TCS Daily


Coulda Had a G8

By Constantin Gurdgiev - July 14, 2006 12:00 AM

This week, anticipating a tough G8 summit in St. Petersburg, the EU leadership finally issued a long-overdue statement of intention to move to a free-trade deal with Russia following Russia's accession to the WTO. The statement, issued by the European Commission president, Jose-Manuel Barroso was widely expected given the recent changes in EU-Russia relations.

First, starting in November 2005, Russia began reasserting the need for further liberalization of its energy trade relations with the former Soviet Republics and Eastern Europe. Ukraine, Georgia, Armenia, Moldova, followed by Slovakia, Bulgaria and Belarus, all saw Gazprom, Transneft and ROA ES -three giants in the Russian energy export sector - opening new rounds of negotiation on the issue of abolishing post-USSR subsidies for energy deliveries. Despite the repeated assurances by President Vladimir Putin that Russia will remain a reliable source of energy exports to the EU, the fear of potential disruptions in transit lines passing through Ukraine to the West continues to drive Brussels' energy policy.

Second, since summer 2005, Russia and the EU have been negotiating a new partnership and cooperation agreement - the current one expires at the end of this year. Originally, the new agreement was supposed to focus primarily on trade liberalization, terrorism and migration, with added emphasis on post-Kyoto environmental agreements. However, with formation of the G6 group of Asian-Pacific states, Russia has been increasingly shifting its energy and environmental policies focus away from the EU in favor of closer cooperation with China, India, Japan and even the US. Adding insult to injury, in recent months, the EU stepped up pressure on Russia to commit more of its gas and oil transport infrastructure and natural reserves to foreign competition, while yielding nothing in terms of Russian long-term agenda to liberalize bilateral trade and travel regimes.

The latter has resulted in a significant cooling of relations between Russia and the EU, culminating in a chilly reception given to Barroso in Moscow by Putin earlier this year. The former has effectively shifted Russia out of the orbit of the states supportive of the Kyoto-style restrictions-based environmental policies and into the new trajectory more closely aligned with the US.

Looking for Alternatives to Kyoto.

Since the beginning of the Kyoto negotiations, the US has stressed the need for creative and innovative approaches to environmental policy. This position contrasted with that of the EU, which chose from the start to lend full support to the idea of prohibitive targets and tax-and-price measures in combating emissions.

In response to the EU-led Kyoto Protocol initiatives, at the 12th ASEAN Regional Forum in Laos on 28 July 2005, the US, Australia, China, India, Japan, and South Korea - accounting for approximately half of the world's greenhouse gas emissions (GHG) - created the Asia-Pacific Partnership (APP). The idea behind the partnership is that by focusing on clean development and energy security, the problems of climate change and pollution can be addressed with minimal disruption to global economic growth.

According to the APP vision statement, the partnership will "promote and create an enabling environment for the development, diffusion, deployment and transfer of existing and emerging cost-effective, cleaner technologies and practices..." These include, amongst others: promotion of clean coal, integrated gasification combined cycle (IGCC), liquefied natural gas (LNG), methane capture, civilian nuclear power, geothermal energy, advanced transport systems, bioenergy, forestry and hydropower.

Although Russia is not a signatory to the APP, all of these technologies are among the priority development targets set out by Putin for Russia for the next ten years.

For internal domestic markets, Putin focuses on the strategic importance of developing clean coal technologies, acceleration of agricultural investments, including the production of energy-capable biomass, methane capture, forestry and bioenergy.

Yet, far more important from the Russian point of view is the potential for developing new markets for energy exports outside Western Europe. In this context, the expansion of pipeline networks connecting Central Asia with Turkey and Southern Europe implies the need for Russia to diversify its export capabilities in the Far East. Here, APP offers plenty of opportunities. IGCC and LNG, combined with advanced transport technologies offer opportunity for exporting Russian gas and oil to the APP member states, including the US. Development and more intensive utilization of nuclear power, geothermal energy, hydropower and bioenergy in close cooperation with APP can open Chinese, Korean and Japanese markets for Russian exports of electricity and other energy carriers.[1]

Guarding Future Growth

There is an additional long-term benefit for Russia in aligning closer with APP. Since the G8 summit in Gleneagles, Scotland, in July 2005, the European Union has been stepping up the rhetoric on the importance of setting new, longer range and stricter targets for global CO2 and other emissions. These post-Kyoto targets are likely to have a significant detrimental impact on future growth potential of the Russian economy. After nearly seven years of continued robust growth, Russia is beginning to reach the point where rising emissions are threatening to spill over the limits set out by the Kyoto Protocol. APP offers Russia an exit strategy from any potential post-Kyoto agreements brokered by the ever-zealous EU.

