Hungary and Russia sign off on cheaper South Stream

Gazprom chief Alexei Miller and Janos Eros, president of the Hungarian Development Bank, yesterday March 11 signed a deal to create a joint venture to build Hungary’s section of the South Stream gas pipeline by 2015. According to the Russians, the estimated cost of the project has fallen over half to 10bn euros, and the pipelines projected capacity has increased.

South Stream is a joint project of Gazprom with Italy’s Eni to pipe Russian gas to Italy and Austria through countries including Hungary, Serbia and Greece.

The Russians reported improved parameters for the pipeline. Russian Prime Minister Vladimir Putin, attending the signing ceremony, stated that due to lower materials and services prices, the cost of building the South Stream pipeline is expected to fall to about 10bn euros compared to the previous estimates of 25bn euros, according to Interfax.

Gazprom CEO Alexei Miller also announced that total transportation capacities of the pipeline could be higher than previously estimated, with the Hungarian section alone could pump up to 10 bcmpa.

Hungary’s Prime Minister Ferenc Gyurcsany was also present. Gyurcsany said the deal would help his country improve its energy security. Hungary currently receives all its gas through Ukraine, and was directly affected by January’s cutoff of supplies in connection with the Russia-Ukraine gas dispute.

“Hungary is not interested in there being one gas pipeline or one oil pipeline,” he said. “Hungary is interested in having as many pipelines as possible.”

Gyurcsany also said the South Stream project should not be considered a rival to the US-sponsored Nabucco pipeline, intended to pipe gas from Azerbaijan and the Caspian basin to Europe. He argued Budapest would benefit from transit fees from both pipelines.

The deal also includes Gazprom and Hungary’s oil and gas giant MOL building a large underground gas storage facility in Hungary for 1bn cubic meters of gas. Gyurcsany said existing such facilities helped Hungary cope with the gas shortages resulting from January’s dispute between Russia and Ukraine, according to Itar Tass.

The South Stream pipeline will bypass Ukraine and directly link Russia and Central and Western Europe. The pipeline will run beneath the Black Sea to the Bulgarian coast and then split into two branches – one heading South to Italy and one going North to Austria with a total combined capacity of 31-47 bcmpa.

Gazprom has already signed intergovernmental agreements with Bulgaria, Greece, Serbia and Hungary and negotiations with Slovenia and Austria are on schedule.

According to UralSib’s Victor Mishnyakov , “questions remain. We welcome Gazprom’s intention to diversify gas routes and increase its presence in the key European market. We regard this news as positive from a strategic perspective but neutral at the moment, as many questions remains unanswered.”

“In particular,” says Mishnyakov, “the Southern regions of Russia do not have sufficient gas deposits to supply the South Stream and the high-sulfur Central Asian gas would need to be treated before being transported. We also doubt that the current macroeconomic environment makes the project economically viable and do not believe that it will be built by 2015, as originally planned.”

Alfa’s Ron Smith is also downbeat about South Stream prospect: “We are still less-than-certain that South Stream will ever be completed. It is not clear that there will be enough European demand for Russian gas to justify the additional route, especially if Russia’s relations with Ukraine eventually quiet down.”

However, Russia’s PM Vladimir Putin had a quick response to doubters yesterday, according to Moscow Times. “If we aren’t able to build South Stream, which I doubt,” said Putin, “we’ll liquefy our gas and sell it to you for more.”

Russia and China sign US$25bn loans-for-crude deal

Graham Stack for business new europe (www.businessneweurope.eu)

Rosneft, Transneft, China National Petroleum Corporation (CNPC) and China Development Bank have signed off on a deal for $25bn in loans for the Russian state-owned companies in return for Russian crude oil supplies to China, according to newswires

The agreements were signed in Beijing on Tuesday February 17 at a meeting between Russian Deputy Prime Minister Igor Sechin and Chinese Vice Premier for Energy Wang Qishan.

Following the meeting, Sechin, who is also chairman of the board of Rosneft, said that Russia is expected to export 15 million tonnes per year (301,000 barrels a day) to China over a period of 20 years in exchange for the loans.

“We agreed on supplies of 15 million tonnes of oil every year over a period of 20 years,” Russian Deputy Prime Minister Igor Sechin told state news channel Vesti 24.

The China Development Bank signed the loan agreements with Rosneft and Transneft. Rosneft and CNPC signed documents on Russian oil deliveries to China for a 20-year period.

Transneft Vice-President Mikhail Barkov told Reuters his company would receive $10bn of the loan and Rosneft the other $15 billion.

“The maturity is around 20 years and this credit is linked to supplies,” Barkov told Reuters. “It is a historic event and the start of a big journey.”

China agreed to reduce the annual interest rate by one percentage point to 6 percent, RIA reported. Vedomosti speculates that the interest rate for the loan is 5.5-6% annually.

The deputy premier also signed a second deal on construction of a branch of the Eastern Siberia-Pacific Ocean pipeline (ESPO) to the Chinese border. CNPC and Transneft signed a corresponding contract on construction and operation of the ESPO branch, according to Prime Tass.
Russia will supply 30 million tonnes through the pipeline link to China when it reaches full capacity, a Transneft spokesman told Prime Tass.

VTB Capital’s Lev Snyvkov writes, “Rosneft could resolve its debt repayment issues without the Chinese loan, but it could be more expensive and problematic given the current tight liquidity conditions. We estimate Rosneft’s net debt at the end of 2008 at about USD 24bn, with USD 8.5bn to be repaid in 2009. The company’s 1Q09 repayments (USD 0.9bn) were covered by operating cash flow, while the 2Q09 repayments (USD 4.1bn) have already been agreed with banks (refinancing). In 2H09, Rosneft needs to repay USD 3.5bn.

