers without refining.  One problem was that the crude was also sour (i.e., had a high sulphur content) and this corroded boiler tubes.

But the bigger problem was that it was very volatile, due to the large quantity of naphtha in the Tarakan crude.  This proved to be deadly to the IJN carriers Taiho and Shokaku (a veteran of Pearl Harbor) during the decisive Battle of the Philippine Sea (waged during the US invasion of Saipan).  When these ships were torpedoed by American submarines, the highly volatile fuel (and the vapors from aviation fuel leaking from ruptured tanks) eventually ignited, turning the ships into huge infernos.  The fuel eventually exploded, obliterating the huge carriers with massive losses of life. (Poor damage control on Taiho contributed to its destruction.)

Oil is not to be trifled with.  Which makes it all the more amazing how much is transported, stored, and consumed without incident.  Yes, Bakken presents challenges, but I am sure that economic imperatives (liability, the desire to avoid seeing valuable oil go up in flames, and yes, regulation) will result in adequate precautions and technical innovations that will substantially reduce the risks.  Desperation made the Japanese carriers fatal run risks with the oil they burned: we are not so desperate.

Russia is distributing passports in Crimea. Particularly ominous in light of Medvedev’s shrieks about Ukrainian oppression of “Russians.”  This was a Russian stratagem before the Russo-Georgian War, allowing Russia to claim that it was invading to protect Russian citizens.

Russian special forces reinforce Sevastopol, and adjacent areas on the Russian coastline:

Russia’s large landing ship Nikolai Filchenkov has arrived near the Russia Black Sea Fleet’s base at Sevastopol, which Russia has leased from Ukraine since the fall of the Soviet Union in 1991.

The ship is reported to be carrying as many as 200 soldiers and has joined four additional ship carrying an unknown amount of Special Forces troops. Flot.com also reported over the weekend that personnel from the 45th Airborne Special Forces unit and additional divisions had been airlifted into Anapa, a city on Russia’s Black Sea coastline.

Again, Russian armed intervention is not ordained.  But Putin and the Ставка are assembling the forces, and building the case to use them.

But I’m sure one more Kerry call to Lavrov will make everything copacetic.

Although some have expressed relief that Russian tanks have yet to roll into Ukraine, and taken note of the absence of a Putin rant, and from this concluded that Russia will respond to the events in the country in a patient, benign and constructive way, such a judgment is wildly premature.

The only certainty in the situation currently prevailing in Ukraine is wild uncertainty.  And as real options theory teaches, typically the best alternative in such a situation is to wait and see how things develop.  Putin may not think explicitly in such terms, but he is a savvy enough customer to understand that fools rush in where angels fear to tread.  So I think he is biding his time.

He also realizes that it is best for the supreme leader to remain silent in such circumstances, so as to not commit himself prematurely, and to permit him to keep his future options open.

But his placemen and proxies are shrieking apocalyptic descriptions of the situation in Ukraine, thereby laying the predicate for future Russian intervention of some form. Lavrov has vented to Kerry and European foreign ministers.  The Russian Foreign Ministry released a statement roundly condemning in harsh terms the new government in Ukraine and the process by which it took power.  Medvedev also sharply criticized the process and outcome by which the opposition seized power.  Medvedev also warns that the opposition has threatened Russians and Russian interests.  Medvedev and the FM blame the West for meddling and taking a hand in overthrowing the legitimate government of Ukraine.

There are several themes here.  Most notably, that the opposition reneged on a duly authorized agreement with Yanukovych, and hence their seizure of power is illegitimate and the government is illegitimate.  Moreover, the Russian government officials routinely portray the opposition as balaclava wearing (there’s irony for you!), Kalashnikov brandishing (more irony!) thugs and terrorists and pogromists and tools of the West.

This is all right out of the standard Russian playbook for establishing the justification for armed intervention.  Just look at Chechnya (both in 1994 and 1999) and South Ossetia and Abkhazia.  They checked all the same boxes then.

I am not saying that the tanks will inevitably roll.  But Russia is building the case to justify it.  This is also useful in justifying other actions short of war, including particularly economic pressure (embargoes on Ukrainian goods from the entire Eurasian Union, cutoffs of gas and oil).

Yanukovych’s whereabouts are unknown.  (As I tweeted Friday: “Where in the world is Victor Yanukovych?”)  Current rumor has him in Russian hands.

Putin no doubts despises Yanuk, not least for blowing the management of the situation in Ukraine (though Putin himself is almost surely primarily culpable-but that can’t be admitted, can it?).  But he is the elected President of Ukraine, and the Russians will say that he is the only legitimate authority in the country.  If they do roll in, Yanukovych will be in their baggage train.  Yes, in the event he will be discarded like last week’s leftover fish after he serves his purpose.  But right now he is the Russian’s main claim to legitimacy in Ukraine, and they have every interest of keeping him from the hands of the current government, which has indicted him for mass murder.

Things are still extremely fluid.  The Maidan has accomplished the easy part.  Now the real work begins, and given the debilitating legacy of the Soviet experience, the country’s pervasive corruption, and its lack of any credible institutions, the prospects for a easy transition are bleak indeed.  Especially given that this transition will have to take place under substantial Russia pressure of one form or another.

The most pressing difficulty is economic.  The country’s debt is crushing, and reserves are short.  The US, EU, and IMF have pledged assistance, and their words need to be turned into deeds-and ducats.

One interesting angle here is that Russian banks have a substantial exposure to Ukrainian debt, public and private.  That represents a substantial source of leverage of Ukraine and the west, and a very real potential flashpoint in conflict between the new government and Russia.

If there is an online equivalent of writing blog posts in pencil, this is the time to use it.  Things are very volatile, and could change quickly.  It is precisely this volatility that makes it dangerous indeed to take a lack of Russian action as a sign of Putin’s acquiescence to defeat.  As I said the other day, what has just transpired is the end of the beginning.  And to mix military aphorisms, Vladimir Putin has not yet begun to fight.

Given the actions of the Rada in Ukraine and the flight of the regime leadership to Harkiv, it is evident that (a) the Russian financial assistance that barely kept the country aloft financially will end, and (b) Russia will engage in economic warfare against the country (even if it does not engage in armed warfare).   Thus, Ukraine faces economic collapse.

This is something that the west-the EU and the US-and international organizations-notably the IMF-can prevent.  It’s only a matter of money.   Emergency economic assistance is imperative.

Concerned about the cost? Don’t be penny-wise, and pound foolish.

And one hopes that after its bitter experience in the past, that Europe has contingency plans in place to respond to a Russian cutoff of gas.  Not just gas going through Ukraine, but through Nordstream as well.  For Russia is blaming Europe for what is happening in Ukraine.  A full cutoff would cut against Gazprom’s interests (and hence the interests of the Russian power structures which feed off it), but the stakes in Ukraine are big enough for Putin that he could well consider that a price worth paying if he believes it will stampede the Europeans into abandoning the opposition-or, I should say, the new government in Ukraine.

Putin is playing for keeps, and this setback to his schemes will only enrage him and steel his resolve to prevail.  He will pull economic levers to do so.  The west should pull the economic levers of its own.