INTERVIEW: Shuvalov, like Kremlin, appears deaf to EU criticism

By bne IntelliNews January 26, 2007

By Ben Aris in Berlin -

Does the Kremlin actually care what the rest of the world thinks about its actions? Talking to Igor Shuvalov, special economic advisor to Russian President Vladimir Putin, it appears not.

Shuvalov was in Berlin last week to speak to politicians, press and investors where he gave a joint presentation with former chancellor Gerhard Schroeder, who now heads the Nord Stream consortium that is building a pipeline connecting Russia's north-western gas fields to Germany's Baltic coast.

Igor Shuvalov is perplexed and was on his back foot at a lunch ahead of the speeches. The gas spat with Ukraine in 2006 and the oil row with Belarus earlier this month have simply been misinterpreted by the Western media, he says. All Russia was doing was ending the Soviet-era subsidies and putting relations with these countries on market terms – essential in order to reach a new "balance" between consumers and producers, and create true energy security.

Why is Western Europe getting so worked up? After all it was the west that has been pushing a market economy Russia as hard as it can for most of the last 15 years. The Kremlin admits it has handled its PR badly, but talking to Putin's point man on economic issues, this seems to be the main thrust of the Kremlin's thinking in its energy dealings with the west.

"It was a mistake not to explain to our partners our motivations in the case of Ukraine and we waited a month, too long, to make our case," said Shuvalov. "But from the economic standpoint, [cutting off Ukraine's supplies of gas] was exactly the right thing to do."

The Kremlin's decisions to cut off gas to Ukraine in January 2006 and oil to Belarus this month were the main topics of conversation and Shuvalov seemed bemused that these two events caused such a fuss - or that they even be lumped together in the first place. He went on to repeat the Kremlin's policy that was first voiced in public by Gazprom CEO Alexei Miller at last June's gas conference in the Netherlands.

"Global energy security is not the same as traditionally the OECD countries have seen it, as consumers of energy. We believe that real energy security needs a change of balance, to balance the needs of the consumers of energy with that of the producers of energy. It is a complex equation and we have to be flexible in understanding the consequences," said Shuvalov.

However, he failed to clearly answer questions on just what this "balance" involves in concrete terms. Instead, he emphasised that first and foremost the relations between the partner must be based on market principles; the buyer of energy should be allowed to choose who to buy from and at what price, before going on to reject the EU's insistence that Russia ratify the Energy Charter and sign off on transport protocols. The Kremlin's point here is that they don't want to lock themselves into any agreement in a market it sees as in transition.

"The infrastructure is in flux and we need to be able to react to the market. We can increase energy security by reducing the influence of politics so that no political decision can affect oil supplies. But we are reluctant to commit to 25-year-long deals in this context as things are changing. At least the EU should share the risk of these changes 50-50. Until it does, we can't ratify the energy charter," said Shuvalov.

There is an irony in this policy. If Russia under former president Boris Yeltsin was a free-for-all where oligarchs grabbed what they wanted of Russia's state assets, Alexander Petrov, scholar in residence at the Carnegie Institute in Moscow, says: "The pendulum has swung the other way, and it has swung too far." Putin is lambasted on almost a daily basis in editorials around the world for his "authoritarian tendencies" and "creeping statism."

However, less acknowledged is the fact that the pendulum of Russia's international diplomatic relations has also swung too far: under the Soviets, relations with the West were all politics and no economics; under Putin, it seems relations are all business and no politics.

Andrew Neff, an analyst with Global Insight, asked recently in a paper: "Does Russia care whether or not it is a 'reliable' energy supplier?"

"Russia seems to be relatively unconcerned by European accusations that the Belarus and Ukraine episodes mean Russian energy exports are unreliable. Although Russia is by no means immune from criticism, and there is every indication that it wanted a quick restart to the Druzhba as well, its presidential administration at the Kremlin demonstrated this week that it was willing to sacrifice its reputation for 'reliability' and its standing in Europe in pursuit of its own economic goals," wrote Neff.

It has become a golden rule of Russia-watching that if the Kremlin is faced with the choice between acting in Russia's best domestic interests and damaging its international reputation, then the Kremlin doesn't hesitate to choose the former.

