This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.
Panel 5 – Case Studies: Special Relationships
Politicized Oil Trade: Russia and its Neighbors
Ariel Cohen, Heritage Foundation
This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.
Politicized Oil Trade: Russia and its Neighbors
Ariel Cohen
The views expressed herewith are the Author's only and do not represent the views of The Heritage
Foundation
Describe the nature of the oil-specific trade relationship between Russia and the FSU countries. How has it
evolved and what is its present status, in terms of quantity of crude oil or refined products, flow direction,
mode of transport, transparency, and otherwise?
According to the Oil and Gas Journal, Russia’s proven oil reserves were 60 billion barrels as of
the beginning of 2010, most of which are located in Western Siberia. In 2009, Russia produced an
estimated 9.9 million bbl/d, and consumed only 2.9 million bbl/d. Russia exported roughly seven bbl/d in
2009; including about 4 bbl/d of crude and the rest in products.
Russia's oil exports have grown dramatically since the beginning of the century; 103.1 million
more tons of oil was exported in 2009 than in 2000. The growth in Russia's crude exports would be even
more pronounced had the exports in refined products not doubled during the same decade.
According to the Central Bank of the Russian Federation, over 10 percent of the Russian crude,
26.6 million tons out of 250.7 million tons of oil exported by Russia in 2010, made their way to CIS
countries. 2010 was the first year in a decade that exports to this region dropped. Crude oil exports from
Russia to CIS countries grew steadily from 16.9 million tons in 2000 to 36.5 million tons in 2009.
The average price of crude oil exported by Russia has consistently been considerably lower for
the former Soviet states than for the rest of the world. In 2010 CIS states bought the Russian crude at a 35
percent discount, paying an average of $56.20 per barrel, while the rest of the world paid $76.24. This
figure does include the prices charged to Belarus and Kazakhstan, members of the Customs Union. In the
past, the discount was even deeper. The largest discount – 44 percent – was extended in 2008. In the year
when oil prices spiked to over $100 a barrel for a time, CIS countries paid $66.11 per barrel of crude from
Russia while the rest of the world paid $95.27 on average. This is the cost of doing business, or more
accurately, of keeping the sphere of influence – excuse the pun – oiled.
Most of the oil produced in Russia is transported through their massive pipeline network, which is
dominated by the state-run Transneft. Transneft transports 90% of all oil produced in Russia. There are
also eight ports in Russia serving as export outlets for Russian oil to various markets. The largest Russian
port is Primorsk with a capacity of 1.5bbl/d. Rail exports comprise roughly 5% of Russia’s exports, and
are used to supplement Transneft routes. Rail is more expensive than pipelines and is used sparingly.
Analysis of the bilateral oil relations between Russia and its neighbors is complicated by the lack
of transparency in Russia's energy sector. Russia is currently classified as 143rd out of 182 countries in
Transparency International's Corruption Perceptions Index, and most attempts towards openness is lip
service to foreign investors.
In 2010, Putin removed Transneft from the $59 billion privatization plan of the Russian
government, and its share prices dived. Following this, Prime Minister Putin signed an order forcing
Transneft and its subsidiaries to disclose data on shipping tariffs, financials, investment programs,
services, and spare shipping capacity. There are anecdotal stories of “trucks of cash” shuttling in and out
of Transneft offices, but even without it, the absence of independent audit data raise serious questions
about the company’s modus operandi.
Contracted oil prices for individual CIS countries are rarely reported. Partial disclosure about
Moscow’s oil trading relationships comes from the tariff rates it charges sovereigns, and from average
crude prices reported by government agencies.
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This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.
The most recent development in the transparency arena came in December 2011, during a
meeting at the Sayano-Shushenskaya hydro-power station in Siberia, following a man-made disaster
there, that took lives of dozens. The Prime Minister called for tighter control of state run monopolies and
the disclosure of information pertaining to income and property ownership of the Energy Ministry
officials. Yet, Moscow experts viewed this as a further consolidation of Putin’s power rather than genuine
progress.
According to a transcript of the PM’s speech posted on the government website, Putin also asked
for Gazprom, Sberbank, development bank VEB, oil pipeline monopoly OAO Transneft, nuclear holding
company Rosatom Corp., shipper Sovcomflot and OAO Russian Railways to disclose ownership of their
affiliates within two months. He also left to door open to expanding the mandate to other “infrastructure
spheres” in the economy. Thus, the criticism promulgated by the anti-corruption crusader Alexei Navalny
against the government graft appears to finally impinge.
