Several unprecedented global events have awakened international interest in Russia as the world’s major energy exporter. The high political risks involved in world energy supplies following September 11, 2001, the Iraqi campaign, structural changes in energy consumption (especially as coal tends to be replaced by natural gas), integration inside Europe and the ex-Soviet Union are influential developments which place greater emphasis on the energy question. Major consumers of energy resources — the EU, the United States, Japan and China — may even turn out competitors for future supplies of Russian gas and oil, as well as the right to engage in the development of Russia’s export infrastructure.

The European Union was the first to begin an in-depth energy dialog with Moscow when economic growth slowed in the developed countries and competition intensified on the world markets. By the fall of 2000, after a decade of decline, Russia had gained political stability and was beginning to show high growth rates. Nevertheless, it took the economically developed countries two more years to recognize Russia as a market economy state. In the fall of 2002, a new, reformed Russia became an integral part of the global community once again.

The energy market is a mixed bag of interests: countries, energy firms and producers of energy-intensive products are all vying for position. The complexity of the situation demands that Russian policymakers make well-balanced and responsible decisions which conform with the country’s long-term interests. In its relations with the EU, Moscow cannot maneuver between positions of various countries. Its sole negotiating partner in Europe is the European Commission, the EU’s executive body which expresses the collective will of the 15 member countries, whose number will soon grow to 30 nations. This collective will is the result of a complex process of harmonizing many diverse interests: governments of various countries (budgets), the European Commission’s directorates (for energy and transport, and for competition), consumers, major wholesalers of energy resources, and European energy producers. It would be unwise to indulge in illusions with Russia’s trading partner — the European Commission will show maximum tenacity and assume a hard stance in its desire to safeguard European interests. Russia’s dialog with a united Europe will only prove successful if the various interests inside Russia (those interests would cover the budget, exporters of energy resources, exporters of energy-intensive goods, and the economy in general as a target for re-investing export revenues) reach a solid consensus defining exactly what its national interests are inside the energy sphere.

Europe And Russia In Close Interdependence

Russia’s energy dialog with the EU started during the Paris summit in October 2000, while the very idea of integrating Russia into the European economic and social space was outlined in the EU’s collective strategy on June 4, 1999. These steps followed the Partnership and Cooperation Agreement (PCA) between the EU and Russia, which took effect in December 1997, but failed to yield any substantial results. In May 2001 and May 2002, under the aegis of Russia’s Deputy Prime Minister Victor Khristenko and Franоois Lamoureux, EC Director General for Energy and Transport, two synthesis reports were published. The EU’s main goals in the energy dialog are securing stable energy supplies to the continent amid toughening environmental requirements, and enhancing European industry’s competitive ability.

In the coming years, there will emerge a unified market in direct proximity to Russia’s borders, which will potentially embrace 30 countries. (Throughout this article estimates are given for 30 member countries of the future EU — 15 current member countries, 12 applicants in Central and Eastern Europe, the Baltics and the Mediterranean, as well as Turkey, Norway and Switzerland — since Russia must build its policy for the long-term future.) This vast area, with a population of 450 million (around 8 percent of the world’s population in 2001), accounts for 22 percent of the world’s GDP (proceeding from the purchasing power parity in 2001) and imports the bulk of Russia’s exported energy resources. There has arisen a situation when extremely important energy supplies to Europe are delivered by a European country, but they are not regulated by European rules. While the European Union can regard oil and gas from Africa, the Middle East, etc. as imports from remote sources, Russia’s proximity to the EU has prompted the latter to view Russia as a partner of potential integration.

During the past 12 years, Russia’s reintegration into the global economy, following the breakdown of the Communist bloc, has been accompanied by shocking losses for Russian manufacturing industries; Russia has maintained a competitive position only in the arms market, and some other market niches.

Russia owes its success in overcoming the transitional crisis, financing the country’s development and ensuring a favorable trade balance to a small group of energy-intensive goods and energy resources. Integration into the European economic space via energy resources is important for Russia as an instrument of accelerating its further development and modernization and — eventually — reducing the heavy role of energy exports in the national economy.

