With global energy needs growing at an unprecedented rate, the world has come to consider Russia as an increasingly important source of energy. Holding substantial oil and natural gas reserves, Russia stands as an attractive option for a world desperately in search of new sources of energy. Against this backdrop, Europe has become increasingly dependent on Russian energy imports, leading many analysts to view such a relationship as a dangerous predicament rather than a mutually beneficial exchange. As key allies to the United States, Europe’s energy dilemma stands as a mounting issue that may not only affect the region, but also the broader transatlantic alliance. Hence, this post seeks to analyze Russia’s reliability as a source of energy supply to Europe. In doing so, this post will first examine Russia’s current energy situation with regards to its oil and natural gas sectors, energy strategy, and infrastructure. This post will then analyze Russia’s political dynamics with Europe, examining if such a dependence on Russian energy is problematic for the region.
The current substantial rise in global crude oil prices reflects the insatiable energy demands of an expansive world economy being nourished by only moderate energy supplies. While global oil consumption rose by 1.1 million barrels per day (bbl/d) in 2006, the Organization of Petroleum Exporting Countries (OPEC) announced plans to cut production in the same year by 1.2 million bbl/d. Concurrently, non-OPEC production has been unable to keep pace with global oil demand, with production declines evident in Mexico, the United States, Norway, and the United Kingdom. Such a decline in production vis-à-vis high demand has led crude oil prices to rise substantially to an unprecedented US$ 96.32 in November of 2007.
Within such an unbalanced scenario, it is of little surprise that the outside world has increasingly turned its attention to alternative suppliers like Russia. As the Energy Department stated in its short-term outlook, “Russia and other countries of the former Soviet Union combined are projected to account for nearly half of the gain in non-OPEC supplies in 2008.” Such a renewal of interest in Russia’s energy resources has had direct effects on the country’s output. Russia’s total liquids production has increased substantially in comparison with its relatively low production in the mid 1990s, experiencing a turnaround in output in 1999.
Relative to OPEC producers, Russia’s output is also seen as a significant source of energy. While OPEC production growth was negative in 2006 and 2007, Russia and Caspian Sea production levels were concurrently positive, signaling the country’s role in compensating for OPEC’s lower production levels. Despite the Energy Department’s forecast of a substantial increase in OPEC production in 2008, current news reports indicate otherwise, as OPEC’s main producer, Saudi Arabia, has recently rejected lifting OPEC oil supply. Thus, the demand for Russia’s energy exports is likely to remain in the short term.
Given Russia’s role as an energy supplier, what is the country’s energy situation? What are the Russian oil and natural gas reserves that have acquired the world’s attention and demand? Furthermore, what are Russia’s production levels relative to increased world consumption? The largest country in the world, Russia is located over a landmass of considerable oil and natural gas endowments. Holding around 60 billion barrels of proven oil reserves, Russia’s oil reserves are the eighth largest in the world. Most of the country’s oil is located in Western Siberia, between the Ural Mountains and the Central Siberian Plateau, although Eastern Siberia has been reported to have some 35 million barrels of oil. With such oil endowments, Russia ranked second behind only Saudi Arabia as the world’s top oil producer in 2006, producing approximately 3.5 billion barrels that year. Despite Russia’s significant oil production, the country’s true energy potential lies in its abundant natural gas reserves. The largest gas endowments in the world, Russia’s 1,680 trillion cubic feet of natural gas reserves are twice as large as those of Iran, which has the world’s second largest reserves. In 2004, Russia was the world’s largest natural gas producer (22.4 trillion cubic feet (Tcf)), as well as the world’s largest exporter (7.1 Tcf). In 2006 Russia was the second largest producer, behind the United States but ahead of large producers in the Middle East.
Russia’s substantial production of oil and natural gas has had a positive impact on the country’s economy. Comprising 20 percent of Russia’s GDP in 2005, the oil and natural gas sectors generated 60 percent of Russia’s revenues and 30 percent of the country’s foreign direct investment that year. In 2007, the sectors’ share of GDP has risen to 64 percent of Russia’s revenues. A possible correlation between increased production levels and a rise in GDP is seen in Russia’s GDP values starting in 1999, when the country’s production levels began to rise. Although Russia had experienced a persistent decline in GDP from 1991 to 1999, the country began to experience a consistent rise in GDP since 1999, from US$ 195 billion to the current value of US$ 986 billion. Thus, it is possible that high oil prices may have substantially contributed to Russia’s recent economic expansion.
