A Bearish Economy: The Economics of Russian Aggression
In the early 1800’s Carl von Clausewitz, the father of modern military theory, wrote, “War is the continuation of politics by other means” (1832). Simply stated, war is a forcible way to meet a desired political end state. War in the classical sense is decisive set of violent engagements where oppositional forces “duke it out” until surrender is achieved. In the modern world, decisive conflict between state actors has become less acceptable and less violent. Today, more divisive, but still forcible approaches are being used to manipulate a desired political end state.
This first became apparent in the Cold War. Neither the Western nations nor the USSR were willing to commit to total war, and in 1991 the economic unity of the West was able to force USSR’s surrender and subsequent diaspora. The Cold War was not the only catalyst for economic unity, but for the purposes of this paper it important to understand that it did stimulate economic unity. It also furthered the political divide between the West (Americas, Europe, and Australia) and the East (Asia, Middle East). The need for strong allied fronts on both sides of the conflict invigorated globalization and global economy. After the fall of the Soviet Union in 1991, globalization continued fueled by technological advancement and the increased global demand for extraction commodities.
The interconnectivity of global economic markets and the dichotomy between the East and West directly led to a new type of conflict, coined “economic warfare”. Aircraft, ships, and tanks were replaced with sanctions, energy policy, and financial controls. Economic warfare can be understood through the lens of modern Russian aggression. Specifically, one must analyze: Russian economic objectives, trade agreements, hybrid use of both the economy and traditional forces in the Georgian and Ukraine, and the West’s economic response.
Russian aggression began in 2008, with the annexation of South Ossetia, Georgia. It continued through 2010-2012 utilizing aggressive trade agreements with Libya, Syria, and Iran that systematically relieved those countries of debt, proliferated defense systems (weapons), and gave Russia rights to extraction commodities (fossil fuels). In 2013-2014, Russian aggression peaked with the annexation of Crimea, Ukraine. This cost Ukraine nearly 20% of its Gross National Product (GNP), and gave Russia exploration rights to off-shore (Black Sea) oil repositories valued over three trillion dollars (Blank & Kim, 2016). A deeper analysis of Russia’s foreign and economic policy illuminates Russia’s primary economic objectives.
It was previously addressed that war is a forcible way to meet a political end state. Russia has three primary objectives (end states): reverse depopulation, gain economic leverage over the West, and tame the commodities market. All of these can be linked to Russia’s economic and foreign policy agenda.
As of 2016, Russia had a 1.18 death to birth ratio (Rybakovskii, 2013; Central Intelligence Agency, 2016). In layman’s terms, this means that for every four births five people die. The cause of Russian depopulation is attributed to poor healthcare, immigration, and low fertility rates. (Anderson, 2002; Rybakovskii, 2013). All of these causes can be attributed to the declining Russian economy. Russia has had two significant periods of economic decline.
The first period began in 1991 after the fall of the Soviet Union when its GDP was nearly cut in half (Chen, 2009). During this period the fertility rate in Russia fell by 48% to 1.23, which is below the population sustainability rate of 2.0 (Anderson, 2002). This can be directly attributed to the Russian economic decline that resulted increased food costs and a decrease in the social pro-natalist policy, such as paid maternity leave and housing proration for large families (Anderson, 2002; Rybakovskii, 2013). Additionally, there is a correlation between economic decline and increased mortality rates (Anderson, 2002; Rybakovskii, 2013). In the first period of economic decline Russia also experienced above average infant mortality rates, and declining life expectancy (Rybakovskii, 2013). Once again, this is attributed to the rising cost of food, and a decrease in both socialized health care availability and the governmental proration of energy.
