The issue of Russia’s ratification of the Energy Charter Treaty (ECT) – or rather its refusal to ratify the document – long ago became a purely political issue. Moscow continuously stresses how detrimental it would be to its national interests to sign the treaty. Meanwhile, Western politicians (including, strangely enough, those in the U.S., although the United States itself does not intend to ratify it) are not giving up their attempts to convince Russia otherwise. Political considerations hamper a balanced, professional assessment of the treaty and a realistic analysis of its viability.

The EU evidently overstates the importance of the ECT, regarding it almost as a panacea for all risks connected with its dependence on Russian energy supplies. Being as it is a document in international law, the ECT does not provide a universal politico-economic solution, nor guarantees reliable supplies. The ratification dispute reflects a broader problem: filling in a legal vacuum in the troubled energy relationship between Russia and the EU.

CONCERNS

Oil and gas production in the North Sea is declining, while Europe is becoming increasingly dependent on energy imports – primarily from Russia. The EU’s course toward the liberalization and de-monopolization of energy markets is at odds with the Kremlin’s economic policy, aimed at strengthening the role of national energy monopolies, above all Gazprom, as well as with the general trend toward their growing influence on the European market.

The expansion of Russian national champions is natural: the relationship between Russia and the EU in the energy sphere transcended the bounds of wholesale transborder trade a long time ago. However, the growing presence of Russian corporations is a source of concern to the Europeans as a potential threat to their competitiveness. This concern is not entirely groundless, especially considering the situation that is developing on the Russian energy market. That caused the imposition of some constraints on investment in the EU by Russian energy companies.

Problematic relations between Moscow and countries located along energy transit routes to Europe create a source of instability and undermine the reliability of supplies. In light of this situation, the future of Russia’s energy ties with the EU – the primary market for Russian energy resources now and in the foreseeable future – looks bleak.

Is it possible to eliminate this long-term uncertainty and agree on a mutually acceptable model that is built on a sound, civilized foundation for resolving energy problems? Many link the building of this foundation with the signing of a comprehensive energy agreement that is independent of the ECT. The Europeans themselves have numerous complaints against the treaty as its limited format does not guarantee that its ratification will resolve all of the problems.

It is far more important to answer the central question that is presently hidden behind the criticism of the ECT’s specific provisions: Is Russia ready in principle to join legally binding international agreements that set their own rules, and can these rules work in Russia? In other words, does Russia’s negative position result from the document’s specific shortcomings, or is it dictated by its general reluctance to assume international obligations and fulfill them?

SETTING THE RULES

The answer to this question is of principal importance not only for political-economic relations between Russia and the EU. The approach toward the Energy Charter reflects the psychological imperative that exists for a large part of the Russian elite, which refuses to bear responsibility for the fulfillment of international rules that it did not establish. Both the Charter and a broad range of political and economic issues concerning Russia’s relations with the outside world are today viewed from the “we don’t want to be bound by any unnecessary obligations” position.

This approach to international problems may be a result of the complacency that the Russian authorities have developed in the past few years as the country’s economic situation improved, including the attainment of financial self-sufficiency. It seems that in the energy sphere, this complacency is the result of Russia having the world’s largest oil and gas reserves, whilst its role in supplying the Old World with energy resources will only be growing in the long term. The “there is no way the Europeans can get away from us” formula is very popular within the Russian political class.

Taking Russia’s interests into account, it is not only beneficial, but also vitally important for it to sign a legally binding international agreement on energy problems, primarily on transit and investment, even though some tactical advantages may have to be sacrificed.

THE CHARTER HAS OUTLIVED ITS USEFULNESS

The Energy Charter Treaty provides a dubious foundation as a binding agreement. First, the EU’s approach toward the document remains unclear. Russia signed the ECT in 1994. At that time it was designed to regulate supplies amid the general uncertainty that existed in the post-Soviet area. After the EU’s enlargement, the area of the Charter’s application has decreased considerably as former Communist countries, which made the bulk of the states that ratified it, now have to play by the EU’s internal rules. The Charter has failed to become a full-fledged global agreement, since the Middle East and North American countries failed to endorse it. In Asia, it was only ratified by the Central Asian states, Mongolia, and Japan.

