Containing Russia

Yuliya Tymoshenko

From Foreign Affairs, May/June 2007

Summary:  Russia's imperial ambitions did not end with the fall of the Soviet Union. The Kremlin has returned to expansionism, trying to recapture great-power status at the expense of its neighbors, warns one of Ukraine's most prominent politicians. The United States and Europe must counter with a strong response -- one that keeps Russia in check without sparking a new Cold War.

Yuliya Tymoshenko is the leader of Ukraine's parliamentary opposition. From January to September 2005, she was Prime Minister of Ukraine.

PIPELINE POLITICS

One key question is just how reliable the Russian energy supply really is. Despite having the world's largest gas reserves, Russia now faces a domestic shortage of gas. Gazprom, the country's dominant gas supplier (which, when it comes to foreign policy, doubles as an arm of the Kremlin), is not producing enough for an economy growing at more than six percent a year. Production from Gazprom's three biggest gas fields, which account for three-quarters of its output, is in steep decline. The one large field that the company has brought on-stream since the end of the Soviet era is reaching its peak. Overall gas production is virtually flat.

According to the Institute of Energy Policy, in Moscow, Gazprom's capital investments in new gas production in the years 2000-2006 were one-quarter the size of its investments in other activities: media companies, banks, even chicken farms, as well as its downstream investments in western Europe's energy networks. Despite the enormous revenues to be gained from the new production of gas, Gazprom rarely attempts to find or produce more. As a result, it is unable to come up with enough gas to meet internal demand and its export obligations.

After more than ten years of delay, Gazprom has decided to develop a big field on the Yamal Peninsula -- a barren and barely accessible region in the Arctic. But the earliest that gas from Yamal will reach the market is 2011. Meanwhile, demand for gas -- from RAO Unified Energy System of Russia (UESR), Russia's electricity monopoly, as well as from expanding industrial companies and households -- is growing by about 2.2 percent annually, according to a recent report by the investment bank UBS. "The risk of supply crisis is real," the report noted, if growth in demand accelerates to 2.5 percent.

The impending shortage means that Gazprom will not be able to increase gas supplies to Europe, at least in the short term -- something that European countries should be aware of and concerned about. This may explain why Gazprom abandoned its plan to send gas from the Shtokman field, in the Barents Sea, to the U.S. market as liquefied natural gas and diverted it to Europe instead. The decision, initially interpreted as a move intended to irk Washington, may actually have been a sign of desperation: sending Shtokman gas to Europe would free up Siberian output for domestic consumption.

The problem, of course, is not a lack of gas -- Russia has 16 percent of the world's total known reserves -- but Gazprom's investment strategy. Over the past few years, the company has spent vigorously on everything but developing its reserves. It has built a pipeline to Turkey, taken over an oil company, invested in UESR, tried to gain footholds in European distribution markets, and become Russia's biggest media company. All this was done in the name of creating and sustaining a "national energy champion." Yet investment in Gazprom's core business was grossly inadequate.

There is another problem facing Gazprom: the actual engineering costs of developing new gas fields in Russia. In the Shtokman gas field and on the Yamal Peninsula, in particular, the engineering costs, including the cost of transporting the output to Europe, are twice as high as for new gas fields in North Africa and the Middle East. The international gas market is already beginning to recognize this, and, over the long term, it could be enormously dangerous for Russia. Indeed, Russia may actually be putting itself out of the gas business, because high engineering costs for new projects in Russia are signaling to the market that Russia and Gazprom lack the capacity to develop these fields. Western companies could come in and do the job, but given the Kremlin's recent usurpation of Shell's investments on Sakhalin Island, these companies would be remiss in their fiduciary duties if they undertook such investments.

The only way to avoid a crisis is to break Gazprom's monopoly on pipeline infrastructure and to license independent gas producers. Independent producers already account for 20 percent of domestic gas sales in Russia and are boosting their output. Further gains would require market-based incentives. Europe can help by explicitly linking its acceptance of Russia's WTO membership to Russia's ratification of the Energy Charter and its attendant Transit Protocol, which would guarantee access to Russian pipelines for Gazprom's competitors.

Any worthwhile energy security policy for Europe would also seek to loosen Gazprom's monopolistic grip on the pipelines. European competition policy, which has successfully brought companies as big as Microsoft into line, could -- if used skillfully -- also help turn Gazprom into a normal competitor. Establishing an independent regulator, as Russian Economy Minister German Gref has suggested, would also be an important step toward splitting Gazprom into a pipeline operator and a production company. But Putin has vehemently rejected such a move. Thus, he now faces a choice between domestic gas shortages that threaten to slow economic growth and losing the Kremlin's "national energy champion."