But all the positive effects of energy production on Russia’s economy also demonstrate the country’s current dependence on oil and natural gas. Russia is highly vulnerable to fluctuations in world oil prices. It is reported that an annual US$1 per barrel increase in Urals blend oil prices raises federal budget revenues by 0.35 percent of GDP. Russia’s widening current account balance also reflects its economic dependence on high oil prices. As stated in a World Bank report, record oil prices pushed Russia’s current account to a record high of US$ 56.5 billion, a 32 percent increase from the first half of 2005. Russia has registered a substantial increase in its current account surplus since 1999, having increased concomitantly with Russia’s GDP and production levels.
While trading the currently high-priced hydrocarbon commodity can bring quick income to the government, economic dependence on the oil and natural gas sectors places the economy in the hands of volatile resource revenues. As stated in an in-depth study of the Russian energy sector by the Swedish Ministry of Defense:
Russia’s reliance on … hydrocarbons … demonstrate[s] that there is a risk of … a ‘resource curse’ … which bring[s] along risks of long term problems in terms of trade, revenue volatility, ‘Dutch disease,’ [and] crowding out effects.
In terms of resource volatility, the World Bank report on Russia’s economy concluded that a sharp fall in oil prices could lead to a steady evaporation of Russia’s current account surplus, and quickly push the country’s balance of payments into deficit. Therefore, while in the short-term Russia’s economic boom is feasible, its sustainability in the medium to long term might heavily rely on high oil prices.
Given the importance of energy to Russia’s economic expansion, it is of little surprise that the Russian government regards energy resources and economic security as closely linked. According to Russia’s latest energy strategy, published in 2003, the government’s key objectives is to strengthen the position of Russia in the global energy market, maximize the efficiency of Russia’s energy exports, and ensure that Russian companies have equal access to foreign markets, technology, and financing. Such an endeavor demands full attention of the Russian government in order to ensure Russia’s energy security – an important feature of Russia’s national security.
Hence, since the “Yukos affair” in 2003, Russia has been increasingly incorporating the energy sector under state control. The dismantlement of Russia’s largest private oil company, Yukos, unleashed a reorganization of Russia’s oil and energy sector that has led to the strengthening of the state’s position in energy. Non only did the state purchase most of Yukos’ assets, making the state-owned company Rosneft the largest in Russia, but the Kremlin also carefully placed members of President Putin’s inner circle in key positions in strategic companies. As stated by a study conducted by the Polish Centre for Eastern Studies, “these nominations were not just about granting lucrative posts to the president’s people; above all it was a sign that these same people were to coordinate the Kremlin’s new policy towards the oil sector.”
The Russian government’s presence in the energy sector is tangibly noticeable in Russia’s two major state-owned energy companies, Gazprom and Transneft. Responsible for 90 percent of Russia’s natural gas output and all of the country’s domestic and international gas pipeline networks, Gazprom stands tall as one of Russia’s most important energy players. The largest gas company in the world, Gazprom has no valid natural gas competitors both domestically and abroad, holding 17 percent of the world’s proven gas reserves, and producing 19.4 percent of global natural gas output. It is of little surprise, therefore, that a company of such stature in Russia is managed by a number of Russian officials close to President Putin. These officials include the First Deputy Prime Minister Dmitry Medvedev, the Minister for Economic Development and Trade, German O. Gref, the Minister for Industry and Energy, Viktor Khristenko, and the special representative of the President for International Energy Cooperation, Igor Yusufov.
In the oil sector, apart from owning Russia’s largest oil company, Rosneft, the government exercises control over the sector’s pipeline system. As noted by the Swedish Defense Ministry, “in short, the Kremlin controls the oil tap.” Controlling crude oil transport by pipeline, state-owned Transneft monopolizes a highly strategic segment of Russia’s oil sector. As the case with Gazprom, Transneft’s board of directors is comprised of key Kremlin officials, namely the head of the President’s Expert Department, Simon Vainshtock, the Deputy Minister for Industry and Energy, Andrev Dementiev, the Deputy Head of Russia’s Federal Property Management Agency, Yuri Mevedev, and the Minister of Industry and Energy, Viktor Khristenko.
