Russia, An Energy Partnership and Iraq

Soon after the September 11 attacks, Russian President Vladimir Putin made a speech proclaiming Russia's readiness to become a reliable alternative for oil in case of a shortfall from an unstable Middle East.

Soon after the September 11 attacks, Russian President Vladimir Putin made a speech proclaiming Russia's readiness to become a reliable alternative for oil in case of a shortfall from an unstable Middle East. Since then, the Putin and Bush Administrations have made energy cooperation a strategic imperative and the cornerstone of American efforts to assist Russia's modernization. With Russia's vast reserves and increasing production, Russia is poised to become a more active player in world energy markets and, if Russian and American companies work together to develop these resources, could become a major oil supplier to the United States and world markets.

At the Houston energy summit this past October, Russia was, for the first time in many years, referred to as a "superpower", albeit in energy and not in military terms. As Vladimir Lukin, Deputy Speaker of the Russian Duma and former Russian Ambassador to the United States put it recently, "Oil and gas . . .  is an instrument to influence world politics, which will make up for Russia's lagging behind in other areas." Vagit Alekperov, Chairman of LUKoil, predicted that by 2010 Russia could supply 10 percent of the total oil consumed by the United States.

After two productive summits and a host of meetings - just as the bilateral relationship seemed to have developed some political and economic momentum - differences in approach toward Iraq injected an element of uncertainty and tension into the relationship. The debate over what to do in Iraq is also illuminating once again Russia's limited leverage on American policy and the dependence of its economy on energy exports.

Russia's dilemma is that it does not want an American war with Iraq, nor does it want conflict with the United States. In the past few months, it has kept its distance from the Saddam regime and has warned Iraq that it must strictly implement past UN resolutions. At the same time, however, it has sought to shape, change, and blunt what it fears may be a U.S. rush to war. Despite its criticism of U.S. policy, Russia has benefited both economically and politically as the U.S. has focused increasingly on Iraq. In recent months, the price of oil has risen to $30 per barrel, providing additional revenues to the Russian budget.

However, both economic and geopolitical reasons impel Russia to argue against U.S. military action in Iraq. First, most Russians believe that a war with Iraq will imperil Russia's investments, which stand today at around $20 billion. In addition, Russian intermediaries handle approximately 40 percent ($1 billion) of the oil sold under the UN's Oil for Food Program and Russia is owed about $10 billion for Soviet Cold War-era weapons sales. This past summer, Russia and Iraq agreed to expand their economic ties once sanctions are lifted, signing a multi-year bilateral agreement that increased the potential for investment in Iraq to $40 billion. In addition, Russian oil companies such as LUKoil, Rosneft, Tatneft, Slavneft, and Zarubezhneft have agreements to develop Iraqi oil fields that they are unable to exercise because of UN sanctions. Clearly, certain Russian interests have a significant material stake in Iraq, and any effort to topple Saddam could threaten those interests.

Compensating Russia for debts owed to the Soviet Union and ensuring that the claims of Russian oil companies are honored has been the subject of on-going talks between U.S. and Russian representatives. Putin told British Prime Minister Tony Blair that he would not make negotiations over Iraq into an "Eastern bazaar", but a Russian acknowledgment that there is a price tag on Russia's acceptance of American-led military action against Iraq could provide the basis for an understanding with the United States that protects key Russian interests in post-Saddam Iraq.

However, a quite different scenario, one less advantageous to Russian interests, is also possible: that a U.S. military presence would remain for some time after the conclusion of hostilities, even playing some role in the administration of the oil fields. In this (for Russia) "worst case" scenario, the U.S. would use its dominant position in Iraq to ramp up Iraqi oil production as rapidly as possible in order to lower global oil prices and spur global economic recovery. YUKOS Chairman Mikhail Khodorkovsky outlined such a scenario at a recent Duma meeting sponsored by Russia's largest political party, noting the dire effect a war in Iraq could have on Russia's oil industry and national budget. Were this to happen, U.S. and Russian economic interests would clearly diverge, especially if oil prices were to fall below the level necessary to attract Western investments in oil field development, transportation and port infrastructure needed by Russian oil and gas companies.

Russia's economy is extremely sensitive to changes in the price of oil. Thus, what happens to oil prices in the context of a post-Saddam Iraq will impact Russia's ability to sustain economic reform and growth. Russia's 2003 budget is based on a price of oil at approximately $22 per barrel, a projection the Ministry of Finance calls "realistic." If oil prices fell below $18 a barrel, Russia would probably be hard pressed to support even current levels of social spending. Some Russian experts predict that the Russian government would face social upheaval at home if oil drops below $12 per barrel.

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