August 2009 Vol. 236 No. 8

Features

Pipeline Politics: Russias Natural Gas Diplomacy

(Editor’s note: This article was written before the worldwide economic decline that has affected Russia and the rest of the world.)

Natural resources are the lifeblood of the Russian economy and Siberia’s riches excite envy and awe from onlooking countries. Revenues from exports of oil and gas made possible one of the greatest economic comeback stories in recent memory. From the wreckage of the fall of communism and the subsequent currency collapse of 1998, an economic and political powerhouse has emerged. Russia is emboldened by renewed wealth and has no qualms about using its considerable clout in the energy industry to twist the arms of its neighbors. Some 157,000 km of natural gas pipelines serving more than 30 export markets are both an engine of economic growth and a powerful political sword.

In the privatization frenzy of post-Soviet reconstruction, many of Russia’s energy resources were sold off to individuals and corporations, often at cut-rate prices. However, under President Putin, energy assets were systematically and strategically brought back under state control. Deeply embedded in the Russian psyche is a belief that politics is a zero-sum game, and advancing “national interests” is the chief driver behind political decisions. Casualties are not only tolerated, they are expected. In the energy business, this mentality effectively gives Gazprom, the majority state-owned natural gas producer and distributer, liberty to take politically significant actions under the mantle of a legitimate business activity.

The Kremlin and Gazprom have intertwining purposes and interests. The company produces more than 90% of Russia’s natural gas and provides the state with roughly one quarter of its total tax revenue, in addition to owning and operating the massive pipeline infrastructure. Russian President Dmitry Medvedev is former chairman of Gazprom. This cozy relationship allows the Kremlin to influence international commodity markets for political gain.

Natural gas is less of a fungible good than oil and this distinction is reflected in the inconsistent prices for the resource. Pipelines are the only effective means of transporting natural gas at today’s prices and with today’s technology. The price of a unit of Russian gas varies by the terms of contracts set between Russia and its individual customers. Pipelines, by their fixed nature and high capital cost, force a long-term relationship between buyer and seller.

Unlike the situation for oil suppliers, a gas producer cannot quickly divert his or her product to another willing buyer should the initial customer be unable, or unwilling, to pay. Buyers do not have much flexibility either. In the short term, they have little choice but to purchase gas from the supplier at the other end of the pipeline. The relative rigidity of the natural gas industry inextricably links European gas consumers to Russia’s foreign policy objectives. These goals – broadly increased wealth, influence and security – are realized through the web of Gazprom’s pipelines crisscrossing the continent.

The term “energy security” from a Russian perspective has the opposite meaning from the use of the term in energy-importing countries. Russia’s dependence on the petroleum industry means that to achieve energy security, Russia requires assured long-term demand for its oil and gas products. Energy importers think of energy security in terms of reliability of supply. In order to ensure its own security, Russia has adopted a strategy of building bypass pipelines to avoid transit countries en route to more lucrative markets for its gas. Hardly a new trend, the stakes of this strategy have increased by several orders of magnitude as pipeline designs become daring feats of engineering and political brinkmanship reaches a boiling point.

Of Friends And Foes
The 4,000-km Yamal-Europe pipeline links the gas fields of the Yamal Peninsula in northern Russia with Western Europe via Belarus and Poland. The Yamal-Europe line was ostensibly built to provide Germany, Russia’s largest gas customer, with greater supply capacity, but German demand was far from the only motivation to build the Yamal-Europe line along its specific route. Tension in the political theater in former Soviet bloc states was at least as influential in this choice as market forces.

Ukraine has been the traditional transit country through which Russian energy supplies reach Western Europe, but Russia and Ukraine have long had a tumultuous relationship and Russia’s energy security is less certain when the supply route to its most profitable market is at risk of being disrupted by political skirmishes. Russia is fearful of being branded an unreliable supplier of energy by customers in Germany, France and other countries in Western Europe.

Ukraine retains ownership and operating rights over gas pipelines domestically, therefore limiting Russia’s ability to sell gas to Western Europe unilaterally. Ukraine has significant leverage over Russia in its ability to reduce gas flow to Western Europe. It is most inclined to use its disruptive power when Russia attempts to impose rapid and steep price increases on the gas sold to Ukrainian customers, as was the case when gas transit to Europe was limited in 2006 and 2008, angering both Russia and end customers in Germany and elsewhere.

Although 80% of Russian gas exports to Europe still travel through Ukraine, Russia is increasingly intolerant of Ukraine’s behavior and completely preoccupied with maintaining its image of dependability in Europe. The Yamal-Europe pipeline was intended to alleviate this problem. However, even Belarus, a traditional ally of Russia, has proven to be a difficult trading partner. Belarus racked up $500 million in gas debt to Russia by the summer of 2007.

Transit countries are also customers of Gazprom, albeit far less profitable ones. The combination of lower gas tariffs Gazprom charges former Eastern bloc states and the hostile politics between them and Russia have inspired the construction of many transit routes that avoid them altogether. These projects are undertaken even when the economics are illogical and the technical challenges daunting.

Watery Solutions
The most audacious pipeline proposal officially announced by Gazprom is the Nord Stream project. Scheduled to come online in 2011, this pipeline will run for more than 1,200 km along the floor of the Baltic Sea from Vyborg, Russia, to Greifswald, Germany. The underwater component will be connected to more than 900 km of pipeline in Russia from the gas source to Vyborg and another 850 km of pipeline to reach customers south and west of Greifswald. The dual pipeline construction is expected to carry a combined 55 billion cubic meters at capacity.

