Derek Brower in Istanbul -

Whatever else the commentators will say about the presidency of Vladimir Putin, one thing is certain: he will bequeath to his successor Russia's near-total control of energy relations with its consumers. Russia has the oil and gas that Europe and other Western nations crave; but it's the Kremlin now that decides how much energy and at what price those consumers will import it.

It makes for a remarkable turnaround - not just from the dark days of decline under former president Boris Yeltsin, but also from the early years of Putin's own presidency. In the first years of the century, the strategic momentum was firmly behind Washington's efforts to liberate Central Asian and Caspian oil and gas from Moscow's control.

That brought the US its one main success in the region - the 1m barrel a day (b/d) Baku-Tbilisis-Ceyhan (BTC) oil pipeline, which came on stream in 2005. The BTC pipeline broke Russian control of exports of oil from the Caspian Sea and opened a new transport corridor in the region.

It was a defeat for Russian interests that would not, however, be repeated. And as Putin's presidency winds down, the Kremlin's mastery in the geopolitical sphere has eclipsed the achievement of BTC. That pipeline now looks like a high-water mark for Western influence in the Caspian region and beyond. A host of new infrastructure projects being developed by Russia will put the strategic goals of Washington and Brussels firmly in their place.

"It's the infrastructure, stupid"

One explanation for the resurgence of Russia in the energy politics of its "near abroad" is that the Kremlin has grasped better than its rivals the extent to which energy politics is the politics of infrastructure.

In oil, control of the crucial infrastructure now puts all exports from Central Asia in Russian hands. Kazakhstan, where the biggest increases in production will come from its giant fields in the Caspian Sea, has little option but to rely on Russia to provide the infrastructure to export its oil. Proposals to build a sub-Caspian oil pipeline to export directly from Kazakhstan to Azerbaijan and onwards to Ceyhan in Turkey - a plan favoured in Western capitals - continue to be stymied by Russia and Iran. As littoral states to the Caspian, they have a veto on any infrastructure built on its seabed. That leaves Kazakhstan relying on clogged Russian export pipelines. The bottleneck is the Caspian Pipeline Consortium's (CPC) infrastructure, which connects fields in the northern Caspian with the Russian Black Sea port of Novorossyisk. CPC is already running at full capacity of around 700,000 b/d. So when Kazakh fields like Kashagan and Tengiz increase production as planned over the next few years, the region will face a severe shortfall in its export infrastructure.

The members of CPC have always said they intend to increase the pipeline's capacity: the latest plan is to double throughput to around 1.3m b/d by 2010. But while it's Kazakhstan that most needs the new capacity, it is Russia that is CPC's largest shareholder. Moscow has used that strong bargaining position to win a concession from Astana: additional crude that flows through any expanded CPC system must, after it has passed through the Black Sea, ship through another Russian-controlled pipeline, the Burgas-Alexandroupolis link between Bulgaria and Greece.

Astana has agreed. And it's a deal that has wider implications for the region. First, it guarantees sufficient crude throughput at the new Burgas-Alexandroupolis pipeline to make it profitable. That will be good news for Gazprom Neft, Transneft, and Rosneft - the three Russian companies that own 51% of the project. The second consequence, however, is to nix the plans of Ukraine and Poland to import Kazakh crude in order to diversify their imports away from Russia. New Kazakh crude would only get to the Black Sea if CPC expands its pipeline; and CPC will only expand its pipeline if that new crude also flows through Burgas-Alexandroupolis. That ends any dreams Warsaw and Kyiv had of extending an existing pipeline between Odessa and Brody to ship Central Asian crude to Gdansk in Poland.

The politics of Burgas-Alexandroupolis have hardly dominated news agendas in the EU. But they are of a part with Russia's strategy in its natural gas exports - an issue that has the potential to undermine the EU's other political goals and which has brought energy relations between Brussels and Moscow into the mainstream.

The problem with Gazprom

The most immediate source of the EU's "Gazprom problem", as some officials in Brussels call it, was the so-called "gas war" between the Russian company and Ukraine in early 2006. Because some 70% of the gas that Gazprom exports to Europe passes through Ukraine, Russia's decision to halt supplies to its neighbour left consumers in Central and Eastern Europe short. The dispute was brief, with supplies resuming just a day later. But the political fallout was not.

