Staking a Claim: Having Won a Battle in the Gas Wars, Russia is Still Fighting

Following the disputes over energy with Ukraine in 2005-6 and the interruption to supplies to Georgia after bombs took down two electricity pylons on Jan. 21, 2006 and the gas pipeline the next day, the “oil and gas” wars with Belarus in 2006-7 have once again led to all around uncertainty and further damaged Russia’s reputation as a reliable and key energy supplier to Europe.

But caught up in all the brouhaha in Europe and the West about Moscow’s alleged unreliability as an energy supplier and its use of energy as a political weapon, the economic implications of the oil and gas wars have received less attention than they warranted both in Russia and abroad.

At his annual press conference with Russian and international journalists on Feb. 1, President Vladimir Putin pointed out yet again that Russia’s energy subsidies amounted to between $3-5 billion per year, without mentioning any one country. In late 2005 and early 2006, however, he quoted similar figures just for Russia’s subsidies to Ukraine in televised remarks before the Russian cabinet.

In fact, this state of affairs had been going on since the collapse of the Soviet Union, so Russia’s losses run into tens, if not hundreds, of billions of dollars – sums which, as Putin has often pointed out, the country could better spend on its own domestic needs.

Moreover, the Russian media had been reporting for years that Ukraine and Belarus had not only been selling on their cheap energy supplies from Russia to Europe at higher market prices without paying a kopeck to Russia, but also siphoning off Russian oil and gas destined for Europe for their own domestic needs.

And although the outside world professed shock and horror at the gas wars, the West had long criticized Russia’s energy subsidies as an attempt to retain or reassert political control over its former empire. International financial institutions had been calling not only for the break-up of Gazprom, but also an end to energy subsidies – a move which the WTO had also been demanding from both Russia and Belarus.

Belarus has relied heavily on receipts from refining and re-exporting Russian oil, importing about 21 million metric tons of Russian crude every year, while its own domestic needs are only 7-7.5 million, so it is therefore able to refine the rest and sell the products to the European Union. But since the refining capacity of Belarusian companies is only some 18 million metric tons a year, Belarus sells nearly 3 million metric tons of unrefined crude to Lithuania and Poland at dumping prices, which brings in average annual revenues of at least $550 million.

Minsk used to sell around 11 million metric tons of petrochemicals refined from the duty free Russian crude, exports which totaled around $15 billion per year and accounted for 50 percent of the country’s annual export revenues.

It was against this background that on Jan. 1, Moscow doubled the gas price for Belarus to $100 per 1,000 cubic meters and also imposed an oil export duty of $180.7 per metric ton.

Minsk retaliated on Jan. 3 by introducing a transit fee of $45 per metric ton for crude passing through its territory to Central Europe, at which point Moscow turned off oil supplies through the Druzhba pipeline, one of the world’s largest, which passes through European Russia to Belarus, where it divides into two branches. The northern branch supplies Poland and Germany, while the southern route passes through Ukraine to Hungary, the Czech Republic, and Slovakia. Russia currently exports some 20 percent of its oil via the Druzhba pipeline, and the loss of that route could leave Russia with an oil surplus.

As with the dispute between Russia and Ukraine in 2006, Moscow and Minsk reached a compromise relatively quickly despite all the brinkmanship and sabre-rattling, with Russia agreeing to cut the export duty from $180.7 to $53 per metric ton retroactive to Jan. 1, 2007.

For Ukraine and Belarus, the price increases are particularly problematic. Belarusian GDP amounts to just $35 billion, and the economies of both countries are not only small and inefficient, which makes it hard to pay higher prices, but also heavily reliant on steel and heavy industry, which are very energy intensive. With Russia ending not only cheap gas, but also duty-free oil supplies to Minsk, the Belarusian economy will be forced to undergo some major adjustments.

However, Rene van der Linden, the president of the Parliamentary Assembly of the Council of Europe (PACE), said during a visit to Moscow in January that he hoped the recent oil and gas dispute between Russia and Belarus would encourage Minsk to expedite its transition to a market economy and that PACE could play an important role in promoting market reforms in Belarus because his organization has a more flexible mandate than other international bodies, including the European Union.

The new contract between Russia and Belarus more than doubles the price of gas for Belarus in 2007, from $46 last year to $100 per 1,000 cubic metres of gas this year, and provides for a steady increase in gas prices over the next five years to bring them into line with European prices by 2011.

