15.06.2008
The Gains and Failures of the Energy Superpower
№2 2008 April/June
Alexey Grivach

Alexey Grivach is Deputy Director of the National Energy Security Fund.

The phrase “the energy superpower” has
a special place among the phrases that are customarily used to
characterize Vladimir Putin’s Russia. It is true that Putin himself
has tried to distance himself from such a description of the
country he has led for two terms. “As you may have noticed, I never
say Russia is an energy superpower of any kind,” Putin said in
September 2006 when he met with members of the Valdai Debating
Club. But then he added: “Yet we have more opportunities than
almost all other countries… Everyone should realize that these are
our national resources, and should stop casting a greedy eye on
them as if they were their own.”

Whatever the Russian president’s
attitude is toward this impressive phrase, many people associate it
with his presidency, which was marked by an extreme politicization
of the energy business. Natural gas – Russia’s main export – is a
priori not free from the implications of political influence, but
in the past few years gas supplies have completely turned into an
object of large-scale strategic bargaining. As for gas
transportation projects, it looks like their economic feasibility
has moved to the background. Business plans have given way to the
geopolitical concepts of a reviving great power.

Naturally, Russian gas giant Gazprom
sets the priority of economic interests since their implementation
is necessary for turning the company into a global energy
corporation. And yet the Kremlin’s political considerations have
become crucial for mapping out the gas monopoly’s model of conduct.
It is not accidental that Gazprom’s decision to change over to
unified principles of price formation in trade with neighboring
countries – a step quite reasonable in itself from the economic
point of view – occurred right after Ukraine’s Orange Revolution,
which was far from an economic event. It is also obvious that the
new gas prices are set for different CIS countries proceeding not
only from commercial considerations.

The politicization of cooperation
problems in the energy sector has had a generally bad impact on
Gazprom’s business development plans. Even the projects much needed
for the development of the market and to upgrade Europe’s energy
security have bumped into fierce resistance – like the Nord Stream
pipeline – or have been ruined altogether – like the plan to build
gas storage facilities in Britain and Belgium. The situation with
the purchase of assets in the European Union is no better. The
growing political friction between Moscow and Western countries and
the Kremlin’s path to limit foreign investment in Russia’s
strategic industries have led to a virtual blocking of access for
Gazprom to large assets in Europe.

Another egregious example are the
consultations on purchasing Centrica – Britain’s biggest gas
distribution company – which provoked an unequivocally discouraging
reaction in society and power agencies even at their initial stage.
Earlier, E.ON Ruhrgas, Gazprom’s partner in Europe, refused to sell
the Russian giant a large stake in the Verbundnetz Gas distribution
company, the de facto monopoly operator in the former East Germany.
Efforts to swap assets with a number of other European companies
were also unsuccessful.

The only transaction made in that
sector was the swap of a stake in Severneftegazprom, a Gazprom
subsidiary that is developing the Yuzhno-Russkoye deposit, for a
15-percent stake in the Wingas distribution company. But this deal
was successful only because Gazprom’s status in Wingas has not
changed radically – the Russian company remains a second-tier
partner there. Gazprom has pushed forward with its projects in
Europe and has signed agreements on building pipelines, but on the
whole its gains are confined to isolated spot buys. In contrast,
the original idea was dramatically different and presumed
full-scale integration through a marked change of the corporation’s
role in the European market.


AN ALARMED WORLD

So what happened? One should remember
that Vladimir Putin’s presidency had a very hopeful beginning.
Russia launched intensive energy dialogs with the EU and the U.S.
It seemed that Moscow had tapped a pool of steadily growing
revenues and – more importantly – a lucrative place in the
international division of labor, which could become instrumental in
getting a worthy position in the nascent world order of the 21st
century.

Yet Russia failed to choose the correct
tone that would facilitate building a steady system of mutually
beneficial barter relations (energy resources for technologies and
access to mineral wealth for access to markets). This is due in no
small degree to major changes in the global situation that occurred
after Putin’s election as president. The international environment
has become far less stable and predictable and general nervousness
has grown. The U.S. campaign to democratize the Middle East that
was meant – among other things – to enhance the developed world’s
energy security, has failed. Meanwhile, the era of sky-rocketing
oil prices that began in 2003-2004 is fueling Moscow’s sense of
importance and success, while simultaneously breeding an overblown
and often irrational phobia of energy resource dependence in the
West – above all, in Europe.