In the 1990s, a relatively stable model of Russia’s trade relations with Europe took shape. Two groups of commodities prevail in Russian exports: energy resources (mostly oil and gas) and energy-intensive commodities, such as metals and chemical products.

Graph 1. Russian exports to the EU and Central and Eastern Europe in 2001, %

Russia’s imports from Europe include consumer goods, engineering products, as well as popular and expensive travel services. The migration of labor from Russia to Europe is insubstantial. Capital is exported from Russia in various forms and imported into Russia in the form of loans.

Russia and Europe are now economically more attached to each other than ever before. For the first time, energy imports from Russia have become vital for the European economy, and this importance will continue growing in the future. As the share of energy resources is extremely high in Russian exports (65 percent), Russia has developed a new type of dependence as well. Head of the Delegation of the European Commission in Russia, Richard Wright, rightfully says that Russia has no choice but to gradually adapt its legislation to that of the EU. But rapprochement with Europe does not remove from the agenda the need for Russian businesses to adjust to the realities of Asian markets, as well as those of other regions, where the share of the manufacturing sector’s products in Russian exports is substantially higher than those exports to Europe.

To a great measure, Russia’s move toward aligning itself with European legislation is prompted by its market reform and expected accession to the World Trade Organization. However, it will hardly be able to selectively borrow certain provisions from its European neighbors, while remaining outside the system. But energy markets are the least regulated in the WTO framework, which makes the energy dialog a more innovative sphere than the others. Anticipated growth in the demand for energy resources in Europe over the next 20 years requires capital investment by companies (no matter what country they come from) which will have to sell their energy resources in the enlarged European Union, while producing them outside the Union. The more similar the investment environments, the less the business development costs, and the European Commission has provided for that in advance. Specifics of investment, worth billions of dollars, in the production and transportation of vast amounts of energy resources over thousands of kilometers must provide for political factors, commercial risks, the duration of construction, and competition among companies and countries whose well-being depends upon energy exports.

It is impossible to understand the essence of the dialog with Europe unless we take into account the real trends in demand for various types of energy resources. These trends must be considered for the future 30 member countries of the European Union. During the past 25 years, Europe has rapidly shifted from the consumption of traditional fuels, primarily coal and oil, to natural gas and, to a lesser degree, nuclear energy. Between 1973 (the last year when oil was cheap) and 2000, the share of coal in energy consumption dropped from 25 to 14 percent, and oil from 60 to 42 percent, while the share of natural gas increased from 10.5 to 23 percent. The use of nuclear energy increased from 1.5 to more than 15 percent (hydroelectric power and other types of energy account for the rest of energy consumption). In the 1990s, the European shift away from coal to natural gas rapidly intensified due to reasons concerning efficiency, as well as environmental considerations.

In Europe, the only substantial energy producers to speak of are the U.K., the Netherlands and Norway. In the Netherlands, the peak production of gas has already passed. The U.K., while remaining an oil exporter, is expected to become a net gas consumer by 2005, or somewhat later. In Norway, oil production has tended to stabilize, while there are prospects for stepping up its natural gas output.

The figures are an expert judgment — data from various sources for the past periods differs by 10-15 percent. The new member countries are Bulgaria, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Norway, Poland, Romania, Slovakia, Slovenia, Switzerland, and Turkey.

While the world’s natural gas consumption has grown 20 percent over the last decade, it has increased nearly 40 percent in Europe. Although European nations seek to develop their own renewable resources (wind energy, biomass, solar energy), this will not solve their energy problems in the foreseeable future. There have appeared theories seeking to prove that growth is possible at stable, non-increasing amounts of energy consumption. France and Germany have achieved certain success in these efforts, but their growth rates have been low; besides, they have had to increase their consumption of natural gas. So, the demand for Russian gas is likely to grow even if the overall energy consumption remains stable.

Europe views an increase in the share of natural gas in its energy balance as the solution to the main problems faced by its energy sector: making EU products more competitive and minimizing the negative impacts on the environment. This increase implies more reliance on imports — by 2020, 60-70 percent of Europe’s natural gas will be imported. One of the main sources of natural gas for Europe is the imports from Russia and the Commonwealth of Independent States.

