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Tuesday, January 23

This one's for the idiots at the US Department of State

I am having trouble with this post, on account of throwing things across the room every time I start writing, I am so upset with State. So what I'm going to do at this point is just republish two reports without my added comments, except to note:

> Yes, Russia's decision to renege on their promise to the US regarding the gas shipments is a terrible blow to US energy policy. However, the decision was not motivated by anti-US sentiment at the Kremlin, nor was it motivated by a desire to play the US against Europe. You will see this if you read -- not skim but read -- the second report.

> Get it straight: China is the Borg. From that viewpoint, you should be breaking out the champagne every time you see Russia making a move to strengthen their ties with the EU.

Got it? Don't make Pundita get down on her tummy and draw little stick figures in the effort to explain more clearly.
Russia gives Germany a role as strategic partner
by Judy Dempsey
International Herald Tribune, October 12, 2006

BERLIN -- As both sides of the Atlantic compete for reliable energy sources, Russia appears to be playing off Europe against the United States by favoring Germany as its most important strategic partner and the main transit country for Russian gas to lucrative markets in Western Europe.

The goal of linking Europe's largest economy much more closely to Russia emerged clearly this week: Moscow shut American firms out of development of a major gas field and reneged on previous plans to send liquefied natural gas from that field to the United States, and President Vladimir Putin spelled out priorities to Russian and German political and business leaders in Dresden.

Returning to the city where he was a KGB agent from 1985 to 1990, Putin dwelled on the new North European Gas Pipeline that Russia and Germany are building under the Baltic Sea. Once in place, he said, Germany will gain a special role in Europe's energy market.

"This would mean that Germany is not only a consumer of natural gas but would make it a big European distributor of Russian gas," Putin said. "It would transform the energy face of Germany and strengthen its role in European energy matters."
Gazprom, Russia's state-owned gas monopoly, already supplies a third of Germany's energy and a quarter of all gas consumed in the European Union.

While West Germany started developing trade and energy contacts with the Soviet Union in the 1970s, the current big push by both countries to forge closer economic ties is thrusting well beyond traditional realms. At €25 billion, or $31.4 billion, German-Russian trade for the first six months of this year almost equaled that for all of 2005.

"Putin and Gazprom have a lot of cards in their hands," said Jonanthan Stern, director of research at the Oxford Institute for Energy Studies. "This is their time."

Two American oil companies, ConocoPhillips and Chevron, were dealt losing cards this week when Gazprom -- in line with earlier Russian moves to renege on deals giving Shell oil from fields it is developing in Sakhalin -- said it would exclude foreign companies from shares in the Shtokman gas field and instead develop the field alone.

Two European oil firms, Total of France and Norsk Hydro of Norway, had also hoped for a Shtokman deal. But the United States suffered the added blow of being denied liquefied natural gas supplies from the field once it is developed.

"Shtokman will be the resource base for Russian gas exports to Europe via the North European pipeline," said Alexei Miller, the Gazprom chairman. Foreign firms will participate only on specific technical contracts, he added. "This decision is an additional guarantee of the Russian gas supply to Europe, security in the long term, and proof that the European market is of dominating significance for Gazprom."

Stern said that this decision, announced on Monday just before Putin met Chancellor Angela Merkel in Dresden, marked a return to Russia's original plan. "Instead of sending gas to the U.S., it will now send the gas from Shtokman via the new pipeline to Europe," he said. "There is no doubt about it. Europe and Russia will become even more dependent, as Europe buys more gas from Russia and Russia depends on Europe as a reliable market."

Alexander Rahr, an analyst at the German Council for Foreign Relations in Berlin, said: "Russia is changing the rules of the game when it comes to energy."
The Kremlin is "squeezing foreign companies out of Shtokman," Rahr said. "Maybe Putin is playing off Europe against the U.S."

Certainly, European governments and companies are now keen to do business with Moscow - none more so than the 1,000 German companies who have already established offices in Russia.

Despite outcry over such events as the murder last weekend of the investigative Russian journalist, Anna Politkovskaya, Germany and Russia are forging a new strategic relationship.

A former physicist in East Germany, Merkel is keenly aware of human rights issues and critical of the weak rule of law in Putin's Russia.

In Dresden, however, she expressly favored a "partnership," based on a level playing field. "It is important for me to have realized that we are acting on the same business principles as the Russian government in this cooperation," Merkel said. Both sides, she added, were working out "a joint charter in which these principles will be enshrined."

The terms of this partnership, first raised by Merkel in Moscow last January, are taking shape. Gernot Erler, state secretary at the foreign ministry and a Russia expert, said that when Berlin takes over the rotating presidency of the European Union in January, it will seek support for a special free-trade zone between the 25-member bloc and Russia. The EU has rejected such zones in the past, saying they do not comply with WTO rules.

Erler also said the government wanted to help German and Russian companies swap stakes in a bid to encourage stability and mutual profit. "We are considering a program of intertwined companies," Erler said in Dresden. "We hope to develop a win-win situation based on mutual dependency."