Gaining Economic Leverage
Russia responded to the first crisis by creating an economic growth model that was reliant on extraction commodities, specifically natural gas and oil. (Blank & Kim, 2016; Connolly, 2016; Gidadhubli, 2007; Park & Yun, 2010). It later became Europe’s primary source of petroleum and natural gas. Following this period, the Baltic and Balkan states became entirely reliant on Russian imported energy, and the Western states in Europe were receiving up to 50% of their energy from Russian imports (Blank & Kim, 2016). By 1999, the Russian economy had recovered and it economically boomed from 2000-2008 (Chen, 2009). This boom was due to the rapid rise in oil prices caused primarily by the destabilization of the Middle East (Blank & Kim, 2016; Connolly, 2016). During this time Russia was able to meet the demand of Western nations who paid up to 160 dollars per barrel (Goenner, 2007).
From 2000-2008, Russia benefited from sustained GDP growth of 12% annually. The real income per capita rose by 40% and Russia moved from the 12th to the 7th largest economy in the World (Chen, 2009). Growth during this time period was mainly due to the global commodity boom. Unfortunately, Russia failed to use this as an opportunity to diversify its commodities driven economy. Significant governmental entrance barriers for small businesses existed, and 30% of Russia GPD came from 23 firms, 20 of which were extraction based (Gidadhubli, 2007). In 2003, the government began purchasing large portions of the oil and natural gas industry. This allowed the Russian government to have strict oversight of these businesses which, as previously stated, supplied much of Europe with energy (Chen, 2009; Mau, 2016). Russian corporations continued to become increasingly state-run and, at the same time, began to develop ties to Western corporations. Russian gas and oil industry took out substantial loans from Western lenders in order to grow their corporations (Chen, 2009). Primarily this growth was seen in Europe and China which became the chief importers of Russian commodities (Mau, 2016; Gidadhubli, 2007). Western corporations and banks invested trillions of dollars in Russian corporations, but by Russian law, investors were not allowed to have controlling shares in the Russian corporations (Gidadhubli, 2007). During this time period, Russia was consolidating economic power and at the same time increasing its sphere of economic influence.
Experts disagree about the amount of Russian economic dependence on oil and gas exports. Russia will typically hide exports or categorize exported goods as other economic categories through the uses of sub-standard accounting practice (Goenner, 2007). According to Russia, oil exports accounted for only 9% of total GDP while economic analysts typically place oil as 20-30% of Russia’s GDP (Goenner, 2007). Experts do agree that Russia’s dependence on extraction commodities causes volatility in the Russian economy and drastically overvalues the long-term exchange rate of the Ruble (Chen, 2009; Goenner, 2007).
The global great recession took place from 2008-2010 and began impacting Russia in 2009. Russia saw a 15% decline in its GDP in only two quarters, due mainly to a drastic decline of oil prices that plummeted from 161 US dollars to 47 US dollars. Russia was also indirectly effected by US sub-prime mortgage crisis (Mau, 2016). The price of Russian oil plummeted by 54%, and several Western investors pulled out of the Russian Economy (Mau, 2016; Blank & Kim, 2016). These investors used currency options to lock in 2006-2007 level currency exchange rates. This compounded issues in the financial sector, and several Russian banks either defaulted or were at risk of defaulting prior to government intervention (Mau, 2016).
Taming the Commodities Market
Russia blamed Western nations for its economic decline. They believed that the US and other Western governments were responsible for encouraging investors to withdraw their investments as a response to the 2008 Russian Georgian War (Cornell, 2009). The US responded to Russia’s accusations stating that private investors had not been politically motivated (Connolly, 2016). Most likely the latter is true. Economic analysts agree that the Russian oil bust, in 2009, was due to the volatility of the commodities market (Mau, 2016; Rybakovskii, 2013). In 2007-2008, oil prices reached an all-time high and in response consumers purchased less oil (Blank & Kim, 2016; Cornell, 2009; Mau, 2016). In the US alone the demand decreased by 8% (Chen, 2009). Meanwhile, several members of OPEC (Organization of Petroleum Exporting Countries), whom Russia competes with, did not realize the effects of decreased oil demand and continued to produce and export oil (Chen, 2009). They continued to flood the market, even after the effects of declining demand were realized, due to their dependency on oil exports. (Chen, 2009). The decrease in demand and the continued supply of oil caused a fall in oil prices, and ultimately resulted in the Russian Recession of 2009 (Chen, 2009). Economist assert that large upward shifts in oil prices have historically correlated with recessions and plummeting oil prices (Mau, 2016).
