Russian Energy Policies Assessed

The Heritage Foundation's senior researcher for Russia, Ariel Cohen, recently outlined the United States' assessment of Russia's energy policy. Cohen was testifying before the US House Committee on Foreign Affairs, according to the Asia Times. Cohen said the United States believes:

1. The Kremlin views energy as a tool to pursue an assertive foreign policy;



2. Russia's is attempting to exclude the US from Central Asian and Caspian energy markets;



3. Russia is using energy to "re-engage" with India, Southeast Asia, the Middle East, Africa and Latin America;



4. Russia is forcing neighboring countries to use the Russian pipeline system for energy exports;



5. Western countries are blocked from entering into Russia's energy sector by an absence of the "rule of law;"



6. Russia is not interested in developing energy ties with the United States.

Cohen said the United States has identified a number of geopolitical concerns arising from these policies:

1. European demand for energy is projected to grow, leading to a greater dependence on Russia. This has serious implications for Russo-European relations;



2. The German decision to abandon nuclear energy and increase energy imports from Russia could eventually weaken European unity and the underpinnings of NATO;



3. Russia wants to be a part of the European energy distribution system, and the energy retail market. If successful, it raises the question of Europe being able to side with the US on key issues;



4. Russia is supporting the Shanghai Cooperation Organization (SCO) to keep the US out of the Central Asian energy preserve, and has begun discussions with Pakistan about the mechanics of building the Turkmenistan-Afghanistan-Pakistan-India (TAPI) pipeline Moscow is outflanking the United States in the subcontinent.

A Russian diplomat confided similar conclusions to Sentaku Magazine as reported by the Japan Times, noting that the Kremlin's strategy is to decouple Western Europe from the United States, based on its abundant natural resources. Moscow wants to create discord among NATO members and block any expansion of NATO by promoting bilateral ties with individual NATO countries.

Russia's policies are fueled by energy exports. But can Russia keep up the pace? This question needs to be divided into two subfields: oil and gas. Prime Minister Vladimir Putin argues that Russia can continue its production of oil at 500 million tons annually for decades, but it will require investments of 280 billion dollars over the next ten years, Oil and Gas Eurasia quoted the Xinhua news agency.

The Russian Ministry of Natural Resources concurred with Putin's assessment, but was more pessimistic about how long the production can last, says AFP. Russia is tapping into its existing light crude reserves in western Siberia at alarming rates while failing to replace them with new finds in regions that sit further away from Russia's industrial heartland. According to the study, oil quality was deteriorating steadily, and Russia can only sustain its current production rate for another 13-15 years. Most of the oil that Russia possesses (70%) is heavy crude that is hard to recover and cannot be used on the world market without additional processing.

Russian natural gas production has grown slowly, only 0.5% from 2001 to 2009, according to the president of Coburn International Energy Consultants, Leonard Coburn. In 2009, production fell almost 20% because of Russia's closing of the Ukrainian pipeline system for two weeks in January 2009. Gazprom, the producer of 85% of Russian gas, is delaying investments in new production, trying to husband domestic resources while purchasing gas from other countries. This strategy is being challenged, however, by Central Asian countries selling their gas to China instead of to Russia. Coburn notes that when Turkmenistan opened its gas pipeline to China in December 2009, Russian President Dmitry Medvedev immediately launched a tour of Central Asian capitals to repair relations. The establishment of a new customer for Central Asian gas was a wakeup call for the Russians, that Central Asia has the ability to maintain some independence.

Russia is also looking to China as an energy market. The International Energy Agency (IEA) told the St. Petersburg International Economic Forum that European demand for gas was stagnating, according to a Financial Times blogger. The IEA's chief gas analyst told the Forum that China would be the main driver of increasing gas demand, accounting for one third of global growth. The IEA predicted that the global growth in gas would be 2.4%, so that would mean that the Chinese would account for .8% of global growth in gas consumption.

What conclusion can we reach? Russia has a 15 year window to throw its energy weight around. After that, it gets difficult. It appears that Russia has plenty of natural gas, but the weak economic recovery and the shale revolution is slowing Europe's demand for the product. Russia needs the sale of gas to maintain its own economic recovery, and that means they will have to turn to China as a new market. American concerns are valid for the next decade but, in the long run, Russia's energy superpower status will begin to fade.

