TCS Daily

"The Lights Are Going Out All Over Europe"

By Peter Nolan - January 11, 2006 12:00 AM

Does Russia's confrontation with its European neighbors over gas exports signal a new cold war? During the early nineteen-eighties, the Reagan administration lobbied strongly against its NATO allies in Europe becoming dependent on gas supplied by the Soviet Union from its vast Siberian fields. This, Washington feared, would have allowed the Kremlin to hold Western Europe to ransom by threatening its energy supplies. With the end of the Cold War and oil and gas cheap and plentiful, these fears largely faded and Europe's dependence on Russian gas has grown unchecked.

According to the International Energy Agency, the developed economies' forum for coordinating policy on energy imports, Russia is the source of a third of gas imports for its members in Europe. Apart from monopolising supplies to Finland and the three Baltic states, Russia supplies about three quarters of gas used by Austria, Poland, Hungary and the Czech Republic. France (21%), Italy (31%) and Germany (43%) are also vulnerable -- not to mention Britain whose own gas reserves are running out, making it a net gas importer for the first time in decades.

With the collapse of Soviet military power, control of oil and gas has become one of Moscow's few remaining claims to being anything other than Nigeria with permafrost. In Central Asia, new pipelines from the Caspian Sea fields to Turkey's Mediterranean coast have finally broken the Russian monopoly on energy exports, loosening the economic and ultimately political dependence on Moscow and underwriting the process of democratic evolution in the region.

Russia's other neighbours, without their own energy reserves, have been less successful in wriggling from its grasp. The Baltic states have periodically faced shut-downs of oil and gas pipelines during political disputes with Russia. Last year, even weak and compliant Belarus found itself in a dispute with Russia over gas prices and the sale of stake in its pipeline company. The Russian state company Gazprom shut down the pipelines and millions were left to face the sub-zero winter without heating. A rapid capitulation by the Belorussians followed. Ukraine's democratic and market reforms, as well as its reaching out to the European Union have further angered the Russians. After dioxin poisoning (reminiscent of the court intrigue of the decadent Roman emperors at their worst) failed to kill or incapacitate Viktor Yushchenko, the Kremlin has instead turned to what has become known as "gas diplomacy".

The prospect of greater interdependency for energy needs increases the risk of disruptions that are not easily manageable at the national level, so that energy security policies to prevent such crises are increasingly being spoken of at international level - e.g. at the IEA, the European Union and the G8.

The European Commission's January 2004 research report on energy security presents two possible futures. Under an optimistic scenario, we might see efforts to allow markets to operate for the mutual profit of producers and consumers, with open access and stable frameworks for the investment to find new reserves and develop production and global trade, free from security challenges. Multilateral bodies such as the IEA and WTO might provide a forum and a framework for managing the global energy industry. The report dismissed the environmentalist alarmists who claim that oil production will soon peak.

However, Russia's path highlights another alarming prospect, namely that markets are overridden by interference from governments hostile to democratic values and economic freedom. Economic and political instability would result as find energy costs and availability uncertain and producers their revenues curbed.

Although we might be accustomed to thinking of the major integrated energy companies such as BP, ExxonMobil and Royal Dutch/Shell as embodying the oil business, in reality governments control most of the world's oil and gas reserves. National oil companies, such as Saudi Arabia's Aramco, have legal monopolies, often backed by constitutional provisions, on producing some 75% by volume of the world's known or probable oil fields. Gazprom, although publicly-quoted, is majority owned by the Russian state and packed with President Putin's placemen; it alone controls a quarter of the world's known natural gas reserves.

Hamstrung by corruption, used as piggy banks by short-sighted governments, and lacking the spur of competition, the performance of these state industries has rarely proven as impressive as that of the private sector. According to a recent OECD report, the production increases by Russia's private-sector oil companies accounted for between one-fifth and one-quarter of growth in national income in 2000 to 2003. Like the slothful aristocrat Oblomov in Ivan Goncharov's classic novel, the state-controlled oil companies seems to have had problems motivating themselves: "It is unlikely that Russia's private oil companies could have achieved the growth of the last few years if they had remained under state control," the OECD wrote. With the Kremlin consolidating control of oil and gas under the umbrella of Gazprom, arbitrarily confiscating the assets of Russian businesspeople and excluding foreign companies, the prospect for Europe having Russia as a reliable energy supplier looks bleak.

"Russia has looked at Saudi Arabia and decided that it likes the model. Nobody criticises the Saudis - they are too important as a supplier," the Financial Times quoted one Moscow banker as saying during the Belorussian crisis. Conspiracy theories denouncing Operation Iraqi Freedom as a grab for Iraq's energy (even though foreigners remain barred from owning fields by the new constitution) are widely held among the EU's politicians and public. Meanwhile the silence has been deafening as Putin has systematically dismantled Russia's nascent democracy and killed a quarter of a million Chechens (out of a population barely over a million) in the indiscriminate military bludgeoning of the oil-rich region.

Again, the prospect of greater interdependency for energy needs increases the risk of disruptions that are not easily manageable at the national level, so that energy security policies to prevent such crises are increasingly being spoken of at international level. Indeed, rather than being tamed by responsibility, Russia's gas dispute with Ukraine came just as Russia was about to begin a stint as chair of the G8, which it promised to use in advancing initiatives for energy security. Another multilateral effort, the Energy Charter Treaty was conceived in the early 1990s as a way of facilitating flows of energy principally -- but not exclusively -- from Russia to Europe and preventing exactly such incidents. Later, the Transit Protocol to the treaty was drafted to give a legal framework, with independent dispute resolution. Russia still has not, despite determined prodding from without, committed itself to ratify either the Treaty or the Protocol.

Free markets can be fostered to provide the needed investment in Russian and other producing countries. Reform of European gas and power monopolies, now being pushed by the European Commission over French and German opposition, can bring the drastic price cuts and supply growth that Britain has already experienced after liberalisation. Removing unnecessary hindrances to new energy infrastructure can allow Europe to build storage facilities for emergency stockpiles and import more gas from outside Russia by ship-borne Liquid Natural Gas (LNG). Reversing the shut-down of economic nuclear power stations demanded by Green parties throughout Europe can lessen dependency on gas imports. Windfall taxes that penalise much-needed investment in the EU's domestic oil and gas production should be eased. Otherwise, Europe may find its economic wellbeing and its foreign policy independence held hostage by the ruthless Machiavellians in the Kremlin.

Peter Nolan is a London-based investment analyst and spokesman for the Freedom Institute Ireland.


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