A bear at the throat
Apr 12th 2007 | BRUSSELS AND MOSCOW
From The Economist print edition
http://www.economist.com/world/europe/displaystory.cfm?story_id=9009041
The European Union is belatedly grasping the riskiness of its
dependence on Russian gas, but it is disunited and short of ideas for
how to reduce it.
RUSSIA'S president, Vladimir Putin, must be feeling smug. His strategy
of using the country's vast natural resources to restore the greatness
lost after the break-up of the Soviet Union seems to be paying off. If
power is measured by the fear instilled in others—as many Russians
believe—he is certainly winning.
The Soviet Union relied on its military machine for geopolitical
power: its oil and gas were just a way to pay for it. In today's
Russia, energy is itself the tool of influence. To use it the Kremlin
needs three things: control over Russian energy reserves and
production, control over the pipelines snaking across its territory
and that of its neighbours, and long-term contracts with European
customers that are hard to break. All three are in place. For all the
talk of a common strategy towards Russia, the EU is divided and stuck
for an answer.
Gazprom, Russia's energy giant, cherished by Mr Putin as a “powerful
lever of economic and political influence in the world”, has long-term
supply contracts with most European countries, including France,
Germany, Italy and Austria. It also has direct access to these
countries' domestic markets. The EU reckons that half its gas imports
now come from Russia. Newer EU members, such as Hungary and the Czech
Republic, are almost entirely dependent on Russian gas. Moreover, a
pipeline network that it inherited from the Soviet Union gives Russia
control over gas imported from Central Asia.
The EU has few ideas for how to deal with its chief energy supplier.
“We know we should do something about Russia, but we don't know what,”
one Brussels official says. “In the EU we negotiate on the rules,
whereas Russia wants to do deals.” The deals are coming thick and
fast. Last month, Russia secured one to build an oil pipeline from
Bulgaria to Greece that will bypass the Bosporus. Symbolically, it
will be the first Russian-controlled pipeline on EU territory. The
pipeline will carry Russian and Central Asian oil straight to the EU,
avoiding Turkey.
Oil can at least be bought from elsewhere. The bigger worry is about
the EU's dependence on Russian gas. The flow of natural gas depends on
the routes and control of pipelines, as European consumers were
reminded when Russia switched off the gas supply to Ukraine just over
a year ago and Ukraine started to steal Russian gas that was destined
for the EU. Russia's pipeline routes encircle the EU from the north
and south.
Russia and Germany have teamed up to build a gas pipeline under the
Baltic Sea, bypassing Ukraine and Poland (see map). Gerhard Schröder,
a former German chancellor signed up by Mr Putin to preside over this
Nord Stream pipeline, claims that it will make Europe safer. But a
study by Sweden's Defence Research Agency concludes that it will
divide the EU and increase dependence on Russia. It will let the
Kremlin turn off gas supplies to Ukraine, Poland and Belarus without
affecting “more important” customers. Understandably, Poland is
anxious. The pipeline will increase the flow of gas to Germany and
hook in countries that do not yet consume much Russian gas, including
the Netherlands and Britain.
In the south, Russia has a pipeline across the Black Sea which
supplies gas to Turkey. Now Russia wants to extend this Blue Stream
pipeline to Hungary. That would compete directly with Europe's own
plan to build a pipeline called Nabucco from Turkey to Austria.
Nabucco has been one of the EU's few concerted responses to Russian
domination of its gas supplies: it would be filled up with gas from
Central Asia and thus bypass Russia altogether. But it is now creating
more friction than unity.
Hungarian rhapsody
Last month Hungary's prime minister, Ferenc Gyurcsany, called Nabucco
a “long dream”. Instead, he suggested that Hungary would support the
extension of Blue Stream. Gazprom already supplies 80% of Hungary's
gas and has promised to build a large gas-storage facility that could
be a hub for central Europe. “Blue Stream”, enthused Mr Gyurcsany, “is
backed by a very strong will and a very strong organisational power.”
(When Hungary was accused of undermining the EU's common energy
policy, the tart response was that it was impossible to undermine
something that did not exist.)
