A Pipeline Runs Through It

A Pipeline Runs Through It

Mini Teaser: With Russia in the driver’s seat on energy issues, Europe should worry about running on empty. For more on the Russian elections, the internal state of the country and Vladimir Putin's nomination of a successor, check out our

by Author(s): Jonathan Haslam

IN THE early 18th century, the great Enlightenment philosopher Baron de Montesquieu pointed out that producers of manufactured goods possess a distinct trade advantage over producers of raw materials. The oil crisis of 1973, however, showed that this is not always true. Recent events underline that fact, the political consequences of which have yet to be fully considered.

Eight years ago the price of oil dropped to $14 a barrel. This turned out to be the best time to buy. A bull market in commodities was under way, and Russia was-and remains-a leading beneficiary. As a resurgent power, Russia may wield its newest and powerful weapon-a growing natural resource monopoly.

An unexpected windfall has descended on states dependent for the greater part of their income on exporting raw materials, including hydrocarbons. The reasons are many and clear. They can be found in China's burgeoning economy, rising global demand (not least in the Middle East and Africa), failure to sustain investment in further exploration and extraction (due to low prices) and the drying up of long-established wells (the last major find was in 1976 at Cantarell in the Gulf of Mexico, and the Kashagan field in the Caspian Sea has yet to yield an ounce of oil).

In 2006, and for the third consecutive year, global oil reserves have failed to compensate for depletion. Demand continues to outpace supply. A draft report, "Facing the Hard Truths About Energy", prepared by the National Petroleum Council for the U.S. energy secretary argues that "the global supply of oil and natural gas from the conventional sources relied upon historically is unlikely to meet projected 50% to 60% growth in demand over the next 25 years." This is a notable event: the first open admission from the petroleum industry that reserves will not meet consumption.

The former Soviet Union has thus found itself a major beneficiary of the emerging boom, coming immediately after the humiliating devaluation of the ruble in August 1998 and Russia's subsequent default on over $150 billion in external debt. Oil and gas had long formed the overwhelming source of Russia's foreign-currency receipts. The windfall from higher energy prices rapidly transformed the country from a doubtful debtor into a potential creditor, and Moscow rushed in to take full advantage of the opportunity. In 2006, Russia became the largest oil exporter in the world. This year the total will amount to some 240 million tons, nearly double the peak of Soviet oil exports for any one year. Of these, 80 percent of the oil revenues and 60 percent of the gas consumption have come from Europe, which relies on Russia for half its entire gas supply.

The dramatic rise in prices-peaking at $78 a barrel in 2006 and again this August-was bound to have a significant impact on the Kremlin's view of its own potential. The bear market in commodities through the greater part of the previous two decades had played its role in debilitating Soviet economic power, hastening a decline in Russia's influence on a global scale. Worse, there was the additional unwelcome side effect of bringing NATO and the EU to Russia's doorstep, as well as the added humiliation of charitable foundations arriving from the United States to teach Russian citizens how to be good democrats. But now the trend is reversing itself.


The Resurgence of Russian Ambitions

IN THE wake of the Clinton Administration, the United States struck out on a unilateralist path for a Pax Americana. Those from both the Left and Right advocated the extension of U.S. influence through the Caucasus into Central Asia, slicing away at Russia's traditional spheres of control and the territories of the former Soviet empire. The defeat of Serbia-hitherto viewed sympathetically by even the most liberal of Russians, despite its acts of genocide-and the indignity suffered through the UN's control over Kosovo only served to underscore Kremlin impotence.

The sudden deflation of Russian power, and the indifference with which Moscow was viewed, exacerbated post-imperial sensitivities and aroused a spirit of revenge amongst a key section of the elite that came to be epitomized in Vladimir Putin. No longer would Russia be ignored or pushed around. Just as the puny young Putin had trained in judo to protect himself at school from the eternal bully, so too would vulnerable Russia, shorn of its overwhelming military might-except for nuclear weapons-now arm itself with techniques designed to set the adversary off balance and, if necessary, deliver grievous blows at vulnerable pressure points.

