Putin Undermines Gazprom As Ukraine Pact Freezes Out Yushchenko

MOSCOW, Russia -- As Russia and Ukraine reached a mid- January accord in their long-running natural-gas dispute, Russian Prime Minister Vladimir Putin had at least one thing to cheer him up.

Russian Prime Minister Vladimir Putin.

He had frozen his pro-Western nemesis, Ukrainian President Viktor Yushchenko, out of the negotiations, reaching an agreement instead with Ukrainian Prime Minister Yulia Timoshenko, who had shuttled back and forth to Moscow during the crisis.

At home, this left Yushchenko looking ineffectual: One opinion poll put his approval rating at 3.4 percent even before the settlement. Yushchenko is a Russia basher; Timoshenko isn’t. Her poll numbers are rising, and she has voiced a desire to run for Yushchenko’s job in the next elections, which could take place at year’s end.

During Putin’s eight year presidency, which ended in May 2008, he made it his goal to strengthen Russia’s position as the dominant European gas supplier while becoming a global energy power with sway over energy supplies and policies far and wide.

To that end, the Ukraine gambit is part of Putin’s ongoing strategy to divide Europe and thwart the U.S., which is concerned that Russia intends to exploit its energy dominance to influence European politics.

Rough Test Ahead

Marginalizing Yushchenko was one tactical Putin victory; that the West could do little more than issue statements and grumble at Russian temerity was another. The European Union’s helplessness was reminiscent of its inaction during Russia’s invasion of Georgia in August.

Putin’s gamesmanship is in for a rougher test as oil prices drop and the Russian and global economies slump. He also must deal with a blow to the credibility of OAO Gazprom, Russia’s gas monopoly, which he employed as his proxy in the Ukraine fight.

Still, Putin plows onward. He has used the Ukraine crisis as an opportunity to flog two new pipelines, known as Nord Stream and South Stream, as a way to break what he has characterized as Ukraine’s monopoly on European gas deliveries.

The new pipelines would also increase Russia’s export capacity to Europe by 50 percent from current volumes; Russia now supplies about 25 percent of Europe’s gas.

“You’ve got to give Putin credit, he’s outplayed the West,” says Chuck Wald, former deputy commander of U.S. armed forces in Europe. “It’s not as easy now without $100 oil, but he’s driving the issues.”

Huge Losses

Two developments could yet derail or at least stall Russia’s energy ambitions. One is the 70 percent drop in oil prices, which peaked at $147 a barrel in July 2008 before falling to a low of under $34 a barrel on Dec. 19. The other is that Europe, jarred by the Russian gas cutoff, is now seriously thinking it needs to diversify its energy supplies.

“We must not allow ourselves to be placed in this position in the future,” said European Commission President Jose Barroso as gas started flowing again through Ukraine’s Soviet-era pipelines on Jan. 20.

Putin’s actions also caused Gazprom to bleed. By the company’s own estimates, the Ukrainian dispute cost it more than $2 billion in lost revenue.

“Was this agreement worth such efforts, such costs?” Putin said in a Jan. 25 interview with Bloomberg Television. “I think yes, because at some point you need to move to normal civilized market relations.”

‘Political Tool’

Those losses were piling up at a time when Gazprom was saddled with 1.1 trillion ($31.4 billion) in debt; that and sharply declining revenue could weaken the company’s ability to raise outside capital as global credit markets dry up.

“De facto, Gazprom is being used as a political tool,” says James Beadle, chief investment strategist at Pilgrim Asset Management, an investment fund in Moscow. “It’s not functioning as a corporate enterprise, putting business and reputation first.”

Other casualties could include the Nord Stream project, estimated to cost 7.4 billion euros ($9.6 billion) and scheduled to go online in 2011, and South Stream, projected to cost about $20 billion and slated for completion in 2013. “The question is, where is Gazprom going to get all the financing?” says Keith Smith, an energy analyst at the Center for Strategic and International Studies in Washington.

He contends that the projects are primarily political, as it’s prohibitively expensive to find and develop the Arctic fields that hold the gas with which Russia plans to fill the pipelines.

Gazprom’s position as a natural-gas provider isn’t going to shield it from falling oil prices -- European gas prices are pegged to the oil market, lagging crude prices by six to nine months.