As well as controlling pipelines, Gazprom has also been busy buying up
pieces of Europe's gas infrastructure. It owns 35% of Wingas, a German
distribution company, and also has stakes in the Baltic countries'
distributors. It has 10% of the interconnector pipeline between
Belgium and Britain and wants a similar share of a British-Dutch link.
It is also muscling its way into electricity, oil and liquefied
natural gas (LNG) projects. “It is not enough for us to meet 25% of
global gas consumption. We want to be the biggest energy company in
the world,” Alexander Medvedev, Gazprom's deputy head, has said of his
company's modest ambition.
Most European governments have been careful not to alienate Russia. As
long as Gazprom plays by the rules, they say, it should be allowed to
invest in their markets. Belgium recently said it had no problems with
Gazprom owning parts of its infrastructure. Russia, in contrast, has a
big problem with foreign companies owning, let alone controlling, any
of its natural resources. It has bullied Royal Dutch Shell into ceding
control of the Sakhalin-2 project in the far east of the country; it
has blocked BP's plan to develop a gas field in eastern Siberia; and
it has kept foreign companies out of the development of the giant
Shtokman field in the Barents Sea, saying that it will go it alone.
In the same spirit, the Kremlin has flatly ruled out ratifying the
EU's energy-charter treaty, which would require it to open up its gas
pipelines to other countries and other suppliers. The Russians have
made a mockery of a joint declaration on energy issued at the G8
summit they chaired in St Petersburg last July. The declaration called
for more honesty, competition and transparency. Yet just two days
later, Mr Putin enshrined into law Gazprom's monopoly position as the
sole exporter of gas.
Then there is the talk of creating a gas equivalent to the OPEC
oil-exporters' cartel. On April 9th Russia joined other gas producers
in Qatar to discuss the possibility, and offered to lead a study into
gas pricing. The next meeting of the group will be in Moscow. With
almost 60% of the world's gas concentrated in just three countries
—Russia, Iran and Qatar—the notion of a cartel sounds appealing. But
fixing prices for a commodity that is not traded on world markets will
prove much harder than it has been for oil. Even so, as Mr Putin said
earlier this year, “it would be a good idea to co-ordinate our
activities.”
Gazprom has already signed a memorandum of understanding with
Algeria's Sonatrach to co-operate in gas production. This has unnerved
European consumers, as Algeria is their third-largest supplier of gas,
after Russia and Norway. America, too, is nervous. “Russia's
commercial and political shadow over the governments in central Europe
makes it harder for us to deal with our allies,” says a senior State
Department official.
The EU's dependence on Russian energy is hardly new. Nor is tension
between Russia and America. “The Americans were constantly telling us
we were too dependent on Russian gas in the 1970s and 1980s,” says Sir
Rodric Braithwaite, a former British ambassador to Moscow. Yet,
throughout the cold war, Russia remained a reliable gas supplier. Why
should things be different now?
First, says, Cliff Kupchan, director of the Russian programme at
Eurasia Group, a consultancy in Washington, DC, the Soviet Union was
politically more predictable than its successor. “It was run by
geriatrics, but we knew that one geriatric would succeed another.”
Russia's political stability is ephemeral. It relies on Mr Putin's
will, not on an institutional transfer of power. With nationalism on
the rise, it is anybody's guess who will be in charge of Russia in ten
years' time.
A second difference is that the energy relationship between the Soviet
Union and the West stopped at the border—albeit the border of the
Soviet block. The oil and gas ministry, Gazprom's predecessor, did not
try to take over any of western Europe's infrastructure. Gazprom has
no scruples about using its muscle to buy such assets. Gazprom's
desire to control their pipelines has been central to Russia's recent
clashes with Ukraine and Belarus.
Third, the Soviet energy business was run by technocrats who
implemented centrally planned decisions. Today, it is controlled by
former KGB men obsessed with money and power. Gazprom has several
ex-KGB members on its board of directors. Rosneft, the
state-controlled oil champion, is chaired by a former agent who is now
deputy chief of the Kremlin staff. “People in Europe have a natural
apprehension about their homes being heated by these people,” says one
commentator on Russia.
