Hasan Selim Ozertem Eurasia Expert USAK/JTW printable version send your friend message to author add comment ()

Friday, 13 February 2009

Every year starts with new hopes, great expectations, and efforts to forget bad memories of the past. While nobly intended, I feel that we only change the calendar and begin, once again, counting down each day until the New Year.

Unfortunately, this feeling of mine failed to change once again due to two crises which broke out just next door of Turkey. One of them was the gas dispute between Russia and Ukraine, which has become a tradition, and the other one was Israel’s Gaza operation, the effects of which were felt even in the Davos Summit. Even though the second one is not in the framework of this article, I still/continue to wish a long lasting peace would come to the Middle East, bringing stability and prosperity to the region.

A Ritual or the Rules of the Game?

So, what do Russia and Ukraine want from each other? Peter Rutland describes the ongoing dispute as an annual ritual that breaks out in January between Russia and Ukraine, as Ukraine complains about the transit payments and being overcharged by Russia for its natural gas consumption.[1] The book was published in 1999, but the main discourse has not changed in 10 year time period.

In the past few years, Russia has followed a more pragmatic policy while selling its natural gas to major consumers in Europe. It can be described as multi-vector market domination, since Russia follows a pro-active policy having both economic and political concerns. While conducting this policy, Russia is also well aware  its comparative advantages. It is a known fact that Russia has the richest natural gas reserves in the world, and it has inherited not modern, but well established distribution and extraction infrastructure.

So, what are the pillars of Russia’s multi-vector market domination?  First, Russia is gradually increasing the price of natural gas. Gazprom executives talk about market prices, but it is mainly the Russian locomotive that gives signals to the market to increase prices. Here is the question: what are the dynamics of the market, and who decides the prices? It is known that oil and gas prices move together. Alexey Miller states that natural gas contracts are based on price formulas which depend on petroleum prices for nine months.[2] However, as the price of oil has decreased more than 60% since the global economic crisis broke out, we are talking about $400 - $500 of price level for 1000 cubic meters. I am well aware of the fact that Russian Ural Oil price decreased 20% in the last nine months and because of this there is a lag effect in down trend of natural gas price. However, if we are talking about market dynamics, the environment of the financial crisis should be taken into account, and these prices should be reassessed. But as known, while renewing their contracts with Ukraine, Russia insisted on these numbers. Gazprom authorities say that this system helps consumers to make better predictions regarding the future. However, unlike oil, it seems that there is rigidity in the market. Therefore, it does not seem to be an advantage, but rather an unbalanced situation between the producer and consumers.

Secondly, Russia not only controls the demand market, but the supply market too. Due to its existing infrastructure system inherited from Soviet times, Russia has the monopsony power (the sole buyer) in this region and it has a higher hand on energy politics in the region. This helps Russia to strengthen its position in a political sense, and also provides a certain amount of rent for Gazprom. However, in the last decade as new projects gained impetus in the region, Gazprom’s threat perception regarding its advantageous position has become more sensitive.

Until 2008, the payments made to Central Asian states were really funny, when the Russian revenues from the Western market are taken into account. Turkmenistan and Uzbekistan were receiving just two digit numbers for 1000 cubic meters of gas, while Russia was earning triple the amount. Beginning in 2008, Gazprom agreed to pay higher prices of around $350 - $400 to these states.[3] This also caused the tension to increase the price level and brought legitimacy to Russian price policy. However, it is not only the legitimacy advantage we are talking about; within the framework of these agreements Russia has also guaranteed its dominance in the region, at least in the medium term, thanks to strong interdependency it created with these agreements.  Thus, while proposing higher prices it has also eliminated the other options since the states in the region got what they want (hot money) from their new agreement with Gazprom.

In fact, the West’s problem of creating a consistent foreign policy towards the region paved the way for Russia to become the dominant actor in the region, despite of losing its higher hand after the collapse of the USSR. But still it is hard to be pessimistic about the future, because the states in the region would assess their concrete options to be able to balance Russia.

Thirdly, Russian dominance in the gas sector via well known Gas OPEC politics is another factor in Russia’s multi vector policy. Gazprom authorities claim that it is only a forum for discussing developments in the gas industry, but many think that it also represents a cartel structure, since all these states hold almost 60% of the proved reserves in the world. Any common decision that would be taken among these countries would have direct effect on the market.

Lastly, it seems that Russia also wants to be the dominant actor in the transmission sector. The Nord Stream Pipeline project, between Germany and Russia, directly by-passes any third party on its way to reach Western Europe. When this pipeline is completed, it will carry 55 bcm per year. Moreover, Russia wants to decrease its dependence on Ukraine while sending gas to Europe. As known, around 80% of Russia’s gas exports pass through Ukraine, and any problem in their bilateral relations causes an energy crisis in the continent. After this crisis, pipelines like South Stream and Nabucco have become popular once again. One may say that Russia is gambling, but as known, profit that you will get at the end of the game is directly related to the risk taken. If it succeeds to build this pipeline, then it will send 85 bcm of gas, bypassing both Poland and Ukraine.

In the last crisis I have some doubts regarding Gazprom’s declaration that it was only economic concerns that caused this serious problem to emerge, just in the middle of winter. It is true that we are talking about two billion dollars of Ukrainian debt, but it is estimated that Russia’s total loss was also two billion dollars due to gas disruption. But it may worth it, because Russia could easily control Ukraine’s caprices, such as their desire to become a member of NATO or limiting the Russian navy’s presence in Crimea, if it ccould bypass Ukraine and sell its gas directly to Europe?

To conclude, we may say that reel-politics are back in business, and the Russia-Georgia war was the beginning. And unlike Europe’s dilemmas, Russia takes –may be too much- courageous steps in the game.

Hasan Selim Ozertem
hozertem@gmail.com