Nonetheless, today’s global economy –
largely based on the growing consumption of hydrocarbons – has its
own implacable reality. Energy market players will either have to
make arrangements among themselves or learn how to live without
each other. The latter option requires a markedly innovative leap –
the West should drastically reduce its consumption of energy and
switch to alternative sources of energy, while Russia needs to
extensively diversify its economy away from a predominant
orientation toward the export of raw materials. However, no
prerequisites for such radical breakthroughs are in sight yet, and
so talks and further compromises are thus far only mandatory
elements of the agenda of a global political dialog between Russia
and the West.

The scope of world market players
includes major and fast growing importers of resources, such as
China and India, and regions where gas imports are gradually
increasing – like North America and Europe. It also comprises
exporters: those that have no claims to a sizable increase in the
internal consumption of resources – like the Middle East and Russia
– falling into the group of major exporters. But Russia, too, faces
the task of a profound industrial modernization that may bring
changes to its energy balance and stimulate a growth in the
domestic consumption of energy. For instance, the implementation of
plans for the mass construction of new power generation facilities
will require huge amounts of natural gas to fuel power generators,
while currently the country is short of resources to meet the
demand for fuel at a handful of new medium-sized
installations.

The risk of Russia turning into a net
importer of energy looks theoretical now, but it cannot be ruled
out that Russia will find itself in the future unable to meet the
ever-growing demands of foreign customers. In this light, the fears
of Western consumers that they will be left with nothing after the
slices of Russia’s “resource pie” are doled out do not look
paranoid, even though they are overstated.


A HOPEFUL BEGINNING

Until recently, the idea of an
equitable dialog between Russia and its Western partners looked
like little more than a tribute to diplomatic politeness. It was
difficult to imagine that a country that had just lost an
ideological and economic race and had veered off the track of
political and economic transformation might start claiming the same
status as the winners. Nonetheless, by the middle of Putin’s
presidency, Moscow felt that it was mature enough – both morally
and materially – for talking to the West on conditions of parity.
The process of national rehabilitation was fostered by a factor
typical for countries rich in resources; namely, the hike in world
prices for crude oil and the associated increased value of European
contracts for natural gas.

In 1999, when Putin was nominated for
prime minister and then as the successor to Boris Yeltsin, a barrel
of Brent crude only cost $17.98. It had climbed by as much as $10
per barrel the next year, which was followed by a period of
international market volatility, with prices suddenly falling to
$24 or then going up to $29. The time of a steady and steep growth
in prices only began in 2004, when a barrel of Brent was sold for
$38. One record followed another in the next phase. The average
annual price rose to $54 in 2005; to $65 in 2006; and then to $72
and higher in 2007. In other words, prices have quadrupled over the
past eight years and this trend is not expected to change. The
leaps above the psychologically important mark of $100 or even $110
per barrel do not surprise anyone anymore and the next average
annual indicator will obviously set one more record.

Export prices for the natural gas that
Russia sells to the EU and former Soviet republics also went
rampant, soaring to $350 per thousand cubic meters in the first
quarter of 2008 from $64 in 1999. Gazprom’s gross revenue shot up
to $38 billion in 2007 (as assessed by experts) from $6.8 billion
in 1999.

The market frenzy was coupled with a
tax reform in the oil industry that ensured the maximum imaginable
skimming of excessive profits to the state budget and with an
overhauling of property in favor of state-controlled corporations,
thus imparting a new quality to the Kremlin’s foreign policy. This
policy aims to streamline bilateral investments providing for an
equivalent exchange of assets and support of a technological
modernization of the Russian economy. However, the West
demonstrated an apparent lack of readiness to accept this change in
Russia’s conduct, viewing it as “energy blackmail” rather than an
invitation for civilized bargaining.

This turnaround did not take place
overnight. Putin’s first term saw the unfolding of an energy dialog
with the U.S. and discussions of cooperation with Europe were more
fruitful than ever before or afterwards, and even with reciprocal
concessions. Gazprom agreed to eliminate the ban on the reselling
of Russian gas from agreements with European customers, and the
European Commission acknowledged the inviolability of those
long-term agreements, even though this change did not match
Brussels’ drive for the liberalization of the gas market. It should
be noted, though, that the liberalization has triggered stern
resistance on the part of corporations inside the EU.