Yet dependence cuts both ways. Europe may depend on Russia for half
its gas imports, but Russia is dependent on Europe for the bulk of its
export revenues. Repeated threats by the Kremlin to divert the flow of
gas to China mean little without pipelines that it would take many
years to build. Switching off gas to Europe will never make commercial
sense for Gazprom. The fear in some EU countries is that commercial
interests may one day become secondary to political ones. Of 55
cut-offs, explicit threats or coercive price actions by Russia since
1991, only 11 had no political underpinnings, according to the Swedish
defence study.
Running on empty
If all this is not worrying enough, there is another, more immediate
source of concern for the EU: that Russia may be physically unable to
produce enough gas to satisfy demand. Even worse than being dependent
on a company like Gazprom may be to be dependent on a Gazprom that is
short of gas.
The output of Gazprom's three super-giant fields, which account for
three-quarters of its production, is declining at a rate of some 6-7%
a year. Output from a new gas field brought on stream in 2001 has
already peaked. Last year, Gazprom decided to develop a massive field
in the Yamal peninsula—frozen and barren Arctic land—but that will
take years. Meanwhile, Russia's domestic demand for gas is growing by
more than 2% a year. For all its swagger, Russia is short of gas, a
problem that is already affecting its electricity-generation capacity.
This does not reflect any lack of reserves—Russia has the world's
biggest—but rather a longstanding failure to invest enough in their
development.
Gazprom has argued that it will invest in new fields only if it can
pre-sell the output to Europe. Instead it has been spending lavishly
on pipelines and downstream assets. This has a certain monopolistic
logic. Raking in the middleman's profits from exports is easier and
more lucrative than investing billions in developing new fields for a
domestic market which, although it consumes two-thirds of Gazprom's
production, generates hardly any profits, as regulated Russian gas
prices are much lower than most European ones.
Meanwhile, Gazprom relies on Central Asia, especially Turkmenistan, to
plug the gap in gas supplies, which makes many investors and consumers
nervous. A study by UBS, a bank, concludes that Turkmenistan may have
signed contracts to supply twice as much gas after 2009 as it can
actually produce. The nervousness over potential shortages of gas,
though, plays in Gazprom's favour: as with talk of a gas OPEC, it
prods the Europeans into striking special deals with Gazprom.
Gazprom's position is reliant on support from Europe's national energy
champions such as Gaz de France, ENI of Italy and Ruhrgas of Germany.
Companies such as Ruhrgas and Gazprom have each other's interests at
heart. Indeed, Ruhrgas owns about 7% of Gazprom, worth some $17
billion, and has a seat on Gazprom's board. ENI and Enel of Italy this
month acted directly for Gazprom when they bought the expropriated gas
assets of the bankrupt Yukos company in a controversial auction. Under
a pre-arranged deal, the two Italian companies agreed to cede control
of these assets to Gazprom, which was too cautious to bid in its own
name. In return ENI and Enel were given a foothold in Russia's gas
fields and possibly a seat on the board of Gazprom's oil company.
Gazprom also has long-term gas contracts with ENI, which gives it
direct access to Italian consumers.
Gazprom has similar arrangements in Germany and France. Vladimir
Milov, the head of the Institute of Energy Policy in Moscow, says that
the links between Gazprom and its European counterparts amount to a
cartel between wholesale buyers and sellers. The losers in this game
are European consumers who are forced to pay gas prices that are
several times higher than the wholesale price which their national
companies pay to Gazprom.
Trying to persuade Russia to break up Gazprom's monopoly is a futile
task. The best way to increase the EU's energy security would be for
it to liberalise its own market and unbundle its national utilities.
This would cut profit margins in gas distribution, and thereby reduce
Gazprom's appetite for European domestic assets. It would encourage
European network operators to invest in interconnectors between
electricity grids and pipeline networks, weakening Russia's ability to
play off one customer against another. No wonder Gazprom does not warm
to the idea of European energy liberalisation, which it has called
“the most absurd idea in the history of the world economy”.
