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The Politico-Economic origins of Germany’s natural gas dependency on Russia

December 20, 2022
By CGC
Insight & Analysis,The Cold War Project
Photo Courtesy: Financial Times

By Yash Singh on December 20, 2022

Introduction 

The build-up of political and military tensions between Russia and Ukraine for the past year over Kiev’s prospective membership of the North Atlantic Treaty Organisation (NATO) precipitated a military action by Moscow. Russia invaded Ukraine on 24th February as President Putin accused NATO of turning its neighbour into a hotbed of ““hostile anti-Russia on our own historical territories” … to attack Russia”. (Seddon, 2022) As per reports (Reuters, 2022a), the G7 member nations, led by the U.S., and the E.U., continue to impose a range of strict economic and political sanctions on Moscow as means of retaliation to hurt its economy and deter any further Russian aggression. However, Russia’s largest source of hard currency (i.e. its energy exports) was exempted as the industrialised E.U. countries are significantly dependent on oil, gas and coal imports from Russia. Energy imports from Russia to Europe were composed of 43% of gas, 29% of (extra-EU) crude oil and 54% of coal in 2020 (Eurostat, 2020a).

Focusing on this critical energy trade, the country under research for this paper is Germany, Europe’s largest economy. Berlin’s hydrocarbon imports from Russia outsize its E.U. counterparts both in terms of volume and revenue. In 2020, Germany imported 66.1% (in terms of Gross Calorific Value) of natural gas imports from the Russian Federation (Eurostat, 2020b). In 2021, Russian exports fulfilled Germany’s 35% of oil, 50% of hard coal and 55% of natural gas requirements (Smith, 2022). Moscow’s annual revenue from energy exports in 2021 was USD 244.2 billion and is projected to be USD 337.5 billion in 2022 (Reuters, 2022b). If Germany’s such profound reliance was considered risky before the war, Belin’s energy policies have come under huge scrutiny and criticism amid calls for the de-hyphenation of its economy from Russian hydrocarbons. Revenue from energy exports has been identified and designated as the most critical source of income that has been powering Russia’s war machine. In the first two months of the invasion, Germany alone bought 9.1 billion euros for fossil fuel imports from Russia, predominantly natural gas (Chadha, 2022).

As the western sanctions unfolded, President Putin implemented geo-economic policies to blunt their impact on the Russian economy. Moscow weaponised this energy dependency by forcing European governments to buy its hydrocarbon imports in rubles (to lift its currency) or face cuts in energy supply. Russia has also reportedly used the threat of energy cuts to deter/discourage any further political/military support to Ukraine by the E.U. to resist the invasion. The shutdown of Nord Stream-1 on 5th September 2022 has been attributed to Moscow’s hawkish policies. These acts of geo-economics have instilled volatility in global energy markets (especially gas), given Russia was the global leader in natural gas exports in 2021. Russia exported 241.3 billion cubic meters (bcm) of gas of which 201.7 bcm was via the vast pipeline system to Europe (Statista, 2022).

The recurrent threats of supply cuts along with the plausible sanctioning of Russian energy have soared the cost of energy across Europe. Germany, being the economic powerhouse of the continent, risks plunging the entire Union into recession as inflation impacts its economic productivity. Given gas is predominantly used in Germany by industries (36%) and for household heating/cooking (31%), the country risks lengthy periods of inflation, job losses and a decrease in living standards (per-capita income). The invasion is likely to cost 3% points of GDP growth in 2022, with the economic impact lasting till 2025 (Reuters, 2022c). Such structural damage to the economy threatens large-scale deindustrialisation of the country in the long term if stable, cost-effective import substitutes are not identified quickly. This economic scenario will negatively impact the Union and may create political fissures within the united front that Europe has put up to punish Russia for its military acts. 

Hence, a question arises: how and why did such a profound  political and economic perilous dependency of Germany on Russian energy originate? The answer takes us back to the Cold War period in the late 1960s. Undertaking a qualitative content analysis of the available literature on the history of German-Soviet economic and political relations, the paper outlines two prime motivating factors: on the one hand, the policy of “Neue Ostpolitik” implemented by then West German Chancellor, Willy Brandt to pursue close economic ties with the Soviets; and the other hand, the economic imperatives of the Soviet Union which compelled Moscow to thaw its trade relations with Bonn. These two independent variables unravelled in synergy thereby interlocking the supply-demand dynamics of hydrocarbons between Moscow and Bonn respectively.

