RUSSIA’S ENERGY CONUNDRUM — LONG TERM BENEFIT OR SHORT TERM GAIN?

The recent Belarus-Russian row over oil transit masks a deeper problem. The end consumer, the European Union, is now heavily reliant on Russian energy imports, for better or worse, and is hostage to Russian President Vladimir Putin’s hardball tactics with Russia’s neighboring former Soviet republics. In a notable understatement, Russian Prime Minister Mikhail Fradkov remarked that the impasse in Russian-Belarusian economic relations “has marred the image of Russia as a reliable supplier of energy”(Interfax, January 11), while Deutsche UFG analysts informed investors, “The disruptions in oil supplies have yet again undermined Russia’s efforts to establish itself as a reliable source of fuel supplies to Europe”(Pravda, January 11).

Russia is the European Union’s third-largest trading partner, after the United States and China. The EU is Russia’s largest trading partner, accounting for more than 52% of its overall trade. Europe depends upon Russia for 44% of its natural gas imports and 30% of its oil imports, while Russia sells 60% of its exported gas to the European Union (freemarketnews.com, December 29, 2006). Germany alone receives some 20% of its oil imports from Russia’s Druzhba pipeline, which has a capacity of two million barrels per day. The Druzhba pipeline carries 12% of the EU’s oil through Belarus.

Analysts have commented that the Belarus-Russian tiff spells the end of the post-USSR Commonwealth of Independent States. The energy conflict has effectively doomed the CIS. Over the last ten years, Russia supplied CIS member states with inexpensive energy in the hopes of eventually wooing them into reintegrating with Russia. Now that the Putin administration has concluded that even its closest former ally, Belarus, is uninterested in reunification, it has moved from treating the states as coddled former satrapies to capitalist countries capable of paying prevailing market rates, despite the damage inflicted on their struggling economies.

Europe first got a taste of this new policy in January 2006, when Gazprom shut off natural gas deliveries to Ukraine, which carried 20% of the EU’s total natural gas imports, where Russia piped over 90% of its EU exports through Ukraine. For the first time in 30 years Russian energy tactics disrupted European energy imports, which had not occurred even at the height of the Cold War. In 1984 the Regan administration pressured London to halt the British John Brown Engineering Co. from selling compressors for the USSR’s new natural gas line from Siberia’s Urengoy fields to Germany. At the time almost 90% of the Soviet Union’s energy resources were located in the Russian republic, mainly in Siberia. British Prime Minister Margaret Thatcher subsequently told Mikhail Gorbachev in November 1984 in London about the incident, stating, “A contract is a contract.”

During the recent dispute the Russian government hastened to assure its European clients that its dispute with Belarus was insignificant. Russian Deputy Foreign Minister Alexander Grushko told journalists that Russia’s European partners were being fully informed about the dispute and that oil transit would continue under “fixed contracts” once the dispute was resolved. Grushko added that Russia would resolve its dispute with Belarus under the terms of the June 4, 1999, CIS agreement regulating transit issues through member states as well as the terms of the January 1998 CIS customs union agreement (Interfax, January 10).

The Putin administration may be shooting itself in the foot for short-term political and fiscal gains. International Energy Agency and UK experts predict that in the absence of massive investment, leaky pipes and underinvestment in new fields could see Russia fall severely short of its domestic and export gas needs by 2010 (EU Observer, January 9). Transneft, the government monopoly that controls Russia’s 29,000 miles of pipelines and exports 90% of the country’s crude oil, is in severe need of new capital, as much of its equipment dates from the Soviet era and is in some cases more than 40 years old (U.S. Department of Energy, www.eia.doe.gov/emeu/pgem/ch4a.html).

Russia’s contradictory policies towards its energy assets have increasingly alienated potential Western investors. Just last month Moscow pressured the British-Dutch oil firm Shell to relinquish its more than 50% stake in Sakhalin-2, Russia’s last wholly foreign owned oil project, to Gazprom.

If Russia is to attract foreign investment, it will need to modify its approach to former Soviet states lest it further alienate potential partners. As Deutsche UFG oil analyst Stephen O’Sullivan said, “Gazprom has a range of capital expenditure heavy projects going on, and it needs to bring in a partner with deep pockets” (Moscow Times, January 12). In 2006 Russia increased oil production by 2.2%, to 480.4 million tons, and exported 208.9 million tons (transneft.ru, January 10). If Russia wishes to retain the fiscal benefits of rising production, then it is going to have to find a way to treat both transit and consumer countries as stable and reliable partners, rather than cash cows to be milked as thoroughly as possible.