From: "Vlad Sobell" <Vlad.Sobell@dir.co.uk>
Subject: Russia's gas diplomacy
Date: Tue, 10 Jan 2006
Moscow’s gas diplomacy
Russia plays geopolitics, but not as is customarily believed
10 January 2006
Vlad Sobell
Daiwa Institute of Research
• The Kremlin has blundered by allowing itself to be drawn into a situation in which Gazprom briefly cut off supplies to Ukraine, thus disrupting the flows to the European Union. It should have foreseen that the blame would fall squarely on Russia rather than Ukraine, badly damaging its reputation.
• However, the dominant interpretation that Russia’s strategy is motivated by the desire eventually to blackmail the EU is misconceived. By increasing the prices paid by the former Soviet republics, Russia is trying to overcome the structural and logistical heritage of the Soviet Union, not re-build its Soviet empire or bully the West.
• Russia certainly differentiates in its pricing policy in line with perceived geo-political friendliness/unfriendliness of the country in question. But this differentiation actually is not very significant, as both “foes” and “friends” have been under pressure. At the same time, it certainly is in the interests of countries such as the Baltic republics that they increase the prices of their imported gas in line with their EU competitors.
• It has been alleged that the spat has flared up because of Russia’s desire to directly interfere in Ukrainian domestic politics, with parliamentary elections due in March. However, even allowing for substantial Kremlin incompetence, it is difficult to see how this could be its objective, as such crude methods would certainly misfire.
The Kremlin again blunders over Ukraine
The closing weeks of 2005 and the start of the New Year witnessed another turbulence in Russia’s relations with Ukraine and, by extension, with the European Union and the West in general.
As January approached, Russia and Ukraine escalated their yearlong dispute over the price of Russian gas supplied to Ukraine. Unfortunately, with both sides digging in their heels, Russia precipitously acted on its threats and briefly interrupted supplies to Ukraine. The latter predictably responded (as had happened before) by appropriating some of Russian gas destined to the EU, with many EU countries reporting significant supply shortfalls. The net result was a brief appearance of the fearsome apparition, which the generally hostile commentary had long claimed was lurking in Moscow: the authoritarian, neo-imperial bully, ready to blackmail its former Soviet neighbours as well as the West European democracies.
More prosaically, Russia was also inevitably cast as an unreliable partner, ready to place neo-imperial politics above any other considerations. And this at the very precise moment when it assumed the chairmanship of G8 for 2006, on Moscow’s own insistence meant to deal with energy security!
Although the dispute was swiftly resolved to both parties’ ostensible mutual satisfaction, there can be no doubt that by allowing it to escalate to this critical point and hence externalising it, President Putin has committed a major PR blunder. Whatever the rights and wrongs of this complex case, the fact remains that the regime has failed to grasp that Russia would be seen as the chief villain of the piece. As in the late 2004 at the time of Ukraine’s “Orange revolution”, the regime has displayed a disturbing inability to think and act rationally when it comes to things Ukrainian.
Nevertheless, it is important that the spat with Ukraine is seen in its proper context. While some of the starkest interpretations routinely advanced by mainstream media see Putin’s neo-imperialist Kremlin as harbouring plans to eventually bully the EU (and then perhaps the entire globe) in the same way as Ukraine, it has passed virtually unnoticed that the Kremlin is actually trying to rid itself of, rather than restore, its post-Soviet heritage.
It is in Russia’s best economic and political interests to develop a normal, stable trading relationship with Europe, East and West, in which no country would have an opportunity to blackmail any other, and in which energy and finances would flow to everyone’s satisfaction. The post-Soviet heritage has been a major obstacle to this vision, having acted as the same distortion-generating deadweight as the Common Agricultural Policy in the European Union. Unlike the EU, Moscow is moving beyond this 20th century anachronism, with its recent spat with Ukraine being a significant manifestation of the painful adjustments yet to be undertaken.
Back to the USSR
The reasons why the true factors at work have been obscured have to do with prejudice and incredulity: how could Russia be anything other than “increasingly authoritarian” and neo-imperialist? It seems that the global picture would simply remain incomplete if it failed to feature an evil empire, forever plotting to take over the world. Perhaps someone must perform this role otherwise the global system might go out of kilter and, given its recent Soviet past, Russia is the most suitable, “default” candidate.