 

Willy Brandt’s Ostpolitik

Ostpolitik or “Eastern Policy” was a Cold War-era approach during the 1960s implemented by the Federal Republic of Germany (hereafter referred to as FRG) to pursue closer economic and political relations with countries in eastern Europe and the USSR. Though this was not a new concept in FRG’s foreign policy, Brandt’s Chancellorship altered its blueprint to pursue a policy of détente towards the east, independent of NATO/U.S. influence. Under the previous administrations of Ludwig Erhard and Kurt Kiesinger, Ostpolitik was employed to pursue closer political and economic relations with the eastern Europe countries using economic incentives to build secure political connections. This policy involved the renunciation of the Hallstein Doctrine, a policy which precluded diplomatic relations with any country that recognised East Germany (German Democratic Republic/GDR). In January 1967, the FRG established relations with Romania, followed by Yugoslavia in December of the same year. Moscow interpreted these manoeuvres as Bonn’s contrivance to weaken the Warsaw Pact solidarity by empowering and encouraging the political agencies of these countries to make sovereign foreign policy decisions. In response, the USSR led a meeting of European communist parties in Karlovy Vary in April 1967 where it was proclaimed that “no other member of the Warsaw Pact would establish diplomatic relations with the FRG until the GDR was officially recognized” (Stent, 1981, p.150).

Czechoslovakia, under the reformist leadership of Alexander Dubček, also decided to pursue a pragmatic policy of reconciliations towards the FRG. “In their Action Program of April 1968, the Czech reformers took a more flexible stand on the FRG, supporting improved relations with “realistic” forces within West Germany” (Stent, 1981, p.151). Bonn and Czechoslovakia thus signed a trade deal in August 1967. But Moscow saw this period of reformation and political liberalisation (commonly known as ‘Prague Spring’) as a threat to its sphere of influence. As a consequence, the Warsaw Pact invaded Czechoslovakia in August 1968. Stent (1981) mentions that the USSR justified the invasion as an act to preclude FRG’s attempt to break the ‘Warsaw Pact’ by corrupting Prague to join the West. This purportedly forced the Czechoslovakian political class to request Moscow for an intervention. Even though Erhard and Kiesinger’s administrations desired détente with the east, including the USSR, the acquiesce of Moscow to Bonn’s sovereignty over West Berlin and the agreement over an imminent German unification was a sine-qua-non for any political and/or trade treaty. 

Nevertheless, Moscow’s preconditions for a normalised relation with the FRG was the de jure recognition of GDR and post-WWII political boundaries, including the Oder-Neisse line which demarcated Poland’s western border. The USSR, under the leadership of Leonid Brezhnev, had reverted to belligerence towards the FRG in 1964 after a brief period of attempts at rapprochement during the final days of the Khrushchev-era. The Soviets wanted to consolidate their leadership and strengthen the socialist solidarity within the Warsaw Pact. The threat of alleged revanchism of the FRG was a significant raison d’être to discipline the Warsaw Pact members as the “uncompromising hostility towards [Bonn]… had for so long been one of the linchpins of Soviet foreign policy” (Stent, 1981, p.147). Brezhnev went as far as calling the FRG “Soviet Union’s main enemy in Europe” (Hogselius, 2013, p.68). The Czechoslovakia invasion convinced Willy Brandt, then Foreign Minister in Kiesinger’s government, that any attempt to establish political and economic linkages with eastern Europe must have Moscow’s prior approval (Sarotte, 2001, p. 35).

According to Hogselius (2013, p. 105), declaring the USSR as a pariah state after the Czech invasion was not the preferred policy choice for the West, including the FRG. Rather, the post-invasion dynamics provided a perfect opportunity for Bonn to leverage the insecurity of Soviet policymakers vis-à-vis fears of global isolation as well as their desire “to restore its legitimacy and reputation…” (Hogselius, 2013, p.105). This strategy also took inspiration from the structural change in NATO that was symbolised by the “Harmel Report” of December 1967. The report called for the “NATO to pursue détente with the Warsaw Pact while continuing its traditional security role” (Sarotte, 2001, p. 35). This report was endorsed by US President Lyndon Johnson as well as his influential French counterpart Charles de Gaulle. According to Werner Lippert (2011), the Harmel report interpreted détente and military security as two mutually influencing factors that can usher in an era of diplomacy and peace in Europe. He further states that the advent of nuclear parity in the 1960s and the resultant stalemate raised questions on Washington’s commitment to come to the rescue of its western European allies, especially the FRG, in case of a Soviet (-backed) invasion. 