From 2001-2008 Russia bought back about 60% of its international debt, and also managed to save or invest nearly 30% of tax revenues (Blank & Kim, 2016). This came at the cost of social projects and government subsidies specifically in agriculture and housing. The consumers fell victim to 20% increase in food, and a 100% increase in housing from 2005-2007 (Connolly, 2016). This caused inflation to increase to a high of 11% even during the economic boom (Anderson, 2002). In order to combat the inflation Russia began implementing governmental price controls on products, specifically national energy, believing that low energy prices would help to stimulate the economy and off-set the loss of governmental subsidies (Connolly, 2016). This forced the energy sector to make-up for the loss of revenue on the international market, thus making Russia even more reliant on international trade (Connolly, 2016; Blank & Kim, 2016).
Russia’s ability to save and invest revenue during the oil-boom period allowed it to weather the global great recession. The Russian Central Bank released over 500 billion rubles in order to slow the deflation (Blank & Kim, 2016). It used the money to purchase the debt of both the financial and energy sector effectively nationalizing private businesses (Blank & Kim, 2016). By the end of 2009, Russia was recovering from the recession, had nationalized the energy industry, and was still suffering from a decline in population due to a domestic policy that placed economic hardship on the Russian population. It had also successfully waged war with Georgia.
Russian Annexation of South Ossetia
The most publically supported history of Russo-Georgian conflict (in recent history) begins in 1990’s when Russian ethnic groups, predominantly in South Ossetia, started a revolt against Georgia. The Georgian government reacted violently and Russia entered the conflict in a mediation role. Russia was a chief international proponent for South Ossetia’s sovereignty and even recognized them as a self-governed state. Georgia never accepted South Ossetia’s Sovereignty, but it did reduce both military presence and the number of Georgian governmental officials in the region. In 2006, Russia issued passports to all Ethnic-Russian Georgian’s in South Ossetia, and it began a propaganda campaign against Georgia (Mau, 2016). The Ethnic-Russians began peaceful protest against Georgia. Russia then established a trade embargo on Georgia which resulted in the loss of 20% of Georgia’s GDP. On multiple occasion it ceased exportation of natural gas (Blank & Kim, 2016; Mau, 2016). Russia’s actions delegitimized the Georgian national government and led to more protests. In 2007, Russia began training exercises on the Georgian-Russian international boarder. In response to the Russian force projection Georgia stationed troops in South Ossetia for the first time in 17 years (Cornell, 2009). Russia called this a humanitarian disaster and responded with a high intensity conflict that resulted in the annexation of South Ossetia.
Economist are quick to point out that Russia may have had economic motivations for the annexation of South Ossetia. Georgia, Turkey, and Azerbaijan had agreed to establish twin pipelines in order to supply Europe with both Azerbaijan’s gas and oil (Cornell, 2009). The pipelines would have laid the foundations for economic reform in Georgia while allowing Europe to diversify imports. The Russian invasion of South Ossetia occurred ten days after the completion of the Baku natural gas pipeline and demonstrated that the West was unwilling or unable to prevent Russian aggression. Furthermore, it sent a message to Azerbaijan that Georgia was not stable. Following the invasion Azerbaijan diversified its exports and decided to invest heavily in in Asia (Cornell, 2009). Overall, this increased European dependency on Russian gas and oil (Blank & Kim, 2016). The Russian-Georgian conflict demonstrates three things: Russia’s ability to use economic weapons in a low intensity conflict; Russia’s ability to mobilize out-of-state Ethnic-Russians; and Russia’s willingness to use military force in order to maintain economic leverage on the West. All three are strategically significant to Russia’s aggressive foreign policy.
