Friday, November 17, 2006

The World in 2007

Power politics

Edward Lucas
From The World in 2007 print edition

Russia will flex its energy muscles

A new power struggle between an increasingly assertive Russia (rich in oil and gas) and a weak-willed West will start in earnest in 2007. The big battleground will be energy.

Poland and its allies in the Baltic states will try to diversify their energy supplies, by agreeing to build a new nuclear power station at Ignalina in Lithuania, hooking up their electricity networks and accelerating their plans for a terminal on Poland’s northern coast to import liquefied natural gas. But Russia will find this little obstacle. Its cash-rich energy firms will step up their purchases of downstream firms in Europe.

Even ex-communist countries will be signing up for special deals with Russia. Hungary will increase its dependence on Russian gas; as an austerity programme bites into living standards and employment, cheap gas will be a useful lubricant. It will be a similar story with the leftist-nationalist government in Slovakia, which will face sharp disapproval from its west European neighbours because of its increasingly harsh treatment of minorities and its authoritarian ways. Friendly ties with Russia will be a welcome balance.

Farther east, Russian companies will continue to gobble up the energy infrastructure in chaotic Ukraine. In Belarus, rows with the Kremlin over energy are the most likely source of trouble for the regime of the eccentric autocrat Alyaksandr Lukashenka.

The Kremlin’s energy clout and cash pile spell doom in 2007 for plans to build new pipelines bringing non-Russian gas to Europe. Nabucco, a trans-Balkan pipeline which aims to bring Middle Eastern and Central Asian gas to Europe via Turkey’s excellent gas infrastructure, will be at the heart of the power struggle. The EU counts this as one of its top energy priorities. But without individual customers willing to sign up, and pay up, for its construction, buying more Russian gas through existing pipelines will seem an easier and cheaper option. In 2007 Nabucco will be forced to accept Russian involvement, including a hook-up to the underused Blue Stream pipeline that links Russia and Turkey.

Russia will develop its energy muscles in 2007. But it will flex them selectively. The Kremlin is keen to be seen as a reliable partner, playing by market rules. Those customers that pay on time will receive prompt deliveries. But countries and companies that challenge Russian energy hegemony will face short shrift.

Poland’s PKN Orlen, for example, which will complete its $3 billion acquisition of Lithuania’s clapped-out Mazeikiai refinery in 2007, will find itself facing a gale of financial and commercial pressure. Oil supplies from the Russian-controlled pipeline to the refinery will be erratic. The resulting fluctuations in its share price will be an excellent opportunity for Russian insider traders to make a killing—and build up their stake in the company. By the end of 2007, PKN Orlen will be trying to sell Mazeikiai, to Russian bidders. In next-door Latvia, Russia will continue to block oil transit to that country’s Ventspils terminal, again with the same end in view: acquisition of energy infrastructure at a bargain price.

Europe will also find that some of its alternative oil and gas suppliers will come into Russia’s orbit. A multi-billion-dollar arms deal with Algeria, and joint ventures in extraction and marketing, will underline Russia’s return as a major power.

That may dismay east Europeans, but Russia’s resurgence will bring juicy profits to financiers in London. Russian energy IPOs will be one of 2007’s most lively financial stories. Regulatory worries will be brushed aside. The profits will win Russia respectability—and influence. If a former German chancellor, Gerhard Schröder, can accept a well-paid directorship from a Russian-backed joint venture, why should other politicians and officials hold back?

America will worry more about Europe’s energy security in 2007. It successfully promoted the Baku-Ceyhan oil pipeline (which came onstream in the middle of 2006, connecting Azerbaijan and Turkey via Georgia); by early 2007 the gas pipeline from Baku to Erzurum in Turkey will be functioning too. But these will prove mere pinpricks in Russia’s advance.

The mood in the former satellite countries of eastern Europe is bleak. Where energy dominance is assured, political clout necessarily follows. Europe’s uneasy and reluctant adaptation to the new realities of energy politics will continue. Two decades after the Kremlin started beating the retreat from the Soviet empire, a new hegemony, based on pipelines rather than tanks, is advancing—and shows every sign of proving durable.

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