And it is worth bearing in mind that while the Yeltsin team was steeped in the Soviet traditions of playing diplomatic cat-and-mouse with the west, Putin's team that took full control of the Kremlin only in 2004 were little more than senior regional bureaucrats in St Petersburg, without much experience of diplomacy. The change in the Kremlin's style in its foreign relations following the 2004 presidential elections was dramatic. It first major foreign policy foray was an attempt to push Viktor Yanukovych's cause in the 2004 Ukrainian elections that ended being a debacle of misjudgement and clod handed manipulation. This was not the subtle giant of the Cold War at work.

EU and Russia talking at cross purposes

Talking to Shuvalov and you get the impression that the Kremlin doesn't even see that its actions damage Russia's image.

Under Yeltsin, Russia was an economic basket case, but enjoyed excellent relations with the West. Under Putin, Russia is emerging as an economic powerhouse, but relations with the West are bad and getting worse.

Asked specifically why the Kremlin had allowed relations with the West to deteriorate, Shuvalov again answered by talking about the market prices for oil and gas, international law and supply and demand. Shuvalov's answers suggest the Kremlin is not thinking about diplomacy at all. All the problems of relations with the West are phrased exclusively in terms of markets and commercial relations, and cutting off Belarus and Ukraine doesn't affect these relations so there was no reason to refrain form doing it.

Shuvalov seemed frustrated at the questions. He admitted that the Kremlin, "made a mistake," by not going to its international partners sooner, but he seemed bemused this should be necessary in the first place.

"It was a mistake not to explain to our partners our motivations in the case of Ukraine and we waited a month, too long, to make our case," says Shuvalov. "But from an economic stand point, [cutting off Ukraine's supplies of gas] was exactly the right thing to do... Russia shouldn't be a black box of politics, but we need to develop [relations with Western Europe and the rest of the world] as a business partner."

Shuvalov went on to say that the story with Belarus was completely different.

"It was a force majeure," he said, using the legal term that covers the actions of one side in a deal responding to an unpredictable event beyond their control, such as an act of God or a strike. "Our partners knew we were in talks and under international law we have every right to react when Belarus started siphoning off oil."

Strictly speaking Shuvalov is right. There is no economic argument to justify the cheap prices for oil and gas that Moscow charges Minsk, something even EU Trade Commissioner Peter Mandelson has conceded to bne. And legally speaking, Minsk's decision to unilaterally impose a transit tariff for crude and then immediately siphon off oil in lieu of payment is also probably in contravention of international law.

Asked why the Kremlin didn't warn all of its customers before the taps were turned off, Shuvalov simply said: "I don't know if Putin called Merkel."

This is a stunning statement, as it says that it didn't even occur to the Kremlin that Berlin, Brussels, Prague, Budapest and all the other EU states that would be affected would freak out at being cut off from their oil

If relations with the West were governed solely by commercial obligations, there is no need to warn your partner in the case of a force majeur, which is, by definition, unpredictable. However, the case for a call for the sake of good diplomatic relations is overwhelming.

Maybe it is telling that Shuvalov holds a law degree from the prestigious Lomonosov Moscow state university, where he specialised in jurisprudence, or the philosophy of law. Certainly the way he argues makes him look like a specialist in normative jurisprudence who asks what law should be like and overlaps this with political philosophy to include questions of whether we should obey the law and on what grounds law-breakers might properly be punished. (Putin also graduated from the Leningrad State University in 1975 with a degree in law.)

The West has been falling over itself to encourage Russia to adopt a market economy and it seems the Kremlin has learnt the lesson too well. Under Yeltsin, Russia was still a master of international diplomacy as many of the Soviet-era diplomats were still in top jobs, but the style of the Kremlin's foreign policy changed dramatically in 2004 when it is believed the last of Yeltsin's team left the Kremlin and the so-called Siloviki - those with ties to the security services - took over, bringing with them the corporate Kremlin.

The criticism of Russia has changed too. Under Yeltsin the op-eds were concerned with rape of the state by the oligarchs – there was not enough control over businessmen. Today no one doubts Russia is a market economy or that there is plenty of control over businessmen. If anything it has gone too far in the other direction, as this control has cut into civil liberties and increasingly the freedom of business. But no one is complaining about the lack of a market economy. If anything the fear is the Kremlin is using its control of Russian business to increase its influence in the markets across the region.