Brandt fully comprehended these systemic changes: “[His]…  initiatives focused on using the nuclear stalemate between the superpowers to Germany’s advantage” (Lippert, 2011, p.16). Even though his military policy pivoted towards the West, he aimed to leverage this parity to carve out a diplomatic space to build crucial economic and political linkages with the USSR. This policy materialised in the form of decoupling between the FRG’s military commitments and economic priorities in the realm of foreign policy. This decoupling had rational bases in history. In 1962, the North Atlantic Council banned the export of large-diameter steel pipes to the USSR. This was seen as a passive sanction on the Druzhba oil pipeline which was being built primarily to transport oil from the USSR to its Warsaw Pact allies. NATO had interpreted the pipeline as a strategic move by Moscow to seek avenues “to export… crude to Western Europe and… expand its economic leverage with NATO countries, especially [Bonn]…” (Flade, 2017). He further mentions that the pipes were essentially being imported from the FRG. 

From Moscow’s perspective, this further aggravated the sentiments of mis-trust and suspicion with the West as the pipeline was a vehicle to consolidate its trade position in eastern Europe. It also reinforced the image of Bonn as a revanchist power and NATO’s premier foot soldier against the “prosperity” of the eastern bloc. With Brezhnev’s inherent suspicion of Bonn, the FRG’s role in the pipe embargo and the dreadlock over key political issues (Berlin clause, renunciation of force, German reunification), Brandt turned to no-strings-attached economic linkages to thaw the relations. The difference here was that unlike the Ostpolitik of his predecessors, agreements on critical political issues became the ends rather than the means of the strong confidence-building initiatives in the economic realm. As per Brandt, the prerequisites for agreements on the desired German unification were strong economic and resultant political linkages transcending the Iron Curtain. Such a policy was to be carried out without challenging Moscow’s pre-eminence in the Eastern Bloc. He employed geo-economics by leveraging the FRG’s industrialised economy to lure Moscow into trade relations. 

Unlike his predecessors, who either employed trade restrictions against Moscow as a tool for political concessions or circumvented the Soviets to build linkages with eastern Europe, Brandt punted on a strong Bonn-Moscow trade relation as the key anchor of his Neue (New) Ostpolitik. “The FRG was in no position to offer a meaningful military or strategic concession [immediately] that in and of itself could have enticed the Soviet Union to pursue détente” (Lippert, 2011). Hence, Brandt chose economic linkages to legitimise the USSR as a systemic actor in the international system of states by de-securitising the bilateral relations. In his inaugural address to the Bundestag as the Chancellor in 1969, Brandt claimed that “the German people need peace in the full sense of the word, also with the peoples of the Soviet Union and all the peoples of Eastern Europe” (Lippert, 2011, p. 45).

Brandt wanted to leverage the reduced threat perception of the USSR which, as quoted by Lippert (2011), had dipped to an all-time low of 7% in September 1969. Simply speaking, Brandt was pre-empting any sharp criticism of a possible future economic/political treaty, with concession, to the USSR aimed at building bilateral trust. According to Stent (1981), Brandt implied that Bonn will have to compromise on the Odor-Nisse line as well as push the reunification agreement into the future instead of inserting it as a prerequisite to conclude economic agreements with Moscow. Such concessions fitted well with the Soviet demands of dropping the Berlin Clause in any trade agreement (Stent, 1981). Brandt’s opinion on economic linkages as leverage was backed by his close advisor, Egon Bahr. As Von Dannenberg (2008) notes, Bahr believed that significant progress in the economic aspect may create favourable conditions for political rapprochement. To realise his aspirations, Brandt looked for avenues for close economic cooperation.

Because of a lack of a trade deal with Moscow, Stent (1981) mentions that Bonn ran a negative trade balance with the USSR for every year since 1963. The FRG’s major exports to the USSR were machinery and ships. The major imports from the USSR were petroleum derivatives (kerosene, heating oil) and wood products. Soviet Metallurgy, owing to its inferior quality, did not have a huge demand in the western market. Brandt understood that a strong economic partnership required a healthy yet balanced trade where both sides recognised the stakes in terms of maintaining such linkages to support domestic labour-intensive industries and earn crucial hard currency. This is crucial given that trade with the FRG, she further notes, made up only 2.18% of its total trade. 