Describe the current political relationship between Russia and these countries. How (if at all) has the oil trade
relationship between the two countries affected their political
relationship? What about the reverse: How (if at all) has their political relationship affected their oil trade
relationship?
Anatoly Chubais, the architect of Russian privatization, famously declared, “Russia's ideology in
the 21st century should be liberal capitalism with the aim of creating a liberal empire.” In Mr. Chubais
opinion, “this is the only way to cooperate with our partners on equal footing and protect the peace and
freedom in the world. This is the mission of our great country,” he stressed.
Following this advice, Russia’s current attitude towards its former Soviet brothers is accurately
described by President Medvedev’s now infamous phrase, “zone of privileged interests.” This is the view
from Russia’s “liberal” half of the ruling tandem.
The better half, Prime Minister Vladimir Putin, views the collapse of the Soviet Union as “the
greatest geopolitical catastrophe of the century.” And if this was a catastrophe, Mr. Putin can offer a
remedy: in October 2011, just as Russia was nearing an end to its 18 year negotiations to join the WTO,
he floated the idea of a Eurasian Union in an Izvestiya article. He also made no secret of his skeptic
outlook on the global trade watchdog.
Kazakhstani President Nursultan Nazarbayev dreamed up the idea of a Eurasian Union more than
20 years ago in order to reinvent and save the USSR. The Kremlin views the Eurasian Union as a political
expansion of its Customs Union with Kazakhstan and Belarus, which is a single economic space. Putin
claims that the project would not resemble the Soviet Union, but will be a supra-national body which
would coordinate “economic and currency policy” between its members. The Customs Union's aim,
according the Prime Minister, is the removal of all barriers to trade capital and labor between the three
countries, modeled on the European Union. The Union will also be open to new members, which may
find the Russian orbit comforting, such as Kyrgyzstan or Armenia. In case of energy-poor members,
Russia is likely to continue subsidizing members of the Eurasian Union through discounted oil.
Belarus. Belarus sells the bulk of its inexpensive and duty free oil supplies as refined oil products to EU
countries at a hefty profit. The Lukashenko regime depends on Russian oil to support its economic
activity, and survives because of it. The political relationship between the two nations is rocky at time,
and shapes the oil trade policy. This is the implicit arrangement that exists between Russia and its
neighboring states that depend on the Kremlin's support.
On December 15 2011, the Lukashenko regime received two lavish New Year presents from the
Kremlin. Russia agreed to supply 21.5 million tons of crude oil to Belarus by pipelines in 2012, or 3.5
million more than in 2011. This is in addition to the $1 billion loan Belarus received from the Savings
Bank of Russia and the Eurasian Development Bank. Prime-Minister Mikhail Miasnikovich stated that
according to the agreements the two countries reached, the Sberbank would issue extra USD 4 billion of
loans for implementation of various projects in Belarus shortly. .
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At times, there were spats in the relationship between the two East Slav brother nations. In 2007
Russia moved to curb this energy subsidy to Belarus. Russia imposed tariffs on oil supplies to Belarus,
and Belarus retaliated by increasing transit fees on oil supplies headed to Western Europe. When Russia
refused to pay, Belarus cut off oil supplies headed to Western European countries, angering governments
there.
The crisis was doused when Belarus agreed to match Russian export duties on crude and refined
products heading to Western Europe. In exchange Russia would exempt Belarus from most of the new
Russian oil export duty. Moreover, Belarus agreed to hand over to Russia 70% of all proceeds it receives
from its exports of refined oil products to western markets. This figure was revised to 85% in 2009.
Russia is also looking to reduce dependence on Soviet era pipelines that transit Ukraine and
Belarus, such as the Druzhba Pipeline, which runs through Belarus, by increasing capacity at its oil
terminal at Primorsk on the Baltic Sea and, in case of natural gas, the Nordstream pipeline to Germany...
Ukraine. Ukraine is also particularly dependent on Russian energy imports. In 2006 Russian oil
imports accounted for 78% of Ukrainian oil consumption, and 14% of Russian oil passed through its
pipeline network. In the same year natural gas amounted to 50% of Ukraine's energy consumption, 66%
of which came from Russia.
In 2007 the “Orange” parties won an election victory. Following this upset, Putin proclaimed that
Russia had no desire to provide cheap energy to the “Orange” forces, which he considered anti-Russian.