The pricing parameters of crude supplies (as yet unknown) are important for assessing the true cost of the loan. The news is in line with what was announced earlier but is still marginally positive for Rosneft and Transneft as the agreement is an additional source of liquidity in the tight liquidity conditions on the market.”

UralSib’s Viktor Mishnyakov writes, “we believe the loans received might provide an impetus to massive development of Eastern Siberia. Assuming the government will exempt the East Siberian fields from export duty, the biggest winners will be Rosneft (which has the most projects in Eastern Siberia), TNKBP, Surgutneftegas, Slavneft and Gazprom Neft. Regional development would also likely trigger the extensive use of independent oil field services in the region, with Integra benefiting the most.” We think China might receive certain benefits in return. We believe that two options are possible: greater access to the East Siberian fields (currently two upstream projects via a JV with Rosneft) and the potential transformation of ESPO into a joint stock company, with China getting 49% or 50% control in it.”

Russia forms ‘Gas Opec’ with Iran and Qatar

Graham Stack for business new europe (www.businessneweurope.eu)

Russia, Iran and Qatar, the world’s top three countries by gas reserves, who together control 60% of global gas resources, yesterday agreed to start forming a “Gas OPEC” or “Gas Troika” in Moscow.

The three countries agreed to set up a ‘technical committee’ as a prelude to creating a natural gas equivalent to oil cartel OPEC. The committee will be responsible for drafting the organisation’s charter to be presented at the next meeting of the Gas Exporters Countries’ Forum (GECF), to date a largely informal structure.

The goals of the new organisation are not  clear yet, with cooperation expected in the areas of gas production, processing and marketing, according to Rencap analysts. The new body will hold regular meetings three to four times a year, with the first meeting to take place within weeks.

According to UralSib analyst Victor Mishnyakov, Russia views the gas OPEC as a platform to discuss logistic and pricing mechanisms, not as a political instrument.

Mishnyakov says forming a price cartel similar to the oil OPEC would mean “that Gazprom would have to shift away from signing long-term “take-or-pay” gas contracts, which provide for less volatile export prices and guaranteed gas deliveries.” Gazprom is thus highly unlikely to support such a move.

When then President, now Prime Minister Vladimir  Putin first backed the idea of a Gas Opec at a press conference in January 2007,  he also emphasised it would not be a price cartel like oil Opec, but a forum for cooperation.

Indeed, according to analysts, an effective unified pricing mechanism is unfeasible because Gazprom exports natural gas via pipeline and there is no tradable exchange instrument for natural gas (like Brent for crude oil). The Persian Gulf countries export LNG, for which prices are volatile and set differently than under Gazprom’s natural gas contract prices.

There is currently therefore no such thing as a world gas market such as there is for oil. Shortages in one part of the globe have little or no impact on the supply/demand balance in another part of it.

This will change over time, believe analysts from Alfa bank, as liquefied natural gas (LNG) becomes a larger part of the gas supply chain. However, LNG will not have a material effect on international pricing for at least a decade.

Centrifugal forces

There is also considerable scepticism about whether the three countries have enough shared interests for the new organisation to be coherent.

Russia usually competes with OPEC gas producers such as Qatar and Iran for the European market. A topical example is the current rivalry between the planned  Nabucco and South Stream gas pipelines. The Nabucco project is intended to supply gas from Iran as an alternative to Russian gas due to be supplied through South Stream.

Consequently, Alfa’s Ronald Smith believes that “while this story captures headlines, in reality it should have little impact on the fundamentals of Gazprom for at least a decade, even should the proposed cartel hold together.”

UralSib’s Mishnyakov argues that the powerful centrifugal forces in the cartel will be exacerbated by Russia’s close cooperation with non-cartel members in Central Asia. “The creation of a gas OPEC must not neglect the interests of the CIS gas producers – Turkmenistan, Uzbekistan and Kazakhstan – or of Belarus, the main transit country for European deliveries. In our view the gas OPEC may create additional difficulties for Russia as it will now have to balance the interests of the Persian Gulf producers and its historical partners in the CIS,” says Mishnyakov.

Russia gets a head start in the Arctic race

Graham Stack for Russia Profile

Despite media hysteria about alleged conflicts looming over Arctic resources, most experts say Russia is playing a constructive role.

Russia’s planting of a titanium flag on the seabed at the North Pole last summer was one of the media eventsof 2007. In combination with soaring energy prices and melting Arctic ice, the images sparked sometimes wildly speculative panic-mongering about the “coming Arctic war.”

In fact, the hype around the flagplanting was little more than an election campaign gag for the pro-Putin United Russia party – the United Russia flag was one of the items deposited on the seabed in a time capsule, and expedition leader, famous explorer Artur Chilingarov is a United Russia deputy.

But there was a scientific purpose to the expedition as well: to gather seabed samples. They were required to support of Russia’s claim that the submarine Lomonosov ridge running through the Central Arctic is an extension of Russia’s continental shelf.

Russia is filing its claim in the framework of the United Nations Convention on the Law of the Sea (UNCLOS). UNCLOS allows countries to expand their maritime Exclusive Economic Zones (EEZ) beyond the current 200 nautical miles from the coastline up to a maximum of 350nm, in the case that their continental shelf extends so far out to sea. A country has sole rights to exploit mineral deposits located in its EEZ.

And for a country like Russia that positions itself globally as an all-round energy supplier to Europe and beyond, the Arctic’s oil and gas resources constitute not just a source of extra income, but crucial to the Kremlin’s plan of building Russian energy companies into global majors.

This might be a source of friction were Arctic resources tantalisingly outside of Russia’s reach. But in fact the lion’s share of Arctic hydrocarbons seem to be located in recognized Russian waters. Making Russia the least likely country to launch aggression to change boundaries.