Brussels has on numerous occasions ignored the ECT: the ECT was only mentioned in passing in its “green papers” on energy policy in 2000 and 2007, and there seems to be little desire to encourage non-EU countries (above all, Russia) to ratify it. The EU is in no hurry to apply ECT rules: in particular, EU representatives insisted on including notorious Article 20 in the draft ECT Transit Protocol (the so-called provision on regional economic integration). That article effectively exempted EU member countries from the mandatory application of Transit Protocol provisions on their territory. Therefore, the Transit Protocol has become a document regulating relations predominantly outside the EU.

The obviously discriminatory nature of this approach once discouraged its advocates in Russia (including this author) from endorsing the ECT’s ratification. It was for similar reasons that the Transit Protocol was not signed in December 2003.

That failure seriously devalued the Charter per se. The problem was that the ECT’s principal value consists not in its energy trade procedures, which essentially duplicate WTO rules, but its provisions on transit and protection of investment (there are no such provisions in the WTO rules). But they were almost never used in practice. The Transit Protocol was never signed, while investment protection norms only acquired legal force in those countries that ratified the Charter – i.e., countries that either have no significant energy assets, or where the investment climate is already quite favorable and does not discriminate against investors (Europe, Japan).

Thus, the Charter, signed 13 years ago, has never become a full-fledged international legal document – the cases of its application for signing contracts or solving disputes are but rare. The burden of problems that has accumulated around the Charter makes its ratification by Russia a remote prospect. Moreover, there seems to be little sense now in seeking the ratification of the Charter in its present form.

TRANSIT DEPENDENCE

That does not mean, however, that Moscow should ignore the pressing need of creating a common energy space based on international law. On the contrary, it should initiate the drafting and signing of a legally binding agreement with the EU on energy matters.

There are several reasons for this.

First, Russia depends on energy transit to the main energy markets via third countries, and this dependence will remain in the future. Therefore, it needs an effective legal instrument to protect itself against transit risks.

Second, Russian companies are actively entering the European market no longer as suppliers of raw materials but as investors and shareholders. Therefore, it is important for them to secure their rights, especially in light of the growing trend that seeks to limit their investment activity in Europe.

Third, regardless of protectionist trends, Russia is interested in the establishment of supranational regulations in the energy realm. Such legislation would make it less dependent on the internal rules that the EU unilaterally adopts on various energy issues, which, amid a legal vacuum, can extend to the entire European market, which does not always respond to Russia’s interests.

Unfortunately, Russian politicians do not prioritize a transparent regulatory system in the energy sphere, but closed bilateral agreements with specific countries and companies, and even with specific political figures. This foundation is shaky and insecure, since positions can change while politicians come and go. This approach makes Russia exposed and vulnerable to the aforementioned challenges, and effectively conserves its current status on the European energy market. It is the role of a wholesale supplier which has almost no access to the retail market and depends on the political situation and changes in transit terms and conditions. This role by no means secures for Russia a stable presence on the European energy market. 

ECT opponents often draw parallels between Russia and Norway, which is also a major oil and gas producer and supplier. The fact that Norway, a democratic European country, has not ratified the treaty purportedly confirms that it does not benefit energy producers.

There is, however, something that sets Russia apart from Norway: this northern country does not depend on energy transit. Unlike Russia, Norway produces its entire oil and gas on the sea shelf and exports it via underwater pipelines, or in the form of liquefied natural gas (LNG). It does not require the services of transit states, nor does it deliver these energy resources to mainland territory (the bulk of Norway’s electricity is generated at hydroelectric power stations). Since Norway does not depend on transit risks, it does not really need the ECT.

Russia’s case is entirely different. It has always depended and will continue to depend on transit routes leading to the main markets. The idea of building “bypass” pipelines is nothing but an illusion of independence: what really happens is that one group of transit countries is replaced by another.

For example, the Nord Stream gas pipeline across the Baltic Sea bed, which is regarded by many as a kind of a bilateral Russian-German project, in reality is designed mainly for natural gas supplies to third countries’ markets. Should it reach full capacity, Germany will consume less than 50 percent of the gas that will be piped through it, with the bulk of supplies going to Benelux, France and the UK to supplement the declining North Sea output. Of the gas supplies contracted to date, 40 percent will not go to Germany but to other clients (Denmark, France and the UK). Therefore, Russia will simply trade its dependence on Belarus and Poland for its dependence on Germany.

