As oil and gas prices skyrocket and the dangers of climate change become more apparent, energy security has become an increasingly important item on international agendas. This article, divided into two sections, focuses on two distinct but inter-related energy issues. The first section analyzes the relationship between Russia and key Russian energy importers. The second section examines the capacity of the Russian economy to withstand a possible drop in oil and gas prices.

RUSSIA’S RELATIONS WITH ITS KEY ENERGY IMPORTERS

International commentators often suggest that there is an enormous divergence between the views of Russia and the views of key importers of energy from Russia. However, when examining this position, it appears that much of it is constructed on rhetoric and media-hype, rather than the reality of relations between Russia and the importers of its energy.

In order to analyze these relations, one must first clarify what is meant by “key Russian energy importers.” These are large and small European corporations, as well as several European national governments. Neither the former nor the latter are opposed to Russian energy strategies. Russia actually maintains good business relations with the buyers of its energy. These relations do not suffer from major conflicts or antagonism; the only pressures they face are those resulting from competition and the market environment. Therefore, at the commercial level, we see that sales of long-term energy contracts are on the rise, joint efforts to build new pipelines are increasing, and access to Europe’s downstream assets is continuously broadening.

Indeed, the divergence between Russia and its energy importers exists only at the political level. Opposition to Russian energy strategies comes from U.S. and EU political leaders who try to manipulate the views of actual buyers of Russian energy. Russia in general and Gazprom in particular are the victims of a number of myths. These myths are aimed at creating a powerful negative image and turning Western public opinion against Gazprom. They include the view that Russia’s energy monopoly results in the EU’s political dependence on Russia. They also include unfounded accusations that Russia is utilizing energy as a weapon against its neighbors. This rhetoric has led many to overlook the fact that it was the U.S. that “advanced” its negative economic arsenal in relations with Russia when it openly pushed for the construction of oil and gas pipelines that deliberately avoided Russian territory. It was the U.S. that sent angry signals and condemned every important energy deal between Russia and individual European states. Such behavior demonstrates a much greater politicization of energy issues than any of the oft-cited examples referring to Russia’s actions.

However, the politicization of energy is not a new phenomenon. Oil and gas have always been closely connected with politics. The entire history of the formation and rise of Western oil and gas industries demonstrates the connections between energy resources and politics. In fact, a troubling phenomenon recently has been the contradictory stances adopted by the European Commission. It supports U.S. rhetoric regarding the threats posed by Gazprom to the EU, and calls for uniting around an anti-Russian stance to counter Russian “schemes.” Yet, on the other hand, the European Commission accuses Russian gas corporations of not being active enough in exploring and developing new fields to satisfy growing demand for gas in European countries. These two opposing positions seem difficult to reconcile. To illustrate the Western media’s anti-Russian bias, I quote a letter to the Financial Times by Jonathan Stern, a leading British natural gas expert: “FT readers do not expect the daily’s headlines to reflect anything positive about Russia. However, despite their opinions, your journalists at least should try to present facts correctly.” Stern was referring to an editorial which stated, incorrectly, that during its 15 years of existence, Gazprom had not explored a single new significant field.

Such unfounded criticism is problematic. In this context, it is also worth highlighting the European Commission’s recent paper on energy, submitted to the European Parliament, in which it suggested that the further liberalization of the “unified EU energy market” would serve as a universal panacea. This paper has received ambiguous responses from several EU member states, and is also viewed skeptically by a number of European companies that fear their competitiveness will be affected. While these concerns are internal EU matters, the notion of a “unified gas market” is in itself highly problematic. For Russians who lived through the Soviet planned economy, the document seems to reflect a new form of administrative and bureaucratic economic system. Gosplan (the State Planning Committee) of the Soviet Union also artificially established a “unified national economic complex” in a country where capitalism had not yet completely unified the Russian domestic market. It was therefore not surprising that, following the collapse of the political system in the Soviet Union, its patchwork economy split into parts that were not linked by a market.

So far, the EU is made up primarily of an aggregate of different national economies. For a unified energy market to take shape, it is first necessary to build a network of all-European gas pipelines. To start by pursuing a unified gas policy to counter its chief gas supplier – as the EU is trying to do – is not an effective strategy. It is an over-politicized bureaucratic method that has no future and risks undermining established relationships. Again, according to the above-cited energy paper, the European Commission plans to “identify” – and not build – “the most significant missing infrastructure by 2013.” It suggests that only four “of the most important priority projects” should be started. Only one of these four projects is related to natural gas; i.e. the Nabucco gas pipeline, for which reliable natural gas supply sources have still not been identified. One cannot accuse the European Commission of working too hard to supply Europeans with their needed energy.

On the other hand, Gazprom – through projects such as Nordstream, South Stream, and the development of southern Russian gas fields and Shtockman offshore fields – is actively working to provide more and better gas supplies. Of course, Gazprom is a profit-based corporation and is pursuing its own business interests. These business interests often, but not always, match Russia’s national interests. This is much discussed, but what is not acknowledged is that they often also serve Europe’s interests. All of Gazprom’s activities in the EU have been fully in line with the key interests of its member states, and most are being implemented in coordination with European oil and gas companies on the basis of inter-governmental agreements. The further implementation of Gazprom’s projects would benefit the EU by:

• Helping to meet the rising demand for natural gas in Europe;
• Minimizing transit risks;
• Strengthening cooperation between the Russian Federation and the EU as well as deepening interdependence – rather than unilateral dependence – between the two parties based on mutual benefits of oil and gas cooperation within the framework of joint ventures;
• Expanding the scope for competition in consumer gas markets;
• Supporting and expediting the process of forming a unified gas market in the EU.