Reform Of The European Energy Markets

European power and natural gas markets are undergoing reforms initially described as deregulation and now known as liberalization. Until recently, the economies of France and Italy were dominated by state-backed national monopolies. In Germany, where strict anti-monopoly legislation is in place, several major companies held key positions. That creation of the natural gas sector was due to the fact that this industry had been developed with the state’s active involvement during the past 30 years (gas began to be consumed on a large scale in Europe in the 1970s). Gas was mostly imported under intergovernmental agreements. Powerful infrastructure was created for gas delivery and consumption with the help of all sorts of preferences. As a result, economic mechanisms, long rejected in other industries, continued to be applied to the gas sector.

Expensive energy resources are a serious drawback, reducing Europe’s ability to compete in the market. Attempts to resolve the problem have been made by reducing the number of intermediaries in the energy supply line, liberalizing the market, etc. The successful liberalization of the gas market has been accomplished in Britain which has its own gas fields, and where the tax system is not as complex as in continental Europe.

Another example is the liberalization of the EU’s power energy market. In the past, each country used to rely on its own potential: Germany relied on coal, Italy on fuel oil, etc. This practice ran counter to the European Union’s fundamental principles (unity of the markets, competition on a EU scale, etc.), and reform in the energy production sector has been fast-moving during the past years. Where energy flows are physically possible in principle, countries producing more electricity than they required began exporting it, which caused prices to decrease by approximately 50 percent. Today, there is a power surplus throughout Central and Northern Europe. Resulting low prices (for example, U.S. $0.025 per kilowatt of electricity in Germany) only reflect a variable component of costs and do not recoup new construction costs. According to estimates, demand for new investment in power engineering may emerge in the EU only after 2010, which may cause an increase in energy prices. This explains why Europe has not been taking any serious steps aimed at integrating Russia’s Unified Energy Systems into the common European market. This aspect of the energy dialog remains in the background today, but interest in it may increase when the EU faces shortages of general energy capacities since the level of investment is quite low now in this area. Importantly, the liberalization of the EU electricity market has been accomplished under conditions of surplus capacities, and on the basis of the EU’s own generating capacities — this is an essential difference from the situation in the natural gas market.

The EU’s directives aimed simultaneously at liberalizing and unifying the European market (the directive for the power sector was adopted in 1996, and for the gas market in 1998) will influence the supplies of energy resources for many decades. In 2002, it was decided that the liberalization process will be completed in 2005 (rather than in 2008, as the EU initially planned). Major companies now combining both natural gas transport and natural gas marketing functions will be split up and there will emerge two distinctly different types of organizations.

The EU’s initiative was primarily political and the main goal was to launch a program of liberalization; this approach failed to address in detail, however, such issues as taxes, the behavior of suppliers, and the like. It implied that consumers would have a right to access transport capacities and to sign and extend any contracts. But it turned out that the natural gas market hardly fits into such schemes. It has always been founded on stable long-term ties rather than on the spot contracts. The natural gas trade is impossible without costly pipelines and therefore requires long-term investment both in the production capacities and in the construction and maintenance of the pipelines. By shifting from a supplier’s market to a buyer’s market, the EU hopes to resolve two problems at once: secure long-term supplies (and a probable growth in imports) while reducing gas prices for major consumers (chemical production and power generation) and households.

The liberalization initiative for the natural gas market has been proceeding very slowly and with great difficulties. While in the power energy sector the producers are powerful European companies really able to compete in the common European market, the natural gas sector is different. Here, European companies have been reluctant to disrupt traditional ties, and gas suppliers are companies based beyond the borders of the EU. Major purchasers of natural gas, and its transportation intermediaries, have come to realize that they are no longer guaranteed a comfortable position within their national borders, and thus seek to secure a place in the new market. But even the biggest companies, like Ruhrgas, are not big enough to become pan-European players. Major restructuring has been underway, with companies buying other companies or forming alliances. The market has reacted to liberalization by the reorganization and integration of companies, rather than head-on competition and price reduction, which is the case in other economic sectors. Importantly, this is the initial phase of a dynamic process, rather than a complete system to which one has to simply adjust. Suppliers find it difficult to compute the efficiency of major long-term investments in gas production and transportation, since the situation in the European market is constantly changing.