In the EU, the dispute left politicians wondering if the "dash-to-gas" policy - the push to replace coal and nuclear generation with gas-fired power plants - was in fact a strategic blunder. And critics of the Kremlin argue that the decision to halt supplies to Ukraine was Russia's punishment for that country's Orange Revolution - a series of protests in 2004-05 that helped install the pro-Western President Viktor Yushchenko.

Brussels bought the argument and, in the wake of the Ukraine spat, pushed a policy of supply "diversification." Increasing reliance on Russian energy, the policy argued, would threaten t energy security, so the continent must find other potential suppliers to compete with Gazprom.

Yet the Russian company has always maintained that Ukraine, which at the time of the disagreement was paying a third of international rates for its energy, was siphoning off Russian gas. Furthermore, argued Gazprom, any threat to European supplies came from troublesome transit countries - and not from the Russian company or its political masters. The Soviet Union supplied oil and gas without interruption for the duration of the Cold War - why would it seek to damage relations with its most important consumers and the source of its wealth?

Avoiding the transit countries is central to Gazprom's strategy. Even before the "gas war" with Ukraine, new infrastructure that would pipe gas directly to Europe's biggest gas consumers was on the drawing board. And the strategy to avoid transit countries is behind two new infrastructure projects that will entrench the Russian company's position as the most important energy supplier to Europe and destroy the Commission's diversification drive.

No-ordinary dream

The first of these, the North European Gas Pipeline, or "Nord Stream," envisages two parallel 27bn cubic metre a year (cm/y) pipelines linking fields in northern Russia with Germany. It has been controversial from the start: shortly before leaving office, Germany's then-chancellor Gerhard Schroeder, helped arrange preferential loans from German banks for the project; on leaving office a few months later, he took a senior position with the consortium developing it.

Moreover, Gazprom and its German partners (E.On and BASF) presented the project in 2005 as a fait accompli. The European Commission hadn't so much as seen a feasibility study, say sources. With the change of government in Germany, senior officials in Berlin began to question in whose interests the pipeline was being developed, given that it would increase Gazprom's share of the German gas market to 65%.

On the ground in Europe, however, Nord Stream's swift progress and the fretting about energy security had exactly the opposite effect that the Commission might have wished for. Far from pushing companies to "talk with one voice" in future relations with Gazprom and to seek alternative supply arrangements, European companies rushed to tie up new long-term import contracts with Gazprom.

It left the Russian company able to pick partners from competing companies - and further derailed the Commission's hopes for energy diversification. The Brussels-backed Nabucco gas pipeline project has been the biggest casualty. A consortium headed by Austria's OMV had been promised financial support from the EU's investment banks if it could bring on stream a new pipeline that would ship gas from Central Asia, the Middle East and North Africa through Turkey and the Balkans and into Central Europe. Andris Piebalgs, the EU's energy commissioner, said the project was "vital" and a "necessity" for the bloc's future energy security.

To date, however, Nabucco has been unable to source sufficient gas to justify its development. With Iranian and Iraqi gas out of play for political reasons and Egyptian gas destined for other uses, that left Central Asia and the Caspian as potential sources. Azerbaijan could meet some of Nabucco's needs, but hopes for Turkmenistani or Kazakh gas ended last year when Moscow, Astana and Ashgabat signed a contract making Gazprom the main importer of Central Asian production. And as with a potential sub-Caspian oil pipeline, Russia also remains opposed to building the sub-sea gas infrastructure that would be necessary for Central Asian gas to reach Nabucco.

All this leaves Nabucco as a "virtual pipeline" - the words used to dismiss the project by Alexander Medvedev, head of Gazprom's export unit and arguably now the most important player in Europe's energy sector. Ironically, Nabucco's only real chance of coming on stream is if it's filled by another source of gas: Gazprom's. OMV, say analysts, is inching ever closer to co-opting the Russian company into the project. Gazprom would then be able to ship gas to Nabucco through its existing Blue Stream pipeline between Russia and Turkey. Since Turkey's economic collapse, that infrastructure has been largely underused.