A drawn out gas price dispute followed, when Russia hiked gas prices for Ukraine in 2008 by 38% from
the 2007 levels. Several more disagreements ensued in 2007-2008, when gas was cut of to Ukraine. In
the first quarter of 2009 Ukraine was charged $450 per a thousand cubic meters (tcm), more than double
what it paid in 2008 for gas and higher than customers in Western Europe.
Ukraine's main leverage in price negotiations came from its position as a major transit country for
Russian exports. When Russia's transport infrastructure bypassing the country is finished this leverage
will disappear, and European countries may feel they have less at stake in Ukraine's future for the same
reasons.
The Baltics. Lithuania, Latvia and Estonia, which are members of both the EU and NATO, have
also experienced Moscow heavy-handed tactics in oil trade. About 90% of their oil comes from Moscow
as and 100% of their natural gas. They pay market prices for their energy supplies, but their main concern
has been Moscow's efforts to increase control over the energy infrastructure in their countries.
The Mezeikiai oil complex in Lithuania includes a large refinery, the Butinge maritime terminal,
and a pipeline. This is the largest single enterprise in Latvia, and it accounts for roughly 10% of the
country's GDP. In 1999, the US firm Williams International bought a large stake in Mezeikiai and also
received operating rights. Lukoil, the Russian firm that supplies oil to Mezeikiai, drastically cut deliveries
to the terminal. This led Williams to sell its stake to YUKOS in 2002, which was able to make it
profitable once again.
When YUKOS became a hostile acquisition target of businessmen/senior state officials of the
Russian government, the Polish oil firm PKN agreed to buy out YUKOS despite a bid by Russian
government-controlled oil giant Rosneft. Following the Kremlin's failure to gain ownership, Transneft
announced that the part of the Druzhba pipeline that supplies Mezeikiai was shutting down for repairs.
Transneft has refused to reopen the pipeline citing unprofitability as the motive, while blocking
Lithuania's oil purchases from Kazakhstan through its pipelines. This blatant manipulation of energy
supplies was Lithuania's punishment for trying to diversify ownership in its energy sector away from
Russia.
Another example of attempting to strong arm a Baltic nation into handing over key energy
infrastructure through manipulating energy supplies occurred in Lativa. In January 2003 all oil shipments
to the oil terminal at the port of Ventspils were cut off by Transneft ,after having already decreased
shipments in late 2002. The oil shipments were diverted to the Russian-owned Baltic Pipeline System and
the port of Primorsk. This route has a direct relationship to Putin’s friends and associates, which Ventspils
was lacking.
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The move had a damaging affect on the Latvian economy as a whole, as Ventspils is integrally
important to the country. This was a power play to gain control of Ventspils Nafta which operates the oil
terminal.
A more petty example of oil policy mixing with politics is visible in Russia's actions towards
Estonia on May 2nd 2007. Moscow threw a tantrum after a Soviet war memorial statue was removed from
a square in central Tallin. RZhD, the Russia's state railway monopoly halted delivery of oil products and
coal to Estonia as a result of this news.
Tajikistan and Kyrgyzstan. More recently Russia has used its economic power to increase
political pressure on vulnerable countries like Kyrgyzstan and Tajikistan. Since 2010 Russia has steadily
increased oil duties for countries outside the Customs Union of Russia, Kyrgyzstan depends heavily on
oil product imports from Russia, and the increased export dues would have a visible detrimental affect on
its fragile economy. The Kyrgyz government managed to negotiate a removal of the fees in exchange for
not charging rental fees at Russia's military base in Kant.
Tajikistan imports over 90% of its domestic oil consumption from Russia. It was reported that
Tajikistan was exempt from paying oil and gas tariffs from 1995 to 2010. On May 1st 2010 Russia
cancelled Tajikistan's tariff exemption, and the Russian government has regulated the export duty on light
oil since the beginning of this year. The increase of oil export dues resulted a sharp increase in gasoline
and essential food product prices in Tajikistan. Average gas prices in Tajikistan have increased 59% since
early 2011.
Russia's political ambitions in Tajikistan are most likely centered on gaining access to the Ayni
airbase. The oil price pressure that pushed Kyrgyzstan to accommodate Moscow over the Kant airbase
rental fees appears to be the same with the Tajik government.
Tariff free oil is also a tool to lure poor countries to join the Economic Customs Union and
eventually the Eurasian Union.
Is there a strategic logic to the fact that they trade in oil? Does either of the countries claim there is one, and if
so, does this logic hold up under scrutiny?
