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Russia's Energy Disputes

Author: Lionel Beehner
Updated: February 3, 2010
This publication is now archived.

Introduction

Russia’s use of energy as a tool for foreign policy and its efforts to reimpose Kremlin control of its energy sector has set off alarm bells in foreign capitals. Moscow’s latest infraction: the takeover by the state-owned gas monopoly Gazprom of the $22-billion Sakhalin II project. Russia also has drawn criticism for its heavy-handed efforts to hike up gas prices and cut subsidies to neighboring states like Belarus, Ukraine, and Georgia. With global energy prices on the rise, Russia’s government has sought to reimpose state control of its energy sector and leverage itself as the European continent’s principal supplier of natural gas.

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What is Russia’s role in global energy markets?

It sits atop a fifth of the world’s known reserves of natural gas. Russia supplies Western Europe with a quarter of its gas needs, but delivers the bulk of it through pipelines that crisscross Ukraine and Belarus, both which have had protracted energy disputes with Moscow. Russia has its sights set on energy markets further east, with pipeline projects with China and Japan in the works. “[Russia] has regained the prominence (PDF) in global energy markets it enjoyed in the 1970s and 1980s when the Soviet Union, not Saudi Arabia, was the world’s preeminent oil producer,” writes Fiona Hill, a senior fellow at the Brookings Institution, in Energy Empire: Oil, Gas, and Russia’s Revival.

What are some obstacles to developing Russia’s energy industry?

Some 80 percent of Russia’s energy resources lay beneath the remote and harsh wilderness of Western Siberia and are concentrated in a few large gas fields. The trouble, experts say, is getting the product to market. Given Russia’s climate and the scarcity of deep-sea water ports, energy capacity has not caught up to production. Russia produces roughly seven million barrels of oil per day (bpd), but can only ship around four million bpd via major pipelines. The rest must be transported by rail or river. Russia’s energy sector thus requires expensive extraction and transport systems. “Gazprom has considerable investment needs at the moment to develop the next generation of gas fields as well as infrastructure and pipeline upgrades,” says Katherine Hardin, research director of the Russian and Caspian energy division of Cambridge Energy Research Associates (CERA).

How has Russia benefited from higher energy prices?

They have strengthened Russia’s economy and its geopolitical position abroad. The oil boom has raised Russians’ living standards and prompted a building bonanza in Moscow. Instead of a deficit, Russia now runs a surplus, repays its foreign debts ahead of schedule, and boasts the world’s third-largest currency reserves, not to mention a $50 billion stabilization fund (sometimes referred to as a “rainy day fund”). Outwardly, Russia has exuded more self-confidence, experts say. "I would describe the mindset right now among the Russian political elite as infused with 'petroconfidence',” says Cliff Kupchan of the Eurasia Group, in an interview with the BBC. According to a CFR Task Force on Russia, the Kremlin “has used energy exports as a foreign policy weapon: intervening in Ukraine’s politics, putting pressure on its foreign policy choices, and curtailing supplies to the rest of Europe.” Case in point, say experts, is the Kremlin’s recent interference in the Sakhalin II project.

What is the status of the Sakhalin II project?

In December 2006, Moscow took control of a majority stake in the project, Russia’s largest foreign investment venture, from its three principal investors: Royal Dutch Shell, Mitsui & Co., and Mitsubishi. The original terms of the deal, arranged a decade ago when gas prices were low and Russia's economy was weak, were highly favorable to the foreign investors, reflecting the perceived risks of doing business in early post-communist Russia. For instance, the production sharing agreement (PSA) exempted Shell from paying profit taxes until it recouped its original investment. But with President Vladimir Putin now at the helm, Moscow has sought to reassert control over Russia’s strategic natural resources and renegotiate deals with foreign investors made under his predecessor. Moscow, in this case, accused Shell of violating a number of environmental codes, threatened to revoke the consortium’s license, and downgraded the valuation of the project to account for the environmental damage caused.