Optimistic Projection

Not everyone is that pessimistic. Nord Stream, a 1,200- kilometer (750 mile) route under the Baltic Sea, would cut out transit countries by linking Russia directly to Germany. “They’re going under the assumption that expanded sales will pay for Nord Stream,” says Ronald Smith, chief strategist at Moscow based Alfa Bank. “It will justify itself, even at $40 oil.”

South Stream, on the other hand, a 900-kilometer pipeline under the Black Sea that would link Russia to Bulgaria, is less realistic, he says -- and not just because of its price tag.

Should Europe get serious about importing more liquefied natural-gas and relying more on nuclear energy, demand for piped gas could stagnate, he says. Russia may find it difficult to keep on track many of the long-planned projects necessary to replace declining production, much less undertake ambitious new ones.

Domestic crude output fell for the first time in a decade last year, declining to 488 million tons from 491 million in 2007.

Many of the fields brought online by the last wave of Soviet investment three decades ago are drying up, forcing producers to explore in ever more remote regions in Russia’s Arctic and eastern Siberia.

Cold Comfort

One example is Gazprom’s Shtokman field -- an Arctic offshore project with enough reserves to meet world gas demand for more than a year. The field is financially feasible at a per barrel oil price of $50-$60, according to project chief Yury Komarov.

Delays to the development, projected to provide 11 percent of Gazprom’s gas output by 2020, could also affect exports to Europe, since part of Shtokman’s gas is expected to fill the proposed Nord Stream pipeline.

Merrill Lynch & Co., which had originally forecast 2009 average prices at $90 a barrel, cut that to $50 a barrel in November. Finam Investment Co. of Moscow estimates that 2009 oil prices will average $52 a barrel, while its “pessimistic” scenario projects $37 a barrel oil.

Extraction taxes and export duties on oil and gas provide almost half of Russia’s revenue. Russia’s Finance Ministry, in one scenario projecting Russia’s Urals export blend to average $32 a barrel this year, is forecasting a 2009 deficit of 4 trillion rubles, or about $111 billion -- Russia’s first shortfall in a decade.

Staying the Course

Gazprom insists that despite a looming recession, dropping oil prices and the global credit squeeze, its energy plans are going forward. “All of our projects in production, distribution and transportation will be realized regardless of any difficulties,” Alexander Medvedev, Gazprom’s deputy chief executive officer, said at a January press conference.

Western energy companies, desperate to get in on Russia’s still considerable untapped oil and gas reserves, may bail Russia out as they have in the past. “Russia is the biggest prize left on the planet for international energy majors,” says Chris Weafer, chief strategist at UralSib Financial Corp. in Moscow. “If they have to secure their position by shouldering a disproportionate share of the financing, history shows they will do it.”

For example, France’s Total SA and Norway’s StatoilHydro ASA are already partners in Shtokman, while Royal Dutch Shell Plc and ConocoPhillips may be roped into developing the isolated Arctic Yamal peninsula.

Gazprom plans to build Nord Stream in partnership with German energy companies E.ON AG and BASF AG; South Stream is proposed as a joint venture with Italy’s Eni SpA.

Putin’s Irritation

On the surface, the latest Ukrainian dispute, which erupted on Jan. 1, was about Gazprom’s attempt to discontinue selling gas to Ukraine at a discount and start charging market prices. The political subtext was Putin’s irritation that Yushchenko is seeking membership in the European Union and the North Atlantic Treaty Organization.

The U.S., at least vicariously, got dragged into the Ukrainian fray. At the height of the dispute, Gazprom’s Medvedev suggested that Washington was behind Ukrainian obstinacy. “It looks like they are dancing to music which is being orchestrated not in Kiev but outside the country,” he said, referring to a U.S. Ukraine strategic partnership charter signed in Washington on Dec. 19.

The agreement, similar to one Washington reached later with Georgia, contained a clause saying the U.S. would help Ukraine refurbish its gas pipeline network.

U.S. Skepticism

The American response to Russian criticism was a mid-January statement from the U.S. Embassy in Moscow that said, “We hope Russia will do its part to end this dispute, resume and maintain gas supplies and avoid similar crises in the future.”

That the U.S. is wary of a Russian stranglehold on European gas supplies is no secret. In May 2006, four months after Russia cut off gas to Ukraine the first time, then U.S. Vice President Dick Cheney, on a visit to Lithuania, scolded Russia by declaring “no legitimate interest is served when oil and gas become tools of intimidation or blackmail.”