The EU is now working on its second directive concerning natural gas imports. The first directive was a difficult compromise between individual countries. The second directive will place greater emphasis on reciprocity (synchronization of transparency of national energy markets with each other). This provision may gradually become part of the EU’s internal regulatory legislation, then an element of the common economic space (for example, for Norway). Finally, the provision will become an important part of the energy dialog between the EU and Russia.

One example of the EU’s position in the course of its internal transformation is the Transit Protocol to the Energy Charter Treaty which Russia signed in 1994 but has not ratified yet. Transit regulation issues are rather complex: provisions concerning available capacities, transit tariffs, the “right of first refusal,” etc. In fact, the parties negotiated for the transparency of gas supply procedures for Russian companies exporting gas to EU member countries under long-term contracts — what actually can be referred to as a “grandfather clause.”

The situation is different with regard to the applicability of the Transit Protocol to EU member countries. This issue was raised quite unexpectedly in the fall of 2001, when the European Union’s delegation proposed adding to the Transit Protocol a provision on its applicability to the EU as a single entity. In other words, this provision interprets transit as the transportation of energy resources across the EU as one single entity. Thus, the EU would free itself from transit-related commitments with respect to outside suppliers, as the transportation of natural gas would be regulated by the EU’s internal legislation rather than by international agreements. This interpretation of transit means that with respect to natural gas exports from Russia it will only apply to a limited number of cases — for example, transit across the EU to Switzerland. Following the European Union’s expansion in 2004, the Transit Protocol will only apply to Russian energy exports flowing via Belarus, Moldova and Ukraine, and these issues can be resolved on a bilateral basis. As for transportation of energy resources across Russia from third countries, this situation would be covered by the Transit Protocol in full measure, thus effectively making it an international agreement on transit across Russia.

The attempts of suppliers to retain long-term gas contracts and other attractive prospects are similar to the wishes of Western investors who search to find an absolutely stable investment environment in Russia. Alternatively, they may demand to insert a “grandfather clause” into their major contracts, or provide for production sharing contracts. Difficult negotiations concerning the future regime of the natural gas trade with the EU have been going on for several years. In the long run, the EU — in the Second Progress Report, presented by Victor Khristenko and Franоois Lamoureux — has confirmed, however reluctantly, the enduring significance of long-term contracts: “The Commission has made it clear that long-term take-or-pay gas contracts are indispensable.” (Still, it is not clear if it is the European Commission’s final position, as the view of the antitrust directorate is different.)

As distinct from the oil market, the gas market is characterized by a very high share of transportation costs. In the past, the balance of interests between the suppliers and consumers was based on the fact that gas producers were guaranteed sales for many years and could reasonably hope for a payback on their investment. There remained risks for the suppliers, because gas prices were, and still are, pegged to the price of a barrel of oil, thus making it impossible to accurately predict profits. Yet, gas suppliers were spared the need to think about retail sales. Now, the companies which transport gas will have to go through a difficult transitional period, while the number of intermediaries will be reduced. In the future, Russian suppliers will be able to compete with each other for consumers, but the risks of this approach will grow. The new environment will require high management efficiency, new approaches, and access to local infrastructure. In principle, suppliers may turn out to be the actual winners, but one cannot be absolutely sure about this. Renunciation of long-term contracts and a shift to a spot market and short-term deals are among the main goals of the liberalization. Although the need for long-term contracts was confirmed during the discussions, future prices that are based on short-term deals — like in the oil spot market — could shift the risks on to producers. In this case, the transportation company will charge its tariff, while the margin between the spot price and the tariff will go to the gas producer. In the future, producer profits may vary wildly, like oil prices. If this is the EU’s goal in liberalization, a surplus of gas supply would be desirable in the main regional markets. The price of gas delivered to Germany ($115 per 1,000 cubic meters), while oil prices are high ($23 a barrel), would guarantee relatively high profits. But if the price of oil drops to $16 a barrel, the price of gas will decrease to $80. With transportation costs subtracted, this leaves $10-$15 in profits — no production project can survive this rate of return. And the associated high risks inevitably reduce the suppliersХ willingness to invest.

