Russian and Caspian Oil & Gas: Cooperation or Competition?

On January 9, 2003, the Carnegie Endowment for International Peace hosted a presentation entitled "Russian and Caspian Oil and Gas: Cooperation or Competition?" by Martha Brill Olcott from the Carnegie Endowment and Amy Jaffe from the James A. Baker III Institute for Public Policy. They addressed a number of questions about how the development of regional energy resources affects relations between Russia and other Caspian states and whether there can be an integrated Russian and Caspian energy policy. Andrew Kuchins, Director of the Russian and Eurasian Program at the Carnegie Endowment, chaired the presentation, which was followed by a question and answer session. In his introduction Kuchins noted that the present one is the first in the series of meetings that will address energy issues in Russia and Caspian states over the next few months at the Endowment.

Amy Jaffe began her presentation by mentioning the continuing oil strike in Venezuela and the consequent promise of Saudi Arabia to increase its production in order to compensate the shortage of oil. Such dynamic on the hydrocarbon market is particularly critical in the light of a potential disruption of oil supply from the Persian Gulf with the imminent war on Iraq. Consequently, the prospect of war creates an inclination for considering alternative sources of oil exports such as the CIS states. Jaffe noted that the issue of the CIS region becoming the supplementary source of oil has both short-term and long-term aspects. There is no question of increased flows of oil from Russia and the Caspian states. Yet the time frame extends to several years, not the next month. For instance, at the present moment, Russia cannot serve as an immediate relief source of oil for the West in order to smooth out the current disruption caused by Venezuelan strike or potential one in case of war with Iraq. In addition, the month of February has been a particularly difficult period for oil exports from Russia due to, first, weather conditions in ports, and second, to an increase in internal consumption of oil and gas for heating.

In her discussion of long-term aspects for increasing energy exports from Russia, Jaffe emphasized two policy issues for the country. The first one concerns fuel efficiency. Much of the public policy directives have been in the area of increasing oil production, not restructuring Russian industry in order to make it more fuel-efficient. In fact, this is one area where there is a lot of potential over time to free up increased amounts of oil for export. The second area of concern, according to Jaffe, is the gap between the desired and actual implementation of increasing investment in assets in Russia. There has been a lot of effort on the part of both the US and Russian governments to create and foster opportunities for investment in the Russian energy sector, including a recent US-Russian energy summit at the Baker Institute in Houston and a working group that also involves commercial companies. Yet, despite such strong support from the Russian leadership, it is still an incredibly difficult task of transforming these goals into reality given the plurality of political voices whose interests are involved in the energy sector. Orchestrating policy from the top down is quite a challenge in the Russian system, which constitutes the second policy issue in development of the energy sector in the long term.

Recent development of such cooperation between Russia and the US signifies a beginning of a new pattern in relations between two countries in the oil sector, that of a strategic partnership. From the perspective of maximization of oil production, the relations between the Caspian states and Russia should also be those of partners, not competitors. It's a provocative question, particularly in the light of the fact that a lot of discussion around the gas and oil of the Caspian has presupposed existence of the rivalry between the US and Russia for export routes that blocks Kazakh oil. All these issues become moot if one regards Russia, the US and Caspian states as an integrated geopolitical bloc. Thus, the next step to take for the US strategy towards the Caspian region in the dialogue of partnership in the energy question between the US and Russia would be to include the Caspian states.

Jaffe continued by suggesting to approach the question of energy production in Russia/Caspian states through the lens of fundamental economics, in which case the issue would become how to export the maximum amount of oil along the lines of the cheapest and most efficient routes. This goal could be reached through a unified strategy between the US, Russia and the Caspian states in the energy sector. This integrated approach could resolve the problem of Bosphorus. Diversification away from Novorossiysk would allow elimination of bottlenecks in the Russian pipeline system so that this existing route to Bosphorus could be freed for exporting the Caspian oil. For instance, one project that was mooted around in the 1990s and killed because of political reasons was reversing the Adria pipeline, which would enable bringing out Russian oil to the West without involving Turkey at all. This system would require very little investment in comparison to current pipeline constructing projects.