Furthermore, unlike Kyoto, APP envisions real and tangible provisions of investment funds for development and dissemination of new technologies. At the first ministerial meeting in January 2006, the US and Australia pledged $128 million for these purposes, including money for adoption of technologies developed outside the APP group. The latter proviso is of paramount importance for Russia. Just two weeks ago, the Russian Academy of Science hosted its annual Innovation Forum and Awards. At the awards ceremony, Putin delivered a speech placing significant emphasis in Russian economic policy on strengthening the country R&D capabilities, including in the area of new environmentally friendly technologies and alternative fuels.

Bilateral Plays

In the run-up to St. Petersburg, Russia has increased its rhetoric both against the EU and US. Yet, beneath these surface spats, the gaps between the Western demands and Russia's interests are deeper in the case of EU.

Consider, for example the energy sector. The Russian-US bilateral accession negotiations for the Kremlin's bid to join the WTO - the last stumbling block in the approval process and an irksome topic for Kremlin insiders - are stuck on issues of trade in agricultural goods, access to energy markets for the US investors, banking and intellectual property rights. On energy markets liberalization, the US is pushing Russia to open up its oil and gas industries to foreign ownership - something that is not allowed by the majority of the oil producing states already members of the WTO. Russia knows this and it can be expected that the US will be willing to compromise on the issue, limiting its demands to Russian guarantees of not closing service contracts in the sector for foreign companies. Furthermore, public share offers by Gazprom, Rosneft and potential listings by other state-owned companies will also go some way to meet US demands.

On the other hand, the EU is demanding that Russia liberalize its state-owned pipeline monopolies, Gazprom and Transneft, allowing access to foreign traders and companies. Unlike an amorphous and largely theoretical US agenda, the EU demands are more concrete and politically taxing for the Kremlin.

The issue will be raised at the G8 summit and there is no compromise that can be acceptable to both sides.

For example, responding to similar European demands, on April 20, Sergei Kupriyanov, a Gazprom spokesman, told the Financial Times that Gazprom "just want(s) European countries to understand that we have other alternatives in terms of gas sales. We have a fast-growing Chinese market, and a market for liquefied natural gas in the US. If the European Union wants our gas, it has to consider our interests as well."

On June 13, speaking at an International Economic Forum in St. Petersburg, Putin clearly stated that he does not foresee any change in Gazprom's monopoly position as the sole gas exporter in Russia. On June 7, two Russian parliamentarians submitted a bill in the Russian Duma aimed at further strengthening Gazprom's position and there is no indication that the Kremlin will not support it. Furthermore, there is some indication that Russian government may move to consolidate its ownership of pipeline transport networks through a potential merger of the state-owned Transneft, Transnefteproduct and SGTrans - all responsible for shipments of oil, petroleum products and LNG - along with the state 24 percent share in the Caspian Pipeline Consortium - a private pipeline company delivering Kazakh oil to the Black Sea.

All of these plans contradict the new energy policy proposals emanating from the EU, but are less of a concern for the US.

Long-term Strategy: "Energy Superpower"

Since the December 22 meeting of the Russian Security Council, Putin has consistently developed his strategic vision of making Russia a "global energy superpower". According to Kremlin.ru, Putin believes that Russia has "competitive, natural, and technological advantages" that could place it in a leading position in the global energy sector. "In fact, Russia has no other area in which to claim leadership."

In order for this plan to succeed, Russia needs a complete overhaul of its pipelines infrastructure, heavy investments in LNG and associated gas processing facilities, integrated policy on other energy sources, particularly nuclear and hydroelectric, as well as development of innovative technologies for alternative fuel sources.

The Russian government and state companies clearly understand these objectives. This year alone, Russia launched at last three major pipeline projects: one for Baltic sea line to Germany, another connecting Western Siberia to the northern port of Murmansk, the Pacific Oil Pipeline to China, Japan and Korea. Transneft has recently announced its own plans for network expansion.

However, over recent months, Putin has increasingly emphasized the need for Russia to regain its competitive advantage in the areas of nuclear energy and hydroelectric power. If successful, these can serve as sources of major export revenue from the shipments of energy itself as well as from the sales of expertise, know-how and technology to the energy-hungry Asian markets. In this context, Russia's interest in APP initiatives offer a natural point of new markets' entry.


[1] Gasprom has recently stepped up its LNG investment programs, while a host of independent Russian oil producers are aggressively targeting the liquefied associated gas technologies. Currently, associated gas accounts for around 5.7% of all gas production in Russia. Up to 40% of the associated gas that reaches the surface is flared. Russia produces annually more associated gas than the annual demand for Russian gas from Ukraine.

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