Nonetheless, whatever happens to the ruble, because Russia is so rich in natural resources, foreigners and Russians will almost certainly remain interested in investing in Russia, especially in mining and drilling. There will also even be some interest among Western manufacturers in opening up operations in Russia. If Russia promised to provide some tariff protection from foreign imports, that would probably attract even more investors. But encouraging more domestic production will not be easy nor assured. In part this is because fostering domestic manufacturing within Russia becomes all the more challenging when energy prices are high. The reason for this is that the higher energy prices go, the higher Russian export revenues are likely to be. To pay for their purchases of Russian oil, foreign buyers will need more rubles. This leads to a higher demand and thus a higher value for the ruble relative to other currencies. But this makes all Russian exports, not to mention the export of “expensive” Russian manufactured goods, less attractive compared to “cheaper” manufactured goods that can be imported from elsewhere, particularly Asia.
These are not easy problems to overcome. For that matter, Russia has never really been competitive in world markets. Certainly Russia has much to be proud of when it comes to advances in space and military technology. But almost all of these achievements are the result of a hothouse artificial environment where the Russian government has subsidized such developments through its military and space budgets. (The same can be said about the space and defense sectors in the United States.) Nevertheless, there is only so much that government underpricing and support can achieve at a time when an economic downturn has enveloped most of the countries of the world. As demand declines, energy prices fall. Even if the Russians offer to export their goods at a more competitive price, a recession, as in 2009, takes a heavy toll not only on the world’s buyers but on its sellers. As a result, even if Russian exporters lower their prices, potential foreign purchasers who might normally be interested in buying goods from Russia almost certainly will be forced to cut back on their consumption. Moreover, competing exporters will also cut their prices. That is why even in a recession, demand for Russian products including oil and gas is also likely to suffer.
What impact have these economic developments had on the Russian political scene? It was Vladimir Putin’s good fortune to be appointed prime minister in late 1999, near the end of Boris Yeltsin’s tenure as president at what turned out to be an economic low point. Beginning a few months later in 2000, however, the Russian economy began to grow an average of 7–8 percent a year until 2009, which just happened to coincide with the end of Putin’s tenure in office as president. As a result many Russian voters credit Russia’s decade-long economic prosperity to Putin’s actions as president. In reality, it is due as much as anything to the increase of world energy prices, which began in 1999 and continued until late 2008, just after Putin stepped aside as president and appointed Dmitri Medvedev as his successor. No wonder many Russians associate the sudden deterioration in Russia’s economic fortunes with Medvedev’s assumption of the presidency. In fact, Medvedev had no more to do with the drop in oil prices than Putin had do with their increase a decade earlier. If Medvedev is to be successful, he must win popular support. But unless the world recession comes to a quick end, he will have difficulty doing so as long as energy prices remain low and thus unable to boost Russia’s economic fortunes. This is a problem that Putin did not have to face. In a major way, then, the world price of energy has become a significant factor in determining the success or failure of Russia’s political leaders, an intriguing interplay of economics and politics.
Preface to the First Edition
More than in my past writing efforts, I owe thanks to a set of enthusiastic helpers. They provided invaluable help in preparing my manuscript. Two of them have the ability to read my handwriting, something I am not always able to do myself. Doing my best to ignore the advances of the modern computerized world, I prefer to write out the text in longhand on legal-size yellow pads. Robert Price was able to transcribe those writings for me onto a computer, so I was devastated when he went to work at a higher calling. To my relief Sue Sypko took over and proved to be as able, and, equally important, she hasn’t frowned when I bring her yet another set of nearly incomprehensive scribbles. In fact, I have taken to awarding her Stakhanovite prizes for her efforts. The third member is Coco Downey, who offered herself as research assistant and eagerly agreed to chase after obscure facts and display them in a way that aids the understanding of how things work in Russia. I have come to call her “the wizard.” After reading her charts and diagrams in the chapters that follow, I suspect the readers, even those in Russia, will agree that they can now understand the previously incomprehensible. The fourth and most unlikely member of this quartet is Thomas Luly, a most amazing high school junior. Out of the blue he wrote an e-mail asking if I needed any assistance. To humor him, I sent him an early draft of the manuscript and to my amazement, he not only read the whole thing and made extensive notes, but he found more inconsistencies in the text than I am embarrassed to admit should have been there. He also asked some probing questions that should help both me and I hope future readers deal with issues that are all too often skirted. I am indebted to all four of these collaborators, Robert, Sue, Coco, and Thomas.
John D. Grace also deserves a special note of thanks. He read the manuscript with admirable care and made some especially valuable suggestions, almost all of which I have incorporated. Of course I am ultimately responsible for whatever mistakes remain, but he and the gang of four spared me from many others.
Then there are others to whom I must also express my thanks. The RIA Novosti Press Agency provided me, as part of the Valdai Hills Discussion group, with the opportunity to meet with President Vladimir Putin on four occasions extending over an extraordinary twelve hours. They also took us out to the Priobskaia oil fields and Yuganskneftegaz and arranged a meeting at Gazprom headquarters. It was as if I had died and gone to heaven. They let me come along although invariably I asked the least respectful questions.