Jaffe also pointed out that a united integrated strategy could resolve another puzzle, that which concerns the natural gas resources at the Caspian. The politics and economics of natural gas are all local, that is, selling gas to the closest possible markets. For instance, there is a tremendous amount of gas trapped in Kazakhstan that affects the commerciality of major oil fields in the country. If it were possible to move that gas into the Russian system and make it profitably used there, the schedule for increasing oil production in Kazakhstan could be made earlier. This example demonstrates that such commercial problems could be tackled in a completely different way if one was looking at the system in a more unified fashion, and less in a competitive way.

In addition, Jaffe drew attention to another fundamental problem from the perspective of economics, which is the need for a guarantee for any Caspian exporter who sells 90 % of its oil into Russia to get international prices for its product. This is one of the most fundamental challenges that need to be solved in order for Russia to counter its historical practice of getting products at a highly discounted rate, selling them at a higher price, and retaining all the economic rents to itself.

Jaffe concluded her presentation by positing a whole new host of questions that still remain to be answered. Do we stick to the multiple pipeline strategy knowing that it has extra cost? Is it still valid in the new political world? Is it still the best policy? Are there any gains from abandoning the emphasis on multiplicity? Are the local politics are such that a more integrated strategy could be even realized? Will the regional strategy ever catch up with the change in the general geopolitical transformation since September 11th?

Martha Brill Olcott continued the presentation by raising her doubts about possibility of implementation of a market-driven strategy in the Caspian. [By market-driven strategy she defined a policy that seeks to maximize the total yield of oil from the Caspian states combined rather than from each country separately.] In the region where competing elites use energy to bargain for competing goals, the move from segmented energy policy to a strategy articulated and driven by purely economic incentives is unlikely to happen very soon. Olcott acknowledged that there has been a lot of cooperation in the CIS countries regarding a coherent energy policy since 9/11, more in gas than in oil, and moreover, this trend is likely to continue. Yet, she warned that unless there is drastic change in the way domestic and foreign policy choices are made, at the current rate the envisioned cooperation through a unified market-driven strategy is still a long way off.

Olcott also drew attention to issues of state desire and capacity for implementing a coordinated strategy. There are many discussions of the need for an integrated strategy at investment meetings at energy summits and forums designed to attract investors into each of respective countries. However, the real question remains of whether there is capacity of the state to either implement these policies or that the leaders are interested in pursuing such politics. These are states that have little or no sense of public good among the ruling elite. Continuing lack of political maturity for some of these countries could be taken as an indication of weak state capacity. So far, very few leaders of Caspian region introduced policies that are designed to maximize long-term gains over short-term ones and to emphasize public good.

In her characterization of Russia's capability of pursuing a unified national energy strategy and its further implementation, Olcott expressed her reservation. Among other things, it needs further changes in the investment climate, better regulation of tariffs for transit, and redefinition of TransNeft in the whole problem of transit. Specifically, Russia needs to reform the transport sector of oil & gas industry from a natural monopoly to a set of relationships that are at least regulated in part through market forces, that is to provide other groups an with ability to build pipe-lines. In addition, the role of Russian companies in the process is significant as to whether they can be made sufficient stakeholders of this strategy. Would they squeeze out their neighbors or try to accommodate and play a fair game?

Yet Olcott noted that the major impediments are still not from the Russian side. When one goes to the issue of dynamics of interstate relations between Russia, Caspian and other transit states, and question of domestic politics in any of these states, the number of impediments increases for possibility of any meaningful international single energy development strategy. The discussion would involve a large number states: the three producer-states of Azerbaijan, Kazakhstan, and Turkmenistan, the important transit states- Georgia and Uzbekistan in the Caspian region, and in Europe- Ukraine, Belarus and Moldova. Certainly, in order to have a single market-driven strategy in this area, the states must be ready to put a primacy on these issues in the energy development progress, which is often not in the short-term interest of these states.

