Putin plays the market

Paul Robinson says that Russia was only doing what the EU had demanded when it increased its gas prices this week Idon’t believe that I can be alone in having spent a Russian or Ukrainian winter with the windows of my room wide open. Many buildings in that part of the world are dreadfully overheated, for the simple reason that energy is so cheap. Soon, however, Ukrainians will have to learn to close their windows. Until this week, the Russian gas company Gazprom charged Ukrainian consumers $50 for every 1,000 cubic metres of gas they used. On Sunday Gazprom demanded that they pay $230. The Ukrainians’ first response was to refuse, and the Russians turned off the gas. The choice, it seemed, was expensive fuel, or no fuel at all. On Wednesday, the Ukraine agreed to pay $95 per 1,000 cubic metres for a mixture of Gazprom supply and cheaper gas from Central Asia. Gazprom has, for the moment, said it is satisfied.

What’s going on? With the collapse of Soviet military and economic might, Russia was left with very few means with which to influence the world around it. Now rising energy prices have handed Moscow a new weapon. Russia has 30 per cent of the world’s natural gas deposits and 10 per cent of the world’s oil. Oil and gas production in the rest of Europe is declining, and within a few years the European Union will import about half of all its gas from Russia. This gives Russia great leverage over its neighbours, and the Russian president Vladimir Putin is showing clear willingness to use that leverage.

We Brits love an underdog. As Robert Baden-Powell harrumphed in his classic Scouting for Boys, ‘If you see a big bully going for a small weak boy, you stop him because it is not “fair play”.’ Gazprom’s price hike provoked great howls of indignation in some circles of the British press, particularly as Russia has this week taken over the rotating chairmanship of the G8, and the issue will certainly embarrass Western leaders. According to the Daily Telegraph, ‘The methods of gangsterism and blackmail now being used by Gazprom are reminiscent of the Soviet era.... The West has to tell Russia that, plainly and simply, its conduct is unacceptable if it wishes to remain part of the club of civilised nations.’ Unfortunately for those spinning this simplistic tale of bully and bullied, Gazprom’s ‘unacceptable conduct’ is actually something we have been requiring of it. For in raising the prices they charge for gas in Eastern Europe, the Russians are merely going part way towards meeting demands made by the European Union over several years.

The initial increase in the gas price proposed by Gazprom — from $50 to $230 per 1,000 cubic metres — was certainly a large one, but it is, after all, what consumers in Western countries such as Germany are charged, whereas $50 is below cost price, meaning that Gazprom made a loss by selling gas at that rate. Gazprom is only notionally an independent company; in practice it is an arm of the Russian state, which owns 51 per cent of the stock, and the state is prepared to take a loss in some circumstances for political advantage — bribing potential allies, keeping Russian voters’ energy bills low, and subsidising domestic industry, for instance. Accordingly, Gazprom has been selling its gas at $50, or even less, to consumers throughout the Commonwealth of Independent States (CIS) ever since the collapse of the Soviet Union. As Aleksandr Ryazanov, deputy director of Gazprom’s board of directors has noted, $50 ‘doesn’t even cover our real costs for producing and transporting gas to CIS countries’.

Now you might imagine that it is entirely Gazprom’s business if it wants to make a loss on some of its deals; but not so in the eyes of the ever-meddling European Union, which for years has been demanding that Russian companies stop subsidising energy prices and start charging market rates. In the oil sector, this has largely happened. In the gas and electricity sectors, it has not. Gazprom and the Russian electricity giant UES have, therefore, long been in the Eurocrats’ sights.

In October 2000 the EU and Russia started a series of bilateral meetings known as the ‘EU–Russia Energy Dialogue’. On the European side, the aim of the dialogue is to reform the monopoly system in the Russian gas and electricity markets, open up those markets to EU investors, enhance environmental protection and secure Europe’s energy supply. On the Russian side, the aim is to gain long-term contracts for Russian energy exports, attract European investment and gain unrestricted access for Russia’s exports into the EU. Parallel to the energy dialogue, negotiations took place between the EU and Russia regarding Russia’s entry into the World Trade Organisation (WTO). Much to the Russians’ annoyance, the EU linked the two, demanding that Russia liberalise its energy prices as a condition of European support for its WTO membership.

The reason the EU dislikes the low prices charged by Gazprom to CIS members is that these are considered an unfair subsidy to CIS industries, which gives them a competitive advantage over European companies. This is of particular concern in some sectors such as metals and fertilisers, where CIS exporters have been able to keep costs low through subsidised energy, and then harm European competitors. For instance, the collapse of communism led to a dramatic fall in domestic Russian demand for nitrogen fertilisers. The Russian fertiliser industry responded by what has been called an ‘aggressive export dumping campaign’ in the EU. In accordance with its free-market principles, therefore, the EU has stated that Russian energy subsidies are incompatible with free trade and must go.