Given Russia’s energy situation and strategy, who are Russia’s main consumers? Following Russia’s oil and natural gas pipelines will lead the analyst straight in the direction of its most important market, Europe. Although Russia’s oil and natural gas pipelines are spread out across Eurasia, these pipelines reach out to most of Eastern and Western Europe. With 80 percent of Russia’s oil exports and 60 percent of the country’s natural gas flowing to Europe, the region is evidently an important market for Russian energy exports. Last year, of the almost 4 million bbl/d of Russian crude oil exports, 33 percent flowed through the Druzhba pipeline alone, providing Belarus, Ukraine, Germany Poland and other destinations in Central and Eastern Europe, such as Hungary, Slovakia, and the Czech Republic with Russian crude oil. In terms of natural gas supplies, Gazprom has shifted much of its exports to serve the rising demand of the European Union. European countries comprise the majority of Gazprom’s consumers, as well as the largest amount of Russian natural gas exports.
Such a situation - whereby Europe has become increasingly dependent on Russian energy imports while Russia has increased control over its energy sector - is seen to have set the stage for Europe’s energy dilemma. Europe’s vulnerability to Russian energy imports was made most obvious and alarming during the Russia-Ukraine natural gas dispute in 2006. The Ukrainian gas pipeline system plays a strategic role as an intermediary connecting Russia to growing European markets, with 80 percent of Russia’s natural gas exports to Europe transiting through Ukraine alone.[1] When a longstanding dispute over price and payment mechanisms between Gazprom and Ukraine reached an impasse, the Russian company shut off gas supplies to Ukraine, affecting consumer countries in Europe. Currently only two natural gas pipelines reach Europe from Russia – one through Belarus, another through Ukraine – making Ukraine’s location strategically important for Russia’s natural gas exports.
While some analysts argue that Gazprom’s move was entirely business-driven - since Ukraine still paid a cheaper price for Russian natural gas than its real market value - others contend that state-controlled Gazprom served as a foreign policy tool for the Russian government. As Ukraine had recently undergone the pro-Western Orange Revolution, ousting a pro-Russian government, some viewed such cut-offs as a foreign policy lever to punish the newly pro-Western Ukraine for politically distancing itself from Russia’s sphere of influence.
What does the Russia-Ukraine natural gas dispute mean for Europe? Some analysts are increasingly concerned that if Russia’s main motivation in cutting-off natural gas supplies to Ukraine was politically driven, then energy-dependent Europe could find itself in a similar predicament. Most alarming is the fact that many large European countries are particularly dependent upon Russian gas. Gazprom’s largest consumer of Russian gas in Western Europe, for example, is Germany, the region’s leading economy, with 43 percent of its imports coming from Russia alone. As Ukraine and Belarus pipelines connect Russia to Germany, any stalemates in Russian relations with both Eastern European countries can significantly impact Germany’s - and Europe’s - economic stability. As other major countries in Europe, such as France, Austria, and Italy, also import significant amounts of natural gas from Russia, this destabilizing effect could also occur in these countries. Thus, it is evident that should geopolitical events in the future lead Russia to politically coerce Europe, Russia would have the necessary tools (namely Gazprom and Transneft) at its disposal to do so.
Several analysts judge that the former Soviet giant’s strategy is to make Europe increasingly dependent on Russian oil and natural gas. Russia expert Ariel Cohen at the Heritage Foundation claims that the country is consolidating its grip on Europe’s economic lifeblood by locking in demand and supply of oil and gas, and consolidating its control of alternative sources of gas supplies from Central Asia. On the demand side, Cohen points out that Russia has locked in European demand by signing long term bilateral contracts with most European countries, including France, Germany, Italy, and Austria. On the supply side, Cohen refers to Russia’s increased control of strategic pipelines throughout Europe and Eurasia, with Gazprom purchasing strategic infrastructure in Georgia, Hungary, Ukraine, Slovakia, while actively opposing Western-controlled pipeline projects linking Central Asia to Europe. For example, in a May 2007 deal with Turkmenistan and Kazakhstan Russia thwarted a US-EU plan for a trans-Caspian pipeline that would have enabled Central Asian oil exporters to bypass Russian-controlled routes by way of Caspian Sea-Turkey direction; the Prikaspiiski gas pipeline will carry gas from Turkmenistan to Russia via Kazakstan. In Europe, Russia is constructing the Nord Stream pipeline that will link Germany directly with Russian gas through the Baltic Sea, circumventing Ukraine, Belarus, and Poland.