The strategic logic behind trading in oil is the energy dependence it creates in republics that do
not have the resources or ability to produce or purchase their own in open market. This oil dependence
gives Russia economic and thereafter influence in the post-Soviet states.
Leaders of FSU countries claim that their ties to Russia are mutually beneficial, that they need to
“lean” on the big neighbors to balance off the pressure by China or western criticism of the abysmal
human rights records.. However, this argument holds no water. Russian energy policy in the region is
based on geopolitics rather than economic considerations. Political clout created by energy dependence is
supplemented by Moscow’s involvement in support of leaders who otherwise may lose public legitimacy.
The price at which Russia sells oil to former Soviet republics is based on geopolitics rather than
production costs or market prices. .
Russia depends on its neighboring states for transportation routes, but the crude and oil-product
exports through the transit shipments of the neighboring states are falling. Transportation infrastructure
abroad is used as leverage in energy negotiations with Moscow by countries such Ukraine. There has
been a considerable reduction in deliveries moving through sea terminals in the Baltic States and CIS
countries, and through the Druzhba gas pipeline. Thus, Russia's geopolitical goal is to create energy
dependence among neighbors without needing anything in return..
There is a precedent to this policy. During the Soviet times, the USSR facilitated dependence of
its Third World satellites through heavily subsidized energy shipments, e.g. to Cuba and Vietnam. Today,
Russia has been positioning itself to need less from its neighbors while they depend more its resources.
Energy price disputes between Russia and Ukraine have been running high for a number of years. Yet,
after the election of Victor Yanukovich president in 2010, and the conclusion of the Kharkiv Agreement,
Russia receiving such political concessions as an extension on the lease of a Russian naval base in
Sevastopol on the Crimean Peninsula for a quarter century in exchange for a drop of 30% in gas prices.
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This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.
The Kharkiv agreement, its opponents say, is a surrender of sovereignty signed by Ukraine's
President Victor Yanukovich, who ran on a platform of closer ties with Moscow. Russia used Ukraine's
energy dependence to leverage favorable results in its negotiations.
In 2010 Prime Minister Putin suggested Gazprom absorb Naftohaz Ukrainy which owns
Ukraine's energy pipeline infrastructure and distribution networks. Putin's interest in controlling the
infrastructure is understandable. If Russia were to gain control of Ukraine's pipeline networks, both
Ukraine and parts of Europe would be at Russia's mercy. Currently 70-80% of Russian energy exports to
Europe flow through Ukrainian pipelines. With the recent inauguration of the Nord Stream Pipeline, and
the South Stream in the works, this is bound to change.
The Kremlin has clearly shown that it is not shy about leveraging its economic power to achieve
political goals. This is a lucid showcase of the strategic logic behind Russia's energy trade in the region.
Armenia. Armenia is another country that sacrificed its sovereignty significantly through heavy
dependence on Russian energy and security blankets. In 2003 Armenia owed to Russia $93 million, and
in 2003 Russia demanded repayment of this debt. Instead, the Amenian government, under heavy
pressure from the Kremlin, handed over five major Armenian assets including key energy, research and
development, and manufacturing facilities. Armenia is Russia’s preferred partner in South Caucasus.
Moscow was the first foreign country to recognize Kocharyan's electoral victory in 1998, In effect, Russia
controls Armenia's energy infrastructure in its entirety, redefining the level of energy dependence Russia
is after.
Were the economics of the oil market to make trade less advantageous for either/both parties, would you
envision any political rationale for the trade linkage overriding purely economic considerations? Has such a
dynamic ever played out empirically between the two?
The political rationale and trade linkage are currently inseparable. Russian oil companies’ export
earnings have grown nearly six fold in the last 10 years, but over 90% of revenue is generated by
deliveries to non-CIS countries. In 2010, 26.6 million tons out of 250.7 million tons of the total crude oil
exported went to CIS countries. This amounts to 10.6% of crude oil exported from the Russian Federation
by volume. The average price per barrel of crude was $20.04 less for countries of the former Soviet Union
than the rest of the world. This amounts to $1,090.9 million worth of oil sold at a discounted rate. To put
it another way, if Russia charged CIS countries the same price as the rest of the world in 2010 for crude, it
would have made an additional $3.891 billion in revenue from exports. Not a paltry sum by any means.
Oil played a role in the fraying ties between the Soviet republics during the collapse of the USSR.
