Clare Nuttall in Astana -

An apparent Russian attempt to use energy supplies to force Armenia, one of its closest allies, to choose membership of the Customs Union over closer association with the EU, appears to have failed. With a hike in the price of Russian gas coming into effect, Yerevan said it's looking at alternative suppliers like Iran and holding talks on the sale of its largest hydroelectric power plants to a US company.

Armenia's Public Services Regulatory Commission (PSRC) announced on June 7 that consumers will pay AMD156,000 ($374) per 1,000 cubic meters of gas, 18% higher than the current rate of AMD132,000. This figure is still well below the 60% price hike requested by gas distributor ArmRusGasProm after Russia increased its wholesale gas export price. Since Armenia generates some of its electricity at gas-fired power stations, electricity prices are also going up in July, sparking a wave of anti-Russian sentiment in this relatively poor country. A small group of protesters gathered outside the Russian embassy in Yerevan on June 5 and at the PSRC building on June 7, calling for Gazprom to go home.

To avoid a more widespread popular backlash, the Armenian government has been forced to introduce costly subsidies for energy customers, with Prime Minister Tigran Sargsyan announcing on May 16 that the government would subsidise consumer gas prices by as much as 30%, as well as providing support for poor families. There are also concerns that the increase in energy prices will spark a sharp rise in inflation.

Given Armenia's high poverty rate, energy pricing is a highly sensitive political issue. Opposition MPs have accused the government of striking a secret deal with Russia not to increase gas prices until after the 2013 elections. The government only confirmed the widely anticipated price increase after Serzh Sargsyan was returned to the presidency in February, and his party emerged victorious in the May local elections. At a parliament session on June 12, Energy and Natural Resources Minister Armen Movsisyan even claimed he couldn't remember when the agreement had been signed, Arka reported.

Choosing sides

The decision to raise the gas price is believed to be linked to Armenia's pursuit of an EU Association Agreement, which includes the development of political, trade, social, cultural and security links between the two. As Yerevan moves closer to Europe, the prospect that Armenia will join the Russia-led Customs Union, which also includes Kazakhstan, Belarus and soon Kyrgyzstan, becomes less likely. While Ukraine is Moscow's top target for Customs Union membership, Armenia has long been one of Russia's closest allies, so the move westwards is a blow for Moscow.

"The gas price increase is part of a broader effort to switch to market conditions and end state subsidies, but there is also a political dimension," Richard Giragosian, director of the Regional Studies Cente in Yerevan, tells bne. "The scale of the price increase indicated that Russia is using energy as leverage to deter integration with the EU."

However, Giragosian believes that the pressure from Russia was "too little, too late", coming as it did when Armenia was already at an advanced stage of negotiations with the EU. "Armenia has made it clear to Moscow that it will proceed to the Vilnius summit," he says.

Having chosen its path towards the EU, the Armenian government has been looking for alternatives to the current dependence on Russian gas imports. But because of the country's geo-political situation, these are limited.

Armenia's neighbour Azerbaijan is one of the Caspian region's largest oil and gas producers, but the hostile relationship between the two countries effectively rules out any gas from there. Azeri officials seem to have enjoyed the plight of their neighbour, with the president of Azerbaijan's state oil company Socar, Rovnag Abdullayev, saying in an interview with ANS TV that Azerbaijan had enough gas stored in underground reservoirs to more than cover Armenia's entire annual consumption immediately. Socar followed up Abdullayev's comments with a June 10 statement that Armenia could "participate in regional energy projects" if Yerevan changes its position on the occupied lands around Nagorno Karabakh, an ethnic Armenian enclave that lies in Azerbaijani territory and over which the two fought a war in the 1990s.

Persian possibility

The chief option being discussed in Yerevan is whether to look to Iran for gas imports. Armenia already imports some gas from its neighbour, exporting electricity in return. Potentially, Armenia could ramp up its imports of gas from Iran, but there are some obstacles, mainly the fact that even following the Russian price increase, Iranian gas is still more expensive. According to local press reports, ArmRusGasProm CEO Vardan Harutyunyan told a press conference on June 7 that the company would consider importing from Iran if the price was lower than that from Russia.

Giragosian points out additional problems. "Iran is an alternative, but there are questions about prices and the capacity of the pipeline. Armenia is also very hesitant about expanding its energy relationship with Iran at a time when sanctions are increasing."

Armenian government officials are also close to negotiating the sale of three of Armenia's largest hydropower plants to US-based energy company ContourGlobal - a surprising move in a sector previously seen as Russian territory. ContourGlobal, which has assets in other emerging markets including Latin America and Africa, said in a June 12 statement that commercial terms for the deal are still being finalised, and the purchase price is expected to be "very significant". Together, the three hydropower plants on the Vorotan river account for over 30% of Armenia's electricity generation capacity.