The Great Uncertainty: Russian-Central Asian Energy Relations

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Recent high-level meetings between Putin and Central Asian leaders and the conclusion of several deals that seem to give Russia more power over the latter’s oil and gas have catapulted Russian-Central Asian relations back into the spotlight, and cast them as amicable.  But in reality the relations between Russia and Central Asia are defined by uncertainty.  This uncertainty stems from the current model of relations that Russia pursues vis-à-vis the Central Asian states—one that has persisted since the 1990s despite leadership changes in the Kremlin.  Russia’s main goal in this model is to maintain its monopoly of transport of hydrocarbons from Central Asia to the world market, extracting as much economic rent as possible.

The model, however, is unstable for numerous reasons, not the least of which is consistent dissatisfaction with the current state of relations on the part of the Central Asians, despite official pronouncement otherwise.  Indeed, the desire of the Central Asian states to gain more access to the market for their hydrocarbons and the reluctance of the Russians to acquiesce to their demands has created tension in the relationship since its beginnings. However, current developments seem ready to force changes.   

To digress a little, Russian policy, as mentioned above, is driven by a desire to maintain a monopoly on exports from its neighbors to the south.  But this desire does not just govern its relations with those states; rather it plays a role in its broader strategy.  For example, the reluctance of Russia to ratify the Energy Charter Treaty and Transit Protocol relates to its unwillingness to give third party access to Central Asian resources, specifically Turkmen gas.  Given its dependence on transit countries, the Russians need the Charter or some sort of document that provides a framework for resolving disputes, but its concerns over Central Asia have consistently trumped this interest.

Russia uses its monopoly on Central Asian gas to advance its position in the international market as well as other for other political and economic ends, but doesn’t see how this strategy affects the relations with those states. It has consistently blocked Central Asia’s attempts to get access to European markets, has been reluctant to expand the Caspian Pipeline Consortium (CPC), and just recently reneged on a 10 year agreement with Kazakhstan to ship its oil to a refinery in Lithuania.

Russia simplistic and archaic policy has lead to a permanent instability in energy relations in the post-Soviet space.  A pattern is developing whereby every year one of Russia’s neighbors finds its energy supply cut off, raising doubts about Russia reliability as a supplier.  

Recent developments, however, challenge this model.  The Central Asian states have gained significant leverage vis-à-vis Russia and are showing a reluctance to grant Russian companies access to upstream assets in their countries.  They are using Russia’s desire to get that access to elicit concessions.  The Kazakhs in particular have shown that they are adept at playing the interests of their neighbors against each other and in the process avoiding Russian capture of their energy.

To add to the confidence of Central Asian states, the creation of new transport routes that circumvent Russia threaten Russia’s entire strategy.  The major breakthrough in this area is the Kazakhstan-China pipeline, the first stage of which was completed in 2005.  Russia rushed to apply for access.  Kazakhstan also joined the BTC, but shipping supplies to it will be difficult, entailing either the creation of a tanker fleet or the construction of a Trans-Caspian pipeline.  Nonetheless, these both present challenges to Russia’s monopoly.

Turkmenistan has also been exploring its options, and there are signs that its gas may soon have a new export route, but not via a trans-Afghani or trans-Caspian pipeline as the West had hope.  Rather, the relationship to watch here is that between Turkmenistan and China.  During his visit to Beijing in 2006, then-president Niyazov agreed to the creation of a pipeline to carry Turkmen gas to China.  The project obviously presents significant challenges to both parties, especially given that the gas would have to flow through Uzbekistan, which has a troubled diplomatic relationship with Turkmenistan.  Nonetheless, China’s increased influence in the region could make the pipeline a possibility.

Russia, meanwhile, hasn’t considered an alternative strategy to bolster relations with the Central Asian states, and faces a severe crisis in gas production at home, making every cubic meter of Central Asian gas important to Russia. The proposed Turkmenistan-China pipeline, thus, represents a significant threat. 