As part to build economic linkages with the Soviets, Foreign Minister Brandt had invited the Soviet trade Minister Nikolai Patolichev to the Hannover trade fair in the summer of 1969 which was accepted by the latter. This invitation was seen as Brandt acting in the spirit of the Budapest Declaration of the Warsaw Pact in March 1969. One of the key emphases of the declaration was European cooperation based on infrastructural linkages. Lippert (2011) mentions that trade Minister Patolichev offered to export heating oil, the only petroleum product that the Soviets produced in abundance, but the saturated German market has no space for the import quota. However, “… the German proposals for cooperation led to the development of another…  export commodity: natural gas” (Lippert, 2011, p. 13). Brandt grabbed the opportunity immediately. The tentative policy to import natural gas is critical. As Hogselius (2013) mentions, natural gas contributed to only 2% of the energy supply in Germany in 1965. Also, the FRG had a sufficient supply of energy sources as it had abundant coal and significant gas deposits in the northern part of the country, along with ample gas deposits in the neighbouring Netherlands. 

The Ministry of Economy, in coordination with the Federal Geological Survey, clarified that “gas consumption in Germany by 1975 [will reach] 25–28 bcm and perhaps 37–40 bcm by 1980; 11 bcm of the latter had already been contracted with the Netherlands… but 7–10 bcm still remained to be sourced… there was ample room for Soviet gas on the German market” (Hogselius, 2013). He also mentions that natural gas was quickly becoming the choice of energy source across the coal-dominated FRG. The deal nevertheless faced stiff opposition from the domestic gas producers and distributors as the Soviets, Stent (1981) mentions, were ready to supply gas at a competitive price compared to the Dutch suppliers. Nevertheless, Brandt, backed by his close aide Bahr, pushed for the deal through his personalised and statist approach to policy-making and execution. “Brandt assigned execution of foreign policy to a trusted subordinate outside of the institutionalized policy making structure” (Sarotte, 2011, p. 47). Even though the Organisation theory suggests that the bureaucratic inertia, especially the conservative segments, attempted to impede the deal, Brandt’s zeal for his Ostpolitik made him oversee it going through. This is true especially after he became the chancellor in October 1969. 

After exhaustive negotiations, gas firm Ruhrgas signed the deal with the Soviets to import 3 bcm of natural gas annually, with an option to increase the flow to 5 bcm per year. The deliveries were set to begin from 1st October 1973. For the supply of the pipelines, “The main producer was to be a new joint subsidiary of Mannesmann and Thyssen—Mannesmann-Röhrenwerke…” (Hogselius, 2013, p.121). To make the deal lucrative for the Soviets, Bonn under Brandt’s government subsidised the credits offered from private lenders to the Soviets to build the necessary infrastructure. The FRG agreed to provide a guarantee for half of the credits. The loan was to be paid by the Soviets at an attractive 6.5% interest rate, below the market rate of 9%. Such a generous offer “was yet another confirmation of the perceived political importance for Bonn of actually agreeing with the Soviets” (Hogselius, 2013, p. 122). The deal was formally signed on 1st February 1970. This pipeline system, delivering gas from Orenburg to Germany evolved into what is today known as the Soyuz pipeline system. With the signing of the Moscow Treaty in 1970 and the Basic Treaty (mutual recognition by both the German states) in 1972, energy linkage as a basis of reconciliation policy was considered a success. It was reinforced by the commissioning of new gas pipelines over the years that altered the energy basket as well as the supply-demand characteristics of hydrocarbons in western European countries.

 

The Soviet economic dilemma 

The natural gas deal between Bonn and Moscow can be perfectly described by the proverb “It took two hands to clap”. As mentioned above, the Soviet trade minister proposed the supply of natural gas at the 1969 Hannover trade fair to the German representatives. However, considering that the Soviet Union always refused trade arrangements with Bonn up until April 1968 (Lipper, 2011), why did the Soviets turn around and seek economic linkages with the FRG? 

