Its a good thing Russia cuts off Belarus oil deliveries

By bne IntelliNews January 9, 2007

By Ben Aris in Berlin -

Pipelines delivering Russian oil to Western Europe suddenly went dry Monday night after Moscow turned off the taps in yet another energy dispute with a former Soviet republic, adding to Europe's fears for its energy security.

Russia shut down deliveries to Belarus after accusing Minsk of siphoning off 900 tonnes of oil destined for delivery to Western Europe, says Russian state-owned pipeline operator Transneft.

In a repeat of the Kremlin's decision to turn off the gas taps to Kyiv in January last year, supplies of Russian crude to Germany and Poland via the Druzhba, or Friendship, pipeline ceased completely, while those to Hungary, Slovakia and Czech Republic were dramatically reduced at about 7pm Central European time.

Belarussian diplomats immediately flew to Moscow to open talks at resolving the dispute only a week after Minsk narrowly avoided being cut off from Russian gas deliveries on New Year's Eve. Belarus was resisting the Kremlin's insistence that gas prices would be hiked from $46 per 1,000 cubic meters (cm) – about a third of what all Russia's other customers pay – to $100 per 1,000 cm.

Minsk caved at the last minute and also agreed to the Kremlin's demands to hand over half of the Belarus gas-transit monopoly, Beltransgaz – an asset that Minsk has refused to surrender for years. Negotiations over the transfer of a stake in Beltransgaz were the only reason Minsk had so far avoided the gas prices hikes Russia has imposed on nearly all its former vassal states in the last year. Kyiv has successfully resisted Kremlin demands to take over a stake in the Ukrainian pipeline operator.

However, no sooner was the gas price deal done than another fight over oil transit flared up, resulting in the current rumpus.

Pouring oil on troubled waters

Concurrent with the increase in gas prices, the Kremlin has imposed a duty of $180.70 per tonne of oil passing through Belarus' pipes, ending the duty-free sales of crude to Belarus, worth a total of $3.5bn a year to Minsk's budget or about 10% of GDP, say Russian officials.

Minsk countered by imposing a transit fee of $45 per tonne for Russian crude crossing its territory and immediately started siphoning off crude in lieu of payment, prompting the Kremlin's decision to cut off supplies.

Oil traders took the news in their stride, with the price of crude falling only slightly in Monday's trading session, which suggests they expect a quick resolution to the spat. The halt of Russian supplies is also unlikely to lead to fuel shortages in Western Europe for several weeks.

Under EU rules, member states are supposed to maintain 90-day stockpiles of crude. German has a 130-day stockpile, Hungary's is 90-days and Poland has enough crude to last for at least 70 days. Countries like German and Poland can turn to ports in the North Sea and Baltic Sea, while Hungary has a pipeline running to the Adriatic Sea that can be used to replace the missing Russian oil if the row drags on.

The main damage has been to Russia's already battered reputation as reliable supplier of energy, which was mauled by last year's gas dispute with the Ukraine. This round will be particularly damaging as the EU's executive body, the European Commission, is due to meet Wednesday in Brussels to discuss proposals for a united energy strategy that will be debated later this year at the next summit of EU leaders. (To read more on this click here).

On Monday night, EU officials were scrambling to find out what was going on. Energy Commissioner Andris Piebalgs demanded an "urgent and detailed explanation" from Minsk and Moscow, and said he may convene the EU's Oil Supply Group later this week to make contingency plans if the dispute is not quickly resolved.

The Druzhba pipeline runs from Russia into Belarus where it splits into two main spurs: the northern pipeline runs through Poland into Germany ending at the port of Rostock; the southern spur runs through Ukraine, Slovakia, Hungary and ends in the Czech Republic. The pipeline carries 1.5m barrels a day to Western Europe, about half of Russia's exports to the region and 12.5% of total European crude consumption.

Russia's "New Deal"

The Kremlin must be fuming, after it had almost put the Ukraine affair behind it. The vice president of state-owned pipeline operator Transneft, Sergei Grigoriev, said Monday rather fatuously: "I'm sure this won't affect our reputation as a reliable energy supplier." And Transneft is trying to find alternative routes to maintain supplies to its customers in Europe.

But the fight should come as no surprise as it has been clear for more than a year that the Kremlin is on a campaign to remake its relations and is symptomatic of a "New Deal" being struck with Russia's reluctant neighbours. At the root of this argument is the Kremlin's decision to end the massive Soviet-era energy subsidies and putting its relations with its neighbours in the "near abroad," as Russians call the former east block countries, on a market footing – something that the west has been insisting on for years.

The $100 per 1,000 cm that Belarus must now pay for its gas, and even the $130 Kyiv is being charged, is still way below the $230-260 the Russian gas monopolist Gazprom charges its Western European customers. At the same time duties and transit fees for crude deliveries is also a normal part of the oil business – but noticeably missing until now from most of Russia's deals with its neighbours. Indeed, a key part of the resolution of the row with Ukraine was an agreement that Kyiv could hike the transit fees it can charge for gas flowing over its territory.