For 30 years, there have been German political and business leaders anxious to pursue this strategy in hopes of bringing Russia closer to Europe.

"This has been one of our long term aims," said Klaus Mangold, chairman of the East Committee that actively promotes German business interests throughout the former Soviet bloc.

During the Cold War, such contacts were viewed with suspicion on both sides of the Atlantic by some who argued that this was giving in to Russia's attempts to weaken the NATO alliance.

But now, with Russia reaping cash from high energy prices, German officials and companies sense that Putin will start using the windfalls to diversify and modernize Russia's energy-dependent economy.

"Germany could hold the key," said Stern. "Germany has long experience in Russia."

Putin told business leaders on Wednesday in Munich: "One of the most important tasks of the Russian economy in the short term is its diversification, forging new fields of activity. Germany can be a special motor here for investment." He added without further explanation that these goals "don't meet with a positive attitude everywhere."

Mangold said afterwards that "the future outlook for German-Russian economic relations is excellent."

"Russia has the world's biggest reserves of natural resources," Mangold said. "It is also one of the world's fast- growing economies and is close to Germany geographically. I am confident that German firms will increase their commitment in the years ahead
."
Now we turn to the Energy Charter, which received not one mention in the IHT report:
Gazprom’s Strategy

by Anders Åslund, Peterson Institute
Testimony before Hearing on EU Economic and Trade Relations with Russia, Committee on International Trade, European Parliament, Brussels
November 21, 2006

I am happy to fill in for a Gazprom representative to discuss Gazprom's strategy, but I must make clear that I do this as an independent analyst and not as a representative of Gazprom. Yet, I have chosen the Gazprom perspective to explain what this company is doing.

Gazprom is a peculiar corporate giant. It is a ministry that has become a corporation, and the fundamental question is to what extent it represents the state and business interests, respectively. The last Soviet Minister of Gas Industry Viktor Chernomyrdin formed Gazprom out of the Russian part of his ministry. It incorporated all the elements of the old ministry—production, transportation, distribution, sales, research, and even regulation. This corporation produces close to one-fifth of all natural gas in the world. Unlike oil production, which plummeted by almost half from 1987 to 1996, gas production held up well.

In the mid-1990s, a large minority share of Gazprom was privatized to managers and employees, but share sales were restricted. As a result, a considerable price differentiation evolved between domestic, restricted shares and the few internationally tradable shares. Another consequence was that all Gazprom shares were extremely cheap in relation to the purported asset values. Arguably, Gazprom remained a ministry until President Vladimir Putin changed the management in 2001.

Since 2001, the Gazprom management has been divided into three roughly equal groups. One group, led by CEO Alexei Miller, consists of young economists who worked with Miller and Putin in the mayor's office in St. Petersburg. A second group consists of KGB people from St. Petersburg, while old Gazprom hands form a third group. President Putin takes a very active interest in Gazprom's management, and its split into these three groups gives him great leeway to balance them.

My argument is that the main objective of Gazprom's new management is to boost the stock price. They have done so very successfully. The stock price has increased more than ten times in the last three years. Such a spectacular result cannot be accomplished without being focused on it, however large your assets happen to be. At present, Gazprom has a market capitalization of $250 billion, rendering it about the third most valuable company in the world. It is currently worth three times more than the most valuable German companies, Siemens and Eon.

pany's stock price [sic]. Initially, it focused on recovering assets that had been sold off cheaply to other companies by the old management, and it managed to recover most of them.

Another important step was to liberalize the stock trade so that domestic and international stocks could be traded freely. That was accomplished early this year, which greatly contributed to the stock's price rise.

While Gazprom's Western European customers have paid negotiated market prices all along, former Soviet republics have paid highly differentiated prices, which could only be explained by old political inclinations. In the last year, Gazprom has undertaken radical changes in this price structure. To judge from its dominant public statements, it aspires to eliminate all political discounts and more or less homogenize its prices of natural gas on the Russian border to about $150 per 1,000 cubic meters (mcm), which is currently the approximate netback price from Europe.

These prices are set to rise significantly in the next year. European countries pay much higher prices, but they include large transportation costs in pipelines and substantial taxes. This offensive has led to a number of incidents that appear political, notably aggressive tactics against Ukraine, Moldova, and Georgia, but Gazprom has been approximately as aggressive against supposed friends such as Belarus and Armenia [emphasis mine]. While politics undoubtedly played a role in these dramas, and bluster over prices was standard, the overarching impression is that Gazprom raises the prices relatively fast to a plausible market level.

The next key task to enhance Gazprom's profitability and thus stock price is to raise the domestic Russian gas price. At present, the wholesale price for gas, without taxes is some $42 per mcm. The current government policy is to let the gas price rise by 15 percent next year. After a couple of postponements, the Russian government was to discuss its price policy for gas on November 22.

Three important constituencies are arguing for a partial deregulation of the domestic gas market, namely Gazprom itself, Minister of Industry and Energy Viktor Khristenko, and the Unified Energy System, which despairs at the shortage of gas in Russia.