Break it up
The European Commission has been urging EU members to break up their
vertically integrated energy companies, but France and Germany are
resisting. The problem, says the commission, is that national
governments do not understand the link between liberalisation and
greater energy security. “New member states equate security with
nationalism. But the only alternative to integration is isolation,”
says one senior EU official.
At the most recent EU summit in Brussels, heads of governments pledged
to separate their energy supply and production activities from
transport networks, which will be managed independently. This falls
short of an ownership break-up but it should increase competition. EU
leaders accepted the need to link their energy networks, allowing more
cross-border trade and thus both boosting competition and reducing
Gazprom's power. Europe is also talking of building more LNG terminals
that can be stocked by other suppliers.
The EU's imports of LNG will certainly rise in coming years. The
International Energy Agency (IEA) estimates that European imports of
gas from Africa and the Middle East, mainly in the form of LNG, will
quadruple by 2030. But LNG is expensive, and generally involves
inflexible long-term sales contracts. Moreover, the IEA's projections
assume that the Europeans overcome their squeamishness about building
ugly LNG terminals. Equally improbably, they assume that Russia will
not find some way to impede the emergence of rival exporters.
Getting direct access to Central Asian and Caspian gas is vital to
European energy security. The Russians are well aware of this, as are
the Americans, who have been active in the region and brokered the
deal to build the twin oil and gas pipelines that now run from
Azerbaijan to Turkey via Georgia. The Americans would like this gas to
be carried on from Turkey to central Europe via the Nabucco pipeline,
rather than the extension of Blue Stream.
But Azerbaijan's resources are not enough to make a material
difference to European energy security. The big strategic battle now
will be over gas-rich Central Asia. The Americans have revived their
old plans to build a trans-Caspian pipeline and are actively courting
the region's politicians, however dictatorial and disreputable. A
change of government in Turkmenistan has given these efforts new
impetus. But transporting Central Asian gas to the EU without Russian
involvement will be testing. Apart from the unpalatable option of
building a pipeline through Iran, the only way to get Turkmen gas to
Europe would be across the bottom of the Caspian Sea. But a long
unresolved dispute over the ownership of the Caspian between Iran,
Kazakhstan, Azerbaijan and Russia makes this option explosive.
Russia has been jealously guarding its control over the Central Asian
markets. It has more than doubled the price it pays for Turkmen gas
and now claims to have a deal to buy all the gas the country can
produce for the next 25 years. Last week Sergei Lavrov, Russia's
foreign minister, went to Turkmenistan to promote “close
co-operation”, which means rejecting any American overtures. Russia
cannot afford to lose control over gas exports from Central Asia
because that would severely undermine its power over Europe.
The Kremlin's determination to keep a grip on their gas supplies
should be an obvious worry for Europeans. But it could carry dangers
for Russia too. If the EU ever manages to find an alternative to
Russian energy, in the form of more LNG, Iranian gas, renewable energy
or a pipeline under the Caspian, Russia would lose control of its key
market. Even if it does not, the Russian economy will become ever more
dependent on natural resources.
As Mr Putin contemplates a gas OPEC, he should remember that although
the 1973 OPEC oil shock extended the life of the Soviet regime, it
also left a Russian economy trailing behind its Western peers. “Basing
national power and prosperity on an inadequate monoculture is as risky
as basing them on rockets in the cold war,” argues Sir Rodric
Braithwaite. Still, Russia's ability to cause harm to itself and to
others in the cause of proving its greatness should never be
underestimated.
--
There may come a time when the CO2 police will wander the earth telling
the poor and the dispossed how many dung chips they can put on their
cook fires. -- Captain Compassion.
Wherever I go it will be well with me, for it was well with me here, not
on account of the place, but of my judgments which I shall carry away
with me, for no one can deprive me of these; on the contrary, they alone
are my property, and cannot be taken away, and to possess them suffices
me wherever I am or whatever I do. -- EPICTETUS
Celibacy in healthy human beings is a form of
insanity. -- Captain Compassion
"Civilization is the interval between Ice Ages." -- Will Durant.
Joseph R. Darancette
daranc@NOSPAMcharter.net
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