Russia: An Energy Superpower?

AlterNet: ForeignPolicy

As Vladimir Putin nears the end of his second term as Russian president, it is clear that energy exports have become a major component of a resurgent Russia's foreign policy. According to the conventional wisdom, Russia's vast resources make it a superpower to be reckoned with. Not only is it a major supplier of natural gas to the states of the former Soviet Union, it sells oil and natural gas to Europe and it has made new contract commitments for both oil and gas to China. Additionally, as the January 2006 cut-off of gas to Ukraine, the January 2007 oil and gas cut-off to Belarus, and Gazprom's threat (again) to Ukraine in the wake of the September 2007 parliamentary elections indicate, Russia is willing to use its resources for political purposes.


[..]The January 2006 cut-off of natural gas supplies to Ukraine made headlines. The reporting indicated that Russia was using energy to punish Kyiv for its 2004 Orange Revolution and that Gazprom, the state-owned natural gas company, wanted to gain control of Ukraine's pipeline infrastructure. Energy has been a contentious issue between Moscow and Kyiv since the Soviet collapse, but in December 2005, Gazprom escalated tensions when it demanded that Ukraine pay world market rates for its gas. The government in Kyiv asked for a phased-in rate hike, but Russia instead cut off gas to Ukraine, resulting in serious downstream disruptions. Under intense international pressure, a deal was quickly made: A shadowy intermediary, RusUkrEnergo, would purchase 17 billion cubic meters of gas from Gazprom, at $230 per thousand cubic meters, blend it with cheaper gas from Turkmenistan, and sell it at a guaranteed price of $95 per thousand cubic meters. Steady price increases have occurred since then.


The January 2007 stoppages to Belarus began with Gazprom demanding a steep price increase, with steady rises thereafter to world market rates; in addition, Gazprom demanded 50 percent ownership of Belarus's gas pipeline network. As for oil, Russia initiated export duties on oil sold to Belarus. (Prior to January 2007, Russian oil had been piped to Belarus duty free; however, Belarus garnered huge profits by selling refined products to Europe.) Belarus retaliated by charging Russia an export fee and reducing the amount of oil flowing to Poland. Russia then blocked all oil exports. Again under international pressure, oil flowed freely within days.


In both cases, Russia appeared to have made short term gains: most obviously, Gazprom won the price wars. Moreover, many claim that Russia seemingly influenced the outcome of the March 2006 Ukrainian parliamentary elections in which Viktor Yanukovich, the loser during the Orange Revolution, became prime minister. In Belarus, Minsk was forced to recognize Moscow's claim to a large share of the profits from the sale of refined products and to agree to a debt-for-equity swap of part of its pipeline system. What makes the Belarus case so interesting is that Moscow was clearly willing both to risk another disruption of supplies to Western Europe and to endure damage to its prestige in order to gain major control over Belarus.


Beyond the former Soviet states, the two crises highlighted European vulnerabilities to supply disruptions and raised the possibility that Russia might use its resources to influence European policies. Soviet/Russian supply to Europe began in the 1970s and has continued virtually without disruption until two years ago. Currently, 43 percent of European energy consumption is oil, while only 24 percent is gas. Yet, gas utilization will rise as Europe limits it use of coal. Christian Cleutinx, director of the EU-Russia Energy Dialogue, estimates that EU's gas requirements will increase by 2020 to approximately 200 million metric tons/year. Of that, 75 percent will be imported, mostly from Russia. Table 1 indicates the current European dependence.


In addition to increasing its European market share, Gazprom has sought downstream infrastructure investment opportunities in Europe. Concerned, the European Union is looking both to limit the ability of non-EU companies to purchase distribution and refining assets in its territory and to force Russia/Gazprom to open the latter's pipelines to outsiders. In an effort to enhance competitiveness, recent draft regulations mandate separating resources from transmission infrastructure. The proposed rules have strong implications for Gazprom, which could not own controlling stakes in distribution networks and would have to offer reciprocal access to its domestic pipelines. Press reports at the time of the EU announcement noted that Konstantin Kosachev, head of the Duma's International Affairs Committee, threatened to retaliate against foreign investors. And most recently, Aleksandr Medvedev, the head of Gazprom Export, threatened that Europe risks a doubling of natural gas prices, if it implements the new legislation.


