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Russia Profile
April 30, 2009
Russia Profile Weekly Experts Panel:
Medvedev’s New Energy Initiative
Introduced by Vladimir Frolov
Contributors: Vladimir Belaeff, Ethan Burger, Mikhail Korchemkin

On a visit to Helsinki, the Russian President Dmitry Medvedev outlined a proposal for an overhaul of European energy security. In its proposal, Russia said that energy consumers and producers should share responsibility for the security of gas transit, an apparent rebuff to Europe’s efforts to sideline Russia in modernizing Ukraine’s energy sector and the transit gas pipeline system that carries Russian gas to Europe. Will Medvedev’s new energy architecture proposal fly? Is such a sweeping reform of the international energy framework necessary at this point? How will the United States and the EU react to this initiative?

Russia said that the new document should supplant previous agreements, including the European energy charter, which Russia signed but has not ratified. The Kremlin claimed that “the existing bilateral arrangements and multilateral, legally binding norms governing international energy relations have failed to prevent and resolve conflict situations, which makes it necessary to efficiently improve the legal framework of the world trade in energy resources.”

The document, titled a Conceptual Approach to the New Legal Framework for Energy Cooperation (Goals and Principles), calls on producers, buyers and transit states to share responsibility for the stability of supplies, including monitoring gas supplies and coordinating investment in pipeline systems. It also demands tougher rules to enforce contractual obligations. “Our task today is to ensure the balance of producers, transit states and energy consumers,” Medvedev said in Helsinki on Monday.

Among the main principles of the new legal framework for global energy cooperation the document lists the recognition of indivisibility of sustainable global energy security and interdependence of all world energy exchange participants; mutual responsibility of energy consuming and supplying countries, as well as of transit states for global energy security; unconditional state sovereignty over national energy resources; non-discriminatory access to international energy markets, their opening and increased competition; coverage of all types of energy and utilities and their related materials and equipment; transparency of all international energy market segments (production/export, transit, consumption/import); non-discriminatory investment promotion and protection, including new investments into all energy chain links; promotion of mutual exchange of energy business assets within investment activities; non-discriminatory access to energy technologies and participation in technology transfers; smooth energy supply to international markets, including through transit systems.

The Kremlin wants the new energy architecture to extend to all major energy suppliers, including Middle Eastern states, the United States, Canada, Mexico and Venezuela, and to cover all commercially viable energy sources – from nuclear fuel to charcoal.

Moscow also called for a new Energy Transit Agreement that codifies the obligations of transit countries to ensure uninterrupted transit of energy resources through their territory – a move designed to put an end to Russia’s annual brawls with Ukraine over gas transit to Europe, but also a move to open up Russia’s pipelines to the transit of Central Asian and Caspian energy resources.

It is noteworthy that two days before Medvedev outlined his energy initiative, the U.S. State Department announced the appointment of Richard Morningstar as special envoy for Eurasian energy to support the United States’ energy goals in the Eurasian region. He will work on key energy issues relating to Europe, Russia, Ukraine, Turkey, Central Asia and the Caucasus, and on policy issues relating to the development, transit, and distribution of energy resources in Eurasia.

Will Medvedev’s new energy architecture proposal fly? Is such a sweeping reform of the international energy framework necessary at this point, and if so, what are the reasons for advancing such an initiative now? Does it have a chance of being taken seriously as a good substitute for the existing arrangements? Who, besides Russia, will be interested in such a regime? How will the United States and the EU react to this initiative? Is it an olive branch to the West, or a maneuver to distract attention? What does this move by Medvedev signify for Russia?

Ethan S. Burger, Adjunct Professor, Georgetown University Law Center, Washington, DC:

“Words! Words! Words! Show me!” said Eliza Dolittle in the film version of My Fair Lady. I have no idea who first said that “actions speak louder than words,” but he or she was almost certainly right. It might have even been said in a language other than English.

I have reviewed the Conceptual Approach to the Legal Framework for Energy Cooperation (hereinafter, the energy framework) on the Russian official Web portal. I immediately thought of Article 15(4) of the Russian Constitution, which provides that “[the] commonly recognized principles and norms of the international law and the international treaties of the Russian Federation shall be a component part of its legal system. If an international treaty of the Russian Federation stipulates rules other than those stipulated by the law, the rules of the international treaty shall apply.” This language is for the entire world to see. Wouldn’t it be lovely if this indeed were the state of the law in Russia?