The green light for an energy dialog
with the U.S. was given in spring 2002 during a visit by U.S.
President George W. Bush to Moscow. In the rising tide of
cooperation in the format of the international antiterrorist
coalition, the parties started mulling over new projects for
creating an infrastructure for Russian crude exports to the U.S.
Sometime later, an idea surfaced on producing liquefied natural gas
for target supplies to the North American market.

While the energy dialog with the U.S.
was largely based on political willingness rather than objective
prerequisites, the European sector of cooperation was expected to
bring real practice results. In 2000, Romano Prodi, then President
of the European Commission, initiated the ‘Russia-EU Energy
Dialogue’ which discussed a sizable increase in Russian energy
exports to the EU in exchange for investment and
technology.

The political environment for Russian
investment in the oil and gas sector was advantageous at that time.
British Petroleum was allowed to pool its oil and gas assets with
shareholders of Russian oil company TNK and thus set up the Russian
oil industry’s first-ever private oil major co-owned by foreign
shareholders. At the same time, ConocoPhillips received permission
to get a big stake in Lukoil.

The same period saw the Kremlin’s broad
“easygoingness” in international politics, and this could be seen
in the energy sector, too. For instance, Moscow did not react
sharply when Turkey and Poland started pressing for a reduction in
the amounts of gas they were supposed to take from storage
facilities under long-term agreements.

BROAD JUMPS

This was a short-lived honeymoon
though. In the middle of the 2000s, Russia and the West glaringly
showed the futility of the conviction that policymaking has
economic propellants. The level of political trust began to
noticeably deteriorate – partly due to subjective factors, partly
due to the growth of destabilizing tendencies in international
relations.

Moscow became growingly aware of its
capabilities in a new world of increasingly expensive oil where all
the big powers are obsessed with the idea of energy security. This
is how the idea arose of swapping energy sector assets, and offers
were made to Western partners to pay for access to the development
of Russian deposits with things much more precious than money –
with their own markets and technology.

“If you have strong legs, you’d better
engage in broad jumps rather than play chess; but if you have a big
head, then chess might be better for you. So when we speak about
high technologies and so on, we somehow forget to say where we’ll
get them from,” the Kremlin ideologist Vladislav Surkov said in
February 2006 as he explained the Kremlin’s economic policy in
plain language to members of the United Russia party. Surkov
pointed to the importance of “using our competitive advantages and
developing them. […] Russia’s concept of an energy superpower
stands in line with this approach. Russia must get access to high
technologies by exporting gas, crude oil and oil products,” Surkov
said.

Gradually, the idea of such swaps took
the form of scorn toward oil and gas revenues – naturally, from the
angle of ideology, not budgetary policies. “We must not only think
of how much money we can draw from it – because money is just
paper. We’re dealing with global money issuing centers, aren’t we?
Do the Americans really care for that money? They’ll ‘draw’ as much
of that money as they want. What we need is knowledge, novel
technologies,” Surkov said. About a year and a half later, Vladimir
Putin said at his annual major press conference: “Offer us adequate
assets in return. And if you think about money, no one needs those
scraps any more, and this is our honest and open
position.”

However, this “honest and open”
position did not produce a response from the Western partners,
either in 2006 or in 2008, and Moscow started readjusting it step
by step. In 2005 and 2006, the government worked intensely on a new
version of the Law on Mineral Resources aimed at tightening the
terms for access by foreign investors to Russia’s mineral wealth by
sealing off the largest or “strategic” deposits. The bill is still
only on paper. Meanwhile, the idea of protectionism in the
“strategic branches” of the economy is gaining popularity all over
the world, including in countries that formerly took pride in their
commitment to the principles of free trade.

When Russia declared energy security as
its motto during its rotating presidency in the G8, it became clear
that this was meant to demonstrate Russia’s relationship with the
rest of the club and not the club’s relationship with the rest of
the world. In late 2005, Putin chaired a meeting of Russia’s
Security Council to discuss this country’s role in ensuring
international energy security. He spoke in detail about the
importance of joint efforts to provide traditional types of fuel
for the world economy, as well as the diversification and
reliability of resource supplies, including protecting them against
the terrorist threat.