The threat stems not only from the alternative export route provided by the pipeline, but also from competition the projects presents to Russia’s own China pipeline.  China is not a significant gas consumer and does not need supplies from both Russia and Turkmenistan.

The Turkmenistan pipeline, while threatening to Russia’s current strategy, might be a positive development for the country’s overall strategy, forcing it to reexamine the need to develop gas supplies to China so quickly.  China has a strong domestic coal industry, and has thus been unwilling to offer Russia a profitable price for gas.  Because of this disagreement over price, talks between the two countries have stalled.  Nonetheless, Russia seems content to pull its gas out of more lucrative markets in Europe in order to sell it at a loss to China. 

The Turkmenistan pipeline also looks more feasible because of Turkmenistan looks ready to grant China access to upstream assets in the country.  The fact that the Turkmen government granted CNPC an exploration license for the Southy field may indicate that the country will soon open its doors to foreign investor, including China. Russia for its part has tried everything possible to stop the building of this relationship, including increasing the gas price it pays to Turkmenistan three-fold between 2004 and 2006.  But while it remains unwilling to reconsider its broader strategy, it is unlikely to find many friends in Ashgabat.

In conclusion, it needs to be said again that energy relations between Russia and the Central Asian states are characterized by a great uncertainty.  Russia’s assumptions about the availability of Central Asian gas for consumption and export are not few and also not grounded in reality. In the meantime, the Central Asian states are likely to continue to pursue alternative exports routes with the help of Europe and China and much to the chagrin of Russia.   

Q&A:

Q:  Will you address Russia’s domestic pricing policy for gas and how that relates to its need for foreign gas supplies?  

The government signed a formal resolution on May 20 that lays out a plan to gradually increase to price of gas to $125 per thousand cubic meters by 2011.  Many view this as a significant development, but domestic gas pricing is not that big of a deal.  Gas use is concentrated in several high-energy-consuming industries, which require significant capital investment to modernize.  It is unlikely in the current environment that these companies will be able to raise the requisite capital for modernization of production processes. It is a sad irony that these energy dependent sectors are also the one that are most exposed to domestic risk. If the government raises energy prices any faster, these industries will have trouble surviving.  And regardless of whether or not we raise the gas price, the demand for Central Asian gas will remain the same.

Q: Will the delay in the development of the Yamal deposit affect the likelihood of the Nord Stream pipeline actually being constructed?  What are you thoughts on the Nabucco gas pipeline? 

The key issue to consider when talking about the Nord Stream pipeline is the cost of the sub-sea section.  Gazprom already amended its estimated cost for the land-based part of the pipeline, raising the overall bill to $10.5 billion. Yet they kept the estimates for the most technical part of construction, the marine section, the same.  There has been some protest on the part of the German partners, which have shareholder demanding answers on costs, but Gazprom, realizing that construction will take much longer than it is anticipated is simply looking for places to divert the gas.  The construction of the pipeline was also set back by Russia recent and silly row with Estonia, which has to give its environmental approval of the project.
 
Yamal is a different and complicated story—one that is mostly about Gazprom’s willingness to actually develop the field.  If Gazprom wants to bring it online in 5-7 year like it has previously said, then it will need to invest at least $5-6 billion a year in the project.  It hasn’t, of course, shown a willingness to sink that much money into the project, with investments of only $950 million scheduled for 2007. Given the technically difficult nature of the field, it would be better if it were developed by an international consortium with the best technical experts.

Q: How if at all does global warming factor in Gazprom and the Central Asian state’s planning and thinking about price?

Global warming has never factored into Russian policymaking.  Sergei Mironov, nominally third in power in Russia, has gone as far as to say the he doesn’t believe that a problem with global climate change exists.

In the near future, it is unreasonable to think that any of Russia’s policies will be driven by climate change concerns.  Its ratification of the Kyoto protocol came only after Putin’s top policy advisor triple checked that Russia would not exceed the targets until 2012. In the meantime, the economy in fact is being forced to switch from gas to fuels which have higher emissions. 

It is unclear how much the Central Asians factor climate change into their policy, but it doesn’t appear to be a top priority on their part either.