Putin and Energy Battle over the Caspian

(This post is an extended extract of my articles originaly published in todayszaman, a Turkish daily newspaper, on July 17 and 18, 2007.)

Putin knows very well how important geo-strategic commodity energy is. In a recent speech, for instance, he once again underlined that “Energy supply issues have become a primordial part of international economic policy today.” Not surprisingly, he selected Russia’s extensive oil and gas resources and pipelines, as well as national champion companies as the key policy instruments to play a chess game in the world energy geopolitics.

As far as natural resources are concerned Russia’s hand is very strong: It holds 6.6% of world’s proven oil reserves and 26% of world’s gas reserves. Besides, it currently accounts for 12% of world’s oil and 21% of world’s gas production. In May 2007, Russia was the world’s largest oil and gas producer.

As for national champions, Putin has strengthened and prepared Gazprom (state controlled gas company), Transneft (oil pipeline monopoly) and Rosneft (the state owned oil giant). That is why, in 2006 Gazprom retained full ownership in the giant Shtokman gas field[i] and took controlling stake in Sakhalin-2 natural gas project. In June 2007, it took back BP’s Kovytka gas field and now is behind Total’s Kharyaga oil and gas field. But that is not all.

Putin has seen Russia’s market position weakened in a context of liberalisation of downstream markets in importing countries. If producers should care about consumers’ security of supply (meaning reliable and available energy at reasonable and affordable prices), consumers must care about producers’ security of the market (meaning, access to markets in consuming countries to justify and protect their investments, and long term contracts). Thus, Putin pushed Gazprom to enter European Union’s gas transmission and distribution system which are regulated activities with guaranteed profit.

How about Russia’s energy customers? They are becoming more dependent on imports. For example in the EU, Russia’s largest customer, domestic production of oil and gas is declining while consumption is increasing. Even worse, many factors ranging from logistical difficulties, geological realities to financial burdens restrict options to diversify its supply sources and routes to avoid an over-reliance on a small number of suppliers, in particular Russia, and vulnerability related to import dependency. These challenges led security of supply to be the EU’s top priority.

Putin knows pretty well that the EU needs Russia as much as Russia needs EU. He also knows that the EU lacks a coherent common energy strategy and policy, and unable to speak with one voice. That is why he prefers bilateral relations[ii] to multilateral negotiations with European (Dis)Union. By developing individual strategies he is indeed further weakening the position of the EU and is reducing the solidarity between its members, which deteriorates the position of small countries. It is an irony that most of the companies Gazprom partners with are the EU’s state controlled national champions.

Moreover, cooperation with OPEC countries as well as spreading the idea and follow up of a possible gas OPEC show that Putin sees oil and gas as a possible geo-strategic weapon, not only in energy and economic fields but also in international relations. In addition, a major disruption in the flow of oil from the Persian Gulf would give Russia not only more power for playing a swing producer role but also ability for providing more Caspian oil into markets.

Surely Russia is not immune to weaknesses. The uncertainty about the future economic situation, especially domestic energy needs, declining production[iii] in major oil and gas fields, and not enough investment in developing upstream sector questions the potential of Russia’s future oil and gas export capacity. The latter is one of the reasons why Putin pays so much attention to the “stans” in and around the Caspian, especially Kazakhstan and Turkmenistan.

The Caspian Sea region is at the crossroads of energy politics

In the 19th century and the early 20th century, the great powers, the British and Russian empires, struggled for supremacy in and around the Caspian, which came to be known as the Great Game. With the collapse of the USSR in 1991 oil and gas rich newly independent states of the region again became a geopolitical battle area, coined as revival of the Great Game.

However, this new game has become far more complex than the 19th century due to the mixture of actors, ranging from national/international oil and gas companies to Russia, China, US/EU coalition, and possibly Iran. Even Japan, which used to be rather hesitant or too careful to play power games as such, has jumped in.

This undisguised political battle contains two prizes – control, influence and development of the hydrocarbon resources and their transport routes to the markets.

The US/EU coalition (backed by NATO) mainly concentrates on transport routes. Note that in international pipelines business, politics often comes before economics. And politics mostly determines which route to follow and which countries to transit. The moves of the US/EU coalition in the region follow a strategy that prevents the construction of pipelines through Russia or Iranian territory. The coalition pushes for a corridor to western markets from the fields in eastern shores of the Caspian through the allies Azerbaijan, Georgia and Turkey. And to eastern markets through Afghanistan and Pakistan, as opposed to Iran-Pakistan-India gas pipeline project.

The most recent efforts of the US/EU coalition are the followings:

April 3, 2007: construction of Pan European oil pipeline (Romania-Serbia-Croatia-Slovenia-Italy) was signed. Scheduled to be completed by 2012.

