17.11.2007
Russia-EU Energy Dialog: Filling a Vacuum
№4 2007 October/December

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.