Wednesday, May 17, 2006

Russia's Energy Sector Hides Weaknesses Behind Powerful Facade

Russia's Energy Sector Hides Weaknesses Behind Powerful Facade

Interesting commentary by Dr. Stephen Blank, professor at the Strategic Studies Institute of the US Army War College at Carlisle Barracks, PA. He has authored multiple papers on Russia and Central Asia for the Jamestown Foundation.

The article here is also available in Russian via the link at the bottom of the page. It would appear, based upon Stephen Blank's opinions and information, that Central Asia's more cheaply produced natural gas is a key element of Russia's own energy infrastructure - and thus plays a critical role in allow Gazprom to further develop and bring to market Russian natural gas resources.
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. 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.

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.

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."
My opinion has been that the Putin/Gazprom "energy security" agenda is equivalent to energy blackmail. Gazprom/Russia hopes to lock Europe into long-term price contracts now, when petroleum and natural gas are at all time highs. The supposed selling point to Europe would be a "secure energy source" - Russia promises not to cut off supplies completely or sell to other markets. It seems like pure scare tactics, designed to give a rapid influx of cash now, without foreign investment. Consider if the local gasoline station made a similar deal with you, and what their motives for such a deal might be. This deal likely best serves Russian short-term interests, but would appear to be a difficult idea to sell to any observer of Russian economic warfare of the past year.

As a side note, hydrofracking or hydrofracturing is a somewhat controversial technique that is used to attempt to improve production of wells in fractured bedrock. It involves injecting water or steam into the borehole, under great pressure, in order to further fracture the bedrock, increasing its local permeability (and therefore the connection of the borehole to the groundwater or subsurface petroleum/gas within the bedrock). There are problems cited with the technique; it may produce only short-term gains in production, may contribute to early decline of well production, and may also allow for increased spread of contamination in the subsurface. Theoretically, Russians have been opposed to such practices in the past.

If you care to read more about this topic, consider browsing this somewhat outdated 2002 article from Alexander's Gas and Oil Connections (they cite RusEnergy as a source for their data). That link makes for an interesting read, just to see how quickly and unpredictably things have changed in the Russian energy market in just 4 short years.

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