EXCLUSIVE: PUTIN’S HOUSE OF CARDS COMING DOWN
Alex Alexiev

FAMILY SECURITY MATTERS
January 10, 2009

To little notice in America, a drama is being played out in Eastern
Europe that future historians may mark as the beginning of the end
of Russia’s neo-imperialist ambitions under Vladimir Putin, as the
economic house of cards he built collapses and the tyrant himself
heads for the dustbin of history. Turning off the natural gas spigot
in the middle of a harsh winter to much of Eastern Europe that is
completely dependent on it – and has few alternative sources to heat
its schools and hospitals – is the kind of overreach that imperial
hubris often drive dictators past the tipping point and ultimately
to their downfall.

Few believe that to be the case today and indeed most enlightened
opinion in Europe seems to be playing to Putin’s tune. Thus, the
ever-eager-to-appease-Russian-misdeeds Western European elites
have fallen in line behind the Kremlin mantra that the conflict
with Ukraine is a purely commercial affair unworthy of European
involvement. Meanwhile, Moscow’s army of European lobbyists, led by
paid Gazprom lapdog and former German chancellor Gerhard Schroeder,
sing the praises of ever greater European dependence on Russian energy.

Yet, Europe’s cowardice notwithstanding, it is difficult for anybody
with even a basic knowledge of the facts not to see that this time
Putin has miscalculated badly and is playing a losing hand from an
increasingly untenable position. None of this is to say that Ukraine
is totally without fault in the conflict or that we should disregard
some disturbing evidence of corruption in high places in Kiev with
respect to the gas business.

Still, Putin’s gamble has little to do with business and everything to
do with a desperate attempt to get some political mileage and perhaps
temporarily arrest Russia’s accelerating economic and political
slide. But by doing that with his favorite strong-arms methods of
economic and political blackmail, he has guaranteed that this time
his policies will backfire dramatically.

There are several facts seldom discussed in the Western media that
need to be considered before one can truly understand the nature of
the conflict.

First, to dispense with the argument that this is a purely commercial
dispute, it is worth pointing out that Russia has a sliding scale of
prices it charges for its gas to ex-Soviet republics depending on
the degree of their political sycophancy to the Kremlin. Obedient
clients, like Armenia and Belarus, are charged $110-$120 per 1,000
cubic meters, more independent countries like Georgia and Moldova pay
$270-$280, while current bête noir Ukraine is asked to pay a punitive
$500. This despite the fact that Russian natural gas – the price of
which is pegged to oil with a six-month lag – will soon be worth less
than half that even in the expensive Western European market. There
is nothing commercial about these extortionate Russian demands that
were first announced just two days before 2009 and a week before the
gas was turned off.

Secondly, Moscow’s claims that the gas stoppage aims only to punish
Kiev for its ostensible misdeeds are completely bogus. Ukraine has
by far the largest gas storage facilities in Eastern Europe going
back to Soviet times when it was the center of the gas industry
and can easily survive the cutoff for the entire winter season by
using its stored reserves. The real victims are the half a dozen
Eastern European countries that have neither alternative supplies
nor large storage facilities and are already in the midst of a dire
socio-economic emergency. The Kremlin, of course, knew that very well
and the fact that it consciously and callously caused such hardship
will not soon be forgotten.

Third, the conventional pundit wisdom that the Kremlin as the supplier
is in the driving seat in the conflict looks less wise when the
reality on the ground is considered. The fact is that Russia is almost
certainly more vulnerable than Ukraine to any prolonged stoppage of the
gas flows. Ukrainian pipelines carry 80% of Gazprom’s exports to the
West and the lion’s share of its export earnings. Even a few months
without these cash flows are likely to bring the already teetering
Russian "national champion" to its knees. Therefore, the conflict will
be settled quickly and it’s not going to be exactly on Russia’s terms.

Given that Putin was certainly aware of these problems, it is
interesting to speculate why he engaged in such a crass power play
anyway. While it is difficult to put oneself in the mind of a bully,
some have speculated that the Kremlin hoped that the artificial gas
crisis and the accompanying market instability would cause a spike
in oil prices and reverse the downtrend that’s wreaking havoc with
Russian revenues. Others have claimed – and indeed, both Putin and
Schroeder have been beating the pavement on that in the past few days
– that the crisis was engineered by the Kremlin to convince Western
Europeans to line up behind two more Gazprom-planned gas pipelines
(Nord Stream and South Stream) that bypass Ukraine, Poland and the
Baltics. Whatever the motivation, there is little evidence that any
of these purported outcomes are more likely now than before.

Perhaps Putin’s desperation could be better understood by sketching out
to what extent Russia and its oil and gas industry are in the middle
of the economic equivalent of a death spiral, with potentially dire
political consequences for the Kremlin. It was only six months ago
that Gazprom, at that time the third largest company in the world with
$350 billion capitalization, confidently forecast that it will become
the largest in the world with $1 trillion valuation by 2015. Many a
Western banker also nodded in agreement to Gazprom’s other prediction
of $250/barrel price of oil in 2009.