Russia is aggressively pursuing its national economic interests - which is the root of the showdown in both Ukraine and Belarus - while the West is in effect trying to move the goalposts: economics is not enough but must be tempered with concessions to civil society. It's a confusion that confuses and annoys the Kremlin, which accuses the West of "double standards," - a phrase that Schroeder used in his speech at the Adalon.

Energy Policy

The EU is worried about its energy security precisely because Russia has now cut it off without warning twice in one year. However, Shuvalov was falling over himself to reassure the West that Russia is throwing everything it has into building up its energy resources and will, as a basic tenant of its policy, "completely fulfil all its obligations to its customers in terms of the supply of energy."

Shuvalov spelled out in detail the Kremlin's grand design for developing the energy sector. Indeed, he suggested the Kremlin is as unhappy about being dependant on oil for budget revenues as the West is on relying on one country to supply them.

Without going into the details, the main thrust of the plan is to develop all possible sources of energy at once. Given that the EU's consumption of Russian gas is expected to more than double in the next twenty years, there has been some speculation as to if Russia can actually meet its obligations in the coming years.

Shuvalov said that rather than significantly increase production, the Kremlin will encourage domestic users to use energy more efficiently by hiking prices and introducing the most modern and efficient technology.

"Gas production in Russia is not falling. Our priority is to meet our obligations but we can't ignore of our domestic economy," said Shuvalov. "Our growth is very energy intensive. If the pace of growth remains the same as in 2006 then we will need more energy. By raising the prices over the next ten years we will encourage our consumers to become more efficient in their use of energy and at the same time create more gas to meet our obligations while supplementing our own energy needs with alternative supplies form things like hydropower or coal."

"Gas we will only use [as the primary energy source] where nothing else is possible," says Shuvalov. "We need to work on a programme of energy efficiency and saving by adopting the most modern technology. The internal energy efficiency [of Russian consumers of energy] is in the best interests of our external energy partners as it leaves more as for export.

This drive to create more spare gas for export by reducing waste will be supplemented by shifting domestic users of gas and oil to other sources of energy - namely nuclear power and hydropower.

The World Bank says that the rivers of Siberia represent a massive, and as yet largely untapped, source of hydropower. The first big hydropower stations such as the Boguchanskaya hydropower station are already under construction. The development of hydropower resources is intimately tied up the privatisation of the state-owned utility United Energy Systems, which began in November.

The second strand of this policy is to massively increasing Russia's nuclear power capacity. At the beginning of last year the Duma signed off on a plan to increase the number nuclear power stations from the current eight to 40 over the next twenty years.

Russia has large uranium deposits but Kazakhstan has more and the first project the recently founded Eurasia development bank, jointly owned by Russia and Kazakhstan, has undertaken is to fund the development of rich uranium fields in Kazakhstan. Russia is not alone in turning to uranium as an answer to its power needs and countries like Britain, Ukraine and Italy have also restarted plans; the price of uranium has tripled in the last two years and Russia also hopes to make money off exporting its nuclear power plant technology.

All these plans add up to "boom" in investment into the energy sector says Shuvalov - which will also have a Keynesian effect of stimulating the economy, especially as much of this spending will via state investment initiatives like the state investment fund established last year - and will top $50bn of spending in the next few years alone. This doesn't include the $90bn that UES says it needs to spend to get the electricity sector back on its feet.

He also rejected the accusation that foreign investors are being driven out of the few projects they have in Russia, first by pointing to the fact that the so called "ring fence" around Gazprom's shares - special regulations that prevented foreign investors buying locally traded shares - were dropped at the start of 2006 and went on to confirm that foreign energy companies would participate in the development of the massive Shtokman gas field, the biggest in the world, in the Barents Sea.

"International partners will be invited to participate in the Shtokman project as we need this technology. It will be developed in partnership with the world's biggest energy companies. And we want to distribute this gas via German as one of our main European partners."

Again there is no contradiction here. Analysts say that part of the reason why the deal to bring in an international energy company to the Shtokman project failed last summer was the energy companies were pressured by their governments to refuse asset swaps that would have given Gazprom access to distribution in their home markets. Foreigners are welcome to work in Russia as long as they have a contract but the Kremlin is driving hard bargains these days.

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