RUSSIA’S ENERGY SECTOR HIDES WEAKNESSES BEHIND POWERFUL FACADE
Stephen Blank

EurasiaNet, NY
May 16 2006

A EurasiaNet Commentary

In late April, representatives of Russia’s Kremlin-controlled gas
conglomerate, Gazprom, threatened to reduce exports to Europe after
the EU blocked the company’s attempts to obtain several European
energy entities. EU officials dismissed the threat, believing that
the Russian energy industry could not survive without generating a
hefty European cash flow. They were right. Behind its mighty facade,
Russia’s energy sector, which the Kremlin has used in recent months to
bully its neighbors and expand its geopolitical reach, suffers from
a decaying infrastructure and a dependence on Western technology and
cheap Central Asian energy.

Russian exporters are able to ship large quantities of energy to Europe
and Asia today only because of its unique relationship to Central
Asian oil and gas producers. And the future of this relationship is
crucial to understanding the global energy game.

The Kremlin has significantly enhanced its control over Central Asian
energy in recent years, book-ended by a 25-year natural gas supply
deal with Turkmenistan in 2003 and a massive oil supply agreement
with Kazakhstan last month. [For background see the Eurasia Insight
archive]. To many outside observers, the Russian energy sector
has assumed an aura of a juggernaut. Statistics seem to support
this impression: Russia has been responsible for fully half of the
increase in global crude oil supplies over the past five years. The
image has also been fueled by the Kremlin’s use of conglomerates as
instruments of geopolitical policy. [For background see the Eurasia
Insight archive].

Appearances can be deceptive, however, at least when it comes to
Russia’s energy sector. There are numerous signs that Russia is in
danger of overextending itself, while dawdling on investing in its
energy infrastructure. The overextension problem is most noticeable in
Moscow’s dealings with Asia. Russia has made an array of commitments to
China and Japan to meet those countries’ voracious energy appetite. For
example, President Vladimir Putin in March indicated that Russia
by 2011 would be in position to deliver upwards of 80 billion cubic
meters of gas annually to China via two pipelines. Meeting that goal
will be difficult, however, as the pipeline linking China and western
Siberia has yet to be built. In general, questions continue to hover
over virtually all of Russia’s oil & gas-related deals with China
and Japan. And even if the energy flows eastward as anticipated,
Asian officials are already expressing doubts about whether the
amounts pledged by Russia are sufficient to meet projected needs.

Beyond the question of Russia trying to export more than it can
pump, the country will have to contend in the coming years with
growing domestic demand, along with the need to repair existing
infrastructure and tap into new energy fields. Both of these latter
tasks are enormously expensive, given the difficulties of working in
Siberia’s uninviting terrain and weather conditions. Experts say that
the significant increase in Russia’s energy production in recent years
would not have been possible without the use of Western technology
and techniques, including hydrofracturing, a process in which steam
is forced into a well to ease the pumping of oil.

Likewise, Western equipment and know-how will be needed to develop
new energy sources in the Arctic, as well as off the country’s
Pacific coast.

Despite the need for outside investment, Russian policies seem
calculated to prop up closed domestic monopolies, and thus repel
foreign capital and technology. In addition, foreign investors
continue to face enormous risks when doing business in Russia:
although foreigners can buy minority stakes in Russian energy firms,
the concept of shareholder rights remains poorly developed, leaving
outsiders vulnerable to the whims of a non-transparent and notoriously
corrupt system.

For now, Central Asian energy is helping Russia mask both current
energy problems and future dilemmas. Until recently every export
pipeline for oil and gas produced in Central Asia was routed through
Russia, enabling the Kremlin to import energy at exceedingly low
cost. Putin sought to maximize Moscow’s leverage by creating a gas
cartel led by Russia. Kremlin control over Central Asian energy reached
the point that in late 2005, Russia felt secure in imposing dramatic
price increases on its CIS neighbors, including Ukraine, Georgia
and Armenia. [For background see the Eurasia Insight archive]. A
subsequent pricing dispute with Ukraine prompted Russia to temporarily
halt the energy flow in early 2006. [For background see the Eurasia
Insight archive].

Central Asian governments are not content with existing arrangements,
however, and are turning to China in order to break Russia’s
pipeline monopoly. A 1,000-kilometer-pipeline linking Kazakhstan
to China, opened last December, became Central Asia’s first export
route not to cross Russian territory. Now the authoritarian-minded
leaders of Turkmenistan and Uzbekistan, along with Kazakhstan, are
exploring the feasibility of building more pipelines that parallel the
Kazakhstani-Chinese route. The possible construction of a trans-Caspian
pipeline, which would enable Central Asian energy to hook up with
Azerbaijani-Turkish routes, could further weaken Russia’s grip on
regional exports.

Much of Russia’s neo-imperial designs in Central Asia are connected
with the fact that the Kremlin’s global economic strategy is dependent
on Moscow’s continued access to cheap Central Asian energy.

Central Asian energy is far cheaper to extract than Russia’s, thus the
Kremlin uses it for Russian domestic consumption, which is heavily
subsidized, while shipping Siberian production abroad. The ensuing
price manipulation is the source of enormous revenues that helps
sustain the government and overall Russian economy.

It is easy to see how the loss of control over Central Asian energy
exports and production would severely damage Russia’s political and
economic interests. If Central Asian states start pumping oil to China
and Azerbaijan, Russia would likely have to use its own production
to meet domestic needs. This, in turn, would dash Moscow’s export
plans for Europe and Asia. At the very least, the availability of
other export options would force Moscow to pay considerably higher
prices for Central Asian oil and gas – a development that could have
ruinous consequences for the Russian economy. Two analysts, Vladimir
Paramonov and Aleksey Strogov wrote in 2004; “should energy prices in
the domestic market reach the world level, it will spell the end for
virtually all Russian enterprises. Even if world fuel prices remain
high, fuel production will become uneconomic in Russia.”

Asian and European governments are becoming increasingly aware of
Central Asia’s importance in the global energy security calculus.

Meanwhile, Washington is exerting pressure on Kazakhstan to make a firm
commitment to a trans-Caspian pipeline. Should Central Asia achieve
energy independence with outside help, Russia would quickly come under
pressure to reform its domestic economy, especially the energy sector,
so that it could better compete in a free trade environment. It follows
that economic liberalization would undermine, if not reverse Putin’s
attempts to re-centralize political power in Russia.

Of course, there is one factor that makes the Central Asian energy
game extremely unpredictable – the brittle nature of the regimes in
Turkmenistan and Uzbekistan. Both countries are ruled by despots –
Saparmurat Niyazov in Turkmenistan and Islam Karimov in Uzbekistan
– reliant on the widespread use of repression to maintain their
authority. Many political observers believe Turkmenistan and Uzbekistan
remain vulnerable to social explosions. In addition, the lack of a
political succession mechanism in both states could spark upheaval
in the event of Niyazov’s and Karimov’s deaths. Disorder in either
country — especially in Uzbekistan, Central Asia’s most populous
state – could engulf the entire region. If such a scenario occurs,
Central Asia’s export ability could be impaired and the major energy
players – the United States, EU, Russia and China – would all stand
to be big losers.

Editor’s Note: Stephen Blank is a professor at the US Army War
College. The views expressed this article do not in any way represent
the views of the US Army, Defense Department or the US Government.