As Putin managed to build monetary reserves of $600 billion –
the third largest in the world – Russia did look invincible for a
time. He also bribed the Russian people into political acquiescence
by jacking up salaries and pensions 200% since 2000, even though GDP
and productivity had gone up barely a third of that.

Alas, it was but a house of cards. With no industrial production worth
mentioning, its infrastructure badly dilapidated, virtually all of its
food imported and mortality rates only found in sub-Saharan Africa,
Russia under Putin had become a classic banana republic with oil and
gas. It lived or died depending on the price of bananas over which
it had no control.

It had also instituted an economic model based on a complete
symbiosis between personalized political power and corporate
interests, which is the true mark of a fascist state, according
to Mussolini. With Putin and his puppets directly controlling all
key businesses and using mafia-like methods to eliminate potential
opponents and foreign interests it seemed to work for a time. But
it was rotten inside. Unable to build value with equity capital, the
Kremlin’s favorite state champions and corrupt tycoons depended not
only on high commodity prices but also on ever larger injections of
foreign loans even as the rights of foreign partners were brutally
limited. It was an irrational economic model bound to fail and it
did as oil prices collapsed.

Today, Gazprom, run from top to bottom by Putin’s cronies, with a
market capitalization of $85 billion (or barely a quarter of what
it was) and a debt burden of over $60 billion, is already in serious
trouble. Putin and his coterie have made a significant contribution
to its woes. According to a well-documented book by former Russian
prime-minister Boris Nemtsov and top energy expert Vladimir Milov
titled Putin and Gazprom, the Putin mafia pilfered assets worth $80
billion from the company during the 2004-2008 period.

It will get much worse. As gas prices and the company’s revenues
plummet in the next few months, it is quite conceivable that Putin’s
prize possession would shortly owe more than it’s worth and become
technically bankrupt. It is already begging the Kremlin for $5 billion
in emergency handouts and paying 500 basis points over Libor for
bridge loans to avoid default on loans coming due.

Its longer term prospects look no brighter. With current production in
decline and most of the new fields to be developed in the forbidding
and extremely expensive Arctic region, Gazprom needs a minimum
investment of $20 billion per year over the next 10 years to stave
off production collapse. With its credit-worthiness in tatters and
foreign capital now avoiding Russia like the plague, it is unlikely
to have an easy time finding it.

Nor is the oil sector in better shape. Over the past eight years,
Russian state coffers were filled by exorbitant export and extraction
taxes levied on oil producers that together amounted to more than $50
per barrel. At current market prices below $50, the oil companies
lose money on exports and are shutting down wells. With most major
oil fields well past their peak and many nearly depleted, the oil
industry needs new investment as badly as Gazprom, but is even less
likely to get it. Western oil companies and banks that were once
eager to pay any price to get into Russian oil are now wondering
how to cut their losses. In just one example, Conoco/Phillips’s 20%
stake in oil major Lukoil worth $1.3 billion only four months ago is
now worth less than half that and falling further.

All of this is, of course, very bad news for the oil and gas sector
but it is an unmitigated disaster for a government whose very economic
model is doomed if that sector does not perform. According to finance
minister Kudrin, Russia needs an oil price of $95 per barrel to avoid
an economic downturn and is facing huge budget deficits if it falls
below $70. We’re now well past these points on the way down and the
inevitable bursting of Putin’s make-believe economics bubble is taking
place in front of our eyes.

Russia’s monetary reserves are now nearly half gone as a result
of Putin’s wrong-headed policies of propping up with state funds
dysfunctional Soviet-style enterprises and corrupt oligarchs, while
bleeding billions on a weekly basis in a futile effort to avoid
a massive ruble devaluation. Worse for the Kremlin, the inevitable
political backlash to Russia’s economic meltdown that can no longer be
concealed will not be long in coming. With Russian savings currently
being wiped out by creeping devaluation, unemployment spreading
rapidly and food inflation approaching 30% outside of Moscow it is
only a question of time before people take to the streets. And this
time it would be difficult for Putin’s media to convince people that
it is all America’s fault.

Finally, to go back to Putin’s arm-twisting in Ukraine, it is virtually
certain that when all is said and done, Eastern Europe and, hopefully,
parts of Western Europe as well, would decide that continued energy
dependence on Russia is very bad for one’s economic health and engage
in a crash course of developing alternative sources. It is likely
to involve a new emphasis on nuclear energy with several reactors
already in the planning stages, clean coal power stations as well as
coal gasification and liquefaction and liquid natural gas terminals
among others.

Hopefully, the new focus will involve renewed efforts to build the
Nabucco gas pipeline that bypasses Russian territory, as well as
stopping the construction of the new Gazprom pipelines.

The United States should wholeheartedly support these policies and
while at it think of dealing with its own energy dependence.

FamilySecurityMatters.org Contributing Editor Alex Alexiev is a
contributing editor to familysecuritymatters.org and vice-president
for research at the Center for Security Policy in Wash. D.C. He is
the author of a forthcoming book on shariah finance titled Jihad on
Wall Street: Shariah Finance in the War Against America.

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