Russia Looks Both East and West

As the Group of Eight industrial countries meets in St. Petersburg, Russian oil supply to Europe and western countries was a prominent topic of conversation. Russia supplies 25 percent of the EU’s oil. Russia also looks east to China and South Korea to expand its markets for oil and natural gas. Several projects under negotiation between Moscow and Asian governments would increase the Russian supply flowing east. Access to Russian oil diminishes oil-demanding countries’ dependence on volatile supplies from the Middle East. Many European observers complain, however, about Russia’s heavy-handed state-run companies. Also on top of the agenda at the summit: Iran and its current standoff with many of the G-8 countries, since the Islamic Republic could become an important conduit for oil coming from Russia as well as landlocked Central Asian nations. – YaleGlobal

Russia Looks Both East and West

Andrew Symon
Thursday, July 20, 2006

ST PETERSBURG has always been the city from where Russia has looked out to the West. And this weekend, when leaders of the Group of Eight (G-8) industrial countries (Canada, France, Germany, Japan, Italy, Russia, the United States and the United Kingdom) meet to discuss world affairs, high on the agenda promoted by Russian President Vladimir Putin will be energy security and Russian oil and gas supply to Europe and the West.

But Russia's potential to be a major exporter to North-east Asia and its strong influence over the greater geopolitics of supply from oil- and gas-rich Central Asia to the East, as well as the West, should also not be overlooked. Indeed, it is Russia's energy role that is the biggest card that Moscow can play when it argues for a prominent place at high-level Asia government forums and organisations.

The spotlight on Russia's energy relationships with the West follows from the disruption of natural-gas pipeline supply in January to Europe, when Moscow challenged the Ukraine ostensibly over gas prices - although the greater issue, the Ukrainians argued, was Russia's desire to control their pipeline system. The stand-off between the two resulted in Russia temporarily turning off Ukrainian supply - which had the effect of reducing supply to other parts of Europe as the Ukrainians drew on transit gas to make up for their shortfall.

With Russia supplying 25 per cent of the European Union's gas, the incident pointed to what many felt was over-dependence on Russia, and vulnerability should Moscow choose to use gas supply for political leverage.

The interruption was unprecedented. Nothing of the sort had happened in the 30-odd years of pipeline supply to Europe from Russia. In Soviet days, pipeline supply was quarantined from Cold War politics as it was such an important source of foreign exchange. Arguably, this remains the case today. Russia badly needs the export revenue. Russia is as dependent on market security as its consumers are on supply security.

Oil is another trump card for Russia, now the world's second-largest oil supplier. Russian supply greatly reduces reliance on Middle East supply. Almost all of Russia's oil flows west. But Asian consumers do benefit even if they do not directly take Russian oil, as the oil market is a flexible worldwide commodity market. Russian oil to the West tops up a worldwide reservoir that is available to all.

Natural gas is different. Gas supply is geographically inflexible. Russia's gas supply west does not lead to more gas being available on the other side of the world. Unlike oil, which can be simply and cheaply put in shipping tankers at ports at the end of pipelines, gas cannot be easily or cheaply shipped around the world. There are still cost and logistic limitations to the emergence of a true worldwide trade in shipped liquefied natural gas (LNG).

Nevertheless, the future will see Russia become an important natural-gas supplier to North-east Asia. The question is how soon. The often technically and commercially difficult project developments are being slowed by politics and Mr Putin's reassertion of a dominating role for the state.

A first major new energy supply to the East will begin though, next year, when LNG supply for Japan and South Korea and the US West Coast from a Shell-operated plant commences from Sakhalin Island north of Japan in Russia's Far East. Longer term, this LNG supply should be bolstered by other fields offshore from Sakhalin. Proposed also is gas pipeline supply to South Korea and Japan, although these projects are more economically difficult than LNG supply.

Gas pipeline supply from Russia's eastern Siberia is also targeted - although how far away that is is a moot point. Long-distance, high-volume pipeline supply to north-east China and South Korea has been on the drawing board for at least a decade.

At the forefront is the Kovkyta gas field development near Irkutsk north of Mongolia. This huge gas field is a major play for the joint venture between Russian private-sector company TNK and the UK's BP. Various memoranda of understanding, feasibility studies, and broad but not binding volume supply agreements have been signed and carried out by the Russian, Chinese and South Korean governments.

