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IDSA COMMENT

Overfed Europe, Underpaid Russia: Beginning of a New Energy Cold War?

May 03, 2006

Russia is on the move to become an energy superpower by spreading its influence deep into Western and Eastern energy markets. Possessing the largest reserve of natural gas in the world, Russia's domestic and foreign policies have now come to be largely determined by the energy factor. Apart from the already existing market in the West, Moscow's plan to explore Asian markets was welcomed by the major energy consuming countries such as China, Japan, and the Koreas in the East Asian region. But Russia's market expansion plans in Europe against the backdrop of the gas price row with Ukraine in January 2006 and the concurrent supply disruption have appeared as a threat to energy security of the European Union (EU) countries, which have increasingly come to depend on Moscow for their energy supplies. As a consumer bloc, the EU fears that with the market expansion plans Russia would monopolise its own energy market and may eventually gain a greater influence within Europe. Moreover, Russia shifting its attention to Asian markets has also raised concerns, despite the reassurance that it has provided in this regard, about uninterrupted supply of oil and gas to the EU. Consequently, Russia has come to be increasingly seen as an unreliable energy supplier by the Western market. Europe, which has been a traditional market for Russia's energy exports, receives a quarter of its total oil and gas needs form Russia, with the dependency of individual countries variously ranging from about 30 to 50 per cent.

European officials are concerned about Moscow's growing control over energy supply routes and distribution networks within the EU and in the former Soviet Union. In recent times Russia's energy market expansion plans have witnessed some opposition in the European Union. This opposition came in the wake of the Russian energy company Gazprom showing interest in bidding for Centrica, the largest gas distributor in Great Britain. Gazprom, which exports 30 per cent of its natural gas production to the European Union, has responded by warning importing countries that it would cut energy supplies to them and take its business to other markets if Moscow's market expansion plans in EU are curtailed. On April 20, a spokesman for the EU Energy Commissioner reacted to Gazprom's warning thus: "Russia is free to decide its market and EU is already looking for alternative suppliers." On April 24, the Chief of Transneft petroleum company, Semyon Vainshtok even went to the extent of saying that "Europe is overfed with Russian energy and every single economic manual says that excessive supplies depress prices. As soon as we turn towards China, South Korea, Australia, Japan that will immediately take away part of our oil from our European colleagues." Since a major portion of Russia's energy exports are oriented towards the West, energy flows to the European market is at a fairly low price. Russian energy companies believe that their exports are being underpaid for in the current global energy price levels, given that most of the supply deals were inked before prices started skyrocketing in 2003. With this issue heating up between the EU and Russia, a centre-right German Member of the European Parliament Elmar Brok likened Gazprom's threat to "the announcement of a Cold War with new methods."

The war of words has created a sense of caution on both sides and signalled a threat to the energy supply and market security to EU and Moscow, respectively. While the Asian market with China, Japan, the Koreas and India as customers will provide a large and diverse consumer network for Russia, the EU is keen to explore more export sources in the African, Caspian and Persian Gulf regions. During a landmark visit to China on March 21-22, 2006 President Vladimir Putin agreed to the construction of two pipelines from Russia's Far East to supply China with 60 to 80 billion cubic meters of natural gas per annum. Russia also promised to build an oil pipeline from eastern Siberia to its Pacific port of Nakhodka, which will have customers such as China, Japan and other Asian countries. On the other hand, most EU countries have already made large-scale investment in renewable and other alternative energy sources in an attempt to reduce their dependency on Russian energy. Germany, which imports about 30 per cent of its natural gas needs from Russia, recently announced a new energy plan, under which 30 billion Euro each will be invested in the construction of power plants with distribution networks and renewable energy. According to a report in Euobserver, EU leaders agreed that they should establish a single market for electricity and gas by mid-2007, boost renewable energy use by 15 per cent and bio fuel use by 8 per cent by 2015, as well as use 20 per cent less energy overall by 2020.

Ever since the Ukraine episode, the EU has grown worried about its alarming dependency on Russian supplies. It fears that Gazprom's expansion plans in Europe and its growing control of the energy market will force import dependent EU countries to pay a high price for future energy supplies. On the other hand, Moscow feels that its market expansion interests have been ignored or often prevented. Moreover, it also feels that it has been supplying cheap energy to the EU customers, for which prospective consumer countries in the Eastern market are ready to pay a higher price. The fact is that, despite concerns about mutual reliability, Russia and the EU have one of the most important energy trade ties in the world. Statistics show that Russia along with the other countries in the former Soviet Union exported above 5.3 million barrels of oil to the EU in the year 2004. And natural gas exports from Russia alone amounted to 148.44 billion cubic meters out of a total production of 589.10 cubic meters.

Russia and the EU need to look into some of the basic factors which bring them together as energy trading partners, before mutual apprehensions get translated into an energy cold war. First, neither can afford to ignore the other's interests in the current world energy scenario. Given that no other single supplier can replace energy supplies from Russia, EU countries would continue to be dependent on Moscow. At the same time, shifting the energy market completely from the West is an unrealistic option for Russia given that about 70 per cent of Gazprom's revenues come from its natural gas export, while the rest of the gas produced is sold in the domestic market at a low price. Moreover, completely redirecting the West-oriented energy supply and delivery system eastward would require huge financial investments and would also not be economically feasible.

Ever since the Arab Oil embargo, the world has witnessed petroleum fuels being used by producing countries as a political tool to gain leverage in their relations with the outside world and in times of crisis. In the case of Russia too, energy is now a tool to develop its economy and spread its influence in the neighbouring regions. Though the EU and Russia have shared strong energy trade relations for the past many decades, the alarming growth of demand and the growing price of petroleum fuels worldwide along with Moscow's search for more profitable markets in the East and West seem to have adversely affected this relationship. Current tensions between the two sides are unlikely to lead to a cut-off in supply from Russia for the above-mentioned reasons. But at the same time Europe might be forced to pay a higher price for imports from Russia in coming years. Russia's reluctance to ratify the Energy Charter Treaty, which would have helped the already existing consumer countries in terms of supply security and price also demonstrates Moscow's interest in obtaining a higher value for its exports to the EU. Current developments are likely to turn out in favour of Russia asserting itself as an energy superpower with a large consumer network including the EU and North America in the West and Asian consumers in the East.