The future for investment in supplies to the developed and rapidly developing nations, where demand is particularly high for natural gas rather than oil, is being defined today. The European economic space is an attempt to pool efforts needed to improve Europe’s ability to compete with Southeast Asia (including China) and NAFTA. Liberalized markets and competition among market players are the principles Europe has adopted. But high gas prices for end consumers in Europe are the result of the European distribution system and high taxes, rather than expensive imports.

Natural gas which is exported to central Europe at approximately $100 per 1,000 cubic meters, reaches end consumers along the supply chain at $120-$150 for major consumers, and $300-$350 for remote and smaller consumers. The margin between supply prices of energy resources and end prices paid by consumers is predetermined by tax deductions and social policies. Taxes collected on energy resources partially mitigate various social problems, and help make capital investment in next-generation energy sources, even though the mismatching tax systems of various EU member countries are a clear obstacle to trade in energy resources. In a sense, those profits and tax revenues are being used to finance Europe’s modernization program. Russia should learn from this experience for its own development, and make it an object of discussion in the energy dialog.

Protection of Europe’s economic interests should provide for the balanced protection of all the players in the common economic space; this would be an important consideration for Russia once it has decided to become a member. The pace of internal changes in the EU is growing, requiring a deeper analysis of potential effects of these changes on Russia and its companies in order to clearly understand the state of Russia’s main gas market for the next generation.

Russia’s Interests And Prospects

Clear answers have yet to be provided to a number of key questions. For example, what are the goals of Russia’s energy policy in Europe? What is the scale of Russia’s involvement in EU energy supplies? What are the limitations and risks involved? And how can export revenues be best used for the country’s development? There are few people in Russia who could doubt that the goal of trade in energy resources is receiving and re-investing stable revenues in the long term (20-30 years), rather than maximizing export volumes of some or other type of energy resources. Initially, Russia’s position was simple: as an integral part of Europe, the Russian Federation assumes its share of responsibility for guaranteeing Europe’s ongoing energy security. For that reason, it has entered into an energy dialog with the EU and is prepared to consider stepping up energy supplies on certain terms:

* additional supplies of power energy should be accompanied with investment and transfer of technologies to Russia;

particular attention should be paid to energy-saving technologies, which may be regarded as an independent source in the expansion of supplies;

* free transit for all Russian energy resources to the EU-15 via Eastern Europe (which is now being integrated into the EU);

* the expansion of energy supplies should embrace, along with primary energy resources, power energy (including that generated by nuclear power plants), nuclear fuel, energy-intensive goods (fertilizer and metals), oil products, etc.

Many private Russian companies compete in the European oil and coal markets, and are seeking to gain a firm foothold in Eastern Europe before it has joined the EU. The countries of the ex-Soviet Union account for about 37 percent of European oil imports. Considering projects for Russian oil exports to the U.S. and Chinese markets, this figure will grow, mostly due to the export of oil from Kazakhstan. Russian companies will likely step up their supplies of oil products, although not necessarily from oil refineries based in Russia. In that sense, the integration of Russian businesses into the European economic space is proceeding in full swing.

In the field of power energy, Russia is interested in building bridges to Europe in order to add stability to its energy supply systems. It is also interested in being able to maneuver resources, while ensuring access to the European markets for probable surplus capacities, which may result from basic reforms in the power sector. A program for the construction of nuclear power plants in Russia may also contain an export orientation. The situation concerning nuclear fuel is a separate issue, of course, since all such purchases require licensing, thus artificially limiting Russian exports (even though this runs counter to Article 22 of the PCA). Eventually, Russia will have to formulate its priorities concerning its various forms of exportable energy resources.