Russian Trade Agreements
At the culmination of the Russian-Georgian conflict (2008-2009) and the global recession (2009), Russia was left with an economy based on volatile extraction commodities and the harsh realization that Europe, the chief importer of those commodities, was attempting to diversify its imports. Economists agree that the best policy decision for Russian would have been to diversify the economy (Blank & Kim, 2016; Chen, 2009; Mau, 2016; Peterson & Drury, 2011). Even Russia realized that it needed to diversify its economy. (Blank & Kim, 2016). In 2010, it began aggressive trade agreements in the Middle East, Africa and Asia.
In the Middle East and Africa, Russia struck deals with Syria, Libya, and Iran. In Libya in 2010, Russia forgave four-billion dollars of debt in order to secure a defense systems trade agreement that also came with oil exploitation rights, use of railways, and use of the Benghazi sea port (Fasanotti, 2016). This would have been Russia’s only Mediterranean seaport. The Port and Railway agreements were cancelled in 2012 due to the Libyan civil war and Russia lost arms contracts when the United Nations’ established a ban on defense system exports to Libya (Fasanotti, 2016). Russia, however, still holds extensive oil exploration rights in Libya (Fasanotti, 2016). In Syria, Russia gained off shore oil and natural gas exploration rights in conjunction with arms deals (Borshcheveskaya, 2013). Syria is a major importer of Russian defense systems and has over the last five years has nearly tripled its imports due to the Syrian-Civil war that began with the 2011 Arab Spring (Kozhanov, 2016). In Iran, from 2012-2015, Russia publically backed Iranian nuclear research, increased arms trades and gained a 20-billion-dollar oil import contract (Trotman, 2014). The trade agreements are significant, because both Libya and Iran are OPEC members, and prior to 2014, OPEC retained significant price control over oil (Chen, 2009). Syria, while not a member, does provide crude oil to OPEC members for refinement and sale (Blank & Kim, 2016). It seems that Russia was actively attempting to gain political influence within OPEC, thereby extending its control over international oil prices. The effect of Russia’s economic policy and yet to be realized, because OPEC lost significant pricing power in 2014 after the advent of shale extraction. Shale extraction allowed the use previously unusable oil and natural gas reserves in the West. The flood of new product increased market supply drove prices down, which significantly impacted the Russian economy. (Blank & Kim, 2016).
Following the great recession, Russia also began to make trade agreements with China, Japan, and Korea. These trade agreements were an attempt to reduce Russian economic dependency on Europe though export diversification. Gazprom, the nationalized Russian natural gas supplier, began construction of new pipelines in Siberia that would allow it to increase its export capacity by 15% in 2020 (Park & Yun, 2010). This meant that 60% Russia natural gas would be exported: 25% to Europe, 20% to China, and 15% going to various other countries (Park & Yun, 2010). Additionally, these pipelines increased Russia’s oil export capacity to Asia. In 2010, Russia supplied Asia with 3-5% of its petroleum and by 2020 it is expected to control another 25% of the Asian market which formerly was controlled by OPEC (Park & Yun, 2010). In addition to these trade agreements, Russia has made arrangements with Central Asia (the second largest supplier of natural gas) to gain geographic control over Asian natural gas exports to Europe. Nearly all Central Asian gas is routed though Russia prior to going to Europe (Blank & Kim, 2016; Park & Yun, 2010). This effectively monopolized the European natural gas market.
The political and economic posturing of Russia in the Middle East and Asia in the post-recession environment shows Russia’s continued commitment to extraction commodities. Instead of diversifying its economy, it diversified its consumer base and attempted to gain greater control over the global gas market. The apparent economic agenda is to increase global dependency on Russian extraction commodities specific to Russian nationalized businesses. Russia had previously proven its willingness to use these commodities in conjunction with high intensity conflicts. These trade agreements greatly increased Russia’s sphere of influence and economic leverage over Western nations while simultaneously decreasing Russian dependency on the West.