Soviet oil production peaked in 1988 at roughly 12 million barrels of oil produced per day, and rapidly
declined following this peak to a low of 7 million barrels per day. This is an enormous 40% decrease in
production. There was not enough subsidized oil to ship to the energy poor republics. The drop in oil
production accelerated the economic and political downturn of the Soviet Union. Russia could not support
its non-oil producing partners in the USSR during a time when newly independent states were leaving the
Union. Russia's political clout in the region took a dive, and did not gain traction until oil production
accelerated again in 1996, through an increase in investment and better technology. The Soviet Union’s
oil production and trade was inefficient and contained. The drop in demand and decline in production of
oil made trade not only less advantageous for Russia, but nearly impossible.
However, today Russia's estimated average oil production in 2011 hit a new post-Soviet high of over 10
million barrels of oil per day, allowing to maintain the sphere of influence on the cheap. Now that Russia
maximizes the value of its energy resources in other places, it is able to subsidize oil for countries where
it has political objectives, namely the former Soviet states.
Russia is able to ignore the economics in its oil sales to CIS countries because it can make up the
difference elsewhere. However, its budget, dependent for the 86 percent of the revenue on hydrocarbons,
it precariously balanced at around $100/bl. If the world oil price were to drop, Russia would no longer be
able to override the economic illogic based on the geopolitical rationale.
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This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.
As a thought experiment, suppose that the oil trade between them evaporated overnight. How do you think
their political relationship would change? Conversely, suppose that the political regime in the countries
changed radically. Would you expect its oil trade relationship with the other country to change equally
dramatically?
Without the subsidized oil trade there would be a significant decrease in Russia's influence over
the CIS nations. If Russia ceases to sell subsidized oil, nations that depend on this support will look for
assistance elsewhere. For their oil needs, the obvious place to turn would be their energy rich neighbors in
the Caspian Basin. A good example is Georgia, which formerly dependent on Russian energy. However,
as the relationship deteriorated, Tbilisi was forced to conduct economic reforms and increase purchases
from Azerbaijan.
Kazakhstan, and Azerbaijan each have their own vast hydrocarbon resources and are interested in
exporting capital and influence. Since their independence, these energy rich states have infuriated
Moscow by inching closer to the West and, in the case of Kazakhstan and gas-rich Turkmenistan, to
China, securing billions of dollars in investment in return for supply of energy through reliable overland
pipelines.
For a strong strategic partner to provide economic support, the FSU countries, especially in
Central Eurasia, would increasingly look to China. China has already begun to implement an economic
and soft power approaches and is strengthening ties beyond its Central Asian “near abroad”. In June 2011
Chinese President Hu Jintao and his Ukrainian Counterpart Viktor Yanukovich held formal talks in Kiev
on upgrading friendly and cooperative relationships between the two countries, signed a joint statement
on developing a strategic partnership between the two countries Post-Soviet nations individually have
billions in US dollars of trade deficits with China.
The Shanghai Cooperation Organization was created in 2001 to foster a closer relationship
between China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. It is an organization
partially devoted to China fulfilling its energy objectives in the region, as China is the world's fastest
growing energy market.
In scenario of a hypothetical political regime emerging in the former Soviet Union, that does not
view Moscow as a friend or partner, the oil trade based on real prices would reorient the relationship
between it and the Kremlin. If a country is not willing to make political concessions for Russia, there is
no need for Moscow to make reciprocal economic concessions.
If a nation develops its own energy resources, there would be no need for rapprochement with
Moscow, unless other geopolitical considerations are involved, such as a preservation of an authoritarian
regime, or fight against Islamist extremism and a possible Taliban spill over after the US pullout of
Afghanistan. Some Central Asian regimes view a Russia/China balancing act as a prescription to their
own preservation. The moment the need in Moscow’s patronage evaporates, a more dynamic China or, in
the future Europe and/or the U.S. may be willing to provide assistance in exchange for access to those
resources.
If a pro-Russian regime came to power in a post-Soviet state, however, Moscow would gladly
take it under its wing. The goals of expanding the Customs Economic Union (to include Ukraine, for
example), and the creation of the Eurasian Union are at the forefront of Russian policy. Moscow is likely
to provide a generously subsidized oil imports and waive the oil export tariff contingent upon a country
rejoining the Russian orbit.
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This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.
-- Ariel Cohen, Ph.D., is Senior Research Fellow in Russian and Eurasian Studies and
International Energy Policy at The Heritage Foundation. The author wants to thank Anton A.
Altman, a member of the Young Leaders Program, for assisting in preparation of this report.
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