As for Russia’s domestic interests concerning electricity and gas tariffs, it needs to avoid a serious conflict between the metal and fertilizer exporters, on the one hand, and energy exporters and the budget, on the other. The existing price formation system of Russia’s gas sector dates from the 1970s-1980s when the Soviet infrastructure was created at the state’s expense, as well as to the detriment of other social issues. Seeking to create an export-oriented sector, the state stripped assets from other sectors of the economy, not to mention from the population in general, in order to proceed with its plan. Thus, the Soviet Union was able to invest $10 billion-$12 billion per year in the gas industry. The seemingly low tariffs today ignore the construction costs of that vast infrastructure. Actually, the cheap domestic gas supplies are not only the result of Russia’s natural advantages (rich natural resources), but also a ХgiftХ from the Soviet people — the natural gas infrastructure was financed with their latent savings.

Recently, the European Commission set forth certain demands related to Russia’s domestic gas prices as one of the preconditions for Russia joining the WTO. The Russian newspaper Commersant quoted EU Trade Commissioner Pascal Lamy as saying that Russia should bring its energy prices into line with international rates, thus eliminating the annual $5 billion hidden subsidy within its industry. The current domestic prices, which constitute just one-sixth of the world prices, let Russian producers export their goods at unfoundedly low prices. The issue is too important for the EU to ignore, Lamy said.

It seems rather obvious that the European Union wants Russia’s energy-intensive goods to be more expensive. According to unofficial estimates cited by the press, the EU would like to see gas prices increase to $45-$60 per 1,000 cubic meters for Russian industrial consumers. This would increase revenues for Russia’s energy producers, thus providing for further investment in other export projects. Also, it would make it easier for European metallurgical and chemical industries to compete in the EU internal market.

A steep gas price hike would be a one-time shock for the Russian economy, for which it will be very important to reduce the inflation rate in the coming years. Second, the effect of cross subsidies provided to private consumers by Russian industries, under conditions of extreme social inequality, is not being taken into account. The difference between per capita GDP in the EU and Russia ($21,000 against $2,500 in current prices) is too great to be ignored in the context of the European economic space. Finally, liberalization of the domestic gas and electricity markets is important for Russia, as it will result in a natural growth of tariffs to, potentially, $40 per 1,000 cubic meters from today’s $21, according to an unpublished World Bank report cited by The Financial Times.

Russia’s position is that low energy prices are a natural advantage of a country rich in natural resources. Furthermore, the Russian population, which for decades invested (via the planned economy system) rather heavily in the development of the energy sector, now has the right to enjoy lower energy rates.

Russia now mainly produces gas from the old Soviet network, but new natural gas resources are being gradually commissioned. More and more pipelines need repair, and from 2010, there will be the need to implement large-scale projects, which will require the development of new energy producing regions, as well as the construction of new transportation networks. Given the current prices (not only low domestic prices, but also export prices of, say, $100 per 1,000 cubic meters), it is difficult to invest as much funds toward a project as in the Soviet times as a substantial share of new gas resources will only make up for depleted resources rather than add to output growth.

Long-term planning will also require answers to many political questions. For example, will the consortium in Ukraine work efficiently? Will it be able to renovate the gas pipelines within a reasonable time frame? Would it be worth laying a Baltic pipeline in order to by-pass other countries altogether? This proposal would increase the project’s initial costs rather significantly, but would allow for the reduction of transit tariffs at the same time. Will oil companies, and other energy producers, be offered acceptable financial terms for gas production in Russia as a result of reforms within the sector? The experience of the United States, for example, indicates that in order to ensure reasonable long-term utilization of energy resources, it is expedient to develop small and mid-sized fields. New gas produced by oil companies, or independents at smaller fields, would in the future allow balancing gas supply and demand, as well as helping to free up export routes. The nuclear power plant construction program also objectively serves this purpose, as it will reduce the future demand for gas in the European part of Russia.