However, an additional reason might be that 15 years since the collapse of the USSR and its East European bloc, the analytical community appears to have forgotten this empire’s very unusual principles: namely, that it was based on “fraternal aid” advanced by Russia, rather than plunder and exploitation as was the case with standard empires throughout history. So when Putin’s Kremlin is trying to wriggle itself out of its long-standing Soviet-era obligation by pressing the former Soviet republics into paying the going market prices of gas, it is actually acting in a profoundly anti-Soviet and anti-imperial, rather than Soviet-style and neo-imperial manner.
A quick look back shows that communist Kremlin over the decades of its rule created a system, which supplied its members with plentiful energy and raw materials, well below the going world market prices, while accepting from them in payment substandard manufactures, un-saleable in the external markets, or saleable only at large discounts. In other words, the Soviet bloc was glued together not by capitalist greed, but socialist largesse.
That both the Russian economy, as well as the economies of its vassals, suffered in the process (the former by having to subsidise the empire, the latter (as well as Russia) by their inability to integrate with the rest of the world) was immaterial. What mattered was that the monster kept on running and perpetuating its nomenklatura, which ruled in the name of communist ideology, in return for material benefits in the form of perks structurally undeliverable to the liberated toiling masses. In the post-Soviet period, the former socialist largesse has been converted into a massive feedstock for corruption, as oligarchic mafias have been selling cheap Russian gas (and other materials) abroad and at home for much higher prices.
Still stuck in the USSR
It may be useful to imagine sitting in the Kremlin and observing this former “value destroying” wasteland, only now gradually approaching anything resembling normalcy. Not only is Russia’s own domestic economy addicted to cheap energy and raw materials. It is surrounded by its former Soviet neighbours, most of who still suffer from the same problem. The Kremlin may want to get a fair price for its gas (that is equivalent to the prices paid by the EU), but it cannot, because its former Soviet brothers clearly cannot pay without sending their economies into a tailspin, with negative repercussions on Russia’s own economy.
Ukraine is the fulcrum of this problem. Not only is it the second largest former Soviet republic after Russia (in terms of the economy and population), it is also the most intimately integrated, and mutually inter-dependent, with the Russian economy. Its key export sectors, such as steel and chemicals, are heavily dependent on subsidised Russian energy, while some 90% of Russian gas exported to the EU is passing through its territory. A decade and half since the collapse of communism, the principles on which this close relationship is being conducted remain as fraternally communist as they were in the 1960’s: Ukraine is charging transit fees for its gas well below the going market rates, while receiving gas at a fraction of the prices Russia charges the EU countries.
Trying to determine who is the winner and loser and precisely how much the loser is losing and the winner winning is like trying to compare the monetary values of two telephone numbers. While we can readily come up with a figure of Russia’s presumed loss (by subtracting the dollar revenue it gets from Ukraine from the presumed revenue Russia would obtain had this gas been sold in the EU), this calculation would fail to include the benefits Russia gets by having a (relatively) stable, and until recently fast growing, Ukrainian economy at its doorsteps, offering a favourable environment for the Russian companies.
Furthermore, as was the case in the Soviet bloc, the calculus must also take into account inherent imponderables, such as the geo-political value of having a weighty friendly neighbour such as Ukraine, rather than fledgling regional rivals, such as the EU-embedded Poland, eager to seek revenge for Russia’s historical wrongdoings. This is exactly what Russia was doing when Ukraine was governed until 2004 by the ostensibly pro-Russian regime of President Kuchma and this is what Russia is doing by continuing to charge very low prices for its gas to the loyal Belarus.
The only way out of this insoluble post-Soviet maze is to gradually move to standard economic relations based on the going market prices, accompanied by the transfer to standard inter-state relations, devoid of any “fraternal”, geopolitically driven objectives.
Out of the USSR?
In 2004 Ukraine commenced doing precisely this, by staging its “Orange revolution” and declaring its intention to join the European Union and NATO at the earliest opportunity. This strategic shift widely welcomed in the West as deepening Ukraine’s democratic and European credentials unfortunately has not been matched by corresponding changes on the economic front, with Ukraine apparently continuing to expect indefinitely heavily subsidised Russian gas. (In fact the Ukrainian economy nosedived following the regime change, making its supplies of cheap Russian gas even more necessary).
Although Ukraine successfully lobbied the EC to grant it, in December, the coveted “market economy” status, it has failed to send the same signals to Russia. It is, of course, inconceivable that Ukraine would have been able to move to the EU market prices at the same speed at which it has apparently moved to standard inter-state, political relations with Russia. However, it might have reasonably been expected that, as part of its liberation strategy, Ukraine negotiate with Russia a schedule of medium-term increases in gas prices, offering a credible road map to eventual convergence to EU prices.