Furthermore, all these states still have, at minimum, very complex foreign relations with each other and Russia. According to Olcott, the energy sector issues in these states do not dominate Russia's foreign policy with these states. And nor is Russian policy towards these states is the product of a coherent set of actors of a single group. For instance, the Georgian-Russian relationship is the most striking example in the post-Soviet space of the degree to which personal agendas play out in the foreign policy of these states, where the policy reflects the ambivalent feelings among the Russian elite towards President Shevarnadze.

Personal agendas play no smaller part in the relations among the leaders of all the Caspian states though less publicized. Putin started with a partially clean slate, especially with regard to Kazakhstan, where his new start allowed improving relations between Russia and Kazakhstan. But often it is the opposite. One should heed the bad relations driven by personal agenda between the transit states, particularly between Turkmenistan and Uzbekistan. The recent developments especially highlight the deterioration: the Uzbek ambassador has been called back from Turkmenistan because of his implicated role in the recent alleged assassination attempt of the leader of Turkmenistan. But even before the coup attempt the relations have been deteriorating and the possibility of violence over water issues between these two states was possible. In this light, any suggestion of a unified energy strategy becomes almost nonsensical. Even though Uzbekistan is a key state for the transit of Turkmen gas, personal agendas have played a significant role in defining political priorities.

Furthermore, Olcott noted that the domestic political agendas of these states are still not supportive of this kind of policy. For example, the dependability of Azerbaijan as a partner in the development of oil and gas sector still remains to be fully tested. Most of the guarantees received are rather legal guarantees of a particular leader. Until there is transition in Azerbaijan, it will be difficult to have sense of the nature of long-term investment climate in the country. Kazakhstan offers the best legal infrastructure in the Caspian region for oil and gas investment. But even here investment confidence has undergone a series of serious blows. For instance, Chevron's recent problems at Tengiz have put the second stage of investment at risk because of a disagreement on details in financial structure of the project.

Less well known is the recent statement of the latest political opponent of the Kazakh leader Nazarbayev, Bulat Abilov of "Ak Zhol", an opposition party that seeks to work in dialogue with the president. Abilov, who is a multimillionaire businessman and therefore should be aware of sanctity of contracts, was running for the Parliament. He issued a statement that Chevron and other major oil companies' relationship with the Kazakh government should be redefined. According to his opinion, the Western companies should be required to pay more taxes in Kazakhstan as part of the game that Kazakhstan gets for its participation in the war on terrorism. This incident provides an indication of instability of the investment environment in what is the most stable of the Caspian states. The Russian-Kazakh relationship in oil and gas sector is very complex and driven on both sides by a complicated economic agenda that involves a lot more than simply oil and gas production. Energy sector politics is the derivative of positions on the whole host of other issues of economic integration between the two states.

Olcott referred to Turkmenistan, which is the least stable of the Caspian states, as a good example of a country that violates all the elements that one would want to see in a reliable partner. Energy (gas) in Turkmenistan is a driving force in how the other states have viewed the country, and it has caused the US and Russia to cast a blind eye on developments in the internal politics. Turkmenistan is led by a leader who is clearly "off the rails" and behaves in an inappropriate manner, including accusations in the recent public trial of Boris Sheikhmuradov, the major alleged perpetrators of the alleged coup attempt. Niyazov's behavior violates any modern norms of human dictators. Thus, the example Turkmenistan's leadership demonstrates near impossibility of arriving at a single regional strategy defined by market forces.

Olcott concluded that in the light of the above, a coherent regional integrative market-driven strategy is not in the interest of any of these states. Virtually, each one of the actors loses more than they gains by giving up some of the multiple, non-economic, seemingly irrational, levers that they use in affecting relations among neighboring states, and relations within the elites inside their respective countries. And the residue of distrust and the continuation of the age-old rivalries and deep ethnic hatreds will be invoked to conceal personal gains rather than be the source of real politics.