For the sake of Nord Stream, Moscow abandoned a project to build a second leg of the Yamal-Europe gas pipeline, comparable in volume to Nord Stream. The construction of the second leg (planned for construction in areas with developed infrastructure and in the same corridor with the first leg) would have cost substantially less, around $2.5 billion. As for Nord Stream, it has an estimated price tag of over $10 billion (its real cost is not clear yet, but could be as high as $15 billion). Meanwhile, one of the reasons for abandoning the Yamal-Europe project in favor of Nord Stream was a disagreement on the tariff rate for the transit of gas through Poland, which amounted to a mere $0.18 per 1,000 cub. m/100 km (gas transportation via Nord Stream will not be gratis, either).  Therefore, the “transit maneuver” happens to be more expensive, but does not free Russia from the risks involved. It would have been less costly for Russia to make Poland agree to more acceptable transit terms, specifically by means of international law and arbitration.

Currently, Russia intends to build yet another bypass gas pipeline, called South Stream, across the Black Sea. It will also bypass Turkey, which Gazprom earlier regarded as an alternative to Ukraine. At one time, there were plans to carry gas via Turkey to Southeast and South European countries, including via a second leg of the Blue Stream pipeline, whose possible construction was mentioned by President Putin in 2006.  Today, however, it seems problems have emerged in Russia’s relations with Ankara. First, Turkey, taking advantage of its status as the sole consumer of gas carried along the Blue Stream, forced Russia to review import terms, making them less attractive to Moscow. Later, difficulties arose in securing future transit agreements via Turkey to European countries.

The South Stream pipeline will carry gas to Southeast and South European countries via Bulgaria. According to Russia’s Gazprom and Italy’s Eni, the project will cost over ?10 billion. However, the second section of Blue Stream across Turkey would cost considerably less.

With South Stream, Russia will become dependent on another transit country – Bulgaria, and there is no guarantee that in the future this country will not demand a review of the transit terms, as well. A similar problem arises in connection with the Burgas-Alexandroupoli oil pipeline across Bulgaria and Greece, bypassing the Bosporus Strait. Guarantees that Bulgaria and Greece will honor the terms of oil transit and taxation for the operating company (which is supposed to be controlled by Russia) are temporary. This, incidentally, calls into question the very idea of establishing control over transit infrastructure to protect against risks: the governments of transit countries will always have “regulatory sovereignty,” regardless of who owns a pipeline.

Therefore, the problem of ensuring reliable transit and guaranteed supplies will continue to be one of the key problems in delivering Russian energy resources to the European market. The existing system of relations compels Russia to rely solely on bilateral agreements, which are unstable and unsecured against unilateral revision. These risks are still quite substantial in relations with Russia’s current transit partners – Ukraine, Belarus, Poland, and Turkey. Russia has no effective instruments (except political pressure) for protecting its interests in this realm. The lack of effective international agreements renders Russia powerless to implement legal mechanisms and international arbitration. This situation weakens its image as a reliable energy supplier, which became obvious after the recent high-profile energy price conflicts with Ukraine and Belarus.

THE IMPORTANCE OF A NEW AGREEMENT

The only instrument that can create stable relations in the realm of energy transit is a comprehensive international agreement where rules of international law are used to deal with possible disputes. Otherwise, problems with transit countries will continue to plague us in the future.

There is no doubt that if we want our energy resources to be transported across the territory of third countries, we should provide – for example, for Central Asian gas producers – access to Russian gas pipelines. Yet thus far the issue has been strictly taboo. In the past 15 years, Moscow has striven to retain control over Central Asian energy exports, including the monopoly rent.

In the long term, however, the rent-oriented monopolistic mentality only leads to a deadlock. The Central Asian countries are well positioned to diversify their energy export routes in such a way as to sharply reduce their dependence on transit via Russian territory, and they are already doing that.

Kazakhstan, for example, has successfully completed the construction of an oil pipeline to China and is determined to extend it (incidentally, denying access to Russian companies), and it has also agreed to send oil through the Baku-Tbilisi-Ceyhan pipeline, bypassing Russia. Meanwhile, Turkmenistan has a good chance of achieving a breakthrough soon in building an alternative gas pipeline (most likely to China again).