Yet at the same time, the government
was preparing for an operation destined to show the essence of
Russia’s presidency in the G8. On January 1, 2006, following a
conflict with Ukraine over gas prices, Gazprom slashed gas supplies
to Kyiv. The step – extremely awkward in terms of the propaganda
that accompanied it – produced a far more turbulent reaction in the
West than the Security Council’s decisions. Even though none of the
Western customers experienced any serious problems with gas
supplies and no one made claims against the seller’s right to
demand that customers pay market prices, any discussions of any
kind of joint efforts in energy security lost all practical
sense.

The image of Russia in the minds of the
European public immediately changed from “a reliable energy
supplier” to “an energy gendarme,” while Gazprom got the image of
“the Kremlin’s energy weapon.” Accusing Moscow of politicizing the
energy business, the West also armed itself with an exclusively
political approach. The climax of that approach could be seen on
the sidelines of a NATO summit in Riga in December 2006 where
voices could be heard that energy disputes with NATO member-states
should be considered as an aggression requiring a unified
response.

As for a Russian-German strategic
agreement on the construction of the Nord Stream gas pipeline –
which the two countries had formalized shortly before the
Russia-Ukraine price conflict and which had been viewed as a
harbinger of new relations in the energy sector in Greater Europe –
it turned into a pretext for consolidation for all the adversaries
of a rapprochement with Moscow that could come across inside the
EU.


THE ENERGY FIST

Brussels developed an idee fixe to goad
Russia into fulfilling the requirements of the Energy Charter. An
agreement appended with the Charter and signed back in the
mid-1990s was called upon to cement the principles for protection
of Western investments in the production and transportation of
hydrocarbons and the guarantees on the part of transit countries,
which had emerged in large number after the breakup of the Soviet
Union, in the territory separating the regions of production –
Russia and Central Asia – and the regions of consumption – fifteen
member-states of the then EU. Importantly, some provisions of the
agreement did not cover the territory of the EU, which means its
ratification did not imply a most favored partner status for
Russian investors.

The gas conflict with Ukraine and
Kyiv’s siphoning off of European-bound gas from pipelines confirmed
that joining the agreement (Ukraine had ratified it) would not
offer an efficacious mechanism of control over transit commitments.
As Russia refused to accept the regulations specified in the Energy
Charter, Brussels started speaking about the European Commission’s
right to allow investment in the EU’s hydrocarbon transportation
infrastructures (i.e., pipeline networks and underground storage
facilities) only on the basis of special cooperation
agreements.

Moscow stood firm and did not cede an
inch of its political position to the Europeans, which was a matter
of principle. Vladimir Putin summed up the gist of the situation at
a Russia-EU summit in Sochi in May 2006, just a few weeks before
the G8 summit conference in St. Petersburg. “When we speak about
our full-fledged joining of the Energy Charter and the
supplementary protocol on transits, what are those documents about,
in fact? They are about free access to the infrastructure of
hydrocarbon production and the infrastructure of transportation.
OK, suppose you get that access to those infrastructures, and what
do we get in return? And we hear from our partners: You get the
same. And I’ve already said earlier: Where do you have the deposits
that you’ll let us get to? Or where do you have gas-main lines of
the kind that Gazprom boasts of having? There are none. That’s why
we don’t object to doing this in the future. But we must understand
what we’ll get in return. That’s easy to understand if you remember
your childhood. You go out of the house into the street holding a
piece of candy in your hand and someone comes over to you and says:
Well, give me your candy. And you hold it tight in your sweaty fist
and tell him: And what do I get for this? So we just want to know
what they are going to give us in return. And suppose they don’t
have anything adequate?”

The image of a greedy kid squeezing a
piece of candy in his sweaty little fist did not puzzle Putin when
he cited it as a model of conduct for a great country. More than
that, almost simultaneously with the St. Petersburg summit, the
authorities tightened their energy fist. In early July 2006, the
Russian parliament passed a federal law on gas exports, which
granted Gazprom – the owner of the gas supplies system – “the
exclusive right to export gas.” Putin signed the bill into law
almost immediately after the participants in the summit had left
St. Petersburg.

It is not surprising therefore that the
G8 conference produced unpretentious results. Russia came to the
conference table waving a slogan that said: “Egotism in energy
leads to a dead end.” This understandably meant the customers’
egotism. But while it looked quite suitable in a program article
that Putin timed for the start of Russia’s presidency in the G8, no
one felt like undersigning it in the summit’s final
declaration.