The minimum solution is that the domestic price rise accelerates, so that it reaches $90 per mcm in 2010. But I do not think it will take that long. Russia may experience a shortage of natural gas as early as this winter, and the domestic price is just too low. The Russian discussion over the domestic gas price is the key drama to watch today.

Meanwhile, Gazprom has invested little in the development of new major findings of gas. One reason is that these fields are very expensive to develop, and if the domestic price is Gazprom's marginal price, it is not worth doing so. Another reason is that Gazprom's current main objective is to raise the domestic gas price, which is most easily done if a real shortage of gas erupts. Therefore, the European Union has a common interest with Gazprom in the domestic Russian gas price going up, because such a price hike will help safeguard Europe's supply of natural gas. In addition, it will contribute to energy saving in Russia and thus lessen emission of greenhouse gases.

Naturally, Gazprom wants to maintain and if possible extend its monopoly over gas pipeline transportation. It wants to take over trunk pipelines in other countries, and it works hard on doing so. Gazprom and thus Russia are dead against the European Energy Charter and its Transit Protocol, because it will reduce Gazprom's monopoly powers. In this regard, Gazprom and the European Union have contradictory interests. For years, the European Union has demanded that Russia ratify the Energy Charter, but Russia will never do so.

The Energy Charter was negotiated in 1991, before Russia's new energy interests had been formed. The United States and Canada never even signed the charter because of legal concerns, and Norway had other legal concerns, which made it not ratify the charter. The only sensible EU approach would be to renegotiate the Energy Charter so that at least Europe's main producer countries, Russia and Norway, can join it. An Energy Charter that only the consumers approve of cannot be of much significance, and Europe needs a common trade framework for energy, notably natural gas.

At present, Gazprom has only two outlets to its markets outside of the former Soviet Union, the pipeline through Ukraine, which accounts for 80 percent of Russia's gas exports to Europe, and the pipeline through Belarus and Poland, which takes care of the remaining 20 percent. To Gazprom this cannot be a satisfactory situation. Therefore, it has chosen the Baltic pipeline directly from Russia to Germany through the Baltic Sea. From a market economy perspective, a multitude of transportation options seems desirable.

More troublesome is the Russian ambition to block the construction of a Transcaspian gas pipeline from Central Asia to Europe. Such a pipeline would greatly enhance Europe's energy security and should be a key EU interest.

Other aspects of Gazprom's activities are even less attractive. Gazprom is picking up various assets within Russia quite cheaply because of its combination of monopoly power over pipelines, pricing and exports and state regulation. Small independent gas producers have been squeezed out and forced to sell their assets cheaply to Gazprom. In East Siberia, TNK-BP, half-owned by BP, is being hindered to develop the giant Kovykta gas field in East Siberia. In the Sakhalin II project, Shell Royal Dutch is under pressure to renegotiate its Product-Sharing Agreement, presumably being forced to give a large share of its investment to Gazprom.

So far, I have discussed Gazprom in business terms, but politics remain important. One example is President Putin's recent decision that Gazprom build one or two gas pipelines to China rather than building a liquefied natural gas plant designed for exports to the United States. The bluster in negotiations with the former Soviet republic does have many political overtones.

Recommendations for EU Policy on Gazprom
The ultimate question today is of course what the European Union should care about with regard to Gazprom. I would make three suggestions:

It makes no sense for the European Union to continue insisting that Russia ratify the Energy Charter when it is all too obvious that Russia will never do so. Instead, the European Union should open a renegotiation of the Energy Charter. The European Union needs to insist on its fundamental demands, a liberalization of the Russian (an European) gas market, free and nondiscriminatory access to pipeline systems throughout Europe, including Russia, commitments to uninterrupted supplies, and mutually equal conditions for investment in the energy sector.

But the European Union also needs to acknowledge justified Russian demand to reach a balanced and mutually beneficial agreement that can be ratified by consumers and producers alike. If Gazprom is to be allowed to buy downstream gas assets in EU countries, the European Union must demand the corresponding right to buy upstream gas assets in Russia, and vice versa.

The most serious conflict in Russia's negotiations with the European Union about its WTO accession was Russia's domestic price of natural gas. This was settled on conditions favorable to Russia, when the European Union signed its bilateral protocol with Russia, a milestone that was reached in May 2004. Russia has complied with that agreement, but international gas prices have risen further. Producers of mineral fertilizers around the world are now complaining anew that the Russian domestic gas price is too low [emphasis mine].

The European Union had better to return to the issue of the domestic Russia prices of natural gas in the multilateral part of the negotiations on Russia's WTO accession. The United States is likely to do so, and when Gazprom itself lobbies for higher domestic gas prices in Russia the chances of success are considerable. This price question has also bearing on Europe's energy security, the prospects for investments in Russia's gas production, and the transparency of the gas sector.

Finally, the European Union has an interest in multiple supply lines of energy to Europe. Therefore, the European Union should strongly support the construction of a Transcaspian gas pipeline from Central Asia to Europe outside of Russia's control
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