The absentee landlord

As world leaders gather for the G8 summit in St Petersburg on 15 July 2006, the main item on the agenda will be the question of energy security. It would be unwise to expect any radical breakthrough at the summit, given the fundamental differences in approach among the countries represented, and the general lack of trust between Russia and its Western partners.

Many Western commentators are now arguing that Russia is not democratic enough to be treated as a reliable energy partner. This argument is a little disingenuous, since there is nary an OPEC member that would pass any test of democratic accountability. Questions of democracy aside, Russia is still critical to a successful resolution of the crisis over Iran’s nuclear ambitions, so Western leaders will be at pains to cooperate with President Vladimir Putin in ensuring that the summit conveys at least the appearance of success.

Energy security is a real challenge for G8 leaders — and one whose complexity they will not be able to unravel during a few days of summitry under St Petersburg’s White Nights. The problem is not so much the level of supplies as the fluctuations in price. Oil prices are notoriously volatile, seesawing between $10 and $70 per barrel over the past decade. With both supply and demand inelastic in the short run, shocks on either side can send prices soaring or plummeting. Natural gas has been less volatile, though with its price tripling over the past year it is now drawing closer to the pattern of oil prices.

Both energy-importing countries and energy exporters pay lip service to the importance of energy security, but they each have a very different take on what that term means.

As the world’s second largest oil exporter and number one gas exporter, Russia has a strong interest in ensuring stable — and high — energy prices. In contrast, energy-importing countries want stable and low prices. For them, energy security means a diversity of sources, which serves as a guard against risk and has the added advantage of driving down price through competition.

Currently, neither customers nor suppliers seem very willing to create new institutional structures that would reduce instability if that would mean locking them into a price that is higher (or lower) than what they hope to pay.

In the run-up to the summit, President Vladimir Putin has hinted that he would like to see some sort of framework that would guarantee stable supplies at stable prices. In practical terms, this is a non-starter. Apart from Russia, the key oil producers are not represented at the G8 table, nor is China, the second-largest consumer.

The Western nations don’t want to lock in energy prices with oil at $70 a barrel, and anyway their concept of how to move forward involves things such as open international access to pipelines (a plank of the 1994 European Energy Charter): something that is anathema to Russia. Russia is already the odd man out in the G8: it is the least wealthy and least democratic member of this club of wealthy, democratic nations. The energy issue merely serves to reinforce Russia’s isolation, since Russia and Canada are the only two countries among the G8 that are net energy exporters.

Putin has some cards up his sleeve that he can play to put pressure on his Western partners, such as tenders for joint ventures in Russian oil and gas fields, and even the threat of shifting supplies from Europe to Asian markets. Putin and other officials have dropped not-so-subtle hints along these lines in recent weeks. But these incentives are not sufficiently concrete to persuade Western leaders to go along with some as-yet-unspecified Russian plan to create a new international energy order.

Unfortunately, the energy issue may turn from a hypothetical to an actual topic on the eve of the summit itself. There is a danger of a repeat of the damaging natural gas showdown that erupted between Russia and Ukraine this past January. The temporary, six-month deal patched together on 4 January has now expired, and there is no agreement in place to cover deliveries starting 1 July. Moreover, Kiev has managed to run up $600m arrears for gas supplied between January and April of this year, a sum being covered by hastily arranged loans from European banks.

The basic situation is deceptively simple, but finding a solution has proved impossibly complex. The core problem is one of geography, with Ukraine sitting astride the transit route for Russian gas headed to Europe.

Europe imports 25% of its gas from Russia, and now pays some $230 per cubic metre. For its part Ukraine has become accustomed to securing low-cost gas from Russia to fuel its energy-guzzling industries. In 2005 Russia announced that it was no longer prepared to sell gas to Ukraine at $50/cm, and also pressed for repayment of the $1.6bn in arrears that Ukraine had accumulated since the 1990s.

The Ukrainians complained that the Russian action was political, intended as punishment for the Orange Revolution of December 2004 which saw the pro-Western Viktor Yushchenko ascend to the presidency. The Ukrainians have a point: back in August 2004 Russia had offered a cheap gas deal for Ukraine as part of its abortive efforts to boost the chances of the pro-Russian candidate, Viktor Yanukovich.

For its part, by 2005 Moscow was claiming that it wanted to put politics aside, and charge Ukraine something closer to the same market price that it was charging European customers. At the same time Russia was hiking the price it was charging its political ally Armenia — but kept a price discount for Belarus.

Ukraine and Russia found themselves in a Mexican stand-off, with a gun pointed at each other’s head. If Ukraine refused to sign off on a new contract, they would lose their own gas supplies — but so would Germany and other European countries. Thus, when Russia cut off gas supplies into the pipeline on 1 January 2006 there was panic in West Europe. After just ten hours, Russia’s Gazprom was the first to blink, and restored supplies. Three days later they had hammered out a new six-month deal, in which Russian gas at $230 would be mixed with gas from Turkmenistan (shipped across Russia) at $65, leaving an average price for Ukraine of $95/cm.

One mysterious aspect of the deal was the decision to route the transaction through a little-known third party, the Rosukrenergo corporation. This led to renewed accusations that Moscow was trying to play political games with Ukraine’s gas by channeling the profits to sympathetic Ukrainian oligarchs.

Adding to the confusion was the political turmoil in Ukraine — which leads Moscow to complain that there is no political figure in Kiev with the authority to implement any deal they negotiate. After the Orange Revolution there was an increasingly bitter struggle between the populist prime minister, Yulia Tymoshenko, and the centrist President Yushchenko, that led to him firing Tymoshenko in September 2005.

Tymoshenko condemned the 4 January gas deal, and her party emerged as the strongest member of the Orange coalition in the March 2006 parliamentary elections. After three months of haggling, and just weeks before the gas deal expired, Yushchenko reluctantly agreed to reappoint Tymoshenko as prime minister.

So both sides are now headed back into the Mexican stand-off. This time it is summer, not winter, so a sense of urgency may be lacking. But the crisis is just as real — not least because Ukraine needs to fill its underground gas reservoirs for the winter months. To make matters worse (for both the Ukrainians and the Russians) Turkmenistan is now insisting on being paid $100/cm for its gas.

Given the lack of trust between Moscow and Kiev, and the mutual interests of Moscow and Berlin, a logical answer would be to find some way to bring in Germany as an honest broker. Russia attempted something like this in summer of 2004, by proposing to create a Russo-German-Ukrainian joint venture that would operate Ukraine’s gas transit system. The Ukrainian opposition cried foul: they did not want to give up sovereign control over their prime bargaining asset. Moscow seems to have dropped the idea, for now.

Would Moscow agree to a German-Ukrainian joint venture that bought all the Russian gas at the Ukrainian-Russian border? For that matter, would the Ukrainians agree? Germany would then have the thankless task of dealing with Ukrainian arrears and diversion of gas flows. But if Moscow is really only interested in getting the best price for their gas, that might be the best deal for them.

None of these matters are likely to be solved at the Petersburg summit. One of the key players — Ukraine — is absent, while one player is present — the United States — that Moscow does not want to get involved in the dispute. The US is not dependent on Russian gas, so Moscow believes that it is playing a spoiler role, widening the rift between Moscow and Kiev as part of its strategic goal of weakening Russia.

If a problem has no solution, is it still a problem? For the purposes of energy security at the G8 summit, the answer is probably no.

Peter Rutland is a professor of government at Wesleyan University in Middletown, Connecticut. He is the editor of Business and the State in Contemporary Russia (Westview Press, 2000).