Publication: Prism Volume: 7 Issue: 9

By Sergei Kolchin

It is well known that the Soviet Union’s oil and gas reserves, of which the Russian share was the largest, provided the main life support line for socialist bloc countries. The sliding scale of oil prices adopted within the Council for Mutual Economic Assistance (Comecon), alongside the implementation of joint gas production and transportation projects, allowed European Comecon countries to negate the consequences of the energy crisis of the 1970s. Subsequently, and paradoxically enough, this same mechanism was behind the significant debt owed by the Soviet Union–and then Russia–to its former Comecon partners. To be fair, it should be said that Eastern European countries are aware that the situation was created artificially, and are not making demands for the immediate repayment of the “debt.” A new policy has also been formulated in Russia recently with regard to debts owed to Eastern Europe.

Specifically, Russia has decided not to acknowledge that it should inherit the debt owed to the former GDR. Before Russian President Vladimir Putin met German Chancellor Gerhard Schroeder in July 2001 the Russians published a paper arguing that the Soviet Union’s debt to the old GDR should be canceled rather than figure in the “debts for investment” program. The arguments ran like this: The debt total has not been adjusted; the exchange rate for the convertible ruble used in accounting with the GDR does not correspond to the realities of the world market; if the supplies of raw materials from the Soviet Union are recalculated according to world prices, the account shows a balance of US$4.2 billion in favor of the Soviet/Russian side. The Russians’ reasoning is understandable: Debtors among developing countries and former Comecon partners are using the artificial ruble-dollar coefficient officially used in the accounts during the Soviet period. At the same time, the debt of the Soviet Union–and now Russia–grew at the time when the socialist commonwealth was crumbling, and when there was a transition to world prices in mutual trade (when the criteria for assessing Soviet imports as opposed to raw material exports were ill defined); furthermore, the effect of previously existing preferential terms for Comecon countries when world oil prices were high was not taken into consideration.

The precedent of protesting the Soviet foreign debt in relation to Germany is unlikely to be applied wholesale to all former Comecon countries, particularly European ones. In the Czech Republic, Hungary, Slovakia and Poland there is a realization of the ambiguity of the situation regarding the old Soviet debts, and it is likely to be resolved by mutual consensus.

Moving away from the legacy of the collapsed world socialist economic system, in today’s world too it is a fact that the countries of Central and Eastern Europe depend on supplies of Russian energy for their fuel and energy needs, though this dependence is considerably less than it was. It is important to note, however, that in the new world energy crisis, the issue of Russian energy supplies is once again on the agenda in mutual relations with the former European members of Comecon, and also with the western countries of the former Soviet Union (Ukraine, Moldova, the Baltic States and Belarus). Even Western Europe has started talking about redirecting supplies from the Middle East to Russia (viz. the famous “Prodi plan,” which envisages large-scale investment in the Russian oil and gas sector in exchange for developing its export potential).

We may assert that in recent years there has been serious movement on the plan to bring Russia back into the oil and gas markets of its close European neighbors and former Comecon countries. There are, we think, two main reasons for this. The first, as noted above, is related to the changes in the world energy market. If even western European countries are thinking about reducing their dependence on energy supplies from the Middle East, then for their eastern European neighbors this was “meant to be,” so to speak, given the infrastructure already in place for supplies from Russia. Meanwhile, the newly independent states on the European side of the CIS do not really have an alternative to Russian supplies, despite their widely publicized statements and demonstrative initiatives to look for new partners. Apart from this, they do not have the necessary financial clout.

The second reason, which is no less important, lies in the fact that countries are moving away from emotional reactions in their international relations, in favor of pragmatic solutions. This process is as yet incomplete. The former socialist bloc still fears being once again dependent on their neighbor to the east for oil and gas. Examples of this are provided by the problems surrounding the Mazeikiai oil refinery in Lithuania, Hungary’s gas and petrochemical complex and the new branch of the Siberia-Western Europe gas pipeline in Poland, which avoids Ukraine.

Nevertheless, there has been clear movement in the positions of the Eastern European and Russian partners. Oil refining is a typical example of this. Here the interests of both sides coincide. Russia’s Eastern European partners have discovered that their oil refineries are of no interest to anyone apart from Russia itself, because of both their insufficient technical sophistication and the excess capacity in the rest of the world. Meanwhile, Russian oil companies have come to the conclusion that it is much more advantageous to have their own oil refining capability near their potential sales markets than it is to transport fuel oil, diesel and gasoline to these markets from the depths of Russia.