The energy framework is probably an adequate starting point for working groups to begin developing the details needed for a workable legal framework to enhance energy cooperation and security. The problem arises that no document of this nature exists in general. Indeed, some of the energy framework’s text could be troubling, particularly due to protectionist tendencies, such as those contained in the law Russia passed last year on foreign investment (and certainly other countries’ laws in the same area).

Does “unconditional state sovereignty over national energy resources” mean that a government need not feel constrained by private contracts it may have entered into with corporations (foreign or domestic)? At present, to my knowledge of the major oil companies, all but British Petroleum have been pushed out of the Russian energy sector. ENI (Italy) having sold its 20 percent stake in Rosneft after purchasing some of Yukos’ former assets does not qualify it as a major oil company, since it seems more like a well-paid bit player in what I regard as a politically-motivated abuse of the Russian legal system.

If a formal international agreement were to come into being, I am not convinced that the time and effort spent on putting it together is worth the cost, since it will be difficult if not impossible to implement. The use of natural gas as a political weapon against Ukraine (Belarus and Georgia) not only inflicted significant hardship on Western Europeans, but also damaged Russia’s credibility as an energy supplier and reliable business partner. Yes, the EU is vulnerable to energy blackmail, but after being blackmailed once most persons (countries) begin to take actions to lessen the likelihood of the situation repeating itself.

For decades, the Soviet Union wanted to decouple human rights from economic relations. It should be obvious to everyone who sees the big picture that the rule of law, good faith in business, and economic cooperation are all interlinked. Perhaps those around president Medvedev will convince other members of the Russian ruling elite that the president’s approach is best for Russia. Those individuals who flourished during the Vladimir Putin years have financial and property assets all over the world. I doubt that they want to risk the potential consequences of having to pay damages for causing economic harm or defaulting on other economic arrangements with Western entities. Remember that when acting in a commercial manner, Gazprom cannot invoke the principle of Russian sovereign immunity. Companies that purchased Yukos’ assets may not be entitled to the funds that they sold them for.

I want to briefly draw attention to two phrases in the energy security document that cannot be overlooked: “recognition of security of supply (delivery) and demand (transparent and predictable marketing) as key elements of global energy security,” and “non-discriminatory investment promotion and protection and new investment into all energy change links.”

These sentences strike me as either the aspirations of some well-meaning Russian specialists, or cynical statements that seek to trick third parties into believing that Russian governmental authorities, local bodies, and private Russian entities share a common belief system with Western energy companies. Unfortunately, they do not. Foreign business leaders and investors ignore the past only at their own peril.

Mikhail Korchemkin, Executive Director, East European Gas Analysis, Pennsylvania:

The new energy initiative shows that Russia and the European Union hold absolutely opposite views on the future of the European gas market. While the EU promotes liberalization and free competition, Gazprom still wants to control the whole chain, from the gas well in West Siberia to the burner tip of the European consumer. Russia’s demand for “non-discriminatory investment promotion and protection, including new investments into all energy chain links” contradicts the EU Gas Directive that claims that the “unbundling of supply from transmission activities of integrated companies will serve to eliminate the conflict of interests.”

Russia’s proposal adds a new element to the Energy Doctrine proposed by Vladimir Putin three years ago in his letter to the Wall Street Journal. Putin advocated a “market” without competition between energy producers, and with high, regulated prices that never go down. The new document says the “market” should also have predictable demand. From the Russian point of view, an EU Central Gas Planning Committee (EU GasPlan) would be the best trading partner for Gazprom in Europe.

Russia is the country to be affected the most by its own energy transit concept. Russia is the only country in Europe and the CIS that forbids international transit of natural gas. Gazprom buys all foreign gas that gets onto the Russian territory, and resells it on its own terms. The new energy transit rules suggested by Russia would give Turkmenistan, Uzbekistan and Kazakhstan direct access to the European gas markets. Moreover, the Central Asian gas exporters would be able to monitor the transit flows in Russia, and have firsthand knowledge about the availability of spare capacity in Gazprom’s pipelines.

There is something Orwellian in Russia’s amendments to or replacement of the Energy Charter Treaty, which Russia has never ratified. Russia’s attitude toward the international transit of natural gas across its territory is the same as Joseph Stalin’s feelings about the 1929 Geneva Convention on prisoners of war, which the Soviet Union refused to join. As a matter of fact, Comrade Stalin never suggested amendments to the Geneva Convention.

Gazprom has made a statement on the implementation of the South Stream project regardless of financial conditions. In fact, this means that Gazprom and Russia’s government are willing to take a loss if it helps to win the race with the competing Nabucco pipeline. The South Stream project, just like the Nord Stream pipeline in the Baltic Sea, makes no commercial sense. According to Gazprom, neither pipeline is meant to increase the volumes of gas exported to Europe, which means no additional revenues and profits. The two pipelines are designed to improve the flexibility of gas supplies. The losses to be incurred by Russia are significant.