At the same time, the Ukrainian-Russian relationship remains complicated by the transit pipelines, as Russia is clearly exposed to potential Ukrainian manipulation of the transited gas flows. This risk has been highlighted in the recent spat when, according to the claims by Gazprom, Ukraine illegally diverted some of the gas meant to be supplied to the EU, thus successfully externalising the conflict and casting Russia in the role of supply defaulter. In the absence of standard inter-state relations which are likely to remain elusive in foreseeable future Russia is able to partially resolve the problem by building the new North European Gas Pipeline under Baltic Sea to the EU, by-passing both Ukraine and Poland to be completed in 2010.
Moscow’s differentiation game
While the present analysis casts doubt on the widely publicised notion that Moscow is trying to restore its empire by (among other things) using its energy weapon, it cannot be denied that Russia differentiates the prices it is charging for its gas in line with perceived strategic friendliness/unfriendliness of the former Soviet country in question.
Thus the traditionally friendly Belarus will in 2006 receive Russian gas at $49 per 1,000cu m (marginally up from $47 in 2005), while the prices to “neutral” Armenia and Azerbaijan have increased from about $60 per 1,000 cu m to $110, having puzzlingly received the same treatment as the “unfriendly” Georgia. The new EU members, the Baltic republics, are facing an increase from $90 per 1,000 cu m to $120-125 per 1,000 cu m, with Gazprom pressing for a further increase to the current EU level of $230 by 2008. Moldova, which has recently moved to a more pro-Western course, is presumably being “punished” by an increase from $80 per 1,000 cu m, to $160 in 2006. Ukraine, as noted, was subjected to the demand of moving to the EU level of, although a compromise keeping the price low (at $95 per 1,000 cu m) over the medium term has now been negotiated.
However, it is difficult to understand why this differentiation should be interpreted as a nothing but neo-imperialism. Surely, former Soviet republics desiring, and able, to operate in the EU and global markets at a level playing field should expect and in fact desire a gradual increase in the prices of their imported Russian gas to the level paid by their EU partners. It is in their interest that the prices converge with EU prices, if they are to fairly and effectively compete within the Union.
Similarly, a country such as Belarus, hitching its economic future to the Russian economy (a strategy likely to prevail as long as the present regime of President Lukashenko survives) should be expected to receive benefits appropriate to its friendly geo-political status. Conversely, if Ukraine flaunts its newly found independence, with elements of the regime spoiling for a confrontation with Moscow, it should not be surprising that Moscow’s reaction would be to demand the full “independence” prices for its supplies of gas.
Crude political interference is unlikely to have been the dominant motive
Much has been made of the alleged efforts by Moscow to influence Ukraine’s parliamentary elections due in March. Indeed, the escalation of the crisis just weeks before the elections looks suspiciously like another crude effort to manipulate Ukraine’s politics. However, even allowing for great amount of ineptitude within the Putin’s regime (which appears to be the modus operandi when it comes to things Ukrainian), it is difficult to see how anyone might have hoped that such methods would produce the desired outcome. Russia’s blackmail by withholding the supplies of gas would most likely badly misfire on any politician (the opposition leader Victor Yanukovich), while benefiting the “anti-Russian” President Yushchenko and his allies. Indeed, the alternative conspiracy theory has it that Yushchenko has deliberately provoked the crisis to bolster his position ahead of the elections. Politics certainly is a part of the equation, but not in the crude form of brutal “gas diplomacy” in which it tends to be depicted.
It is significant in this context that in January 2004 (and on other occasions before that), the loyal Belarus found itself in a very similar predicament as Ukraine in 2005/2006, when Gazprom briefly cut its supplies of gas to it, after Belarus objected to paying an increase of price from $30 per 1,000 cu m in 2003 to $46 per 1,000 cu m. (In 2004 the price Russia charged to the EU shot up to $132 per 1,000 cu m). The issue was eventually settled with Russia providing loans to soften the impact of the shock, while Gazprom gained co-ownership of the Beltransgaz pipeline transporting gas to Europe.
Clearly, while differentiating between “friends” and “foes” in its pricing policy, Moscow/Gazprom uses the same “incentive” to induce both friends and foes to see things its way.