BP-Rosneft Deal a Victim of Russian Presidential Politics

Russian presidential politics may have been directly responsible for the collapse of the joint venture between British Petroleum and Rosneft. The deal, which was launched in January 2011 with great fanfare and the blessing of Russian Prime Minister Vladimir Putin, was allowed to die quietly at midnight on May 16. Members of the Alfa, Access and Renova Group (AAR) who are supporters of President Demitri Medvedev, placed insurmountable obstacles before the deal. These oligarchs, who included billionaires Viktor Vekselberg, German Khan, Len Blavatnik and Mikhail Fridman, stood to gain $32 billion if the deal were completed--and yet they refused to grant their blessing.

What happened? In January, BP CEO Robert Dudley inked a deal with his Russian counterpart, Rosneft CEO and Deputy Prime Minister Igor Sechin. Sechin is a Putin protoge. The deal proposed a stock swap: 5% of BP would go to Rosneft; and, in return, 9.5% of Rosneft would go to BP. The deal, valued between $16 billion and $18 billion, was designed to give the Russians access to BP's artic driling technology. In return, BP would have a production sharing agreement for access to the oil. At the conclusion of the ceremony, Putin told a press conference that the BP-Rosneft partnership "may become large-scale and have a serious impact on the global oil and gas industry." Later, when things turned nasty, Putin would distance himself from the project stating the government would not intervene in the controversy--but the prime minister's fingerprints were all over the deal.

It didn't work out. BP was already in Russia, in a 50-50 partnership, called TNK-BP, with the AAR oligarchs. As the former president of this partnership, Dudley should have been aware of the details governing the cooperation between the shareholders, including the granting of exclusivity for BP operations in Russia to TNK-BP. When the BP-Rosneft deal was announced, the AAR consortium promptly filed in a London court to stop the merger. According to sources close to TNK-BP, the oligarchs sought and received Prime Minister Medvedev's support for the legal defense of their interests. One of the oligarchs (Viktor Vekselberg) was involved in an innovatin hub near Moscow that was the result of a Medvedev policy initiative. Medvedev further signaled his displeasure by ordering Sechin (and other government officials) to give up corporate posts to stay in the administration. The battle over the merger became a battle between forces loyal to the Prime Minister, and forces loyal to the President.

The issue ended in an arbitration court that issued a consent order permitting the share swap to proceed, but only with the approval of TNK-BP. Without that approval, the rights to drill in the Artic would devolve onto TNK-BP (and not the parent BP corporation), with the approval of Rosneft. Rosneft officials, however, did not want to work with the AAR partners. Efforts began to purchase AAR's 50% share of the partnership. Bidding rose from $27 billion to $32 billion, but to no avail. The Financial Times quoted one observer as saying, "The feeling is they (AAR) did not want to do a deal at all. They were forwarding conditions that they knew ahead of time that BP and Rosneft could not accept."

The blame game has already begun. According to Bloomberg, President Putin blamed BP's Dudley, stating the CEO had left him "completely unaware" of a potential dispute with AAR. Medvedev, by contrast, blamed Putin protoge Sechin and the entire Putin-led government. "Those who prepared the deal should have paid more attention to the nuances of the shareholder agreement. They should have had better due diligence inside the government," he said.

How could BP have ignored its responsibilities under the TNK-BP partnership agreement? According to the managing partner of Goltsblat BLP, Andrey Goltsblat, the problem lay in the informal nature of the Russian legal and business systems. As published in Business RT, Goltsblat said, "I do believe that lawyers knew about that clause and lawyers informed BP, but unfortunately sometimes in Russia more people rely on relations with the government or with the other level of officials, rather than on the law...BP probably thought that the clause is not that important, yet, as they are dealing with the government they are told that the deal is blessed by the Prime Minister and that there shouldn't be problems to overcome that clause."