A tale of two studies

July 23, 2008, saw the prestigious United States Geological Survey (USGS) publish its widely awaited official analysis of the oil and gas riches of the Arctic. The document is destined to become a key reference point for US policy in the area.

The USGS study trumpeted that the Arctic “may constitute the geographically largest unexplored prospective area for petroleum remaining on Earth.” According to the survey, Arctic resources account for about 22 percent of the undiscovered, technically recoverable resources in the world: about 13 percent of the undiscovered oil, 30 percent of the undiscovered natural gas, and 20 percent of the undiscovered natural gas liquids in the world.

The USGS survey, however, ignores the very different findings of a Wood Mackenzie survey published November 2006. Wood MacKenzie’s study found that the Arctic only contained 3% of the world’s recoverable hydrocarbon reserves. “The Wood Mackenzie is proprietary and we haven’t bought it,” laconically explains the leader of the USGS Arctic team, Don Gautier.

In stark contrast to USGS’s enthusiam, Wood Mackenzie’s lead author, Andrew Latham, commented, “our assessment basically calls into question the long-considered view that the Arctic represents one of the last great oil and gas frontiers and a strategic energy supply cache for the US.”

Without entering into details of methodology, the huge discrepancy between these figures shows just how much remains basically guesswork. And memories of the hyperbole about Caspian Sea resources in the 1990s should incline observers to prefer the more conservative estimates.

But just as significant as their contradictions on quantity, are the studies shared findings on the quality of the Arctic’s hydrocarbons.

Firstly, both studies agree that the Arctic’s hydrocarbon resources consist predominantly of natural gas. ‘Arctic resources are gas-prone with around three times more gas than oil,’ according to USGS’s Don Gautier. According to Wood Mackenzie, 85% of the discovered resource and 74% of the exploration potential is gas.

The second shared finding is that, according to Gautier, while 84% of the undiscovered oil and gas is indeed offshore, most of it “lies within national boundaries as currently defined.” This means the UNCLOS rules on extending those boundaries are in fact of secondary importance.

Thirdly, and crucially, most of the gas is in the Russian sector. “The West Siberian basin in outstanding for gas,” is one of USGS’s main conclusions, and the East Barents Sea is also ranked excellent. Around 60% of total Arctic gas lies squarely in the Russian EEZ.

So it seems Russia has already won the ‘coming Arctic war’ without a shot being fired.

UNCLOS is no cause for alarm
But this still leaves around 30% of Arctic resources lying more than 200 nautical miles offshore. UNCLOS, and it’s expert Commission on the Limits of the Continental Shelf (CLCS) will decide who can claim jurisdictions over these areas.

This is where Russia’s controversial claim to the North Pole, i.e. the Lomonosov ridge, comes in.

Russia’s claim to the Lomonosov ridge is indeed disputed by Canada and Denmark – but purely within the legal framework of UNCLOS. All three countries have voluntarily signed up to accept its findings, and no party has ever said they might not do so.

The crucial point is that all signatory states have committed themselves to UNCLOS precisely as a non-conflictual, impartial means of resolving questions of marine jurisdiction. Only the US refuses to sign – because of the impingement of sovereignty this involves.

“Rights to the resources of the continental shelf beyond 200nm have been enshrined in international law since at least 1994, when UNCLOS entered into force and so far all of the Arctic states have followed the procedures established under UNCLOS for claiming those rights,” says Martin Pratt, head of research at Durham University’s International Boundaries Research Unit (IBRU). IBRU published the definitive map of Arctic boundaries August 5, 2008.

According to Pratt, “all the available evidence still points to a peaceful division of the Arctic.”

“The conflict potential is inflated mainly because people find it exciting to talk and write about, and perhaps also to some extent because some people miss the cold war,” argues Indra Øverland, Head of the Energy Program at the Norwegian Institute of International Affairs (NUPI). “There are in fact not more territorial disagreements in the Arctic than in most other parts of the world. Such disagreements are a normal part of inter-state relations.

The perceived ‘race for the Arctic,’ according to Øverland, is merely a reflection of a UN ruling that a country has 10 years to make claims beyond the 200-mile zone.

Since Russia was one of the first to sign up, in 1997, it is compelled to get a move on in filing its claims.

“Russia does play by the rules laid down in UNCLOS, and agrees with the other Arctic nations that this convention is the basis for future developments in the region,” says Alf Håkon Hoel, head of the politics department at the University of Tromsø in the Norwegian Arctic.

“But that doesn’t mean that the Arctic coastal states aren’t keen to secure rights to exploit resources in such areas in the future,” counters Pratt.

“That is the process in which Russia is currently engaged with the Commission on the Limits of the Continental Shelf,” he continues, “and once the outer limit of the Russian continental shelf has been defined, it won’t be able to claim sovereign rights over any other areas of Arctic seabed.”

However, the idea that signatories to a UN convention regulating maritime jurisdiction would then come to blows over its findings, is as absurd as suggesting war could break out between Germany and Poland over voting rights in the European Commission.

Moreover, the timescale of the division and exploitation of the Arctic is likely to stretch decades into the future, with the UN’s Commission on the Limits of the Continental Shelf (CLCS) not due to complete its work till 2020.

And only when all disputes have been solved, will it be possible to commit the massive investment and start the pioneering work needed to get at oil and gas lying far offshore.

“Referring to the extension of the continental shelf beyond 200 miles, I would say that possible resources in this area will only be relevant in a much longer time perspective, for technical and economic reasons,” argues Arild Moe of Norway’s Fridtjof Nansen Institute.

“There is no imminent conflict over resources there, of which we know little and about which the most recent USGS study is not particularly optimistic,” says Moe.

Technology, not territory, is the key to the Arctic

The barrier Russia and other countries face in accessing Arctic resources is not connected with maritime jurisdiction, but with technology.

