Kremlin Uses Energy Deals to Seek Sway Over Pro-West Neighbors

By Gregory L. White, Staff Reporter, The Wall Street Journal
New York, New York, Monday, December 19, 2005

MOSCOW — Russia’s increasingly hard line in talks with its neighbors over
natural-gas supplies reflects a new willingness by the Kremlin to use the
terms of energy deals to reward the loyal and pressure the intransigent
among the countries of the former Soviet Union, politicians and analysts

“This isn’t the usual winter conflict,” says Nikolai Petrov, an analyst at
the Carnegie Moscow Center. “This is a serious shift to much more

pragmatic relations with post-Soviet countries.”

For most of the decade and a half since the collapse of the Soviet Union,
Moscow has supplied many of its neighbors with cut-price natural gas, just
as it did domestic consumers.

But recently, the Kremlin has grown disillusioned as neighbors that enjoyed
effective subsidies worth billions of dollars a year turned away from Moscow
on key policy issues. That divergence was thrown into sharp relief after
popular revolutions brought pro-Western governments to power in Georgia
and Ukraine in the past two years.

Kremlin officials blame the U.S. and Europe for fomenting those rebellions
and have grown increasingly worried that the West seeks to replace other
regimes in the region, undermining Russia’s influence in what it considers
its back yard. The tough line on natural gas reflects a hardening divide
across the region.

“Russia has for some time been providing politico-economic charity to these
new states, feeding them from its hand and supplying them with cheap
resources, without getting either real political loyalty or appreciable
economic gains in return,” Mikhail Margelov, a senator and top
foreign-policy official, told the RIA-Novosti news agency in August.

As winter settles in, Russia’s government-controlled gas monopoly OAO
Gazprom has in recent weeks emerged as the Kremlin’s preferred tool for its
new, tougher approach.

Gazprom demanded huge one-time increases in rates from Ukraine, Georgia
and Moldova, all of which have hewn a pro-Western line in foreign policy, as
well as the Baltic countries, which joined the European Union last year.

The gas giant insists the policy is driven exclusively by economics, because
it gets much higher prices for the natural gas it ships to Western Europe.
But the suddenness of the increases — as recently as June, Gazprom
executives said the low-price deal with Ukraine suited the company — and
the targeted countries suggest otherwise.

“This is largely a political decision,” Georgian Prime Minister Zurab
Nogaideli said in an interview last month. He says Gazprom’s demand to raise
natural-gas prices to $110 per thousand cubic meters starting Jan. 1 from
about $63 this year will shave as much as seven-tenths of a percentage point
off economic growth next year. Even so, he says he is confident that
Georgia’s moves to open up its economy will mean growth will still exceed

Gazprom’s talks with Ukraine, the company’s biggest customer among the
former Soviet countries, have triggered the most fireworks. Under a 2001
deal, Gazprom agreed to sell large amounts of natural gas to Ukraine at $50
per thousand cubic meters in return for discounts on the fees Kiev charges
to use Soviet-era pipes that carry about 80% of Gazprom’s exports across
Ukraine to Western Europe.

Gazprom until last week said it wanted to raise the rate to $160 per
thousand cubic meters, but company executives now say they are becoming
frustrated with Kiev and will accept only a price pegged to export rates of
as much as $230, which Gazprom says is what Western Europe pays.

Gazprom officials, with the apparent backing of the Kremlin, threaten to cut
off shipments starting Jan. 1 unless Kiev agrees to the new terms. That has
led to fears among some European customers that their Russian supplies
across Ukraine could be interrupted.

The government in Kiev, which has angered Moscow with talk of joining the
North Atlantic Treaty Organization and the EU, has refused to accept
anything but modest increases phased in over several years. Some Ukrainian
politicians have accused Moscow of using the natural-gas issue to influence
parliamentary elections in March. Moscow’s preferred party, now in
opposition, has been gaining strength as popular discontent with the
country’s flagging economic performance has grown.

“Russia is pursuing a geopolitical goal, to block Ukraine’s Euro-Atlantic
shift and tie it closer” to Russia, says Vladimir Saprykin of the Ukrainian
Center for Economic and Political Studies in Kiev.

Analysts say that while tensions could continue to rise, some kind of
compromise is likely, possibly involving Kiev’s giving Gazprom somewhat
greater control over the export pipeline network on its territory or
Gazprom’s agreeing to much-higher transit fees.

Governments that toe the Kremlin’s line have gotten much gentler treatment.
Belarus, whose authoritarian president also faces elections in March, will
continue to pay about $49 per thousand cubic meters for Russian natural gas
next year, basically unchanged from this year.

Though considered a pariah by the West, Belarus enjoys close ties to Russia,
and Moscow has frequently provided it financial support. Gazprom officials
say they are happy with Belarus’s cut-rate deal since Minsk has ceded
control over key export pipelines that carry Gazprom’s natural gas to
Western Europe.

Armenia, which also has been a loyal supporter of the Kremlin, similarly
isn’t facing any gas ultimatum this year.

To ensure its leverage, Gazprom has sought to lock up alternative sources of
supply, mostly natural gas from countries in Central Asia. Gazprom this fall
reached long-term contracts to buy much of that production or to reserve
critical transit pipelines.

“We’re putting the [Soviet-era] unified gas-pipeline system back together,”
Gazprom Deputy CEO Alexander Medvedev said last month. “That’s a big
step forward.”

While the immediate adjustments from Russia’s new hard-line natural-gas
politics are likely to be jarring, ultimately, market prices for gas will
stimulate greater efficiency, economists say, depriving Russia of the energy
lever against its neighbors.

“This will have very substantial influence now,” says Mr. Petrov of the
Carnegie Center. “But it will in the future free these countries, which
depend on Russia economically, from this tool of Russian influence.”

Write to Gregory L. White at greg.white@wsj.com

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