Lukoil has recently acquired four oil refineries in Eastern Europe and Ukraine–in Burgas (Bulgaria), Ploiesti (Romania), Paramo (Czech Republic) and Odessa (Ukraine). The company was guided by the fact that the proceeds from refining the oil and selling oil products abroad were US$25-$30 per ton higher than in Russia. A subsidiary, Lukoil-Europa Holding, has been set up to manage this block of companies.

It is expected that the factories will operate as a single complex, delivering semi-finished products from one plant to another. The main target in the investment program for the whole group of factories is to raise the quality of their oil products to world standards and reduce internal company costs.

Lukoil’s initiative in refining oil abroad is not the only one among Russian oil companies. Last year Tyumen Oil Company (TNK) acquired a controlling stake in the Lisichansk oil refinery, as a result of which the fortunes of the plant, which in recent years has barely made ends meet, have begun to turn around. Slavneft has its eye on the Kremenchug refinery and plans to register a subsidiary in Ukraine called Slavic Oil Products; it intends to acquire over thirty refineries and several storage depots in Ukraine.

But not all is proceeding smoothly in the sphere of Russian involvement in refining oil in Ukraine. In early 2001 Russian companies which own refineries in Ukraine threatened to cease supplies of oil to the country. This was in response to the unprecedented preferential treatment introduced by the Ukrainian government for fuel importers. The heads of the companies involved–Lukoil-Ukraine, TNK-Ukraine, Kazakhoil-Ukraine and Ukrtatnafta circulated an appeal addressed to the Ukrainian authorities calling for measures to be taken against destabilizing the oil products market in the republic. This referred first and foremost to the law passed by the Supreme Rada “On stimulating the development of agriculture in the period 2001-2004,” which put producers of Ukrainian oil products and importers on an unequal footing. Subsequently, Ukrainian importers of oil products stepped up their campaign to defend their privileges over the Russian-owned oil refineries. Thus the battle for property in Ukraine was followed by a battle for the oil market.

We may predict with some certainty that in the next few years the situation regarding the transit and transshipment of Russian energy exports will also change. The reason is the same–the emergence of alternative options related to the launch of Russian transport facilities: the Caspian Pipeline Consortium (KTK), the Baltic Transport System and others. In any case, Ukrainian oil conveyors have already agreed to a through tariff on the Druzhba and Adria oil pipelines. The key to the project is the reconstruction of Adria, the Croatian pipeline, so that oil can be pumped along it not just from offshore onto dry land, but also back again. This will allow the export of Russian oil through the Druzhba pipeline to the deep-water Mediterranean port of Omis, which is capable of handling tankers with a capacity of up to 500,000 tons. Talks on establishing a flat transit tariff began back in 1997 (involving Russia, Ukraine, Hungary and Croatia). Until recently Ukraine was holding up implementation of the project by insisting on a higher tariff. Now the situation is changing. As a result, the main obstacle to creating a new route for the export of Russian oil has been removed. In addition, a new company is being set up in Ukraine based on the assets of Dnieper Gas Pipelines and the Druzhba oil pipeline. It is expected that this decision will reduce tariffs for Russian oil companies pumping oil through Ukraine. Looking at only the three mentioned areas of conflict in the oil and gas sector between Russia and its European neighbors from the old socialist bloc, we can note the following:

1. Regarding the Mazeikiai oil refinery in Lithuania, the Lithuanians have agreed to sell Lukoil one-third of the company’s shares; previously they had been talking about 10 percent. But the Russian company is not happy at playing second fiddle to the American company Williams, and negotiations will continue (Lukoil is the main supplier of oil to the refinery).

But then, competition between two Russian oil companies unexpectedly became a factor. In July 2001 Yukos announced that it had signed a memorandum on cooperation with Williams at the Mazeikiai refinery. Yukos had never concealed its interest in this facility, but the agreement came as a surprise. The document envisages two issues of shares in Mazeikiai Nafta, as a result of which Yukos will control 27 percent of the company, and the Williams share will reduce to the same level from the current 33 percent. The Russian company will pay US$75 million for the shares and the same sum again to the Lithuanians in the form of a five-year loan. Previously Yukos and Mazeikiai Nafta had signed an agreement on terms for exporting crude oil through the Buting terminal. Lukoil has no intention of backing down in the fight for the Mazeikiai refinery either. People inside the company think it is prepared to offer the Lithuanians more favorable terms, and consider the actions of their rival to be “strange.” TNK has also recently expressed an interest in the Mazeikiai refinery.

2. Regarding the Hungarian gas and petrochemical plants TVK and, in particular, Borsodchem, Gazprom’s subsidiary Sibur has also made notable progress in purchasing shares in the company, although there is still a long way to go to clinch the deal here too. In June 2001 the gas chemical concern Sibur eventually became a shareholder in Hungary’s Borsodchem plant. Sibur’s British subsidiary took up its option to buy a 25-percent stake in the plant from Hungary’s CIB Bank. In the future it is very likely that Sibur’s stake in the plant’s share capital will increase through the purchase of shares from other Borsodchem shareholders.