The most ambitious current Arctic project underway is Gazprom’s giant Shtokman field in the Barents Sea. With 3.8 trillion cubic meter of natural gas and more than 37 million tons of gas condensate, the field contains enough gas to fuel Europe for seven years.

But the question is how to get it. The field is 550km off shore from the port of Teriberka, 4000m beneath the seabed. Further hazards include icebergs, drift ice, sub-zero temperatures polar nights, megawaves and an uneven seabed. Quite simply, nothing like this has ever been attempted.

“Nobody has yet attempted multi-phase gas flow transportation over such a distance, and that’s the main technical and technological problem today,” Alexander Selin,an official at Shtokman license holder Sevmorneftegaz, told Interfax at the end of July.

According to Konstantin Batunin of Moscow’s Alfa Bank, not even Gazprom knows yet what technology will be used. Russia’s gas giant has enlisted the help of Norway’s Statoil and France’s Total as junior technology partners, and this international collaboration to pool expertise is another sign of how the Arctic is likely to produce new partnerships rather than fuel rivalries.

Oil and gas development and the opening of the Arctic to shipping due to global warming – the summer of 2008 showed the lowest icelevel since records began  also mean that new shipping technologies are needed to master the Arctic waters.

And here as well Russia is kitting up.

In 2007, Russia started the merger of all state-owned shipping and ship-building assets into two giant holding companies

Sovkomflot-Novoship, now the world’s fifth largest shipping company, and the United Ship-building corporation. Both of these companies are under orders to focus on energy shipping in general, and ice-class vessels in particular.

And March 25, 2008, a state-linked investment company FLC bought a 70% stake in three German shipyards belonging to Norway’s Aker group – shipyards specialized in building dual-action ice-class ships, the stern of which doubles up as an ice-breaking bow.

Finally, August 27, 2008, Russia’s seven nuclear-powered icebreakers were transferred from the trusteeship of a private shipping company and transformed into a state enterprise – Atomflot, part of the newly-formed nuclear power state corporation.

So regarding Russia’s North Pole flag-planting stunt of 2007, the medium was the message: Russia displayed it had the bathyscape technology to conduct Arctic seabed operations.

But much of the Western media preferred to believe that Russia’s flag planting was an aggressive assertion of rule over the North Pole – and conspiracy theorists even perceived a Kremlin masterplan to seize control of Christmas.

Those conspiracy theorists will see their fears confirmed with Chilingarov s next bathyscape dive: as announced end of July, he intends to dive to the bottom of the Mariana Trench, the deepest part of in the world’s oceans. The Mariana Trench is in the middle of the South Pacific – surely indicating a Kremlin claim to Easter Island.

Green as camouflage for Kremlin’s energy agenda

Graham Stack for business new europe

Far from flooding the carbon trading market with hot air, Russia is posing as an environmental purist and using the green issue to push the Kremlin’s energy agenda.

After vacillating for months, Russia’s decision to sign off on the Kyoto Protocol in January made the international agreement that is supposed to regulate international emissions of gases harmful to the environment a real document.

One of the quirks of the document was the chance it gave Russia to sell lots of “hot air:” because the 5% reduction target for 2008-2012 took 1990 as its baseline, before Russia’s post-Soviet industrial collapse, it handed Russia 300m tonnes of carbon emission indulgences to dispose of. Environmentalists and traders were waiting anxiously to see what Russia intended to do with the Kyoto lottery win. Would Russia swamp the nascent carbon trading market with cheap hot air, allowing European companies to ramp up emissions with impunity and turning Kyoto on its head?

They needn’t have worried – the opposite seems to be true. After years of bureaucratic foot-dragging, Russia’s paper-pushers have finally drawn up the regulatory framework for joint implementation – the system whereby companies from signatory countries can harvest carbon credits for own consumption or for trading by investing in carbon-reduction “joint implementation” projects in other signatory states.

And the big surprise: far from letting the lottery win go to their heads, Russian officials have outed themselves as environmental purists.

Vsevolod Gavrilov, head of the natural resources department in the economy ministry, announced at a press conference on March 13 that his department will process joint implementation projects – of which 60 have already been drawn up by investors – according to a rejection-based approach. “The most correct approach is forbidding everything, but allowing certain things to go forward. The worst approach is to approve everything, but say certain things are forbidden,” Gavrilov said. “We are working according to a principle of rejection – we have no interest in creating the largest carbon emissions market. Our goal is to promote norms of ecological responsibility.”

Many potential foreign investors hoping for a slice of carbon credit action in Russia were dismayed at his words, although Gavrilov’s statement was consistent with earlier assertions in January that, “the key goal is to attain ecological benefits both globally and locally here in Russia,” rather than for Russia to earn big bucks.

Considering that the Russian government originally hemmed and hawed over signing up to Kyoto, leveraging a very strong bargaining position to secure EU consent to its WTO bid, is it really the case that Russian officials are now “greener than green” and intent on implementing the agreement for the sole good of the global environment? Or is Russian bureaucracy simply displaying its usual regulatory zeal? Or is there a more sophisticated Kremlin agenda for joint implementation, as for most everything else these days?

Trailing Ukraine in carbon readiness

The proposed stringency regarding project approval follows a long period of foot-dragging by government over establishing the procedures for joint implementation – meaning that for potential investors, time is running out. “The window of opportunity is closing now that with 2008 the commitment phase of the Kyoto protocol has already started,” says Maria Kovalenko, carbon trading analyst at pointcarbon. “Projects have to be completed before 2012, the emissions reduction target date. Newcomers should consider carefully whether there is sufficient time left.”

“Ukraine established its procedures in 2006, and they already have one project up and running,” she says. Not surprisingly, pointcarbon’s CIS office is located in Kyiv and not Moscow. The Ukraine project, the Podolsky cement factory, consists of a €140m investment to replace wet cement production with dry technology. Ireland-based CRH Finance is providing the investment and will acquire the resulting carbon credits.