I must also thank Kathryn Davis, whose chair I held at Wellesley College, for her interest (even at her 100th birthday party) and for her financial support. She has helped to reassure me that there was always someone out there who was as interested in Russia and its sometimes troubling ways as I was. Her son Shelby and daughter Diana share much of that same enthusiasm.
Most of all, of course, I must also thank my wife, Merle. She has to put up with a lot, enough in fact to tighten anyone’s digestive system. While I often ask myself if I can withstand another of her brutal, yes, brutal, editing jobs, in the end I have to concede, but not directly, that I and the manuscript are better off for it. But after fifty-five years, it is a testimony to the strength of our marriage that we have survived a joint husband and wife writing and editing effort. There aren’t many couples I know of who can say the same thing, but Merle is special, and our children and I can never acknowledge how much we owe her.
Petrostate
Introduction
Russia—Once Again an Energy Superpower
THE AUTHOR AS JAMES BOND
At first I was puzzled. Where were they taking us? For such a big, sleek, glass Moscow high rise, Gazprom’s elevator in its headquarters building was tiny (five people could barely squeeze in) and its hall corridors narrow. This was, after all, the world’s largest producer of natural gas, not to mention Russia’s largest company. Following a short walk we were ushered into a darkened, silent room where nothing seemed to be happening. Strange.
It was only when all the members of our group had made their way up on the elevators that the room suddenly came alive. Then for a time I felt as if I had wandered into the NASA Space Center, or was it a James Bond movie set? All that was missing was that out of body voice intoning, “Welcome, Mr. Goldman. We were expecting you.”
In front of me, covering the whole 100-foot wall of the room, was a map with a spiderweb-like maze of natural gas pipe
lines reaching from East Siberia west to the Atlantic Ocean and from the Arctic ocean south to the Caspian and Black Seas. Manipulating this display were Gazprom dispatchers, three men controlling the flow of Gazprom’s gas to East and West European consumers of this Russian natural gas monopoly. No wonder there was tight security. There was also a sense of self-assurance. As measured by the value of its corporate stock, by summer 2006, Gazprom, this state-dominated joint stock corporation (until 1992 it was actually the Soviet Ministry of the Gas Industry), had become the world’s third-largest corporation. Only private shareholder-owned Exxon-Mobil and General Electric were larger.
With a flick of a switch, those dispatchers sitting in this Moscow room could freeze—and indeed have frozen—entire countries. At the very least, they could send their citizens off in a panic in search of sweaters, scarves, and blankets. What an empowering feeling! Should they choose to, those Gazprom functionaries could not only cut off natural gas from the furnaces and stoves of 40 percent of Germany’s homes but also the natural gas that many German factories need for manufacturing a range of products from ammonia fertilizer to plastics. While Germany purchases more natural gas from Russia than any other country in Europe, all of Western Europe is now also hooked up directly or indirectly to the Gazprom pipeline. In the extreme case, the Baltic states and Finland import 100 percent of their natural gas from Russia.
Here then in front of me was the natural gas distribution brain center for virtually the whole European continent. I could not think of anything comparable in Europe where such an essential commodity can be controlled by one country, and more than that, one company. In this very room the dispatchers factor in weather forecasts, special production needs, holidays, and, while they are reluctant to acknowledge it (in fact they deny it), a customer’s political correctness. Despite the fact that the Russian government owns more than 50 percent of Gazprom’s shares and President Vladimir Putin takes a very personal and intense interest in Gazprom’s operations, Gazprom officials insist that politics never, ever affect their calculations.
FIGURE 1 Dispatching Center at Gazprom Headquarters, Moscow. Gazprom is Russia’s largest company and the biggest extractor of natural gas in the world. Copyright © Mauro Galligani/Contrasto-Redux.
“Gazprom is a reliable energy partner” goes the mantra: it adheres to its contracts, guarantees delivery, and assures “energy security.” As Alexander Medvedev, the deputy chairman of Gazprom, told us that same morning, “What is good for a strong Gazprom is good for the world.” Reminiscent of Charles E. Wilson, the CEO of General Motors in the 1950s who boasted that “What was good for our country was good for General Motors and vice versa,” Medvedev’s pairing of Gazprom and the world is understandable but is as much off the mark as was Charlie Wilson’s earlier formulation.
Russia has not hesitated in the past to cut off the flow of both petroleum and gas to strengthen its side of a political dispute, a practice it inherited from its forebears in the Soviet Union’s Ministry of the Gas Industry and Ministry of the Petroleum Industry. Europeans are realizing how dependent on Russia they have become as each year they rely more and more on Russian natural gas imports. Gazprom and, by extension, the Russian government are already beginning to enjoy a power over their European neighbors far beyond the dreams of the former Romanov czars or the Communist Party general secretaries. President Vladimir Putin, with his control of Gazprom as well as another state-owned petroleum company, Rosneft, had become a real-life Dr. No—an archetypal James Bond villain, complete with a yacht and retinue. As President Putin at the time noted in a three-hour meeting following our Gazprom visit, Gazprom and Rosneft are very real and each year are accumulating more and more wealth and international influence, which they are using to advance the interests of the Russian state.