Russian and Ukraine Conflict
The conflict with Georgia marked the first time that Russia used its energy leverage in conjunction with a high intensity decisive action conflict. Just five years later, in 2013, Russia had an eerily similar conflict in Ukraine over Crimea. Issues began in 1997, when Ukraine agreed to allow the establishment of a Russian Port in Crimea. This port was strategically significant because it allowed for the stationing of troops, and it became a major trade hub for Russia. Additionally, Crimea was a predominantly an ethnic Russian enclave, which would be subjected to daily interaction with Russian nationals. In 2011, Russia began launching major propaganda initiatives in response to Ukraine’s petitioning of the European Union to sign an Association Agreement which would allow free trade with the European Union (Blank & Kim, 2016). Ukraine had access to the large oil and gas deposits in the Black Sea and is a geographically advantageous to a Central Asian-European Gas trade route that could bypass Russia (Park & Yun, 2010). The propaganda initiatives in 2011 began to mobilize the Ethnic-Russian population in Ukraine who petitioned against signing of the Association Agreement. In 2012-2013, Russia applied continued political pressure and added economic pressures in the form of sanctions and embargos (Mau, 2016).
Russia had previously used economic pressure in Georgia when it shut off the natural gas supply intermittently in 2008, but these pressures were minute compared to the pressures Ukraine faced. One can argue that Russia’s actions in Georgia can be likened to the development and employment of a new weapon system. Simply put, Georgia was a test for a new economic weapon system that was fully deployed against Ukraine in 2012.
In 2012, Russia ceased natural gas exports to Ukraine and began the development of the Nord Stream II pipeline (Blank & Kim, 2016). This pipeline traverses the Baltic Sea and essential eliminates Ukraine as an intermediary supplier of Russian Gas (Blank & Kim, 2016). Also Russia placed several sanctions on Ukrainian imports, specifically food. It is estimated that in 2013, this economic assault cost Ukraine 40 billion dollars, which was a quarter of its GDP (Connolly, 2016). This caused continued political strife within the country and further emboldened the Ethnic-Russian minority. In April of 2013, the Ethnic-Russian Population revolted. Russia mobilized an estimated 10,000 unmarked troops and combat vehicles in support of the uprising (Blank & Kim, 2016). The revolutionaries stormed the capitol in April of 2013 and forced Ukraine’s parliament to recognize Crimea’s Sovereignty. Russia annexed Crimea four days later (Blank & Kim, 2016).
With the annexation of Crimea Russia claimed 1.2 billion dollars in Natural Gas reserves, the country’s largest gas firm, and exploitation rights of off-shore natural gas deposits in the Black Sea (Mau, 2016). Then Russia incurred a 20-billion-dollar debt on Ukraine by cancelling a 2010 Gas subsidization agreement and cashing out 4 billion in Ukrainian Governmental Bonds (Mau, 2016). Essentially, Russia forced Ukraine to foot the bill for its own invasion (Blank & Kim, 2016).
Response to Russian Economic Aggressions
Western nations did not allow the annexation of Crimea to go unnoticed. In March of 2014 they began to economically target three main sectors of the Russian Economy: energy, defense, and finance. Also, in 2014, Russia suffered an economic slowdown caused by a sharp decline in oil prices which plummeted to 47 dollars per barrel (Connolly, 2016). Economist argue that it is impossible to gauge the actual effectiveness of the West’s economic assault on Russia, because it is too difficult to separate the decline in oil and the sanctions as independent variables (Connolly, 2016). In addition, minor contention exists on both the long and short-term effectiveness of the sanctions.