Konvalenko explains the Russian time lag with the detailed work that the government has performed in establishing procedures for project approval – a testimony to Gavrilov’s professed purism. The very real complexity of the process is all down to the concept of “additionality:” joint implementation projects have to prove that the emissions reduction would not take place without the incentive of carbon credits, to cut down on freeloaders’ distorting the carbon credit market. Needless to say, the bureaucratic effort in ascertaining this additionality is immense. Joint implementation projects are both subject to approval at the national and UN level to guard against any softening of criteria leading to carbon credit inflation. Thus there is ample justification both for delays in establishing procedures and for future delays in approving projects. “Joint implementation is in itself a very slow process,” says Kovalenko.

In Russia, the situation is made even more complex by the currently distorted incentives set by state-controlled prices for power and gas – controls that are about to be phased out. This means that rising domestic energy prices will anyway force companies to invest in improving energy efficiency, without any need for the additional incentive of selling carbon credits.

So the ministry, argues Astrid Moe of Norway’s Fridtjof Nansen Institute, has a powerful argument for handling joint implementation strictly: to fence off “real” carbon reduction emissions from simple energy efficiency improvement stimulated by price rises. “I believe the Ministry of Economy wants to steer [joint implementation] into projects where new technology is needed and let the bulk of easy reductions be taken care of by price reforms, as well as emissions trading further on.”

This is view is shared by Ingo Ramming, executive director of Carbon Trading and Finance, a joint venture established by Gazprombank and Dresdner Kleinwort. “This is a very important statement,” argues Ramming, referring to Gavrilov, “coming against the background of controversies last year about projects in India and China where the additionality of projects was disputable. It seems the Russian authorities wanted to make quite sure about additionality. I would even say it was an important statement upholding the credibility of joint implementation in Russia.

This seems to back up eco-purist Gavrilov when he says, “unfortunately not all the investors are taking this opportunity the right way, some see it as a way to get a freebie without doing any work. We want to avoid these speculative projects.”

Green as camouflage for energy agenda

However, Gavrilov not only surprised potential investors by the stringency of his department’s approach and his green purism, he also surprised them by naming Russian oil major Surgutneftegaz as a shining example of how to implement carbon emission reductions – by capturing the associated gas for power generation instead of simply flaring it.

This relativises Gavrilov’s ecological credentials: since 2007 it has been established Kremlin policy to clamp down on flaring. President Vladimir Putin even mentioned the issue in his last state of the nation speech in April of 2007. Government ministries have started drawing up regulatory measures to encourage a shift towards utilizing associated gas. The Kremlin’s motivation is for cutting flaring is, however, not ecological, but to maximise Russia’s energy clout. This raises the question of whether the tight bureaucratic supervision, combined with the small remaining window of opportunity for joint implementation projects, is not intended to channel Russia’s carbon credit wealth towards strategic projects backed by the Kremlin.

The case of associated gas is one where Kremlin strategic goals and carbon emission goals coincide. However, a carbon-reducing classic – switching power generation from coal to gas – fundamentally contradicts Gazprom’s ideas about how the Russian power sector should develop, and is thus likely to be a non-starter.

Gazprom is lobbying for exactly the opposite to happen: for an increase in the use of coal in Russia, to free up gas for more profitable exports. A planned rise in gas prices should stimulate this process. Gazprom has also just been given the go ahead to merge its considerable power generation assets with those of the SUEK coalmining concern, paving the way for increased use of coal domestically. According to Moe, this means that joint implementation projects envisaging a coal-to-gas switch for Russia are unlikely to win approval, however impeccable their environmental credentials. Russian regulatory authorities have the power to simply delay project approval until time runs out for implementation. So Gazprom’s preferences are likely to shape policy regarding carbon credits as it does in most other policy spheres as well. And all the more so for that Gazprom is hatching big carbon plans itself.

Phillip Dewhurst, head of PR at Gazprom’s London subsidiary Gazprom Marketing and Trading, a vehicle for global carbon credit trading, calls Russia “the Saudi Arabia of carbon.” Gazprom M&T has already made its debut on the world’s carbon trading market, acquiring carbon credits by investing in a Brazilian bioethanol plant and selling to Japanese company Marubeni. According to Gazprom M&T, however, these deals were just testing the water. Gazprom’s ultimate aim is to set up a scheme systematically bundling carbon credits with its own natural gas sales, marketing the package as “carbon-neutral gas.” In this way, Gazprom can leverage Kyoto to expand market share in Europe, in particular facilitating direct access to industrial customers, one of its long-term strategic goals.

And Gazprom is not going to be short of carbon credits. According to Anna Korppoo also of the Fridtjof Nansen Institute, 52% of proposed joint implementation projects and 60% of proposed emission reductions in Russia involve refurbishing gas pipelines to reduce leakage. This means that Gazprom, monopoly owner of Russia’s gas pipelines, will be the driving force behind joint implementation in Russia. Korppoo notes that gas pipeline projects involve a minimum of foreign actors, some of which are anyway Russian companies registered overseas.

In general, Korppoo notes revealing details about proposed joint implementation projects in Russia compared to Ukraine: an extreme concentration of the Russian projects in few hands, with only 17 foreign actors spread between 38 projects, compared to 15 foreign partners for a total of 15 projects in Ukraine.

These figures also point to joint implementation in Russia being nationalized to further the Kremlin’s strategic goals – with restrictive bureaucratic means being used to channel credits to national champions, while maximizing their value by restricting supply to the market as a whole.