But it is not only Europe that finds itself each day becoming more and more dependent on energy exports from Russia. Although the United States is separated from Russia by oceans, it also is beginning to import and consume more and more Russian energy. As in Europe, the United States is trying to reduce its overreliance on energy imports from the Middle East. As part of this diversification, in 2005 the United States imported close to $8 billion worth of Russian petroleum. In 2006, that jumped by 25 percent to $10 billion. True, that represented only 3 percent of our petroleum imports—small, but an increase from the 2.2 percent of 2004 and a hint that we are likely to increase imports in the future.1 More than that, in 2000, LUKoil, one of Russia’s largest private oil companies, purchased nearly 3,000 filling stations in the United States from Getty Oil and Mobil and is now busily converting them into LUKoil outlets. It also should be noted that in 2006, Russia became the world’s largest producer of petroleum, producing more than Saudi Arabia. This is not the first time Russia has produced more petroleum than anyone else. It also reigned as the world’s largest producer in the late 1970s and 1980s. Even this was not unprecedented. As Table Intro.1 indicates, Czarist Russia from 1898 to 1901 also produced more oil than the United States, until then the leader.
Equally unusual, even though there are no natural gas pipelines connecting the United States with Russia, Gazprom is also beginning to export LNG (liquified natural gas) to the United States. For the time being, because Gazprom as yet lacks the technology to produce LNG on its own, it is a swap arrangement. These shipments under the Gazprom label actually originate in Algeria (in exchange, Gazprom pipes gas to some of Algeria’s customers in Europe), but by 2010, Gazprom anticipates (unrealistically) that it will supply as much as 10 percent of the natural gas the United States needs as LNG directly from its own fields.2 Given that the United States has fairly large natural gas reserves of its own and supplements domestic production with imports by pipeline from Canada, it is unlikely that the United States will ever become as beholden to Russia for its energy as Germany or Austria have become. Yet Russia’s emergence as an energy superpower will have a long-term impact on U.S. and world diplomacy if for no other reason than that our European allies will begin to think twice before saying “no” to Russia.
TABLE INTRO. 1 Russian and American Petroleum Production and Exports (mill. metric tons)
EUROPE BECOMES VULNERABLE
I had a chance to discuss this new strategic relationship with President George W. Bush at a June 2006 meeting in the Oval Office. The meeting was called to brief him before the G-8 meeting in St. Petersburg, which was to take place a few weeks later. President Putin as chairman of the 2006 meetings had repeatedly insisted that energy security and Russia’s role as a reliable supplier should be the general theme. “The Russian Federation has always abided by all of its obligations, fully and completely, and it will continue to do so.”3 Considering that only seven months earlier during a cold January 2006, Gazprom had curbed its flow of gas to Ukraine, which in turn reduced the flow to the rest of Western Europe, this was a rather dubious concept. Ostensibly, Gazprom justified the drop in gas exports to Ukraine, as well as to Georgia and Moldova, explaining that it did this because all three refused to pay the European market price. But since other Russian customers, especially Belarus and Armenia at the time, were also paying below European market prices, it was widely agreed that Russia was using its gas more as a political than an economic weapon.
As Russia’s customers have awakened to how vulnerable they have become to future cuts in their energy supplies, there are signs that this overdependence on Russian gas is already forcing at least some in Europe to have second thoughts about standing up to Russia. Nor are the European consumers the only ones who find themselves very much at the mercy of Gazprom. So far Gazprom also determines the fate of three other large exporters of natural gas. To their dismay, if they want to sell natural gas to Europe, Central Asian gas producers such as Turkmenistan, Kazakhstan, and Uzbekistan have no alternative but to ship it through the Gazprom pipeline. This is a legacy of the Soviet era when it was only logical to consolidate shipments of gas produced within the republics of the Soviet Union through one uni
fied system. After all, what did it matter if the gas to be exported came from Uzbekistan and transited through Russia? They were both parts of the Soviet Union. But when the Soviet Union disintegrated in 1991, Gazprom assumed ownership of the bulk of that pipeline, and the newly independent countries in Central Asia, which were previously republics of the USSR, had no other outlet of their own to the West. As a result, this post-1991 monopoly control of the natural gas pipeline allows Gazprom to hold down the price it pays to the Central Asian producers for their gas. In 2006, for example, Gazprom paid less than $50 per 1,000 cubic meters while selling this same gas to the Europeans at prices averaging $230 per 1,000 cubic meters.
FIGURE 2 Primary Russian Oil and Gas Pipelines to Europe (U). Source: EIA.
FIGURE 3 Russia: Government Proposed Far-East Oil and Gas Pipelines (U). Source: EIA
Petrostate:Putin, Power, and the New Russia Page 2