In the absence of much else, Russia could use its superabundance of raw materials, notably hydrocarbons, as a crucial form of leverage in world politics. According to Vladimir Milov, briefly deputy energy minister of Russia, officials under Putin did not immediately react to the rise in oil and gas prices. They took baby steps at first, believing the price rise was unsustainable. Yet confidence slowly grew, making a switch in policy feasible.

The government wanted to acquire maximum control over Russian energy resources. This move coincided with an end to the privatization of the economy and the reemergence of the state. "Gazprom is the key element of the state's energy security system", Putin announced on February 14, 2003. And, he continued, "not less important, powerful leverage of Russia's economic and political influence in the world." Russia has been flexing its energy muscles ever since.


Power in the Pipelines

RUSSIA'S POWER derives not only from its huge gas reserves, but also the means by which those reserves are delivered. Current gas pipeline routes, which run through the Baltic Sea, Poland and Ukraine, have helped perpetuate Russian dominance over European energy markets. But the Kremlin, having lost suzerainty over the Polish and Ukrainian administrations that it held throughout the Cold War, has since sought to use the supply of gas as an instrument of renewed control. It has now moved to create alternative pipelines that would allow it to cut the supply to such countries without simultaneously cutting supply to Western Europe. Russia's leaders thus fully understand the importance of maintaining favorable pipeline routes-and have not hesitated to eviscerate or support a construction project for their country's benefit.

Most importantly, Russia has vociferously protested the development of the trans-Caspian pipeline-which would allow for Central Asian gas deliveries to Central Europe-because it would bypass Russia as a supplier, destroying its monopoly.

To support their cause, Russian officials intone environmental and legal arguments, which are ignored when they favor pipeline construction. According to 1920 and 1941 treaties with Iran, the former Soviet Union owns half of the Caspian. Therefore, Russia can veto the right of any other littoral state from the former Soviet Union (effectively Azerbaijan, Kazakhstan or Turkmenistan) to place a pipeline beneath the surface. Whatever the domestic rationale, however, the net result is the rapid foreshortening of energy options open to the European Union and a consequent rise in the level of political risk.

Meanwhile, Russia has thrown its weight behind two construction agreements-the Nord Stream and South Stream proposals-that promise to marginalize its Central European rivals.

The Nord Stream gas pipeline agreement, forged between then-German Chancellor Gerhard Schröder and President Putin in September 2005, would have a capacity of some 27.5 billion cubic meters and would run 750 miles along the seabed of the Baltic from what was formerly Finnish Vyborg in Russia to Greifswald in Germany. This pipeline would allow Russia to ship gas directly to Germany and Western Europe, circumventing existing land pipelines running through troublesome neighboring countries like Poland.

Russia has also moved to circumvent both Ukraine and Turkey as supply routes. On June 23, Italy's Eni and Gazprom signed a memorandum of understanding for the construction of South Stream, a pipeline from Beregovaya on the Black Sea coast along the seabed to Bulgaria and then to Italy. At a time of high demand or tight supply, the establishment of yet more pipelines potentially will also enable the Russians to switch direction for export to favor one customer at the expense of another. Understanding that it's an expensive option, Novosti economic commentator Oleg Mityayev argues, "Geopolitical rather than economic factors are the chief motivation" for the project. Putin confirmed this when he announced that

both the Balkans and the Black Sea region have always held a special interest for us. And we have always had special political and economic relations with these countries . . . the fact that Russia . . . is returning to these regions and starting to play a more prominent role is completely natural.


Energy as Leverage

WHAT PUTIN has long understood-but what those expanding NATO to Russia's frontiers failed to appreciate-was that the main currency of power in most of post-Cold War Europe had changed. Control of natural resources was now a more useful form of power than military might. Reliance on Russian suppliers leaves states open to sanctions.

Though Yeltsin first experimented with this policy by cutting off energy to the Baltic states in the early 1990s and used it against Lithuania at the end of the decade, it is Putin who has taken the potential power to a new level. By July 2006 Putin's ambitions were out in the open. "Hereafter", he said, "Russia must strive to take over world leadership in energy matters." Gazprom CEO Alexei Miller warned that European attempts to block Gazprom's plans for buying up distribution outlets "would not bring good results."

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