The price increase and exemption from export duties gives Belarus more favorable terms than those offered to other former Soviet republics. Gazprom had originally wanted Belarus to pay $105 for the gas, of which $30 would be in shares of Beltrangaz, the Belarusian pipeline company and operator. By comparison, Georgia will pay $235 per 1,000 cubic meters of gas in 2007.

Therefore, another crucial part of the deal is that Gazprom agreed to pay $2.5 billion in cash for a 50 percent stake in Beltrangaz. Gazprom has thus gained partial control and ownership over Minsk’s distribution system, which is part of a broader strategy for the gas giant to gain control of infrastructure in the form of gas transportation, storage and distribution assets to deliver gas to Europeans over the famous – and much more profitable – “last mile” through its own wholly or partially-owned pipelines and companies.

However, the traffic is not one way, since Gazprom is in fact implementing a strategic assets swap. Foreigners have secured long-term gas supplies and stakes in Russian gas fields, while Gazprom will get access to European gas distribution networks. However, Europeans and international investors want greater access to Russia’s vast natural resources, including majority control, which Moscow is still reluctant to concede.

With Europe keen to reduce its dependence on oil and move to the more environmentally-friendly natural gas, and Russia sitting on one-third of the world’s gas reserves, it would seem that both have a strong common interest. But Europe is already dependent on Russia for much of its oil and gas, and by 2030 is expected to import 84 percent of its natural gas and 93 percent of its oil. The risk of greater dependence on Russia, or on Algeria or Middle Eastern suppliers such as Qatar, is already causing considerable unease, and has prompted German Chancellor Angela Merkel to reconsider her agreement with the Social Democrats in the governing coalition to scrap nuclear power stations. In the United Kingdom, concern was also voiced by the British government that a company such as Gazprom, with its close ties to the Russian government, could gain control of British gas company Centrica, since this move would defeat the very objective of privatizing the British energy sector.

Energy imports cost Europe huge amounts. Germany alone pays around 7 million euros ($9.1 million) per day for the 90 million cubic metres of gas it imports from Russia, with some 17 million German households, nearly half the total, using gas. Germany now gets over 40 percent of its gas from Russia, Austria around 65 percent, Italy 29 percent, France 20 percent and Switzerland 10 percent. But further east, the figures are much higher, with the three Baltic republics, as well as Slovakia, almost wholly dependent on Russia, while Hungary and the Czech Republic obtain some 80 percent of their gas from Russia.

Looking Downstream

But despite this, Gazprom has signed agreements with many European countries in recent years to supply gas and become involved in their domestic energy industries, agreeing with Gaz de France, for instance, to extend contracts for Russian gas supplies until 2030 and sell up to 1.5 billion cubic meters of gas to French consumers as of 2008. The agreement with Gaz de France actually means that Gazprom has made an advance payment to the French state-owned concern in the hope that it will buy some of its assets. During the forthcoming merger of GdF and Suez, the two companies will have to cede control of some of their assets in Belgium and France. A decision has been made to sell stakes in Belgian Distrigaz, including its French assets, and in power engineering company SPE, a joint venture of GdF and British Centrica, as well as Cofathec Coriance, GdF’s thermal network in France.

Italy’s Eni and Austria’s OMV also agreed to make similar concessions as part of agreements to extend their long-term contracts. Eni will enable Gazprom to sell 2 billion cubic meters of gas on the Italian market and increase the figure to 3 billion cubic meters in 2010, while OMV granted the Russian energy giant the right to sell 1.7 billion cubic meters in Austria through GWH and Centrex, two companies affiliated with Gazprom Export and Gazprombank.

Although Germany’s E.ON-Ruhrgas refused to give the Russian gas company access to its sector of the German market, Gazprom has agreed to swap assets with German energy companies. As a result, Gazprom will exchange stakes in the Yuzhno-Russkoye deposit for access to European gas distribution networks. Agreement has also been reached to jointly build the Nord Stream pipeline under the Baltic Sea, a huge infrastructure supported by former German Chancellor Gerhard Schroeder, and which many see as being geopolitical rather than economic. The plan has angered Poland in particular since Warsaw will be unable to earn transit fees, but if realized it will make Russia’s gas exports less susceptible to disruption by third countries.

Ian Pryde is the CEO of Moscow-based Eurasia Strategy and Communications.

Special to Russia Profile, an online and monthly print magazine dedicated to Russia and published jointly by RIA-Novosti and Independent Media, Moscow.

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