LIVING IN THE LONG SHADOW OF A RESURGENT RUSSIA
By Stefan Wagstyl

Financial Times (London, England)
December 15, 2006 Friday

Of all the changes that have swept central and eastern Europe this
year, none is more significant than the emergence of Russia as an
energy superpower. The year had barely begun, when President Vladimir
Putin ordered Gazprom, the gas monopoly, to turn off supplies to
Ukraine in a move which also effected shipments to the European
Union. Supplies were soon restored – but Europe is still digesting
the effects of this harsh lesson in energy politics.

Gazprom has been negotiating big price increases for 2007, particularly
for former members of the Soviet Union which have enjoyed favourable
terms. The gas group has indicated it is ready, if necessary, to cut
off supplies for states that fail to sign new contracts.

The Kremlin insists that Russia supplies oil and gas on a purely
commercial basis. However, in practice, Russian officials have been
adept at using energy for political as well as commercial ends. In
the Caucasus, for example, Georgia, a hostile state in Russian eyes,
is charged considerably more for its gas than neighbouring pro-Russia
Armenia, even though Armenia’s gas is piped across Georgian territory.

Gazprom argues that its aim is to raise prices in the former Soviet
Union to market levels and end subsidies dating back to Soviet times.

It is also increasing Russian domestic prices, although not until
after the 2008 presidential election.

As well as higher revenues, Gazprom is trying to buy stakes
in downstream assets, including pipeline networks to enhance its
market presence and profits. It already has made such acquisitions,
in co-operation with German partners, in Hungary, the Czech Republic
and Slovakia, and this year acquired control of a small British gas
company. However, many European governments are wary of Russian
energy investments, fearing that economic control would generate
political influence.

The EU has responded with new efforts to diversify supplies – notably
from the Caspian basin. New gas and oil pipelines from Azerbaijan to
Turkey were completed this year and more are under consideration. But
the huge costs and the uncertainties over the size of reserves makes
energy groups cautious. Meanwhile, Russia has successfully exploited
tensions within the EU, by playing members off against each other
notably over the Baltic Sea gas pipeline which will supply Germany
but circumvent Poland and other transit states.

Meanwhile, Russia has become an increasingly difficult environment for
foreign oil companies. After years of discussion, the Kremlin decided
to exclude foreign groups from the huge Shtokman gas project in the
Barents Sea and is increasing the pressure on Shell, the Anglo-Dutch
company, and other investors involved in developing offshore gas at
Sakhalin Island in Russia’s far east. This month, Shell caved in and
agreed to sell a controlling interest in its Dollars 20bn Sakhalin-2
project to Gazprom.

Russian officials seem to think that they no longer need international
capital or technology. Mr Putin is instead promoting domestic companies
as global champions, headed by Gazprom and Rosneft, the oil group
that was floated on this year with a value of Dollars 80bn.

The Kremlin seems determined to increase domestic control over
Russia’s resources. There is a growing nationalist mood in Russia,
driven by confidence in the country’s energy wealth, by the confusion
caused by the collapse of the former Soviet Union, and by fears about
possible threats, including global and local terrorism.

Mr Putin has capitalised on these sentiments by following more
assertive foreign policies. A year ago, its main target was Ukraine,
following the 2004 victory of the pro-west Viktor Yushchenko as
president. But the success of Viktor Yanukovich, Mr Yushchenko’s
Russia-oriented rival, in this year’s parliamentary elections, and
his appointment as prime minister have prompted Moscow to soften
its approach to Kiev. Instead, Georgia and its pro-west president,
Mikheil Saakashvili, are in the Kremlin’s sights.

With the 2008 presidential elections looming, Russian politics is
becoming sharper and more brutal. Recent months have seen a string
of high-profile political killings, including that of Alexander
Litvinenko, the former Russian spy, poisoned in London. The Kremlin
denies involvement but the range of possible suspects includes spies
and ex-spies as well as gangsters and business people.

These developments are viewed with concern in central Europe.