If, as it is claimed, Gazprom were trying to pose a threat to the EU, then it is certainly pursuing a very unusual strategy. It spends billions of euros on joint pipelines and gas holders in European countries, exchanges assets with other European energy companies, and places European partners on the executive boards of its offshoot companies. In examining Gazprom’s activities, one can hardly say that they pose a threat to the EU. In fact, Paolo Scaroni, chief executive of Italian oil and gas company Eni, described Gazprom as “the pillar of European energy security.” Much of the perception of a threat is the result of U.S. statements. When U.S. Secretary of State Condoleezza Rice speaks of the threat from Russia’s energy policy, one needs to remember that it is coming from a U.S. official. The U.S., as the EU’s main economic competitor, is not interested in an EU that becomes stronger through its cooperation with Russia.

It is much more difficult to understand why the European Commission, which is responsible for ensuring European energy security, has consistently been trying to place more barriers in the way of successful cooperation with its main gas supplier. Vladimir Putin as president ironically commented that he had the impression that it was Gazprom, and not the European Commission, that showed more concern for Europe’s energy security. European analysts are also critical of the European Commission’s strategies. Wolf Bernotat, head of E.ON, even went as far as to say, “They are all speculating about Russia, but the real threat comes from the European Commission.”

It is time for the European Commission to make up its mind about what it really wants. Does it want to ensure Europe’s energy security based on a mutually beneficial partnership with Russia or to pursue an openly politicized anti-Russian energy policy? Given their geographical proximity and at a time of increasing energy scarcity, it seems that it would be in the interests of both Russia and Europe to pursue cooperation on equal terms. Commercially, such cooperation is already being pursued. It is the political grandstanding that needs to change.

TO WITHSTAND CHANGE IN ENERGY MARKETS

Western political grandstanding discussed above is often accompanied by the idea that the Russian economy is not strong enough to withstand an unforeseen drop in energy prices. The Russian economic recovery is dismissed as being solely the result of the rise in oil and gas prices. Although Russia’s economic recovery was certainly aided by a rise in oil and gas prices, the economy is now diversifying. In any case, a scenario contemplating the fall of prices in energy markets is highly unlikely.

First, there will not be a sharp fall in oil prices and, as a result, gas prices will also remain high. The era of cheap oil is over. Many factors indicate that prices will remain high, if not rise further. These are:

a) speculative trading on commodity exchanges;
b) natural disasters that might temporarily disable machinery and equipment in fields, transport and refineries;
c) political instability and conflicts in energy-producing countries;
d) economic growth and rising demand for hydrocarbons in emerging economies.

Political instability may be particularly important since more than 62 percent of all global oil reserves are found in the Middle East. In this region, many countries are experiencing a historical transition from a feudal and tribal order to a capitalist one in a rapidly globalizing economy. This process inevitably has the potential for instability. However, the potential for instability has increased even more as a result of a U.S. policy that aims to “bring democracy to the greater Middle East.” The destabilizing consequences of such a policy are demonstrated by the unending conflict in Iraq. Such instability is likely to impact markets and lead to higher prices.

On the other hand, a substantial fall in prices seems highly unlikely. There are two scenarios that may lead to such a fall. The first would be the development of new production facilities in unexplored and difficult environments, such as remote areas of the Arctic and deepwater offshore fields. This would require expensive and innovative technologies and is not likely to be profitable any time soon. As for the development of alternative energy sources, most Western experts believe it usually takes 16 to 20 years to convert a promising idea into a commercially viable enterprise. There is also no guarantee that alternatives will be efficient and will not lead to unforeseen problems, as has been the case with biofuels. Efforts to “feed” Western cars with biofuels have led to a food crisis in Africa, Asia and Latin America. As a result, governments are changing their positions and demanding that rainforests and areas for cultivation should not be used to produce biofuels. Hydrocarbons cannot suddenly be abandoned and will continue to play an important role as energy sources.

Meanwhile, economic growth in Russia is diversifying and its dependence on the energy sector is rapidly falling. National and cluster projects have been identified and are being implemented within public-private partnerships with the aim of diversifying the structure of the Russian economy. The last few years have witnessed steady growth in foreign direct investment in Russia. FDI doubled three years in a row from 2005-2007. This demonstrates that the Russian economy is strong and attractive for investors. Investments are now taking place not only in the oil and gas sectors, but also in other production industries. The petrodollars accumulated through the Stabilization Fund and other types of saving funds are being utilized for investment in other sectors of the economy, and this will stimulate further growth. The picture of the Russian economy is no longer one of dependence on oil and gas exports. It has been significantly transformed, and is now a robust, vibrant and diverse economy.

Energy security is increasingly important for both consumer and producer countries. For Europe, Russia is the most important supplier of energy. Equally, Europe is Russia’s most important market for its energy products. It is ironic that the energy security of both states rests with each other, particularly when Europe’s political leaders have fostered the idea of divergence between their respective interests. It is therefore in Europe’s economic interests to move beyond political myths and constructed antagonism, and to develop a better, mutually beneficial working relationship with Russia in the energy sector.

This material was prepared for a discussion at the symposium “Foresight: Russia in the 21st Century,” organized by the international forum of Deutsche Bank, the Alfred Herrhausen Society, in partnership with the Russian Council on Foreign and Defense Policy, and Policy Network, a British think tank.