April, 24, 2007: construction of the Trans-Anatolian oil pipeline (Bosphorus bypass, Samsun-Ceyhan in Turkey), which will connect Samsun to Ceyhan in Turkey, has started. Scheduled to be operational by 2009.

May 11, 2007: Odessa-Brody-Gdanks (from Ukraine to Poland) and AMBO (Bulgaria- Macedonia-Albania) oil pipeline projects were discussed. Follow up is in October 2007 in Vilnius, Lithuania.

The main characteristic of those pipelines is the source of oil, which is supposed to come from the Caspian. Since Azeri may only be enough to feed the Baku-Tbilisi-Ceyhan oil pipeline for another decade, above mentioned lines must rely on Kazakh oil.

A competing project promoted by Russia, however, the Burgas-Alexandropoulis oil pipeline[iv] (Bosporus bypass, Bulgaria-Greece) will soon involve Kazakhstan. Thus, the line’s main source of oil may also be Kazakh oil.

Currently, Kazakh oil is exported in three directions: northward (via the Russian pipeline system and rail); westward to the Black Sea (via CPC and rail, and shipped on a barge to Azerbaijan) and southward (via swaps with Iran), eastward through China (via pipeline and rail). The question is the following: Can Kazakhstan produce that much oil to feed all its customers? Most probably, no. Therefore, it is unlikely that all those projects will be realized.

Also China hunts in Caspian

For years, Beijing has called on its major energy companies to engage in a "go-out" strategy for securing energy resources and making investments in them. Consequently, Chinese firms have traveled around the world searching for oil and gas fields, securing exploration rights and purchasing multi-year contracted supplies, mainly in Africa.

In the past few years, however, China has concentrated on a region closer to home which Russians consider near abroad -- Central Asia and Caspian. Therefore, China has stepped up its involvement in the region by signing a series of bilateral energy sector deals and through successfully carried out investments in several energy projects and assets, mostly in Kazakhstan. This development indicates that Chinese and Russian companies will be competing with each other for the remaining reserves and assets.[v] Though already on rise, they can drop the competition and instead work together as partners on several projects.

In this regard, one of the major cooperation may be oil pipeline to China. Lukoil wishes to direct as much high quality Kumkol oil as possible through the CPC line to western markets, leaving Kazakh-China oil pipeline dependent on Russian crude.[vi] Whereas, Russia may make use of Kazakh-China oil pipeline for its oil exports to China, until its own pipeline to China comes on stream.

The combined weight of China and Russia in Kazakhstan and Turkmenistan should not be underestimated. Russia and China’s overall effect may marginalize the US/EU attempts to bring about political and economic reforms in region’s countries,[vii] and energy transit corridors backed or not backed by them.

Another cooperation may be on the Iran-Pakistan-India gas pipeline, which the US strongly opposes. Two recent developments are worth noting: First, Gazprom expressed the possibility of extending the pipeline into China, which implies a convergence of interests among all regional actors. Second, the delegation of Russian Prime Minister Mikhail Fradkov's recent visit to Pakistan included officials from Gazprom.

Putin’s battle over Caspian energy resources and transport routes

For years, Putin has been determined to win the battle over Caspian oil and gas. During the Russian Security Council discussion on the Caspian (April 21, 2000) Putin made the following statement: “We must understand that the interest of our partners in other countries— Turkey, Great Britain, and the United States—toward the Caspian Sea is not accidental. This is because we are not active. We must not turn the Caspian Sea into yet another area of confrontation, no way. We just have to understand that nothing will fall into our lap out of the blue, like manna from heaven. This is a matter of competition and we must be competitive.”[viii] Today, Russia is the most active player in Caspian.

Putin’s strategy for the Caspian oil and gas involve the following goals: encircle Europe by pipelines from the northwest, the southeast and the middle (for instance the Nord Stream bypasses Belarus and Poland, the South Stream bypasses Ukraine and Turkey); buy most of the gas as cheap as possible from the eastern Caspian states and either use it in Russia or sell it to Europe with a nice profit; use the routes where Russia has control over or construct new ones bypassing “trouble makers” and competitors; kill the Nabucco gas pipeline project from Turkey to Austria unless Russia participates; bring the Kazakh oil to the western outlets through the routes Russia has control over; discourage competing projects but ensure that Russia is reliable supplier; convince both countries that oil and gas exports with guaranteed volumes but low price are more attractive than selling uncertain amounts with high price by bypassing Russia; last but not least promote other means[ix] to make Russia’s ties with the Caspian states stronger.

Putin’s three important moves in the past two months have given him a big leverage to realize his strategy:

May 12, 2007: At the trilateral Central Asian summit between Russia, Kazakhstan and Turkmenistan, the leaders announced their agreement to refurbish and expand the gas capacity of the Soviet-era pipelines that run from the region Asia to Western markets via Russia; to increase gas exports volumes from the region via Russian pipelines; to deepen further Russian participation in developing Turkmen gas reserves; and to commit long-term Kazakh oil exports through Russia. Formal agreement is expected to be signed in September 1, 2007.