As we can see, a Russian monopoly on the export of Central Asian energy resources may be eliminated in the foreseeable future. So, is it reasonable to continue the policy of defending this monopoly at any price? Would it not be better to resolve transit problems on the basis of reciprocity?

If Russia wants to be able to acquire energy assets in Europe, it will have to agree to foreign participation in developing Russian oil and gas resources in some form or other. Granting foreign companies access to our natural resources is beneficial, above all, to Russia (that is a subject for a separate article). What is even more important is that the EU is already actively discussing proposals from the European Commission on imposing investment constraints on a number of state companies. These measures – based on the principle of reciprocity – will affect countries that deny companies from EU member states access to their own markets. Consider the problems that Russian business came up against when it attempted to acquire energy assets in Europe (for example, the oil refineries Mazeikiu Nafta in Lithuania and Europoort in the Netherlands, and the gas company Centrica in the UK).

If we want to secure equal access for Russian companies to invest in energy assets in EU countries, we should sign a comprehensive agreement with Europe on principles of protection and encouragement of investment. Incidentally, a corresponding section of the ECT is quite appropriate for the protection of Russian interests in Europe. However, needless to say, we cannot sign the treaty without opening up our own energy market. But in the long term, the de-monopolization and opening up of the energy sector is imminent. Without such mutual openness, we will have zero chances for investment in Europe.

Russia is not a EU member, but this does not mean that the rules of the European energy market should be worked out without its involvement. Although Moscow’s criticism of the liberalization of this market is not always fair, new measures on energy market regulation pending in the EU are oftentimes at odds with Russian business interests. For example, it is obvious that the rules of free access to pipeline infrastructure come into conflict with the need of securing long-term gas supply contracts. Another example is the EC’s attempts over the last several years of influencing the pricing system on long-term gas contracts by “disconnecting” these prices from world oil prices. Such intentions are well justified, but there is an apprehension that instead of a fairer pricing system we will have to face some obscure invention by Brussels bureaucrats.

In order for Russia to protect itself against such risks, it must create its own defense lines in the form of basic legal principles regulating international relations in the energy sphere. They should be enshrined in an appropriate agreement between Brussels and Moscow, to which other countries could also accede. In the end, everyone would benefit from such legislation, including our European partners who are concerned about reliable energy supplies.

Therefore, if Russia’s long-term interests in the energy realm consist of protecting its resource and transit monopoly, as well as long-term gas contracts and building “bypass” pipelines, it need not sign any agreements based on international law. However, this strategy will soon lead to the loss of certain positions (in particular, the monopoly of energy exports from Central Asia), and deny Russia the opportunity to win new positions (full-scale presence on the European retail markets) and a role in laying down the rules for the European energy market on the whole. In such a scenario, the volume of Russian energy supplies to Europe would grow, whereas Russia’s real influence on this market would decline.

The signing of a comprehensive and legally binding agreement with the EU, regulating relations in the energy sphere, can be very beneficial to Russia. Any short-term losses will be far outweighed by the long-term gains.

The format of such an agreement is subject to a transparent discussion, taking into account Russia’s long-term interests in the realm of international energy relations. Unfortunately, the ECT discussion over the past few years has not been backed up with a clear definition of Russia’s national interests.

Despite the perennial complaints, not least by some high-ranking officials, to the effect that ratification of the ECT is “disadvantageous” for Russia, there have been almost no attempts to take an objective view of the treaty, with its strong and weak points. Its analysis has often been unprofessional, based on political stereotypes and clichés, or an uncritical repetition of the positions of certain corporations (above all, Gazprom). Thus, Gazprom experts had a final say in formulating Russia’s official position on the ECT and related documents, with the negotiators slavishly representing Gazprom’s viewpoint.

It is necessary to abandon such an approach, especially considering that Europe will in the foreseeable future continue to be our principal energy partner, despite the declared plans to divert Russian energy resources to Asian markets. Our national interest does not lie in pumping the maximum possible amount of money out of Europe and other countries. Our interest lies in building long-term stable and fair rules of the game on the European, and, more broadly, the Eurasian energy market.