At an estimated cost of 5-8 billion euros, this pipeline is tremendously expensive and incites much criticism in its own right as viable alternatives (such as the proposed Yamal-Europe II pipeline) would have been far cheaper to construct and operate. But the controversy shrouding Nord Stream is much broader. Security experts are concerned about Gazprom’s use of the Russian military in mapping the route along the sea floor and the potential surveillance uses of the maintenance platforms included in the plans. Environmentalists object to the disruption of the Baltic Sea ecosystem and the risks associated with leaks and other possible malfunctions. However, the most curious part of the debate surrounding Nord Stream is Europe’s unbridled enthusiasm for the project.

Illogical Exuberance
Europe heralds Nord Stream as a means of diversifying energy supplies. However, this reasoning is weak. Nord Stream does nothing to diversify the source of supply, merely the supply route. For Russia, Nord Stream achieves diversification beautifully. It means Russia will have multiple means of reaching its preferred customer. The intransigence of transit countries becomes far less problematic under these circumstances. Germany, on the other hand, must recognize that it could well be treated as a bypass state in the foreseeable future.

According to Vladimir Milov, former Deputy Energy Minister of Russia, the Kremlin is “obsessed” with the British gas market. A pioneer in the gas industry, British production at fields in the North Sea is declining while demand is rising. It is entirely fathomable that Russia’s real ambition in building Nord Stream is to gain better access to the United Kingdom. Russia’s strategy becomes increasingly realistic as the technology and infrastructure for both underwater pipelines and liquefied natural gas improves.

In years to come, Germany may find itself little more than a distribution hub for LNG shipments around the globe. The Nord Stream terminal at Greifswald could become simply a node on an extended underwater pipeline that reaches as far as the English shore.

Surprisingly few alarm bells have been sounded over Russia’s tactics. The repeated strategy of building bypass pipelines demonstrates that Russia is not in any way committed to improving relations with its neighbors and the resulting tensions heighten the probability of supply shortages, price instability and deeper conflict. As a member of the 21st century global community, Russia is not contributing to international security; it is undermining it.

Continental Reach
Russia’s aggressive dominance of Western Europe’s energy markets gives pause for thought on the transference of Russian national interests onto emerging economies. As a vestige of the Soviet era, Russia considers vast swaths of territory now divided into independent states as part of its “sphere of influence.” Central Asian countries are rich with gas and anxious to supply established markets in Western Europe as well as emerging markets in Eastern Europe and East Asia. Russia has proven its determination to maintain an iron grip on the European market with the construction of Blue Stream – another underwater pipeline.

For 396 km, the Blue Stream pipeline runs under the Black Sea, an extreme hydrosulfuric environment, to service Turkey’s more than 71 million people with Russian gas without passing through the existing gas corridor of Ukraine, Moldova, Romania and Bulgaria. Russia is publicly unapologetic about its intent to avoid transit countries with Blue Stream; however, it is less forthright about plans for the future to maximize the utility of Turkey’s strategic location on the Mediterranean Sea. Just like Nord Stream, Blue Stream gives Russia leverage over transit countries like Ukraine as well as the potential for a future terminal for LNG shipments to anywhere in the world.

Blue Stream is effective not only at opening up new markets for Russian gas, but also at obstructing other pipeline projects that could bring greater diversity of supply to Europe. Countries surrounding the Caspian Sea have abundant gas reserves. In the 1990s, European gas companies were planning a pipeline that would have serviced the continent with gas from Turkmenistan, via Turkey. Russia worked around the clock to complete Blue Stream and the European plan was rendered unnecessary and redundant from Turkey’s point of view.

Whither Nabucco?
Europe is considering a pipeline project that could very likely meet the same fate as the Turkmen-Turkey project. The meticulously planned Nabucco pipeline would carry gas 3,300 km from the Caspian region to Austria, via Turkey, Bulgaria, Romania and Hungary. Meanwhile, Russia is busy planning the proposed South Stream pipeline. This pipeline is slated to be a joint venture between Gazprom and the Italian gas giant ENI, as is the case with Blue Stream.

With South Stream, Russian gas would reach Europe through Bulgaria. South Stream is effectively a bypass pipeline of Turkey, which has also been a more prickly trading partner than Russia had anticipated. (Turkey wants to renegotiate contracts with Russia, holding that it does not want the full 14.6 Bcm annually that was agreed upon in the initial contract.)

Russia can be expected to move quickly on South Stream. Near exclusive access to the European market is Gazprom’s obvious objective and thwarting progress on alternatives is a key component of its strategy. Recent cooperation from Hungarian stakeholders is bringing South Stream much closer to reality, whereas Nabucco has scant financial support to date. European gas consumers remain beholden to Gazprom’s will and by extension, the Kremlin’s interests.

Russia’s systematic and resolute effort to diversify its customer base is impressive; Europe’s inability to diversify its supply source is dangerous. The lack of cohesion in the European Union’s energy policy is deeply problematic for the long-term energy security of a region with too little of its own resources. Yet Russia also faces long-range challenges in its refusal to resolve the underlying political contentions with its neighbors. Every country bypassed is replaced with a new country with which Russia must cooperate, but experience shows that pipelines make for fickle friends.

Author
Lindsay Wright is a Toronto-based professional in the energy and environment industry. She focuses on international energy policy and the commercialization of alternative energy technologies. She works at the Ontario Centres of Excellence, a not-for-profit organization. This article was adapted from her graduate research at New York University’s Center for Global Affairs.