Even before the discussions about the proposed EU-wide policy, Gazprom executives threatened to shift export eastward toward China. Russia has already signed several deals with China and announced new pipeline projects to supply Beijing's growing market. Over the long-term, such a shift in emphasis is, of course, possible; however, effecting it in the short- to medium-term is inherently difficult. Vladimir Milov, a Russian energy expert, notes that Russia's limited capacity and technology make it only a regional supplier of energy. He argues that the great distances and high construction costs hinder the development of pipeline infrastructure to China. In fact, this past summer, Russian officials announced considerable delays in new gas pipeline construction to China, and Moscow and Beijing have been unable to agree on oil prices or oil pipeline routing. Thus, at the present time, the threat to redirect exports is hollow.


[..]Russia holds the world's largest reserves of natural gas, approximately 1680 trillion cubic feet, and it is also the largest exporter. Lacking liquefaction technology, Russia exports all of its natural gas through pressurized pipelines. Production has remained relatively flat overall, increasing by only 1-2 percent per year; moreover, Gazprom has invested little in new fields and its three largest fields, which produce 70 percent of output, have suffered annual decreased production. Company officials are hopeful that new fields, such as the recently acquired stake in Sakhalin II and the Shtokman fields, will bolster production.


Thus far the discussion has not centered on domestic consumption and supplies, which are crucial factors in judging Russia's ability to meet its forward contracts. Currently, more than half of Russia's energy consumption is gas; however, domestic gas prices are effectively subsidized. The government acknowledges that prices will increase, but Putin has declared that even at peak they will equal no more than two-thirds of international prices. Low prices do not promote conservation: in 2006, experts estimated that by 2010 domestic gas consumption would rise by 24 billion cubic meters (bcm), or by 6-7 percent per year. Herman Gref, minister of economic development, predicted likely domestic shortages of 5-6 bcm. In comments on October 31, 2006, he noted that "Russia is encountering some real restrictions on economic growth due to a shortage of energy resources." These forecasts were seconded by ministry predictions that output would grow by only 0.9 percent in 2007 and 0.6 percent in 2008.


Estimates vary regarding the extent of Gazprom's gas deficit, but most analysts agree that Gazprom will need both to develop new fields and to import gas from Central Asia in order to meet its contractual obligations. With regard to new fields, the story of the Shtokman fields is illustrative. The fields hold 3.7 trillion cubic meters of gas, but the location north of the Arctic Circle renders them technologically challenging. A year ago, Gazprom withdrew the international tender for the fields, opting instead to develop them by itself. At the time, the decision seemed congruent with other actions to ensure state ownership of energy resources, but it also indicated that Gazprom had decided to rely on new pipelines instead of liquefaction technology. Gazprom apparently rethought its position and in July 2007 reopened the tender, ultimately awarding 25 percent to the French company, Total, and more recently an additional 24 percent to Norway's StatoilHydro. According to Russian press accounts, these new agreements represent open acknowledgment that Gazprom lacked the ability and technological know-how to develop the fields on its own. It can also be seen as recognition that export via new pipelines, instead of in liquid form, would limit the market for the gas from Shtokman.


Prospectively, what is in question is Gazprom's use of those revenues. Gazprom's attempts to snap up assets in Europe indicate that it is not using its huge revenues to invest in green fields and to refurbish decaying pipelines. This leaves Gazprom dependent on cheap gas from Central Asia, especially from Turkmenistan. Second, even if Gazprom were to invest more wisely, would those revenues go to develop fields and infrastructure to supply the European market or would they go to developing sources in eastern Siberia and infrastructure to feed the growing Asian markets? A wise investment strategy -- one that would increase export capacity and develop new fields in both eastern and western Siberia -- requires a steady revenue stream. In effect this means that should Europe successfully find new suppliers, the money available to the Russian state to build new pipelines would be limited. Putin implicitly acknowledged this by repeatedly calling for security of demand, and as noted earlier, Aleksandr Medvedev has threatened huge price increases.


The bottom line is that Russia possesses huge amounts of oil and natural gas, but the legacies of poor investment decisions and neglect of infrastructure hamper its export capacity. Russia may want to use its energy clout, but its neighbors and customers further afield are increasingly wary of its political ambitions. Thus, Russia is indeed an energy colossus, but it is a giant with limited reach and standing on only one foot.