Green fields for biofuel, blue skies for Sukhoi

It’s hardly by chance that the same week Gavrilov outlined government policy on joint implementation, a trio of political heavyweights called on biofuel to become an important new string in Russia’s energy bow. Russia currently has no bioethanol production, but the agriculture ministry estimates there are 20m hectares of idle arable land that could be brought back into use for biofuel production – supported by carbon credits.

No less than Vladimir Putin got the biofuel ball rolling. “Considering that the significance of biological fuel in the global energy sector is steadily growing, special attention will now be paid to countries that have enough arable land to ensure the necessary amounts. Certainly, Russia will occupy a special place among these countries. This is becoming no less important for us than the use of common national resources in the hydrocarbon sector,” Putin said at a meeting with top officials of the State Duma on March 11, according to Interfax.

Duma speaker Boris Gryzlov was even more direct, saying: “we should capture this market, and then we will dictate our terms not only on the sale of gas and oil, but also of biofuel. This is a realistic opportunity for us.”

The day after Putin’s call for action, Prime Minister Viktor Zubkov, attending a timber industry conference, announced a state programme to be launched with the goal of achieving 2m tonnes of biofuel production per year, including construction of some 30 biofuel plants. The timing of his announcement in front of timber industry representatives might indicate future utilization of timber waste for bioethanol production, something done in Soviet times – and also chiming with Kremlin plans to increase added-value in the forestry industry,.

The Kremlin carbon agenda is not limited to energy. At least one of the Kremlin’s pet high-tech projects is also lining up to gain from the carbon credit bonanza: Russia’s flagship civil aviation project, the Sukhoi Superjet, a state of the art medium-range passenger plane yet to go to serial production, boasts significantly lower carbon emission values than its competitors – making it eligible for carbon credits under Kyoto. As Maria Konvalenko of pointcarbon points out, “in Russia a lot of business is very close to politics, and sometimes it is simply the same.”

Gazprom’s Sochi: The Shtokman Field gas project moves towards implementation

On Feb. 21, the CEOs of Russia’s Gazprom, France’s Total and Norway’s StatoilHydro signed a deal establishing the Shtokman Development Company, a joint venture that will develop (but not own) the eponymous gas field in the Barents Sea. The timing was highly symbolic, ten days before the election of Gazprom’s Chairman Dmitry Medvedev as Russian president and ten days after lavish celebrations of Gazprom’s 15th birthday starring outgoing president Vladimir Putin.

The Shtokman project epitomizes Putin’s policy of combining state control over oil and gas with accelerated development. The deal marks a new frontier for the pivotal Russian gas industry firmly under Russian state control. The energy giant threesome formally established what had been agreed months ago. It is a special purpose vehicle that will develop the field while leaving the license in the hands of Sevmoreneftegaz, Gazprom’s 100 percent subsidiary. In contrast, Gazprom holds a 51 percent stake in the SPV. Total has 25 percent and StatoilHydro – 24 percent.

Gazprom comes up trumps

The creation of the Shtokman Development Company puts an end to a number of intrigues that developed over the past two years. In 2005, initial intense jockeying among foreign energy companies to join the Shtokman consortium resulted in a short list, comprising the Norwegian companies Statoil and Hydro, the U.S. majors Chevron and ConocoPhillips, and France’s Total.

Jaws dropped at Gazprom’s hubris in October 2006, when its CEO Alexei Miller declared that the company did not need any foreign partners to develop Shtokman, but would go at it alone.

Then, in July 2007, Gazprom relented and closed a deal with Total, which the Financial Times termed possibly “the worst a foreign oil company has ever accepted in Russia.” Gazprom retained full ownership of the field and the production license while gaining access to Total’s liquefied natural gas (LNG) expertise.Later the same year Norway’s merging Statoil and Hydro agreed to similar terms.

From the Russian point of view, there was poetic justice in avenging the humiliatingly one-sided Sakhalin PSA deals of the early 1990s. These had just undergone a major revision, and Gazprom been cut in on the deal following foreign company harassment by Russian state watchdogs.

In this case, the boot was on the other foot. The deal, which reduced Western oil and gas majors to the role of mere contractors, was seen as catalyzing the era where multinationals would only be able to access reserves in junior partnership to state-owned companies.

Gazprom’s subsequent announcement that all Shtokman gas would go to Europe (without the liquid natural gas supplies previously envisaged for North America) combined with the exclusion of US companies from the project, pointed to geopolitical considerations and caused further irritation.

But this year, the emotional reactions have given way to a calmer approach. Observers were pleasantly surprised to learn that the foreign partners will be able to book the field’s reserves – boosting a key market indicator of long-term economic health of the companies and raising their status.

“They were originally hoping for ownership rights, but it was pretty clear that they weren’t going to get these. They were allowed to book reserves, which surprised analysts. That makes them much more than just contractors,” USB Moscow analyst Dmitry Loukashov said.

“Basically, what the foreigners get from this project is booking reserves proportional to their stakes in the SPV, and secondly, they will be entitled to profits. They will have ownership rights only to infrastructure, not to the field itself or the gas produced,” said Constantine Batunin, an oil and gas industry analyst at Alfa-Bank.

According to French energy expert Pierre Noel, the same results could have been attained through a conventional contract with shared ownership of the field. He argues that the difference is symbolic, but the issue itself, he believes, is all about symbolism of who has the upper hand.

However, one crucial aspect for Gazprom will be far from symbolic. The deal means Gazprom owns the gas, and thus dictates the markets where it will be sold. This secures Russia the extra-economic leverage, the “soft power” it is demanding from its resource base.

The tip of the iceberg

Having decided who will own the gas when it comes on stream, the only outstanding issue is drilling 4,000 meters below an uneven seabed, 350 meters below an iceberg-ridden ocean 550 kilometers from the mainland.

