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Wednesday, February 14, 2007

Annals of Weaponizing Energy: Where Things Stand

Britain's The Business provides an in-depth summary of the Kremlin's efforts to weaponize energy and do with oil & gas what the USSR tried to do with tanks and ICBMs.

Putin's Superpowerplay

Russia has a new weapon with which to bully the West: its vast energy reserves. As the world’s biggest supplier of oil and gas, the Kremlin is determined that industrial muscle will succeed where Marxism failed

When a 32-year-old KGB agent called Vladimir Putin was invited to attend the Red Banner Institute in Moscow, one of the Soviet Union’s elite spy colleges, he couldn’t believe his luck. It was 1984 and the young but deeply ambitious Putin was soon being groomed as a specialist in economic and technological espionage. His teachers were still revelling in a now long-forgotten victory over America: gas was flowing from a brand new Russian pipeline to Western Germany, earning much needed hard cash, despite a lengthy campaign by President Ronald Reagan to block its construction with sanctions.

The pipeline came too late for the Soviets but Putin never forgot what he was taught in Moscow: Russia’s massive energy resources are a powerful weapon in the global power stakes. He reheated the idea in 1997 when he wrote an influential article for a Russian journal recommending that Russia regain control of its energy industry; now, at the height of his powers as President of Russia, he is busily putting his old plans into practice. In doing so this veteran Cold War warrior is waging a new Cold War, as was all too apparent from a disastrous meeting with European ministers last week, though this time Russian power – and the threat that goes with it – is dependent not on Marxism or missiles but on oil and gas.

Since the end of communism a decade and a half ago, Russia’s exports of oil and gas to the West have risen exponentially. New, Moscow-sponsored energy giants have risen while the world’s largest energy multinationals have all made huge investments in the country, turning Russia into the world’s biggest supplier of oil and gas. Combined exports are equivalent to nearly 19% of consumer countries’ demand, compared with just over 18% for Saudi Arabia.

In the early post-communist days, this seemed to be the answer to Europe’s energy problems (and some of America’s too). Now it is clear Putin’s plan all along was to ensure the West got hooked on Russian supplies – then use the dependency to exercise leverage and even control.

The plan has been some time in the making. Three years ago this week Mikhail Khodorkovsky, the founder of oil giant Yukos, was arrested on a bleak Siberian airstrip, marking the first step of the Kremlin’s plan to wrest control of energy production from private individuals and companies. Since then, oil and gas has been used as a tool of foreign policy, much like a weapon, rather than as a standard commodity bought and sold by profit-making corporations.

Oil and gas prices have more than doubled since Khodorkovsky’s arrest, delivering the Kremlin a financial windfall which it badly needed. Russia’s hard currency reserves have risen from a mere $9bn (£4.8bn, €7.2bn) before the 1998 financial crisis to more than $250bn today. Its economy has powered ahead, growing by 6.8% this year, on the back of rising energy prices. Average wages have surged from $50 a month when Putin came to power to $400; needless to say, this has made the Russian president a popular man.

But for politicians in Europe and America, the manner in which Putin and his comrades at state energy giants Gazprom and Rosneft have wielded their new power and wealth has taken tensions with the West to levels not seen in more than 20 years. Alexei Miller, Gazprom’s new chairman, bluntly laid out the new status quo at the World Gas Conference in June: "There are only three countries capable of being a long-term supplier of gas: Russia, Iran and Qatar. When it comes to gas for the development of the European economy, there is no realistic alternative to Russia."

Last week, President Putin sounded just as confident – and aggressive. He warned European leaders to give up any hope of gaining access to Gazprom’s jealously protected gas reserves and network. Western politicians, he said, should not stand in the way of Gazprom’s efforts to push its ownership of gas networks deeper and deeper into Western Europe. As for daring to criticise his human rights record or heavy-handed bullying of Georgia and Ukraine (never mind his actions in Chechnya), this, he declared, was out of the question. Russia’s re-emergence as a superpower, this time on the back of energy, has made the President supremely indifferent to Western criticism on most issues, including the murder of investigative journalist Anna Poliykovskaya.