Despite its protests, the EU is also partly to blame for these fights. There is no economic argument for maintaining the Soviet-era subsidies; all the Central and Eastern European countries should pay the same market rate as in the West. However, in the interests of harmonious relations within Europe there is a strong political argument for gradual price hikes. But as the EU (and NATO) has opened its arms to an increasing number of CEE countries and promises to do the same for the likes of Ukraine, the Kremlin doesn't see why it should do any favours to republics that have rejected its (admittedly unattractive) offers of partnership.

Indeed, the gas price hikes of the last year show that the Kremlin is admitting it has "lost" much of CEE to the EU's sphere of influence. However, the case of Belarus shows that the price hikes go beyond pure political pique and represent an entirely new basis for relations grounded (to an extent) on market principles. That Belarus still enjoys ridiculously cheap supplies of oil and gas is a function of its non-existent relations with Western Europe, but the nature of the New Deal is evident in the fact that even Russia's best friend is being asked to pay twice as much.

Death of a union

Several observers have highlighted that the proposed union between Russia and Belarus is now in danger. However, the Kremlin has never been serious about joining the two countries together. The issue usually comes up in the run-up to a presidential election as it plays extremely well with voters yearning for a return to the glory days of the Soviet Union. Boris Yeltsin made a great deal of political hay out of a potential union in the 1996 elections, as did Russian President Vladimir Putin in 2000, but the idea is always quietly dropped after the polls close. Moreover, the few times Belarussian President Alexander Lukashenko has pushed for concrete action - such as his bid for a currency union a few years ago - the Kremlin always gives him a firm cold shoulder.

What is significant about the Kremlin adoption of a hard line with Minsk now is that it effectively kills even the promise of union, which suggests Putin is feeling so comfortable about the results of the upcoming parliamentary elections at the end of this year and presidential elections in March next year that the Kremlin feels it no longer needs to play the Belarus union card in its election campaign.

The change in relations between Moscow and the near-abroad was always going to be painful, but they are something the EU has been asking for. At the end of 1990s the EU admonished Russia for granting exactly these energy subsidies to the steel industry and refused to grant Russia "market economy" status, a distinction that affects exports quotas and tariff levels in their mutual trade. The EU insisted Russia increase the price of energy to create a level playing field for their competing industries.

The difference this time round is there is no competition to speak of between Russia and Europe in energy production and the export in question is something that Europe desperately wants as much of as it can get. Rapidly increasing energy tariffs were always going to cause fights and while Europe has considerable leverage in Ukraine, following the election of the pro-Western Viktor Yushchenko to the presidency in 2005/6, Brussels has no influence in Belarus whatsoever because it has made it a pariah.

Belarus president Alexander Lukashenko was banking on western support in his fight with Russia

Analysts say that Lukashenko was banking on Western Europe putting pressure on Moscow to boost his hand in talks, but the EU has tied its hands over Belarus and can not be seen to back the man US Secretary of State Condoleezza Rice dubbed "the last dictator in Europe." At the same time because of the poor relations with the rest of Europe, Lukashenko has a free hand, as relations with the EU can hardly get worse than they are now.

Uncomfortable relations between the EU and Russia also made a cut-off more likely. Russia had already done its reputation as a reliable energy partner a great deal of damage by cutting off gas to Ukraine in 2006. However, time and again the Kremlin has shown when faced with a stark choice between saving its international reputation and doing something it feels is in Russia's best interests, the Kremlin has always chosen the latter. The most recent example was the destruction of oil company Yukos and the jailing of its owner Mikhail Khodorkovsky.

"The Russians put up with a lot of damage to their reputation after Ukraine, but now they have their customers in line," Jonathan Stern, head of gas research at the Oxford Institute for Energy Studies, said in an interview. "Every [customer] knows Russia will not let them off the hook easily."

As for energy security, the fact that the main pipelines run through the territories of countries as politically unstable as Belarus and Ukraine was always going to undermine energy security. However, Russia is working to extend its trident of pipelines to Europe to bypass exactly these countries with unpredictable politics.

At the same time Russia's ability to cut off Western European countries is limited. On the one hand gas pipelines mean the gas can only be delivered to the customer at the other end of the pipeline (hence the Kremlin's efforts to push its liquid natural gas projects) and on the other hand it needs the revenue almost as badly as the EU needs the energy: in other words there is a basis for negotiated deals.

Security will be improved by market-based supply deals and diversification of delivery options. A Russia-German joint venture is building a new pipeline in the northeast that will run under the Baltic Sea by passing the states on the Baltic coast and is due for completion in 2012. A second southeast oil pipeline running from Bulgaria's Burgas to Greece's Alexandroupolis that will by pass the Black Sea bottleneck is being negotiated now and looks increasingly likely to happen. Likewise the Blue Stream gas pipeline that runs under the Black Sea to Turkey is being extended into Southeast Europe. All of these projects have the benefit of crossing more stable countries.

But it still leaves open the question of if Western European countries can trust Russia not to turn off the taps for purely political reasons. The answer is a clear "no." What scares politicians in Brussels so much is since 2004 the Kremlin has not only blurred the line between business and politics, but has removed it altogether.

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