Can we trust these two men to turn on the taps in Russia?

In April 2006, President Putin affirmed Gazprom’s statement that, without better access to the downstream gas market in the European Union, they might direct gas flows elsewhere. Russian-European energy relations were consequently thrown into crisis. Suddenly, Russian gas could not be seen as reliable.

By 2008 the relationship was smoother. Perceptions of Russia’s relationship with its neighbours with regards to energy was more balanced: there was a better understanding of Russia’s need to raise prices — that the economic component in these decisions is significant. After all, while the rise in prices for Ukraine in 2006 could be perceived as political, the rise for Belarus in 2007 could not.

The focus now is on Russia’s ability to sustain production and maintain its exports. The Putin-Miller threats do not look convincing and Medvedev, chair of Gazprom’s board from 2002-2008, knows the gas industry much better than Putin who, despite his preoccupation with gas, did not have a strong understanding of the structural weaknesses in Russia’s gas industry.

We are now returning to a more realistic assessment of Russia’s situation and are recognising the mutual independence that underlies the energy relationship. Putin exaggerated Russia’s strength in terms of gas exports and the West took him at face value. We will not see the gas diplomacy embodied by the April 2006 statement again: everyone has learnt, both East and West.

Our major concern instead should be about Russia’s ‘gas balance’ — that is, both Russia’s gas production and consumption. There are serious problems with both. There are grounds for concern at Russian oil and gas productivity, especially as productivity will be hit by limitations on foreign investment and foreign players.

This is demonstrated by events at the Shtokman field, a huge gas condensate field in the Barents Sea. Negotiations started in 2003 between Gazprom and international oil companies to enter into a partnership to develop the field but in October 2006 Gazprom announced that it would not go ahead.

Instead, Gazprom would develop the field alone, buying in Western expertise where needed. Subsequently Gazprom recognised that it could not develop Shtokman even with Western expertise. In 2007 it formed a new partnership with Total and StatoilHydro to develop the first phase of Shtokman, but without foreign ownership rights or rights for selling the gas.

Shtokman may be a model of what Russia might like to see in future: no ownership of licenses for Western companies but some opportunities to invest cash, expertise, initiative and skills. We should know what the final relationship between Gazprom and its international partners in the Shtokman phase one development will look like towards the end of 2009. Whether it is able to deliver the capability and productivity that the sector needs will not be known for some time.

Restrictions on foreign participation in the oil and gas sector passed into law in April 2008: all onshore fields above 70m tonnes of oil or 50bn m3 of gas and all fields on the continental shelf were defined as ‘fields of federal significance’ which only Russian companies may be licensed to develop. Foreign companies will be allowed to have only limited positions in Russian companies exploiting such fields What this means for Russian production remains to be seen.

Russia has huge gas resources but her present production currently relies on four super-giant fields in Western Siberia: Urengoy, Yamburg and Medvezh’ye which are declining by 25bn m3 per year and Zapalyarnoe which is just reaching its production peak and is expected to begin falling in five years or so.

This risks creating a significant production deficit. To address it Russia urgently needs to speed up its development of new gas fields.

One of its best hopes for doing so are the huge gas fields of the Yamal peninsula in northwest Siberia. Two of the largest: Bovanenko, which will be the first to be developed, and Kharasavey are expected to produce around 100bn m3 of gas per year between them. When other fields come online in the mid-2020s the Yamal fields should produce 200-250bn m3 of gas per annum over several decades. With Russian gas production at 600bn m3 per year this is a truly significant project.

However, difficult natural conditions (it protrudes into the Arctic) and its remoteness make these gas fields a difficult project to develop. There is a lot of nervousness amongst Russians about whether these fields will come on-stream in time; if they don’t Russia might well experience production shortfalls between 2010 and 2015.

If there is a crunch in supplies will exports be sheltered and the squeeze taken domestically along with the political problems that would follow, or would it hit exports? Russian electricity and gas consumption is very inefficient; higher efficiency would save them enormous volumes of gas and must be on the agenda of the new government in Russia when it settles down.

If this efficiency is to be attained, price increases and better infrastructure and insulation will be required.

This agenda is the most rational policy that Russia can follow. The price of conserving one unit of energy is considerably cheaper than the cost of creating a new unit of energy. If Russia manages to put together a more balanced policy with regard to both demand and supply then the spectre of a gas crunch could go away.

There is plenty of opportunity for Euro-Russian co-operation in making consumption more efficient and lots of potential for commercial schemes, particularly energy efficient technologies. However, so far Russia is much more preoccupied by gas supply than with demand.

As for the oil sector, it is experiencing some of the same problems as gas. There is too little development and exploration but the consequences for Russia are less important. As long as the oil prices stay high, falls in production will make little impact because the sector is based on short-term contracts which are now worth many times more than just a few years previously.

Although Russia is the world’s second largest oil producer, it will need to find ways of promoting investment in its oil production to provide for the exploration, development and infrastructure requirements needed to keep up production.

Russia has to analyse the scale and nature of its own problems and assess whether it can address them on its own. Europe should play a quiet, supportive role: no big initiatives of its own but a willingness to respond favourably to any made by Russia. Our concern should be that Russia completes its internal debate and moves to balance its energy supply and demand.

Seeing Russia as an asset rather than a risk is probably the best contribution that Europe can make to this.