However, government attitudes to Moscow vary, with Poland and the
Baltic states more willing to criticise Russia than the Czech Republic,
Slovakia and Hungary, which take a more pragmatic view.

Poland, led by president Lech Kaczynski and his twin brother, Jaroslaw,
the prime minister, has developed robust foreign policies.

As well as annoying Russia, however, the approach has raised hackles
with EU partners, notably Germany, and has complicated intra-EU
co-operation.

Across central Europe, new political forces are testing their
strength in the form of populist parties and tendencies. After more
than 15 years of post-Communist change, people are tired of economic
reforms. With EU and Nato accession safely in the bag, politicians
are struggling to persuade voters to accept more change.

In Hungary, for example, political discontent prompted riots in
Budapest. The immediate cause was the admission by Ferenc Gyurscany,
the prime minister, that he had lied over the economy. But the
demonstrators were also concerned about the threat that reform
represents to a generous welfare state.

In south-east Europe, there is relief in Romania and Bulgaria that
they are to join the EU on January 1, despite concerns in Brussels
about the level of preparation. Other countries in the region are
worried that with enlargement fatigue growing within the union, and
a crisis over Turkey’s admission negotiations, the EU may rule out
further enlargements.

In the former Yugoslavia, perhaps the most troubled spot in mainland
Europe, the death of Serbia’s former leader Slobodan Milosevic in his
prison cell at The Hague war crimes tribunal removed one source of
potential instability. But others remain, notably in the strength of
Serbia’s extremist Radical party, the political stalemate in Bosnia,
and the delays in the international community’s efforts to secure a
final settlement for the disputed territory of Kosovo.

Meanwhile, from the Baltic to the Black Sea and from Berlin to the
Bering Strait, good economic growth, with rising living standards.

While political turmoil has a destabilising impact in some countries,
the effects could be much worse if the economy was performing less
robustly.

In a recent annual economic survey, the European Bank for
Reconstruction and Development forecast expected average increases in
gross domestic product of 6.2 per cent this year and 5.8 per cent in
2007. If the predictions are right, the region will by the end of this
year have recovered all the economic ground lost, in output terms,
since the fall of communism and see GDP reach 103 per cent of the
levels of 1989.

There are sharp differences among sub-regions, with central Europe
already enjoying GDP levels more than one-third higher than in 1989,
while the countries of south-east Europe have just returned to 1989
levels and the nations of the former Soviet Union still have a little
way to go. However, south-east Europe and the former Soviet republics
are closing the gap, growing faster than central Europe.

The money is concentrated in the region’s big cities. Moscow, Warsaw
and Prague are all booming, as are smaller centres, including Riga,
the Russian industrial city of Ekaterinburg and the western Romanian
commercial hub of Timisoara. In the former Soviet Union, resource-rich
regions are also expanding rapidly, such as the oil and gas province
of Khanty-Mansiysk in western Siberia, producer of more than half of
Russia’s oil.

However, away from these commercial dynamos, life is generally poorer,
and sometimes it is very difficult. Small towns and villages have
often seen little benefit from post-Communist transformation.

Whole countries are still struggling with serious political
instability, notably in central Asia and the Caucasus.

Even poorer states offer some scope for investment, including foreign
investment. According to the EBRD, foreign investment is forecast at
Dollars 50.3bn for 2006, just short of 2005’s Dollars 53.8bn record.

Central Europe continues to take the lion’s share, with Dollars
22.1bn forecast for 2006, but south-east Europe has increased its
take sharply from Dollars 13bn in 2005 to a predicted Dollars 19.3bn.

Russia and other former Soviet republics (except for the Baltic states)
are attracting considerably less. In this sub-region, the inflow is
forecast to drop from Dollars 13.3bn to Dollars 8.9bn.

But companies in the former Soviet Union are finding other ways of
raising funds, such as the international capital markets. Russian and
Kazakh companies have tapped the London stock market, as have, on a
smaller scale, Ukranian groups. Even when the region’s complicated
politics creates considerable obstacles, money seems to find a way
to seek out potential profits.