First and foremost, the Soviet economy slowed down in the latter half of the 1960s: it grew at 8.6 percent in 1967 and the growth dropped to 6.1% in 1969 (Stent, 1981). The prevalence of bureaucratic red-tape in the country’s economy, its centralised planning system and the resultant control over the market forces meant that there were fewer incentives for private enterprises to flourish. This was true “particularly in fields of advanced technology such as electronics and computers, partly because the military sector siphoned off the USSR’s most efficient economic effort” (Stent, 1981, p. 188). Lack of innovations had particularly impacted the agricultural sector on which Brezhnev laid a great emphasis (Lippert, 2011). An agricultural crisis in 1963 and a lack of significant investment in this sector (harvesting equipment, yield technology and storage logistics) meant that the government had to import large amounts of agricultural produce from the west at the expense of the hard currency: “as debt ceilings climbed, the Soviets looked more and more toward energy sales as the means to finance trade” (Lippert, 2011, p. 69). Moreover, with the advent of the 9th Five-Year-Plan (1971-1975), the Soviets wanted a secure source of hard currency along with access to favourable credits from western financial institutions to import key technologies to revolutionise its industries, especially agriculture. Food self-sufficiency was critical to the legitimacy of the communist regime and the lack of investments in agriculture threatened the country’s social stability. Interestingly, Dannenberg (2008, p. 213) quotes that Walter Scheel, a close aide of Brandt, recognised that it was Moscow’s economic imperatives which was forcing it into such a partnership. 

The USSR’s seemingly perpetual deficiency of hard currency was a result of its export patterns. Zolotarev (1968) quotes that Moscow’s major trading partners in 1965 were the socialist countries with which the trade figure amounted to 10,048 million Rubles or 68% of total foreign trade. Trade with these countries, which included eastern European states, was mostly settled either in local currency or barter system. He further explained that fuel and electricity (17.2%), plant and equipment (20%) and metal ores and goods (21.6%) comprised the major exports. However, as abovementioned, the lack of competitiveness of Soviet machinery exports meant that the market for these goods was limited to its allies. Crude and petroleum products, which were the potential source of hard currency, were mostly exported to eastern European countries at subsidised rates. This energy-for-machinery/equipment barter trade between the USSR and its fellow Council for Mutual Economic Assistance (CMEA) members, albeit to consolidate Moscow’s pre-eminence and the de-facto rank leader of the Soviet Bloc, had come at an enormous cost. Ivan T. Berend (2006) quotes that Moscow provided the CMEA partners USD 30-70 billion over the years via price caps and subsidies via the price system that cushioned the fluctuating energy rates. The price system, which decided the oil price every fifth year based on the average oil prices over the past five years, had put Moscow in an economically disadvantageous situation. 

Like his predecessor, Brezhnev saw energy exports as critical to boosting foreign exchange. And an industrialised FRG was a perfect market to advertise its fuel export capability and itself as a stable energy provider. Brandt’s enthusiastic reception of the natural gas import proposition in 1969 might be one of the reasons behind Brezhnev supporting his chancellorship bid in the 1969 Federal elections (Fink, 2019). The unprofitability of energy exports compounded by high extraction costs of oil and gas meant that the USSR had to pursue economic linkages with the west, especially Bonn. But Moscow had no intention to agree to any economic or political concession as a sine-qua-non for the gas deal. “After the 1963 pipeline embargo… it was widely understood in German government circles that the Soviet Union was deliberately trying to freeze…  [Bilateral] trade” (Lippert, 2011, p. 8). Hence, the gas contract was designated as an innocuous, one-off deal that was isolated from the bilateral political dynamics with seemingly tangible benefits to both economies. As Stent notes (1981, p. 194), political stakes were uncompromisable for the Soviets and hence economic linkages were possible only if they were pursued in isolation. Therefore, Willy Brandt agreed to the prospective deal in 1969 in the hope that in the future “the political and economic rapprochement would reinforce each other” (Stent, 1981, p. 194). The Soviets thus expected that building an economic linkage with Bonn (the supposed prime enemy on the continent) might blunt Moscow’s diplomatic isolation post-Czech invasion and may spur trade with the rest of western Europe. 

 

Conclusion

The focus of the essay on the two abovementioned variables does not invalidate the significance of other factors. The supposed approval of the U.S. National Security Advisor Henry Kissinger for the gas deal; the Sino-Soviet split following the border clashes; the closure of the critical energy route i.e., the Suez Canal in 1967; the larger structure of the Cold War characterised by the pursual of détente and exemplified by the beginning of troop withdrawals from Vietnam, etc., were the intervening variables that acted as catalysts. However, Brandt’s Neue Ostpolitik, followed by the Soviet requirements for hard currency to import key technologies to increase its economic productivity, were identified as the two primary priorities pursued by respective governments. Hence, these two mutually reinforcing variables led to the conclusion of the gas deal thereby triggering the decades-long dependency of the German economy on Russian natural resources.      

 

References

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