Applying Game Theoretic Concepts to Explain the Energy Problem in Europe
The Russian invasion of Ukraine has had many global consequences, the foremost of which for European countries has been the rise in prices of oil and gas. European economic sanctions of Russia have prompted counter-sanctions from Russia, specifically in regards to its energy exports, driving up these prices for most of Europe. Due to its position as one of the largest suppliers of oil and gas to Europe, Russia has used these sanctions to damage the economies of many European countries, which rely on Russia for their energy needs, in the hopes that the EU will lift its sanctions. The end result of these escalating sanctions remains to be seen, but perhaps game theory can offer us clues about the future state of the European energy crisis.
The first way we can apply game theoretic principles is by analyzing the market for energy and other commodities in Europe. Using publicly available trade data (1), we can see that the primary products which the EU trades to Russia are machinery and equipment (19.7%), motor vehicles (9%), pharmaceuticals (8.1%), electrical equipment and machinery (7.6%), and plastics (4.3%), and that Russia’s mineral fuels account for the large majority of its export, around 68%. As such, if we analyze the market for EU exports to Russia using a bipartite graph, we see that Russia has a wide variety of sellers which can provide it with its necessary products (as many EU countries produce machinery, pharmaceuticals, and plastics).
By contrast, if we analyze the market for Russian fuel exports, we see that constricted sets appear relatively frequently, as the two main suppliers of crude oil in Europe are Russia and Norway (2), and nearly all of the EU relies on these products to produce energy. Using our knowledge of how to find market-clearing prices, we see that this means prices will rise, helping to explain rising oil prices in Europe. However, we must also acknowledge the flaw of the model in that it ignores Russia’s ability to sell oil to multiple countries at once. This can be accounted for by acknowledging that the model is simplistic, but still communicates how oil is scarce in Europe and will cause situations in which multiple countries all seek the same supply of oil. As shown here, this market approach has shown us how game theory can provide us with a valuable explanation of how Russia’s position as a supplier of a scarce resource has allowed it to enforce economic consequences on other countries.
We can also use concepts of Nash equilibrium to see that it is a dominant strategy for both the EU and Russia to keep up their sanctions of each other. To show this, we must define our strategies and their respective payoffs. Realistically, both Russia and the EU have a large number of strategies available to them at any time, but to simplify our model we will assume their only two strategies are to maintain sanctions or to lift them.
If the EU sanctions Russia while Russia also sanctions the EU, we will say their payoffs are (-1,-1), with the first number representing the EU’s payoff and the second representing Russia’s payoff, as both countries will suffer economically. If Russia lifts sanctions while the EU maintains them, their payoffs are (0,-2), as Europe’s economy will return to normal while Russia loses its leverage over Europe and continues to suffer economically. If the EU lifts sanctions on Russia while Russia maintains them, their payoffs are (-2,0), as the EU will be losing both economically and ideologically, and the Russian economy will return to normal. Finally, if both the EU and Russia lift their sanctions of each other, their payoffs are (-1,0), as both countries gain economically but the EU loses ideologically. As such, as seen in the following payoff chart, it is a dominant strategy for both countries to continue sanctioning each other, which I might note translates well with what has happened in reality.
As such, we have shown that the energy crisis in Europe can be explained in terms of constricted sets in the market for oil and gas and the payoffs for keeping or lifting sanctions. Applying game theoretic concepts clearly allows us to study and predict the behavior of countries in real-world situations, and as such should be seen as a valuable tool in geopolitical analysis.
References:
- https://policy.trade.ec.europa.eu/eu-trade-relationships-country-and-region/countries-and-regions/russia_en#:~:text=The%20EU’s%20exports%20in%202021,%E2%82%AC4.38%20billion%2C%204.3%25).
- https://tradingeconomics.com/country-list/crude-oil-production?continent=europe
- https://www.econstor.eu/bitstream/10419/261345/1/Ehrhart%20et%20al.%20%282022%29%2C%20Introducing%20a%20price%20cap%20on%20Russian%20gas.pdf