Cheney toured former Soviet republics voicing U.S. support for a proposed “southern energy corridor” that would bring Caspian Sea energy to Europe, bypassing Russia.

The key to the corridor is a European project that was backed by the administration of former U.S. President George W. Bush. Nabucco, named by its Vienna-based consortium for the opera by Giuseppe Verdi, is a $10 billion, 3,000-kilometer pipeline stretching from eastern Turkey to Austria that’s designed to bring gas from Central Asia, Egypt or the Middle East.

Russia Strikes Back

“What happened in recent years in Ukraine is the result, to a significant extent, of the activities of the previous U.S. administration and the European Union, which supported it,” says Putin.

Annoyed with perceived U.S. meddling in Russia’s backyard, Putin journeyed to Central Asia in May 2007. He coaxed Kazakhstan and Turkmenistan -- two logical suppliers to Nabucco -- to increase gas exports to Russia instead of throwing in their lot with the Europeans.

A month later, Gazprom announced its South Stream plans, and Putin courted leaders in Hungary and Bulgaria, both partners in Nabucco, to join South Stream instead.

“South Stream is a Trojan horse to stop Nabucco,” says Keith Smith, the Washington based energy analyst.

‘One Goal’

The Russians bristle at accusations that the pipelines are political tools. “Our relations with our partners have only one goal: to develop business from oil and gas extraction to refining and power generation,” Gazprom’s Medvedev says.

U.S. policy may change little with the Obama administration. In June 2008, Joe Biden, just before he became Barack Obama’s running mate, spoke at Senate hearings on Russia’s energy intentions.

“No wonder the president and prime minister of Russia spend more time running Gazprom than they do running the country,” Biden said. “They have shown that they are willing to use their dominance of both ends of most existing pipelines to extract not just economic deals but, increasingly, political influence.” Gazprom has been the engine in driving Putin’s energy goals and creating Russia’s new wealth.

In 2007, Medvedev first laid out Gazprom’s vision to become the world’s largest company, with an eventual market value of $1 trillion. And as oil prices climbed to unprecedented heights in June, CEO Alexei Miller predicted that a barrel of crude would soon hit $250.

Radical Adjustments

The energy landscape has changed radically since then. Gazprom, amid crashing revenues, has to come up with $10.6 billion in debt payments by the end of June. Its share price by mid January had tumbled more than 60 percent since July, knocking the company from its perch as the world’s third largest, with a market cap of $366 billion on May 16, to 51st on Feb. 3, according to data compiled by Bloomberg.

All of this is happening when other segments of the Russian economy are faring no better than the country’s energy industry. The Micex Stock Exchange has also cratered, declining almost 60 percent since its peak in May, when oil was riding above $130 a barrel.

The ruble -- once touted by Putin as a reserve currency of the future -- has gone wobbly. It sank to record lows against the dollar, falling to 36 rubles per dollar and losing more than a third in value from August. That has forced the government to burn through more than $200 billion of reserves since August in an effort to buttress the currency.

Beleaguered Oligarchs

Russia’s claim to be the world’s hottest billionaire factory has also taken a battering. According to Bloomberg data, a clutch of oligarchs, including Roman Abramovich, who is an owner of steelmaker Evraz Group SA, and Oleg Deripaska, who runs Basic Element, an investment concern with holdings in energy, financial services and manufacturing, watched their asset values shrivel by $230 billion in the five months from May to October 2008.

Some wonder if Putin has overplayed his hand. “Putin’s energy doctrine is in danger,” says Mikhail Korchemkin, director of East European Gas Analysis, a consulting firm in Malvern, Pennsylvania. “It doesn’t work in bad times.”

Putin, a former KGB agent, is acutely aware of the correlation between cheap oil and economic decline. Sub-$19-a- barrel oil undermined Mikhail Gorbachev’s efforts to remake socialism and Boris Yeltsin’s early economic reforms.


Putin is counting on increased political clout and diversification to spare the new Russia. The country already belongs to a once ineffectual organization called the Gas Exporting Countries Forum, which includes the likes of Iran and Venezuela.

Putin has said he wants to energize the group to coordinate investment and output -- similar, critics worry, to the Organization of Petroleum Exporting Countries.

And he is already looking far beyond sales to European gas markets. Later this year, Russia will deliver its first shipments of liquefied natural-gas -- exportable anywhere by tankers -- to Japan and Korea.

Source: Bloomberg