“They simply do not know exactly how they are going to do this,” Batunin said. “Gazprom admits this openly. It doesn’t pretend to hide the fact. But they believe they can do it, and the deadlines are tight, with gas to go on stream in 2010.”

In 1988, when the Soviet Union discovered the sprawling gas field 550 kilometers northeast of Murmansk (on the Kola Peninsula), the super-giant field was estimated to harbor some 3.2 trillion cubic meters, in addition to around 31 million tons of condensate.

The unique features of the field meant that assistance from foreign partners was inevitable. It is technological expertise, and not financial resources or market access that determined Gazprom’s choice of partners.

“It would have been impossible to pursue a project like Shtokman alone both financially and technologically. Total has expertise in LNG and deep sea projects, and the Norwegian companies have expertise in the area, so for Gazprom it is about risk reduction and sourcing technology,” Batunin said.

“Frankly, it’s yet to be decided which technologies should be used for this project. It might not even be the Norwegian technologies. This is going to be an incredibly sophisticated project. All similar Norwegian projects are significantly less ambitious than this one, because the field is located very far offshore, and new technologies have to be created. These will be created on the basis of expertise that Statoil has, but they will be new.”

The project is mind-boggling. There are 565 kilometers of open sea between the Shtokman field and the onshore production facilities at the Barents port of Teriberka. A sea populated by icebergs and drift ice with sub-zero temperatures, polar nights, mega-waves and an uneven seabed. A total of 156 wells will be drilled to a depth of 1,900 to 2,300 meters below the sea floor. Four platforms will be built, and forty wells drilled directly from the seabed.

“Gazprom realized nobody would do this sort of job on a contractual basis,” says Loukashov. “The foreign partners will have more responsibility because of the technological demands.” Pierre Noel agrees that it was the technological difficulties that drove Gazprom to share risks.

But the main technological dilemma concerns the pipeline link to the mainland. Statoil managed to cover 160 kilometers from the pioneering Snovhit gas field to their liquid natural gas plant on Melkoya Island. Anything over that has never been attempted.

Is Gazprom up to the challenge? Politicized, bureaucratic and opaque, it would seem that the company is the weakest link in the Shtokman troika.

However, precisely by relegating foreign partners and taking most of the risk upon itself, Gazprom and the Russian government have turned the development of the Shtokman field into a prestige project – Gazprom’s very own Winter Olympics, substituting Shtokman for Sochi and symbolizing national revival. With the Russian penchant for gigantism and Gazprom’s chairman becoming president, this could mean there is too much hinging on the project for it to be allowed to fail.

Russia Steps On The Gas

Graham Stack for Russia Profile

Germany is Russia’s most prominent European partner, and now Germany’s most important Russia specialist has published a snapshot of Russia and its ambivalent relationship to Europe, containing a wealth of insider information and hot off the press.

Alexander Rahr is almost as well connected in Moscow as he is in Berlin. The foremost German Kreminologist, and member of Germany’s leading foreign policy think tank the German Society for Foreign Policy (DGAP), he is policy makers’ close adviser in the country Russia sees as its natural ally in the West. In particular, he has the ear of former chancellor Gerhard Schroeder and of current foreign minister Franz-Walter Steinmeier. As such, many doors are open to him in Moscow. Including those of the Kremlin.

Rahr’s thesis in his book “Russland Gibt Gas,” published to coincide with the Russian electoral campaign, is a bold one: Russia and Europe need each other deeply in a purely pragmatic, geo-political way, and this basis can be used to build trust and to nurture common values. Rahr sees Russia as actively seeking such a pragmatic interdependence, but in the case it is turned down, it may reorient itself towards Asian giants such as China and India.

His book does not mince words in describing Russia’ many shortcomings – a weak rule of law, lack of media freedom, and human rights abuses. However, in contrast to so many other accounts, it is not primarily a critique of Russia, but of European policy toward its neighbor.

The new Ostpolitik: a pragmatic approach to Russia will bear normative fruit

Rahr argues that Europe’s security depends too much on integrating Russia geo-politically, and this can’t be postponed until European values take over in Russia. Rahr’s thesis is that whether you like it or not, Russia holds the solution to Europe’s energy security problem. Europe has to recognize this pragmatically, and achieve energy supply security by offering the Russians demand security and markets.

If Europe does not do this, Russia could well turn toward Asia. If Europe does do this in a pragmatic way, increased Russian security might well lead to accelerated voluntary value changes in Russia.

Russia may be far from perfect, argues Rahr, but it’s not Saudi Arabia. The fact that Europe, unlike the United States, sources its energy needs from a neighbor with so much shared culture, should be regarded positively in European capitals, rather than as a source of apprehension.

Moreover, Rahr believes the potential for value transfer, once such a deepened long-term pragmatic partnership is established, to be considerable.

It’s no coincidence that this argument comes from a German: the idea takes intellectual roots in the Allies’ post-war strategy of Westbindung of the Federal Republic of Germany. The policy that pragmatically began with the France-Germany coal and steel union, created precisely to defuse the resource question, was the seed of today’s “value community” of the European Union.

The second inspiration was West Germany’s 1970s Ostpolitik (eastern policy) of de-escalating the cold war in Europe by building up trading relationships with the Soviet Union, culminating in the gas pipelines so bitterly opposed by the United States. Again, the pragmatic approach became a non-confrontational channel for value transfer during Perestroika. The historic paradigm that inspires Rahr is thus Wandel durch Handel, change through trade.

The crux of Rahr’s argument is that Russia will be far more open to European values if it is freed from suspicions that these are merely a foil for geopolitical motives, that European “preaching” is simply a pretext for geo-political sidelining and exclusion.

Precisely now that the Russian economy is up and running, Russia is desperately looking westwards for opportunities – markets and investment – to diversify its economy away from the resource base. Such a diversification is both in Europe’s interest and in Europe’s power to support. However, should Europe shut itself off from reciprocal economic engagement of Russia, Moscow could turn east – and take its energy resources with it.