The first time Western Europe was attacked directly by Russia using energy as a weapon was when Gazprom cut off gas supplies to Ukraine in the new year, as punishment for turning its back on Kiev’s pro-Moscow political parties. The action also hit supplies to France, Germany and Italy – and thrust the now obvious problem of Europe’s growing energy dependence on Russia to the top of the political agenda. Not that greater prominence for this issue resolved anything: Europe failed to secure any kind of energy deal with Putin at July’s G8 summit in St Petersburg.

The list of Russian snubs and heavy-handed action keeps growing. Earlier this month plans to ship liquefied Russian gas to America from the giant Shtokman field in the Arctic were abruptly cancelled after more than five years of negotiations, destroying the hopes of US oil firms ConocoPhillips and Chevron to get a share of the project.

Now the oil majors tread warily in Moscow. They have every reason to: the regulatory and legislative powers abused in the destruction of Yukos are being applied to Royal Dutch Shell and, to a lesser extent, BP, Total and Exxon Mobil. Appeasement is the order of the day: BP’s decision, for example, to take a $1bn stake in Rosneft when it floated on the London Stock Exchange in July was widely seen as a way of assuaging the Russian government.

Russia’s neighbours, especially those in the Baltic, Poland, Belarus and Moldova, know only too well how mercilessly their former master can use its resources. In 2003 Russian state pipeline company Transneft arbitrarily decided to cease oil supplies to the Latvia’s Ventspils Nafta oil terminal, ending the port’s existence, in apparent revenge for Latvia’s ind- ependence. This year it did the same to Lithuania. When Polish oil company PKN Orlen beat Russia’s Lukoil and TNK-BP to buy Yukos’s share in Lithuania’s Mazeikiu Nafta refinery, Transneft again shut down pipeline supplies to the refinery, blaming an accident (the refinery was later damaged by fire).

In 2004, Gazprom shut off gas supplies to Belarus in a transparent attempt to bully it into giving Gazprom back ownership of its gas transmission pipeline. Poland is desperately looking to diversify its supplies, seeking to pipe in gas from Norway and even considering a liquefied natural gas terminal at Gdansk. Even Austria’s OMV, one of the first European customers of Russia’s gas, is pushing its neighbours to agree on the Nabucco pipeline to bring gas from Iran, suggesting Vienna regards the anti-Semitic, nuclear-obsessed Mullhas of Tehran a safer bet than Russia.

Last year Royal Dutch Shell admitted the construction costs of the Sakhalin gas project had doubled to $20bn. A few days earlier, it had agreed to sell Gazprom a 25% stake in the project in exchange for 50% of one of its Siberian gas fields, apparently without warning it of the impending bad news. This was a mistake: since then, regulatory pressure on Shell has increased massively and it could be forced to accept punishing new terms to keep control. Total and Exxon also face an endless run of obstacles to their projects.

Europe as a whole is likely to experience the rough end of Russia’s bargaining when it begins thrashing out a new bilateral agreement next month to replace the 10-year "Partnership and Cooperation Agreement" signed in 1997. This time, with energy prices high and Europe anxious for security of supply, Russia has genuine bargaining power, especially with Gazprom this year scheduled to complete negotiations with China’s CNPC on gas supplies.

Europe wants to strike a deal that allows solid contractual guarantees in energy deals between the two blocks. But it is understandably wary of giving Gazprom what it wants in return: control of the "downstream" – in other words gas pipelines, storage, pumping stations and even customer accounts. Part of the reason it cut gas supplies to Belarus in 2004 and to Ukraine at the start of 2005 was to pressure these countries to return control of transit pipelines. Gazprom has this year been pressuring European utilities such as Eon, RWE, GdF, Eni and Centrica to sell or swap stakes in their pipelines for shares in its Siberian gas fields.