What energy disputes exist between Russia and its neighbors?
  • Belarus. Gazprom succeeded in its bid to pressure Minsk to pay around $100 per 1,000 cubic meters of gas, nearly double the current price but significantly lower than Moscow’s original demand. Russia threatened to cut off its shipments of gas, much as it did with Ukraine last January, which sparked an international outcry. In turn, Belarus threatened to deny Gazprom access to its pipelines, through which flows 20 percent of Russia’s natural gas to Western Europe. In the new deal, Gazprom won a 50-percent stake of Belarus’ state-controlled pipeline network, Beltranshaz.
  • Ukraine. Kiev and Moscow settled on a five-year deal that raises the price of Ukraine’s gas to $95 per 1,000 cubic meters. Much of the gas delivered to Ukraine originates in Turkmenistan, and is thus cheaper, but must transit through Gazprom-controlled pipelines. Russia has accused Ukraine of siphoning off its Europe-bound gas in the past. In response, Ukrainian officials have sought closer energy ties with oil-rich Azerbaijan and struck a deal with Turkmenistan’s new leadership to wean Ukraine off Russian gas supplies.
  • Turkmenistan. Turkmenistan boasts among the world’s largest reserves of natural gas. Yet the recent death of its authoritarian leader Saparmurat Niyazov has raised concerns in Russia and in Europe that there might be gas flow disruptions.  But Hardin says in the short term this is unlikely because of the importance of gas to Turkmenistan’s economy. Also, Russia and Turkmenistan just signed a three-year deal to continue Turkmen gas deliveries through Russia. Yet a long-term concern of Moscow is that a new Turkmen regime may seek to diversify its energy routes away from Russia. Iran and the United States, for example, have sought to increase energy ties with Turkmenistan. China, too, given its growing demand for cheaper energy supplies, has sought to attract Turkmen gas, inking a deal with Ashgabat that would bring thirty billion cubic meters of gas per year beginning in 2009 and allow Beijing to develop Turkmenistan’s Iolotan gas fields.
  • Georgia. During its ongoing energy price dispute with Tbilisi, Gazprom threatened to cut off supplies before finally reaching a settlement in December 2006: a doubling of the price of gas to $235 per 1,000 cubic meters. The dispute was the latest in a series of squabbles between Moscow and Tbilisi, including the arrests of four Russians in October accused of being spies and an earlier Russian boycott of Georgian spirits. Gazprom’s price hike prompted Georgia to search for alternative energy supplies. Tbilisi recently agreed to buy enough Azeri gas from Turkey to help meet its energy needs for 2007.
Are these disputes driven more by politics or economics?

It’s unclear. Many observers say Russia’s attempts to raise gas prices in Ukraine were a political gesture, aimed at Kiev’s pro-Western government. But after Russia looked to raise the price of gas in Belarus, traditionally a Russian ally, some wondered whether its motivations were more economic. After all, the argument went, these post-Soviet states were getting their gas at a steep discount compared with the rest of Europe (which paid, on average, $240 per 1,000 cubic meters) and paying well below market-level prices. “The truth is that these price increases are not political,” wrote Nadejda M. Victor of Stanford University’s Program on Energy and Sustainable Development in the Washington Post. “Rather they reflect worrisome economic and geological facts about Russian gas fields.” She says Gazprom’s poor management and a decline in gas production and discoveries from Russia’s major gas fields are fueling these price hikes.

What is Russia’s energy relationship with Western Europe?

Although ground broke on the so-called Baltic Sea pipeline, which would bypass Poland and the Baltic States to bring Russian gas directly to Germany and onward to other Western European markets, Moscow put off ratifying the fifteen-year-old Energy Charter Treaty (ECT) with the European Union. The charter, which Russia signed on to more than a decade ago, would give foreign European investors greater access to Russia’s pipelines and oil and gas deposits. Many analysts predicted that Russia’s chairmanship of the G8 last year, in which it put energy security at the top of the agenda, would pave the way for better energy-security relations but their predictions proved untrue. The low point in the relationship came during Russia’s price spat with Ukraine last January when gas supplies to some European countries were temporarily disrupted, prompting some to seek out more reliable energy sources in the form of gas supplies from northern Africa and Norway as well as nuclear power. Still, as the Financial Times reports, Gazprom has sought to improve its access to European customers by signing long-term deals with a number of EU nations. Europe remains the gas behemoth’s largest customer, accounting for 65 percent of its overall revenues, and analysts expect that figure to grow. “It’s fair to say Gazprom will remain a significant supplier [of energy] to Europe,” CERA’s Hardin says.

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