Neil Buckley in Moscow, Financial Times, London, UK,
Thu, Dec 22 2005

Russia is nine days away from potentially carrying out a threat to reduce gas supplies flowing through a pipeline across Ukraine to western Europe, unless Kiev pays higher prices for gas it takes from the pipe. The result could be winter energy shortages in some European countries.

Yet on the same day, January 1, Russia assumes the rotating presidency of the Group of Eight nations, of which it has made “energy security” a central theme. Moscow is widely expected to use its presidency to promote itself as a reliable energy supplier to the world’s biggest economies.

These two positions may seem contradictory, but in fact point to the same conclusion. While it does so in a variety of ways, Russia is ever more confidently wielding its mammoth reserves of oil and natural gas as a political tool. High prices, tight supplies, and the west’s desire to reduce reliance on Middle East suppliers are increasing its leverage.

“It is not that energy is the new atomic weapon,” says Cliff Kupchan, an analyst with the Eurasia Group consultancy and former state department official in the Clinton administration, “But Russia knows petro-power, aggressively and cleverly applied, can yield diplomatic influence.”

After spending the past year bringing key oil and gas assets back under state control, a string of events have shown how Russia is using its petro-power. Gazprom, the state-controlled gas giant, is demanding that former Soviet states, which since the USSR collapsed in 1991 have enjoyed subsidised prices for Russian gas, finally move to market rates.

But it is doing so in a highly differentiated way. Ukraine, having shifted out of Moscow’s orbit since last year’s Orange Revolution, has been slapped with the biggest demand for a price increase. Prices charged to Georgia and Moldova, which have also turned their gaze westwards, have nearly doubled. Yet Belarus, loyal to Moscow, is still getting gas at the old price.

Russia is using its dominant position in oil, too, to favour Russian commercial interests. It plans to cut oil supplies to Lithuania from January 1 in what analysts see as an attempt to press the Baltic republic to favour a Russian buyer over rival Polish and Kazakh bidders for the strategically important Mazeikiu oil refinery.

The refinery is being sold off by the Lithuanian authorities to pay off a huge back tax bill owed to Moscow by Yukos, the Russian oil company whose main production asset has, in effect, already been renationalised as part of the legal assault on Mikhail Khodorkovsky, its former owner.

Russia is, moreover, squeezing potential competitors in the former Soviet Union – notably Kazakhstan – that are trying to develop their own energy industries independently of Moscow. It is for example attaching tough conditions to allowing Kazakhstan to expand a key pipeline from the vast Tengiz oilfield in the Caspian to Russia’s Black Sea port of Novorossiysk. This is crucial to plans by the field’s operator, Chevron of the US, to ramp up production.

Also this month, Russia started construction, with some fanfare, of the $5bn North European Gas Pipeline, an export route under the Baltic sea to Germany that will bypass the Baltic states, Ukraine and Poland. It attracted even more attention by naming Gerhard Schröder, the former German chancellor, project chairman.

Within days, word leaked that Russia’s president Vladimir Putin had asked Donald Evans, the former US commerce secretary and close friend of President George W. Bush, to chair Rosneft, the Russian state-owned oil company preparing for an initial public offering. Mr Evans this week politely declined, citing other commitments.

How should the outside world make sense of all these different signals? Analysts say Russia has always used energy as a lever with its former Soviet neighbours – and kept natural gas prices low partly to keep them within its fold – though it is being increasingly hard-nosed.

Political and economic interests are intertwined. With gas prices rising, increasing the effective revenue loss to Gazprom and Russia from providing cut-price gas, there seems little point continuing to subsidise states which have already shunned Moscow.

“The time when we built relations by quasi-subsidising neighbouring economies is gradually passing,” Alexei Kudrin, Russia’s finance minister, said last week. “We must think about our own interests.”

Most analysts expect Russia and Ukraine to pull back from the brink before west European gas supplies are threatened; neither would want to be blamed for shortages.

Russia has far too much at stake. It is preparing to project its energy influence to a much wider audience – and its approaches to Mr Schröder and Mr Evans may be an important part of that.

Moscow has already hinted to US officials and international energy executives that it intends to use its coming G8 presidency to assure the world it can be a pivotal energy supplier to Europe, the US and Asia.

Mr Kupchan, of Eurasia Group, believes Russia has studied Saudi Arabia, which has used its energy clout to build a close geo-political relationship with the US – and mute US criticism of its domestic policies. But he suggests Russia is aiming for a “Saudi-plus” model.

“Saudi Arabia has achieved this only with the US. The Russians are looking for something broader,” says Mr Kupchan. Moscow wants to build a wider network of influence and, unlike some petro-states, turn its oil and gas companies into international players.

He forecasts more moves to grant minority stakes to foreign oil majors in Russian companies, both state- and privately-controlled, and oil and gas projects, though with Russia always retaining control. He also foresees more invitations to prominent western executives to take jobs with Russian energy companies.

Both could help confer a sense of legitimacy and transparency on its industry, especially after the state’s asset-grab, and increase Russian companies’ sway in foreign capitals.

But with some, particularly US, politicians challenging Russia’s G8 role amid questions over its democratic record – heightened by the Yukos affair – western officials say Russia will be under intense scrutiny.

Says one person close to the White House: “The G8 is going to be a great opportunity for them to appear adult, responsible and be taken seriously by the world.”

(Additional reporting by Tom Warner in Kiev and Carola Hoyos)

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