The issue now moves to the courts. The Moscow Times provided an analysis of the situation from Russian attorney Vsevolod Miller (Yukov, Khrenov & Partners). According to Miller, there would be a guarantee warranty clause in the Rosneft-BP deal, and BP would be in breach because of its probable failure to disclose the TNK-BP shareholder agreement. "Rosneft will sue BP for breach of warranty--they will sue for direct damages, which are likely to run into the millions," he said. Miller added that there were no grounds for a case against AAR (presumably because AAR was only defending its legal rights). Reuters reports that according to a source close to TNK-BP, the company is considering suing for damages of up to $10 billion.

It is still a couple of years until the Presidential contests but, if one considers this skirmish as the first Presidential primary, Medvedev has emerged in the lead.

Russia and Turkey Holding South Stream Hostage

Turkey and Russia are engaged in a game of chicken over the South Stream Pipeline. Both sides are threatening the construction of the Russian-inspired natural gas pipeline, in an effort to see who blinks first.

Turkey has signed a number of natural gas agreements over the years, and it is committed to purchase more gas than it can use. Unfortunately for the Republic, Turkey's contract with Russia is a "take or pay" contract which means it has to pay for the gas whether it is shipped or not. In addition, the long-term contract price for the gas is much higher than current spot prices. At the same time, Gazprom has been waiting for Turkey to issue the permit allowing construction of South Stream in Turkish waters of the Black Sea. "So far, we don't understand the reasons why we didn't receive the permit," said Deputy Prime Minister Igor Sechin, as reported in the Moscow Times.

According to the online newspaper Gazeta.ru, the reason is obvious: Ankara is looking to use the pipeline issue to lower the gas prices. The strategy may work, as the Moscow Times quotes President Demitri Medvedev that discounts were possible in exchange for unspecified Turkish concessions.

Russia also has hard-ball tactics at its disposal; namely, a proposal to replace South Stream with LNG shipments. According to the Sofia News Agency, Russian Prime Minister Vladimir Putin asked Russian Energy Minister Sergey Shmatko to examine building a liquified natural gas terminal in place of constructing a Black Sea pipeline. Under this scheme, Bulgaria would also have to build an LNG terminal to receive the gas shipments. According to ITAR-TASS, Shmatko said that according to preliminary assessments the most attractive option was the delivery of natural gas from the Yamal Peninsula, because much of the transportation costs would be within Russia.

Shmatko claimed that the European Commission has proposed the LNG terminal as one of many alternatives to the South Stream project. According to the Moscow Times, however, EC spokeswoman Marlene Holzner denied that the Europeans had anything to do with the idea. "This was not discussed during the meeting between the Russian government and the European Commission in Brussels at the end of February," she said.

It would appear that the threatened LNG plan is a ploy designed to pressure the Turks into granting the construction permits without reducing the price of gas deliveries. The key to this assessment is Shmatko's assertion the best option was gas from the Yamal Peninsula. Delivery costs from this area, which is snowed in for much of the year, would be excessive. AFP quotes RusEnergy expert Mikhail Krutikhin: "Has he seen the globe?...Producing on Yamal for the South Stream is nonsense...Once transported it would have the price of diamonds." Krutikhin concurred that it is a bluff: "an attempt to scare the Turks."

There is other evidence that the talk of an LNG option is bogus. According to Steve Levine in his Foreign Policy blog, South Stream pipeline director Marcel Kramer has received no new instructions, and is proceeding with his existing orders to make the $21 billion pipeline work. Further, in their March 17 summit meeting, Medvedev and Turkish Prime Minister Recep Tayyip Erdogan did not discuss the project. (Bloomberg reported that Russian Deputy Prime Minister Igor Sechin tried to dismiss the lack of discussion by claiming it was unnecessary. "Why discuss something we can do on our own?...This was resolved a hundred years ago," he said.) Finally, Shmatko himself denied Russia having any plans to abandon the pipeline. According to the RIA/Novosti, Shmatko said, "We are not wording the issue in such a fundamental way...We'll have several ready alternative routes of supplying gas directly to European countries."

Whether South Stream is ever built is a question yet to be resolved, but it is clear the LNG proposal--for the moment--is a red herring.