The Western nations banned the sale of bonds and also sanctioned the financing of several banks. This resulted in several banks having to refinance loans and caused a reported 20% loss of equity (Connolly, 2016). Richard Conley writes that these are exaggerated numbers and that much of the debt was in Rubles, so the state could have met their obligations simply by printing more Rubles. (Connolly, 2016). Additionally, he states that Russia holds a large reserve of assets, like gold, with high liquidity. These can easily be used when foreign assets depreciate. (Connolly, 2016). In addition, Russian energy firms held an estimated 100 billion dollars in reserve in foreign nations which could be used in the event of an economic decline. However, the unexpected and timely decline of oil prices combined with the sanctions on the financial sector limited Russia’s ability to both subsidize the oil industry and pay-off external debts. The combination of these economic hardships was the major cause of the 2014 decline of the Russian economy and inflation hit an all-time high of 18.4%. (Connolly, 2016; Blank & Kim, 2016). Russia’s need for income drove them to renegotiate trade deals in the Asia that came with substantial up-front payment. The deals allowed Russia to continue to mitigate the financial burden but came at a cost to future income due to price-fixing though 2025 (Connolly, 2016)
In the defense industry, the Western nations banned all imports and exports of weapon systems and goods that could be used to develop weapons. Russia, however, holds very few trade agreements with Western nations for arms (Morley, 2014). In 2014, Russia was still able to boast a net income of 13 billion dollars in arms trades and in 2015 that number rose to 20 billion (Connolly, 2016). The major loss to Russia was the continued development of improved weaponry. Specifically, electro-optical systems that are primarily developed in France and Italy. In response to this Russia has increased investments into research and development, at the cost of social subsidies (Connolly, 2016) (Rybakovskii, 2013). In the short-term, this policy will limit the advancement of Russian defense systems, but in the long-run it may cause Russia to gain a weapons development capability that could be proliferated to states that threaten the West (Connolly, 2016). This however, may be unlikely due to Russia’s inability to attract new industry specifically in technology due to the Russian overtly nationalist business model and continued interference by the state with-in the “private” sector (Mau, 2016). Russia will likely have to grow its own technical industry which could take decades.
In the oil industry, the West also targeted technology by restricting Russia’s access to artic and deep-water exploration technology (Mau, 2016). In the short term this has had very little effect on Russia because they receive nearly all of their oil from on-shore drilling (Connolly, 2016). This could hinder the development of future drilling sites where Russia was dependent on Western equipment. In 2015, imported drilling equipment from China rose by 8% (Connolly, 2016). It is likely that Russia is attempting to find an Asian substitute for Western technology, and in the long term this could undermine the intended consequences of sanctions. A decrease in the global oil supply may not be in the best interests for the West. If the oil supply decreases, then demand will increase along with prices. Increased oil prices often signals the onset of a recession in Western countries (Selden, 2010). A decrease in Russian oil supply will surely have major effects in Europe (Mau, 2016).
Economists agree that Russia’s extraction commodities economic model is not sustainable due to the volatility of oil and gas market. Russia has tried to mitigate the effect of these price variances by isolating and monopolizing the commodities market in Europe. It has done this though aggressive foreign policy, which includes trade agreements with threat nations, economic sanctions, and even the destabilization of neighboring states. Russia has been largely successful in retaining economic leverage over Europe, and recent sanctions by Western nations will likely have very little short-term effect. Russia is in a cyclical state of: economic boom fiscally save economic bust fiscally spend. This has allowed Russia to insulate itself from the volatility of the global commodities market, but it has come at the cost of domestic reform, loss of privatized industry, and inability to economically diversify. Additionally, Russia is isolating itself from the global economy which will have an adverse effect on the Russian economy over the long term due to loss of investments, oil revenue, and the limited availability of technology. This coupled with the lack of domestic spending (which causes depopulation and the loss of laborers) will eventually cause an economic depression similar to that of 1991 and Russia’s economic hostilities will cease.
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