But the project has stalled even though China needs large volumes of gas and South Korea has long wanted to diversify its gas supply away from reliance only on LNG imports. Achieving agreement over prices is one reason for this, especially with China, as gas must compete with very low local coal prices in the all-important power-generation market.

But a more serious obstacle now seems to be the giant Russian state-controlled company, Gazprom. Gazprom wants to monopolise gas pipeline supply and export in the East in the same way that it does in the West. Earlier this year, TNK-BP offered Gazprom a 50 per cent direct equity stake in the Kovkyta project, provided that gas would be sold to China and South Korea and TNK-BP was in charge of field operation. But there has been no response and just how the project proceeds must await direction from Moscow.

Russian oil supply east has seen China vying with Japan as the prime destination. While there is a world market for oil, it remains an abiding policy objective of consuming countries in North-east Asia to geographically diversify sources of supply.

Russian supply east promises then to somewhat limit damage from any interruption to Middle East supply. The outcome of the oil bargaining between the three countries is a 4,100km pipeline costing US$6.5 billion (S$10.2 billion), construction of which began in May. This will eventually take Siberian oil to the Russian Pacific Coast near Nakhodka. A spur line in the course of the pipeline is likely to run also into China. At present, Russian oil enters China by rail and road. Increasing volumes of oil are already being supplied to Japanese and other Asian markets from Sakhalin Island.

Russia's oil and gas resources in the East seem considerable, although there needs to be a great deal more exploration in what are very harsh physical conditions. Currently, the bulk of Russia's identified reserves are in Western Siberia. And infrastructure is oriented towards the West. But Moscow says it now wants to give much more priority to Asian markets to the east.

In part, this is a response to recent frictions with Europe. On top of the gas pipeline supply issue, the West has criticised Moscow for the increasing role of the state in the petroleum industry through heavy-handed and opaque methods, as in the case of the absorption of prime assets of the private-sector Yukos oil company into the state-controlled Rosnetf in late 2004 after the jailing of Yukos' head Mikhail Khodorkovsky for tax evasion.

Underlining the direction of Russian policy, regulations have recently been instituted preventing foreign companies from taking up new majority stakes in large oil and gas fields and prohibiting private companies from constructing and operating gas and oil trunk lines. This month, a new law was also passed explicitly giving Gazprom a monopoly over all Russian gas pipeline exports. Moscow, for its part, says there are barriers to its companies in the West, especially Gazprom's entry into downstream gas distribution and retail segments in Europe.

The story does not end with Russia's own resources and supply. Russia is still the main gatekeeper for supply from Central Asia as most of this landlocked region's oil and gas pipeline infrastructure connects into the Russian system - another legacy of the Soviet empire. Naturally, Moscow wants to maintain its influence over Central Asian supply patterns and gain benefit from them.

But alternative oil and gas pipelines west through Turkey and east to China are coming into operation. The first stage of what will be large-scale Kazakhstan oil supply to China came into operation late last year with the commissioning of a 1,000km cross-border pipeline. China is also looking at taking gas from Kazakhstan in light of the delay in the Kovkyta supply.

Moscow of course would prefer to see gas and oil transiting through its system. It is also possible to see Russian supply being pushed into China through new pipelines through Central Asia.

Longer term, Iran is critical to supply and export diversification for Central Asia. Iran could provide a corridor for landlocked Central Asian oil and gas to the south - and possibly also for Russian oil and gas - and onto markets in Asia. Oil and gas could be piped over short distances relatively cheaply to northern Iran, the country's most heavily populated and industrialised area. Swops could then be made with Iranian production in the south on the Gulf and these exported.

But this trade would depend much on normalisation of Iran's relations with the West, especially the US. Otherwise, there are unlikely to be the flows of foreign investment and technology needed for its development.

Thus, the other main issues at St Petersburg - Iran and fears that Teheran's nuclear power programme will lead to weapons capability - are inextricably linked with worldwide energy security and Russia's oil and gas role and ambitions.

The writer is the Singapore-based Asia manager for the UK political-risk consulting firm, Menas Associates.

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