Against this backdrop, it has been increasingly noticeable in the media that Russia’s foreign policy has become more assertive. As frequently noted in daily news reports, the list of confrontations with the West has been growing – leading some to refer to the post-Cold War period as a “Cold Peace.” Russia’s assertiveness in foreign affairs is evidenced in mounting recent developments, such as Russia’s
– Opposition to the U.S.-proposed missile shield
– Cyber attack on Estonia
– Spy scandal dispute with Britain
– Russian bomber violations of Norwegian airspace
– Refusal to sanction Iran on uranium enrichment
– Explosion of the largest-ever non-nuclear bomb in October
– Control of natural gas to Europe.
These developments indicate that Russia’s energy-driven economic boom has given the country a newly-found confidence that is driving Russia to project itself more assertively in international affairs.
If Russia’s strategy to increase Europe’s dependence on Russian energy imports is the case, then it follows that such dependence could complicate the transatlantic alliance between Europe and the United States. Ariel Cohen believes that Europe’s dependence will significantly limit the region’s ability to cooperate with the United States with regards to issues that Russia disagrees on; Europe’s dependence might force the region to choose between an affordable and stable energy supply on the one hand, or siding with the US on key issues on the other.
Yet, what is the likelihood that Russia would use energy as a foreign policy tool of coercion against Europe? Russia’s 2003-2020 energy strategy recognized Europe as a vital source of economic safety for the country and focused on Russia’s reliability as an energy supplier to its most important market.
During the forthcoming 20 years, we have to realize the export abilities of Russian fuel energy complex and secure the economic safety of the country, remaining the stable and reliable partner for the European countries … The market of Central and Western Europe remains one of the greatest markets in the forthcoming 20 years.
Thus, given the importance of European markets for Russia’s economic sustainability, one can also say that Russia is just as dependent on Europe as Europe is dependent on Russia. A situation of mutual dependence arises whereby each party provides the lifeblood for the other’s economy – with European demand providing for Russian economic growth, and Russian energy sustaining European economies. Writing for the British Ministry of Defense, Michael Fredholm noted that
… even if Russia for political reasons felt obliged to take such a drastic step, disregarding the negative political fallout with the EU, the decision would drastically reduce revenues from export and thus be counter-productive to the Russian ability to go it alone.
Yet, Fredholm also notes that while in the short term this mutual dependence will constrain Russia from exercising political or economic pressure on Europe, mutual dependence will only go so far as long as both parties perceive a need for each other. “He who has nothing to lose will not hesitate to break a relationship of mutual dependence,” writes Fredholm. Thus, in the long term, geopolitical or economic situations may arise that call for Russia to change its political position towards Europe. Such situations could include Russia’s economic diversification and independence from energy commodities, or an eventual political crisis with the United States stemming from the aforementioned geopolitical developments that continue to tarnish Russia’s relations with the West.
Conclusion
The search for new energy supplies has interwoven Europe and Russia into a relationship of mutual dependence. While Russian oil and natural gas imports provide much of the lifeblood of European economies, Russian energy exports are largely sustaining the current Russian economic growth. Such dependence on Russian energy supplies, particularly natural gas, has led many analysts to worry about Europe’s potential vulnerability to Russia’s grip on energy. Yet, in the short term Russia is unlikely to wield energy as a foreign policy lever over Europe, as it currently streams revenues into Russian coffers while Russia pumps energy into European countries. In the long term, however, the tables may turn depending on how this former Soviet giant perceives the geopolitical realities around it, and if it is able to diversify its economy enough to become less dependent on exports of high-priced commodities.
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