In addition, the EU is in the process of liberalising its own energy industry. The Russian habit of signing long-term contracts with different European countries at differing fixed rates is incompatible with the aim of producing an EU-wide free market in energy. ‘Marketisation’ of the Russian energy system is, therefore, an important European goal.

Aware of the inefficiencies and waste caused by its policies (open windows in win ter, for instance), the Russian government in April 2003 laid out objectives for achieving more efficient energy use. This strategy requires marketisation of the energy sector, including liberalisation of prices (albeit gradually to avoid excessive shock) and raising the costs of energy consumption in order to reduce waste and increase exports of surplus energy.

On the environmental side, the EU pressured Russia long, hard and ultimately successfully to ratify the Kyoto accord. This requires a reduction in carbon emissions, and so adds further incentives to reduce consumption of oil and gas by means of raising prices. Consequently, Russia became aware of the advantages of higher prices, and in May 2004 reached a compromise agreement with the Europeans. The EU agreed to support Russia’s WTO accession, in return for which Russia promised to double its domestic gas prices by 2010.

Given all this, Gazprom’s decision to charge market prices to Ukraine is, on the surface, one for which the EU should be congratulating it. It represents at least a small step in a general Russian policy towards liberalisation which has been slowly gaining pace over the past five years, in part due to EU pressure and in part due to the needs of the Russian economy. One of the problems of subsidies is that they distort economic behaviour, creating wastefulness and inefficiencies in the allocation of resources. Ukraine is not the world’s sixth largest consumer of natural gas because its industry requires such enormous consumption, but because its subsidised prices make it indifferent to energy-saving. Paying more for its energy might actually do it some good.

In short, the increase in gas prices is fully in keeping with the West’s desire to complete the process of creating a genuine market economy in Russia, Ukraine and the other countries of the CIS, as well as progressing towards fulfilling the environmental demands of the Kyoto accord. It is an entirely welcome gesture from the perspective of any free-market economist, not to mention any environmentalist.

Economics cannot be the only reason Gazprom has acted the way it has. The company has, after all, chosen to increase its charges to most former Soviet countries by much less than it was threatening to increase those to Ukraine. Gazprom’s charges to Georgia are increasing from $60 per 1,000 cubic metres to $110. Similarly Armenia will now pay $110, Moldova $160, and the three Baltic states $120–125. Until Wednesday’s last-minute deal it seemed as though Ukraine had been singled out for particular punishment. Perhaps the $230 was more bargaining chip than ultimatum, but it is hard not to see Moscow’s move as political — a reaction to the perceived anti-Russian policies of the current Ukrainian administration. Aleksandr Lukashenko, President of Belarus and Russia’s close ally, recently signed a new deal guaranteeing his country continued gas supplies at $47 per 1,000 cubic metres, and gloated about this at the end of last month. His deal, he said, was a ‘reward for loyalty’. Indeed.

Putin seems to regard the key to Russia’s resurrection as being the recreation of a powerful central state. Weak government has been a perpetual problem in Russian history, and has all too often brought economic and social disintegration. For this reason Putin has sought to bring the most important economic assets of the country the oil and gas industries — back under the sway of the state. The renationalisation of Mikhail Khodorkovsky’s Yukos oil company can be seen in this light. Now, having more or less completed this process, the President is flexing his new-found muscles on the international stage.

It is this which causes the current indignation. But in truth, all major nations provide aid and subsidies to their allies, and seek to coerce or punish others. As Eric Kraus, chief strategist at the Sovlink Securities brokerage firm in Moscow, comments, ‘Russia does not have to subsidise countries which are overtly hostile to Russia. The Americans or the French or the Germans can give foreign aid to some countries and not to others. They heavily subsidise Egypt; they don’t subsidise Syria. Does this give Syria the right to complain of unfairness? Russia can choose to subsidise for geopolitical reasons countries of her choosing. It’s a sovereign right.’ Putin’s policy certainly represents a very crude pursuit of national interest, implemented unilaterally and with little regard for international opinion. But as such it is not so very different from the sort of policies pursued by other states, including our own. Furthermore, the marketisation of energy policy which it involves is entirely in keeping with the demands that European states have been making of Russia for several years. While one may sympathise with the Ukrainians who are having to shut their windows, there is in reality very little to be indignant about.

Paul Robinson is author of The White Russian Army in Exile, 1920-1941 (Oxford University Press).