Prior to this, however, Gazprom structures failed to achieve their desired result with the shares in another Hungarian concern, TVK; here control remains for the time being with the Hungarian oil and gas company MOL. Sibur’s (for which read: Gazprom’s) idea is to bring Hungary’s two largest petro-gas-chemical enterprises under its control.

3. Finally, regarding the most important project–the construction of an alternative branch of the gas pipeline from Siberia to Europe (through Belarus)–Russia is also gradually pushing its interests via Poland, relying on support from interested parties in Western Europe. In early 2001 reports emerged that Gazprom and the Polish government had overcome their main disagreements on the question of the construction of a pipeline that would avoid Ukraine. The Poles are not disowning their previous commitments, but are slowing things down with various amendments. Furthermore, in Dnipropetrovsk in early June Poland’s President Alexander Kwasniewksi said that a final decision on his country’s agreement to lay a gas pipeline avoiding Ukraine had not been taken, and that Warsaw would not allow the alternative pipeline to be an instrument for putting political pressure on Kiev. Despite this, the Ukrainians appear to appreciate the precariousness of their position in their relations with Russia in this area. Former Ukrainian Prime Minister Viktor Yushchenko had spoken of creating an “effective gas transport tandem” with Russia. Naturally, the threat of losing their monopoly on the transit of Russian gas was a factor here. As Yushchenko noted in an interview with Vedomosti newspaper on April 3, 2001, “if the political element is taken out of the gas question, and we talk about it as an economic problem, then the subject of alternative pipelines has no future.”

All this allows us to assert that, after a short hiatus and uncertainty with regard to Russia’s oil and gas interests on the western flank of the old socialist bloc, now, with the effects of a new energy crisis and the consolidation of the actions of the countries involved in this market, Russian oil and gas companies have been making progress in pushing towards the West. It is important for them to consolidate this and restore the positions they lost in Eastern European countries and the European countries of the CIS.

With regard to these latter countries, especially Ukraine, the main obstacle–apart from the persistent anti-Russian sentiment in the Supreme Rada–is the problem of the accumulation of debts owed to Russia by Ukraine, in particular for gas. The problem of Ukraine’s debt for Russian gas has unfortunately still not been resolved. It is not only a question of Ukraine’s acknowledging the full amount of the debt (between US$2 and $3 billion); it only acknowledges a debt of US$1.4 billion. To this day the Ukrainian parliament has not shown the slightest sign of agreeing the invoice issued by the Russians. But Ukraine also plans to pay off the acknowledged debt with eurobonds issued by the company Naftogaz-Ukraine, guaranteed by the government. It is not clear how liquid these securities are, and therefore, how realistic it is that Russia will receive payment of the debt in real money, though Ukraine is prepared to accept Russia’s help in drawing up the Naftogaz-Ukraine eurobonds.

Similarly, Russia’s proposal to pay off the gas debt in exchange for Ukrainian gas assets has not met with the support of the Ukrainian side, although Ukraine’s new Prime Minister Anatoly Kinakh has said: “We do not reject the possibility of the further privatization of gas pipelines, but Ukraine would like to see representatives from Europe, at least, taking part in the privatization.”

To sum up the current tendencies in Russia’s relations with her former European partners in Comecon and the former Soviet republics, we may note the following:

1. The last decade, from the break-up of the Soviet Union, has dampened the heated emotional element in assessing these relations. Pragmatic factors have finally come to the fore, and this is in many ways related not only to changes in the world energy market, but also to a new emphasis in Russian foreign policy;

2. Eastern European countries’ entry into the orbit of common European processes has forced them to look differently at their relations with Russia, to whom they no longer appear as satellites, but as part of the normal European sales market;

3. Russia’s relations with the former Soviet republics on the European side (Ukraine, Belarus, Moldova, the Baltic States) still bear a significant subjective hue, but a progressive tendency toward economic rationalization can be perceived here too;

4. The prospects for cooperation between Russia and Russian oil and gas companies and their Eastern European neighbors depend on the positions of three parties: Russia itself and its economic entities in the oil and gas sector; the “receiving party”–their partners from Eastern Europe; and the West, which is keeping a close eye on Russian expansion in the region. Moreover, the West is far from unanimous in its approach: The United States is more worried about its geopolitical interests, while the European Union is more concerned with pursuing its economic interests in the energy sector.

Dr. Sergei Kolchin heads the sector of economic statistics and comparative international analysis of the Russia Academy of Sciences’ Institute of International Economic and Political Studies in Moscow.