David Tynan, General Manager Gulf States explores the impact of Russian policy on EU gas energy markets.

Revenue delivered to the Kremlin by Gazprom from the EU gas energy markets has been integral to the Russian political and economic resurgence. Despite the risk of negative reactions from these EU markets, powerful motivations exist for Kremlin market intervention on behalf of Gazprom. To explain this, I will examine the narrow energy based nature of the Russian resurgence. I will then illustrate the advantages that expanded influence over EU gas markets provides both Gazprom and the Kremlin.

The role of energy in the post-Soviet Russian economy

The process of decline and resurgence that followed dissolution of the USSR in 1991 explains contemporary Kremlin geopolitical strategy.  Weakening of central control precipitated Soviet collapse and diminished market regulation.  A period of ‘frontier capitalism’ ensued in which extensive Russian politico-economic power passed to Oligarchs who had acquired undervalued and enormously profitable ex-Soviet energy assets.  In the early 1990’s oil and gas export prices were relatively strong.  These commodities delivered 80% of the Russian GDP and provided fitful, though unstable recovery within major cities and resource rich regions .

Recovery halted abruptly in 1998 when the “Asian financial crisis” prompted a commodity price slump.  This coincided with the collapse of Russian taxation systems caused by rampant corruption and the inability of, then president, Boris Yeltsin, to impose strong state control .  Subsequent economic collapse was followed by default on foreign debt and a flight of foreign and domestic capital.  Having installed four different Prime Ministers over the 18 months preceding this crisis, Yeltsin appointed Vladimir Putin as Prime Minister in August 1999.  Decisive leadership, tax reform and a degree of political stability were evident during Putin’s first term as prime minister.  As a consequence he was offered and assumed the presidency on Yeltsin’s retirement in December 1999 .

Commodity prices recovered in late 1999 and political stability was delivered on the back of tax revenues from diverse and largely private energy companies.  Rapid recovery ensued with an average 6.7% growth in GDP year on year that delivered 38% growth in the Russian economy up to 2003.  This allowed Russia to pay down the vast foreign debt (on which it defaulted in 1998) to 5% of GDP while acquiring cash reserves of over US$500 Billion .  Part of this recovery was attributed to a five-fold devaluing of the Rouble that stimulated an inefficient Soviet era manufacturing sector.  Ultimately, however, Russian economic and political recovery has tracked international energy prices from 1991 up to the present day .

Delivery of capital to the state through tax revenues from private energy companies was stabilised in Putin’s first term as President.  Despite this, the Kremlin began consolidation of economic and political power through nationalisation of resource companies after Putin’s re-election in 2003.  This re-nationalisation was predicted in a dissertation written by Putin following the collapse of the USSR.  This dissertation argued that Russian resource companies should become ‘National Champions’ that serve state ends internationally and domestically. The state vehicle of choice for Putin was Gazprom. He replaced the corrupt Gazprom management team that had withheld tax revenue in Yeltsin’s time with trusted and likeminded former KGB associates .  Among these new managers was the current Russian President Dmitry Medvedev. This policy pressured any Oligarchs who retained independent corporate strategies to embrace Kremlin domestic and foreign policies. In this way Russia created a state gas export monopoly.  National control over private Russian companies was formalised as “Sovereign Democracy” by the head of the presidential administration, Vladislav Surkov.  According to Surkov, “our concern for sovereignty envisages certain economic restrictions... national capital should either control or dominate in several [strategic] areas”.  These strategic areas specifically pertain to Russian oil and gas .  In Putin’s own words, Gazprom now provides “a powerful lever of economic and political influence in the world” .

Energy and the motivation for Russian neo-mercantile strategy in the EU

Gazprom currently supplies around 50% of EU gas imports that in turn provides 60% of all Russian gas revenue. This equates to 20% of the Russian federal budget .  The importance of these gas revenues is demonstrated by Russian discussions with countries such as Qatar about the creation of a gas cartel similar to the OPEC oil cartel. This is an attempt to ameliorate the effects that the recent economic downturn has had on gas prices and the Russian economy. The Russian economy would be further affected if Russian market intervention precipitated effective EU gas diversification strategies.  Diversification of EU gas supply would require massive capital investment in transport and storage infrastructure.  The cost of diversification is not insurmountable, however, and would be justified by sufficient political or commercial pressure. Along with risks to the EU market, state control has come at a corporate cost to Gazprom.  Diverting revenue to government coffers has stalled investment in ageing Soviet-era infrastructure . 

Destabilisation of foreign investment security has also discouraged expert international exploration and Greenfields development.  As an example of this, intense political pressure was applied by the Kremlin to Royal-Dutch-Shell over its ownership of the Sakhalin-2 gas project in West Siberia.   This pressure resulted in the ceding of a controlling stake of 50% plus one share to Gazprom at sub-market rates .  This has vastly diminished expert development and threatens contracted EU gas supplies in the future.

Despite these operational and market based risks, powerful motivations for Kremlin defense of Gazprom is evident.  As a state vehicle Gazprom is not dependent on delivering shareholders returns for its survival.  Therefore, in serving Russian interests, Gazprom may undertake asset purchases and infrastructure developments that are incoherent in a purely commercial sense .  As a ‘National Champion’ Gazprom provides the Kremlin with domestic political cache by subsidising energy, social and infrastructure programs .  The distribution of gas wealth across the Russian economy has consolidated Kremlin influence among the middle and upper classes. 

Conclusion

Revenue delivered by Gazprom is essential to the Russian economy.  Delivery of capital to the state rather than corporate asset investment means that Gazprom operations depend on expanding revenue from EU gas markets.  For this reason, any gas pipeline that by-passes Russia or delivers non-Russian gas directly to the EU is viewed by the Kremlin as an existential threat. This defense of a fragile energy-export driven economy provides the Kremlin powerful motivation to engage aggressively with the EU gas energy market.