Firstly, Gazprom wants to invest over $26 billion (Gazprom’s share in foreign and Russian sections of South Stream) into a project that increases costs without generating extra profits. South Stream is unable to give any added value for Gazprom. I wonder what the foreign shareholders of Gazprom think about it.

Secondly, Gazprom is willing to buy all Central Asian and Azeri gas and to re-export it to Europe instead of Russian gas, losing a profit of $100 million per one billion cubic meters. Note that re-exports of foreign gas generate no profits, because the sellers do not give Gazprom any profit margin and pay no commission. To export more Turkmen or Azeri gas, Gazprom has to reduce the exports of its own gas, which means reduction of the most profitable business segment of the company. Thirdly, the government of Russia is willing to cut its budget revenues. Re-exports of foreign gas are tax free, while exports of Russian gas are subject to a customs duty – 30 percent of the contract value. At the current price, exporting one billion cubic meters of Azeri or Turkmen gas instead of gas produced in Russia means a loss of $85 million for the state budget. Apparently, the government considers spiting Nabucco a higher priority than maximizing budget revenues and the profits of Gazprom.

The EU should find an answer to a simple question. Why is Russia promoting a money-losing project? As the Kremlin and Gazprom side puts it now, the EU gets all the benefits and Gazprom gets all the costs. It is too good to be true.

Vladimir Belaeff, President, Global Society Institute, United States:

The need for a fresh approach to global energy policy coordination should surprise no one. Economic, political and social configurations have changed since the previous formulation of international energy policy conventions.

Also, two recent episodes, when one dysfunctional energy transit country de facto extorted both suppliers and consumers of natural gas in Russia and Western Europe, reinforce the present need for a comprehensive solution.

The main principles of the new framework proposed by Russia are logical and sensible. As global energy use and interdependence increases, it is evident that the existing patchwork of only partially binding agreements is obsolete. A new, comprehensive international framework is definitely needed. Such a framework would be market-based, and would apply to all participants, including Russia, its initiator.

The theme of transit countries is particularly important and in need of a refreshed approach. The events of January 2009, when the particularly recalcitrant government of a transit country with substantial internal political problems callously disrupted deliveries of natural gas to its Central and Western European neighbors in order to pursue obscure goals of internal political vendettas confirm the need for a new, comprehensive, modern and fully enforceable international legal framework for energy transit, including mechanisms of rapid response to politically motivated disruptions.

It is notable that the natural gas transit disruptions by Ukraine in 2009, like earlier episodes, were attributed to the supplier - Russia, through propagandistic legerdemain in the starkest traditions of the Cold War. As a supplier who depends on reliable deliveries of merchandise sold, Russia is actually a victim of the Ukrainian disruptions, yet Russia was portrayed as an instigator of Ukrainian delivery failures. Meanwhile, direct natural gas deliveries from Russia to Finland (90 percent of Finnish needs) do not experience political disruptions. And there was stable natural gas flow from Russia to the West through Ukraine before the Orange Revolution regime degenerated into a condition of political gridlock.

The above demonstrates the need to consider political and governance issues within transit countries. A new international framework for energy delivery must address and solve the need for intact, stable and secure transit of energy resources at the same level of detail and enforceability as the relationships between resource suppliers and consumers.

What does Russia’s initiative represent? I believe that it is primarily an economic initiative, evidently motivated by recent experience and based on the realization that the present legal architecture is no longer fully operational. This initiative merits attention and development, because reliable, market-priced and readily available energy resources have always been critically needed by every human society.

Will this initiative succeed? This depends on the political will of Russia’s counterparts in Europe. One observes the evolution of a "balancing" network for the delivery of Russian energy resources to other industrialized and developing regions, for example, the recently opened LNG terminal in Sakhalin, already contracted for major deliveries of energy resources to Japan, and the growing pipeline infrastructure for deliveries from Russia to China.

Therefore, it is important for the West to consolidate and improve its current good relationship with Russia as a supplier of energy resources. The benefits for all sides are self-evident. The West will ensure stable and cost-efficient access to energy supplies; Russia will obtain reliable deliveries to its Western customers, and the transit regions will gain fee revenues.

Russia’s initiative is an excellent first step in the process of modernizing global energy relationships - it should be negotiated so that a true win-win solution is achieved. Delays will only allow more episodes of disruption, confrontation and world-wide instability of the vital supplies of energy resources.