The only thing that Moscow managed to
push through at the summit was to formalize on paper “the promotion
of a dialog and exchange of opinions between all the parties
concerned on the problems related to a growing interdependence in
the energy sector and security of supply and demand” as a major
global objective of energy security. The concept of a ‘secure
supply and demand’ proceeded from the assumption that the exporter
of energy resources, i.e., Russia, must have the confidence that
its investment in the upstream segment will not be wasted and the
resources will be in demand. Moscow obviously believed that the
European policy of secure demand should have made itself manifest
in a renunciation of the idee fixe to diversify the sources of
fuel. Europe, too, wanted to make Russia give up diversification –
in terms of markets.


EQUIVOCAL RESULTS

Moscow’s energy diplomacy in the first
years of the 21st century cannot be given a clear
assessment.

On the one hand, other countries have
begun to treat Russia seriously and have stopped calling into
question its right to a tough defense of its national interests –
including those in the energy sector. In spite of the excesses that
could have been avoided and the inconsistency stemming from
political considerations, the system of energy relations with other
post-Soviet states has become more rational and transparent than it
was five to seven years ago. There has been no quality
breakthrough, but Russian companies now have a stronger foothold in
the world market.

On the other hand, the atmosphere of
energy relations has deteriorated; it does not help to attain the
goals that the Russian government set for itself at the very start
of the new century. The sweeping politicization of energy issues,
fuelled by both suppliers and consumers, also destroys the
foundations of the market and pushes its participants toward the
logic of conduct standing far apart from the economy. A rather
limited inventory of foreign policy tools – military and political
influence, information opportunities and ‘soft power’ that are
weaker than Western ones – has compelled Moscow to focus more on
energy levers – a fact that whipped up nervousness among Western
partners and heightened counteraction to Russian initiatives. For
instance, the EU got down to formalizing political restrictions in
2007 on investing in the energy sector on the part of foreign
state-controlled corporations.

A campaign to raise prices for
Gazprom’s clients in the CIS has ended up with the logical result –
ultimatums by Turkmenistan, Uzbekistan and Kazakhstan, which also
demanded European prices for gas supplies to Russia. On the whole,
there has been a hike in the political contest for the sources of
hydrocarbons and delivery routes.

A search for a balance of interests
between suppliers and consumers of energy resources will be the
central tenant of global – and especially European – policies in
the foreseeable future. The mutual rejection of politicized
decisions in energy relations might lay the foundation for a
responsible conduct typical of genuine partnerships.

What distinctive features could this
conduct have?

First, the reliable
fulfillment of commitments. In the past few years, Gazprom has
extended agreements with its major European customers – Germany,
Austria, the Czech Republic, Italy, France and others – for another
fifteen to twenty years, and this is an encouraging
factor.

Second, the development of
transport infrastructure. Whatever the criticism the Nord Stream
and South Stream projects received from some countries, they
certainly play a positive role in supplies to the European market.
Those who are worried about possible energy dependence on Russia
should remember the cost of these pipelines, which is too high to
think about using them as an “energy weapon.” Europe should look at
the economic logic as it seeks to diversify its sources of natural
gas and to choose alternative pipeline routes. This would be less
expensive.

Third, it is high time Russia
formulate the rules of the game on its own energy market and in the
sphere of access to mineral resources. Even if these rules set
tough conditions for foreign investors, the very availability of
clear legal regulations will become a factor of stability and
predictability.

Fourth, politicians in Russia,
Europe and the U.S. should discuss and resolve energy problems with
a sober mind, avoiding mythical threats or breeding mutual mistrust
and blackmail. In this sense, Moscow would be wise to give up
speculations on creating “a gas OPEC.”

Finally, the Russian
authorities should persistently implement the plans for innovative
economic development that were formulated at the beginning of 2008
in a concept of the country’s development to 2020. If one uses
Vladislav Surkov’s phraseology, they are called upon not only to
“coach” the Russian economy in “broad jumps,” but also to teach it
how to be a fairly good chess player. The implementation of those
plans would, in the end, reduce the pressure that domestic demand
exerts on the energy balance and, consequently, would facilitate
the stabilization of the entire European market.