However, there are two major uncertainties surrounding the formalization of that agreement.

First one concerns Turkmenistan: bulk of Turkmen gas is already under contract to Russia until 2028. Exports (up to 30 bcm annually) to China are expected to start in 2009. Also some gas (about 6 bcm) is exported to Iran. In addition, Berdymukhammedov still supports the Trans-Caspian and Trans-Afghan pipeline projects. And now Turkmen gas is supposed to feed the Nabucco project via Iran, announced on July 13. Can Turkmenistan fulfill all these commitments? Very unlikely. Were these issues discussed in Turkmen President’s meetings with US Admiral William Fallon on June 21 and with US Deputy Assistant Secretary of State Evan Feigenbaum on June 26? Will he discuss these issues in his trip to China?

Second one concerns Kazakhstan: Kazakh President Nazarbayev told reporters that his country "was absolutely committed to funneling the bulk of our hydrocarbons, if not all, via Russia’s territory," hence strengthening Putin’s signal to the world that the region is getting under Russian sphere of influence. He is known to be a chameleon policy follower which causes lack of trust. So, is he serious or is it a part of his multivector policy which maintains a balance among the main powers involved in the regions?

June 4, 2007: The Moscow Times reported that Gazprom will study the proposal made by Greek President to build a gas pipeline alongside the Burgas-Alexandroupolis oil pipeline. The line is planned to be connected at the Bulgarian port of Burgas with a link from the Blue Stream. An LNG facility in the Aegean port of Alexandroupolis will ship the gas further by tank.

June 23, 2007: Eni and Gazprom signed a memorandum of understanding to cooperate on the South Stream gas pipeline. The pipeline would start from Russia’s Black Sea at Beregovaya (the same point of Eni-Gazprom Blue Stream line begins), cross the Black Sea and reach Bulgaria. Form there two options are on the table: The southwestern option would continue through Greece and the Adriatic seabed to the port of Otranto in southern Italy. The northwestern option would run from Bulgaria through Romania, Hungary, Slovenia and Austria to northern Italy. Gazprom is reported to have signed MoUs with Hungary and Serbia to participate. Bulgaria and Greece are already ready to participate. Construction would begin as early as 2008, and be completed in three years.

Vladimir Putin could not have better timing for making these arrangements: The US has been busy with Iraq and Turkey with upcoming elections.

Concluding remarks

General Sun Tzu, the ancient Chinese strategist of the 4th century BC, taught his men to "know your enemy" before going into battle. If "you know your enemy and know yourself," he wrote in his book The Art of War, "you need not fear the result of a hundred battles." But, he warned, "If you know yourself but not the enemy, for every victory gained you will also suffer a defeat." He also added, “If you know neither the enemy nor yourself, you will succumb in every battle.” Vladimir Putin certainly knows himself, his subject, his competitors and his country. Most importantly, he works for the interests of his country. He may have made some mistakes in other areas, but this will not prevent him winning the energy battle over Caspian until at least March 2008.

Footnotes:
[i] However, in mid-July Gazprom announced that it will developed the field with France’s Total.
[ii] For example, Gazprom signed long term contracts and swap assets with Germany’s Ruhrgas, France’s Gaz de France, Italy’s Eni and Enel, and Austria’s OMV. Note that Germany’s Ruhrgas has a stake of more than 10 percent in Gazprom today and has a representative on the board of directors.
[iii] Most of the recent increase in production most probably comes from already long-worked fields with old wells, from new wells in those deposits, rehabilitation of existing oil fields, and reopening of closed wells.
[iv] Signed in March 2007 by Greece, Bulgaria and Russia, scheduled to be completed in 2011.
[v] Andrew Neff, “Russian-Chinese competition may marginalize US, European influence,” Oil & Gas Journal, March 13, 2006, 39-42.
[vi] Kimberly Marten, Disrupting the Balance: Russian Efforts to Control Kazakhstan’s Oil, PONARS Policy Memo No.428, December 2006.
[vii] A. Neff, “China competing with Russia for Central Asian investments,” Oil & Gas Journal, March 6, 2006, 41-46.
[viii] Carol R. Saivetz, Caspian Geopolitics: The View from Moscow, The Brown Journal of World Affairs, Summer/Fall 2000, Vol. VII, Issue 2, pp 53-61.
[ix] For example, the Eurasia canal project of Kazakh President Nazarbayev for connecting the Caspian and Black seas. Sergei Ivanov, Russian Deputy Prime Minister, already endorsed the idea on June 15.