The urgency of the matter means, according to Rahr, that Europe has to lower its suspicion threshold for Russian expansion into European markets. Russia wants access to end customers in Europe for its energy resources, as well as increased cooperation in the high tech area (especially aviation) and in logistics. Russia also wants its companies to be allowed to buy into European ones.

This is hard for Europe to swallow, because Russia’s competitive advantages are in the strategically sensitive areas of energy and defense / aviation, where there is great suspicion of collaborating with Russian state-owned companies. In addition, because of the size of the largest Russian companies and their formal or informal links to the state, Russian acquisition of European companies in almost any sector could be deemed to have some strategic goal.

Rahr, however, argues that Europe must have more confidence in the strength of its own institutions to absorb and “tame” Russian corporations, whether state-owned or private.

It must also be made clear to the Russians that there is no question of Europe loosening its ties with the United States for Russia’s sake. The choice is not whether Europe ties itself to Russia rather than the United States, but that Russia binds itself tighter to Europe than to China.

At the same time, “New Europe” must be convinced that a defensive attitude toward Russia based on Cold War resentment is self-defeating in the long run, and that engagement of Russia is the best path to defusing tensions.

Face to face with the siloviki

Along with the geopolitical analysis, Rahr’s book intrigues readers with its vivid accounts of face to face meetings with top officials in the Putin administration. He tells of a two hour interview with Sergei Ivanov, Putin’s friend of thirty years, KGB colleague and long-serving defense minister, who was widely expected to succeed Putin in office – until the choice fell upon Dmitry Medvedev.

The anglophile Ivanov tells Rahr he sees Russia’s future in a two-party system, as in the Anglo-Saxon world. With Putin having established a strong conservative party, Ivanov calls on the Russian Communists to transform into a social-democratic party as in other post-socialists states, and for the EU to overcome its divisions, so that it can become an anchor of stability for Russia.

Rahr also meets with Viktor Ivanov, one of the top-ranking “siloviki,” former KGB officials working in the Kremlin. Viktor Ivanov takes a piece of paper and sketches for Rahr the tangled maze of channels that were used by oligarchs to bypass the Russian tax authorities, including even the Baikonur Cosmodrome endowed with tax privileges in the cash-strapped 1990s.

Above all, Rahr meets Putin himself regularly in the framework of the Valdai Club of western Russia experts. Their most recent meeting was held in Sochi in October 2007, culminating with a stroll along the beach and Putin calling on the EU to step out of the U.S. shadow as an independent actor.

But this star-studded cast is upstaged by a dacha drinking session among FSB top brass, which Rahr faithfully records – and a debate pitting the “conservative” Viktor against the “superliberal” Yevgeni. The opposing sides reveal how the centuries-old opposition between Russia’s adherence to a special path and Russia’s convergence with Europe divides even FSB generals.

For the FSB general referred to by Rahr as Yevgeni, Russians went to the barricades in 1991 to fight “against the Communist putsch and to win freedom for their motherland. The Russian people’s triumph in 1991 was in terms of historical significance far greater than the Orange revolution in the Ukraine. For Russia, the overthrow of dictatorship during the days of the putsch was the entry ticket to Europe.”

His ideological opponent Viktor counters immediately: “The West has regarded us as an enemy for a thousand years. At best as a supplier of raw materials; nowadays oil and gas, five hundred years ago woods and furs. Tsar Alexander I liberated Europe from the Napoleonic occupation. In the Second World War, Russia defeated Hitler’s fascism. And what thanks did we get? Following the Vienna Congress in 1815, Europe united against us, allied with the Ottoman Empire to try and expel us from Europe in the Crimean war. Western historiography simply ignores our victory in the Second World War and even labels Russia the enemy of Europe. And Europe regards Putin’s Russia as her enemy as well.”

In view of this clash at the very heart of the FSB, it is surprising that Rahr follows the conventional approach in ascribing so much block weight and corporate loyalty to the ex-FSB “siloviki.” Whether anything really unites the siloviki beyond Putin, whether they have a shared ideology rooted in “the corporation,” is all a matter of speculation. The popularly-pedaled version of the story is little more than a conspiracy theory. Exactly how the allegedly pervasive silovik influence has led to Dmitry Medvedev being named as favored presidential successor is anyone’s guess.

The Medvedev candidacy, however, does prove Rahr’s general point: Medvedev personifies Russia’s renewed bid to align itself with Europe. With 2007 marking an economic breakthrough in terms of soaring fixed capital and foreign direct investment resulting in 8.2 percent economic growth, Russia can now claim to have put its house in order after the unsustainable 1990s. Now, in the person of Medvedev, according to Rahr, the West is being given “another chance to take up the idea of an intensive strategic partnership.” Medvedev, a 42 year old corporate law scholar, is in terms of political identity “a European” in his own words, and has a greater chance to achieve such a breakthrough than Ivanov, whose KGB roots would inevitably be held against him.

Will Europe take up the offer?

A positive outcome might depend on a factor that Rahr neglects to consider: the 21st century phenomenon of Russian consumerism.

Rahr, for all his relatively liberal view of Russia, completely excludes society and largely excludes the economy from his analysis. The word “Internet” does not feature in the index, and there is no discussion of how the explosive growth in real disposable incomes across the board, the shrinking of poverty and the very real emergence of a middle class have combined with technological (internet, mobile) and generational change to alter society and lifestyles.

Put simply, for all the democracy and law-and-order deficits, Russia is becoming a European society at a very fast rate – on its own. Reassuring Russian elites that Europe is not intrinsically hostile to Russia through establishing a strong strategic win-win partnership would, as Rahr argues, be the best way for Europe to support this process.