Yet another separate question, this in connection with the EU’s nuclear fuel policy: what share of its gas supplies is the EU prepared to allow from any one source? Officially, there are no restrictions on this amount, but it is recommended that not more than 30 percent of gas imports should derive from one source, given the dependency which the future EU members have for Russian gas. Russia now accounts for 36 percent of natural gas supplies to Greater Europe (Britain supplies 31 percent, Norway supplies 16 percent, and these are followed by Algeria, the Netherlands and Nigeria), while the EU’s own gas output is unlikely to exceed 300 billion cubic meters in the foreseeable future. Russia’s exports will stand at about 20 percent of all gas supplies in 2020, with physical export volumes remaining unchanged. But if Russia wants to retain its current share proportion (around 30 percent) in the expanding European market, its supplies should increase from 130 billion cubic meters to 200-210 billion by 2010. This actually means that three additional lines (with an annual capacity of 30 billion cubic meters, each) will have to be constructed to carry the extra amount, given that demand will also gradually grow in Russia and the CIS. In that case, Russia’s ability to simultaneously supply other export markets will remain unclear.

A thorny issue is a ratio of supplies of Russia’s own energy resources and transit supplies from other countries to Europe. Russia will certainly allow transit supplies of energy resources across its territory. The need to serve the old, ‘SovietХ capital invested in the pipeline transport requires that tariffs should include renovation costs, no matter what price formation models are applied.

While anticipating the future situation in the EU-30, the European Commission is trying to create a buyer’s market (with supply exceeding demand) for gas in the foreseeable future by attracting as much gas as possible from faraway regions: Iran, Qatar, Nigeria and Central Asia. Excessive supply can be created only by producing countries or supplier companies if they decide to make long-term heavy investment in the European market now in the hope of its fast growth. Suppliers can also go over to liquefied gas production, which would let them supply the whole of the world market, as oil exporters do. On the other hand, delivery costs are high, and initial investment in the construction of liquefied gas plants and terminals is comparable to the cost of laying new gas pipelines. As vast investment is required, the cost of a mistake would be enormous for the potential investors.

Russian exports to Europe have no alternative for either party at the moment. It is necessary to define export priorities, routes, project costs, sources of finance. So far, no detailed elaboration has been made of specific plans, nor have there been indications of major European investment in the Russian economy. Clearly, the parties will have to make responsible political decisions concerning cooperative strategies before the Russian judicial code is brought into line with European standards. Either those suppliers wishing to expand their exports will provide the investments themselves, and subsequently undertake all risks in the determination of a target market, or the investment will have to derive from European sources after they receive guarantees that the produced energy resources will be supplied to the EU. The more uncertainty there is about the terms of future sales in Europe, the harder it will be to accumulate financial resources for such vast projects.

Along with other basic commitments, Russia’s operation in the common economic space should provide it with certain privileges. For example, EU Хinfrastructure grantsХ for the development of poor regions could become part of joint financing of Russia’s development. This investment in energy production would involve allocations for environmental protection, together with the development of basic infrastructure.

We proceed from the assumption that in the coming decade the EU and Russia will move toward the formation of a common economic space and a higher level of integration. But differences will remain, and the parties will complement each other in the energy market in particular. Russia has certain inviolable rights to know more about the future of Europe’s gas market since it has always С even during the grave political and economic crises of the 1990s С remained an absolutely reliable provider of energy supplies to Europe.

The issue of investment in the production and export of energy resources brings us back to the goals of Russia’s Energy Strategy. Most countries, when they consider their long-term strategies, need to take account of a smaller number of factors. These are one or, at most, two energy industries, the manufacturing sector (fuel prices), and the interests of the population (tariffs) and the state (taxes). In Russia, there are four full-scale energy industries (electricity, oil, gas, and coal), and their interests coincide in some respects and clash in others. The companies operating in these industries are privately and state-owned.

The matter at issue is vital interests of the population, therefore, Russia needs a long-term energy policy and a development strategy that takes into account international aspects of the economy, including the Russia-EU Energy Dialog. In the long run, the state, concerned about Russia’s economic modernization in general, will be interested not in physical export volumes, or even in the value of exports, but rather in export revenues being re-invested in the further development of the Russian economy.