Much of Europe’s gas infrastructure is, in theory, open to be acquired. But European politicians, in Brussels and in member- state capitals, have made it clear that it would block any large acquisitions on the grounds that Gazprom’s control of a quarter of Europe’s gas supplies would threaten competition. The European Competition Commission is expected also to outlaw the long-term bilateral gas contracts with which Gazprom has historically supplied clients.

Gazprom, of course, should not have such a strong hand to play. Europe may import a quarter of its gas from Russia but until Russia builds a pipeline to China or LNG terminals on its coasts, Gazprom can only supply one major customer: Europe. Russia’s importance as an American energy supplier is growing but remains minor (in August 2005 America imported 72,000 barrels of Russian crude per day (bpd): by this August imports had reached 167,000 bpd).

If Western utilities and governments negotiated as one, they would be in a stronger position. But Gazprom will almost certainly succeed in its efforts to frustrate a united front. The company has already developed a closer relationship with Germany, its largest customer, than with any other European country. In the New Energy Cold War, Germany is on Russia’s side. German energy giant Eon holds a small but significant stake in Gazprom, and Burckhard Bergmann, the chairman of its gas subsidiary, Eon Ruhrgas, is the only Western European to sit on Gazprom’s board.

In July Eon offered to swap a 25% stake in the Yuzhno Russkoye gas field in Siberia for large stakes in two of Eon’s Hungarian subsidiaries, much to the Hungarian government’s frustration. BASF’s Wintershall in April swapped a 35% stake in the same field for a further 15% in trading joint venture Wingas, bringing Gazprom’s share to 50%.

In July Eon offered to swap a 25% stake in the Yuzhno Russkoye gas field in Siberia for large stakes in two of Eon’s Hungarian subsidiaries, much to the Hungarian government’s frustration. BASF’s Wintershall in April swapped a 35% stake in the same field for a further 15% in trading joint venture Wingas, bringing Gazprom’s share to 50%.

Scandalously, former German Chancellor Gerhard Shröder was even appointed to the board of Nord Stream, the Gazprom-led consortium building a $5bn pipeline under the Barents Sea to North Germany after he was replaced by Angela Merkel as German Chancellor; he had been instrumental in signing the deal in the first place. Politicians in Poland have pointed out that the pipeline allows the Russians to cut off its gas supplies without affecting the rest of Western Europe.

Sarah Mendelson, a senior fellow at the Centre for Strategic and International Studies in Washington, says: "If the Europeans have a unified response they have a lot more power to influence Russia than they seem to realise. When they do unify they have got the Russian government to back down on various things." She describes the pursuit of sweetheart deals by individual European countries as "exactly the kind of thing that will leave us all in much worse shape".

Europe seems determined not to learn: Dutch gas firm Gasunie earlier this month became the third European utility to offer Gazprom something it wants, gaining a stake in Nord Stream in exchange for giving the Russians a 9% stake in the new BBL pipeline which will this December start shipping European gas to Britain across the North Sea from the Netherlands.

Hawks in the Bush administration have been calling for America to get tough. Last May, Vice President Dick Cheney visited Lithuania, making a speech that was sharply critical of Russia’s drift towards authoritarian rule. But with America fighting on several fronts in the Middle East, Afghanistan and now North Korea – all regions where Moscow has considerable influence – Washington also has to take Russia seriously once more.

Indeed Putin is having his cake and eating it: while Moscow increasingly calls the energy shots, investment into Russia during the first half of 2006 jumped 42% to $23.4bn. Western banks are falling over themselves to fund Gazprom and Rosneft – and were not shy of lending a hand in the destruction of Yukos: this month Rosneft is in talks with a consortium of investment banks to lend it $15bn to $20bn to fund the acquisition of the remnants of Yukos.

The risk was put succinctly by America’s Council on Foreign Relations. "Unless it is associated with higher standards of corporate governance and commitment to commercial norms," it said, "increased access by state-controlled Russian companies to international capital will not serve Western interests. It will mean that international investors are financing the expansion of Russian state power and control." Unless the West understands this – and acts in unison to counteract Russia’s growing imperialistic ambitions – Putin will continue to win the new energy wars.

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