But while Europe might need Nabucco, Gazprom doesn't. Italy's Eni is among the companies that have rushed to tie up long-term supply contracts with the Russian firm. And last year the two companies announced plans to build South Stream - a pipeline that would cross the Black Sea from Russia to Bulgaria before piping the gas on to Austria and Italy. OMV insists that South Stream is no rival to Nabucco, but the Gazprom line would target the same markets and have the same capacity, about 31bn cm/y. On February 27, Hungary shocked Europe by announcing that it would join South Stream, though still insisting that it was fully behind Nabucco. Another Russian coup; another failure for EU solidarity - that's how many analysts see it.

Seen on a map, Nord Stream and South Stream reveal Gazprom's pipeline "pincer" strategy for Europe. Transit countries - especially Ukraine - are out; the gas that lands on the shores of the Baltic and Black Sea will arrive unhindered directly into the EU.

Gazprom's strategy leaves the Commission's policy of gas diversification largely in tatters. The only bright spot for the EU has been February's deal between Swiss-based energy trading company EGL and StatoilHydro to build the Trans-Adriatic Pipeline (TAP), which will transport Caspian and Middle Eastern gas to Italy via a 520-kilometre pipeline running from the Greek city of Thessaloniki through Albanian territory and under the Adriatic Sea. However, that pipeline will only have an initial capacity of 10bn cm/y, perhaps rising to 20bn cm/y depending on how much gas can be sourced from Azerbaijan's Shah Deniz gasfield, which Statoil is helping to develop as a 25.5% member of the consortium.

The Commission's largely failed policy of diversification explains why in its most recent communications about energy policy, Brussels scarcely mentioned Gazprom, concentrating instead on emissions and renewable energy targets.

It also leaves Gazprom in control of its own destiny - and, up to a point, of prices. Indeed, the company admitted recently that it would soon be increasing the price of its gas to Europe by 20% to $350 per 1,000 cm. And for all that the Commission has talked of "security of supply," the Russian company has responded by saying that it needs "security of demand" - meaning it against the EU's energy liberalisation policy which demands that infrastructure like pipelines be opened up to competition and third-party access.

Gazprom needn't worry. In the background to the pipeline politicking of the last few years is the growing realisation in the EU that the continent could face a shortfall in its supply of gas unless more import infrastructure is built. OMV says Europe will need up to 150bn cm/y more gas within a decade. With Russian exports accounting for around 154bn cm/y now (against demand of 440bn cm/y in the EU-27, according to Eurogas), the potential supply crunch could make the diversification strategy even more irrelevant. Gazprom says it will export up to 250bn cm/y to Europe by 2020 (including liquefied natural gas) - far eclipsing any other potential source of imports for the EU.

So what's next for Russia?

End of the beginning

The first task for Gazprom will be to ensure that its two new pipelines come on stream. The budget for Nord Stream has already begun to spiral upwards - to €12bn, says Schroeder - and the deadline for its start-up has slipped by a year to 2011. Now it faces opposition from the Baltic littoral states. Sweden and Estonia, in particular, oppose the project for reasons ranging from damage to the environment, to fishing, to unexploded Second World War mines that the development might detonate. Poland and the Baltic States, which complained that Nord Stream would make them even more reliant on Russia and Germany for their energy, are making popular headway by promoting an alternative, overland route called "Amber." Its supporters say Nord Stream could cost up to three times more than Amber would cost. Donald Tusk, Poland's prime minister, argued Amber's case to Putin in Moscow in February; the Kremlin dismissed his arguments out of hand

Gazprom could hardly be convinced that adding more transit states like Poland to its gas project would lead to anything but more rent-seeking. And, meanwhile, the longer Nord Stream is delayed, the nearer the EU's gas supply crunch comes. As Gazprom's Medvedev told bne in December, "If somebody for political reasons will take responsibility for blocking 55bn cm/y to Europe then that person will have to assume responsibility for a shortage in the region." Brussels seems, at last, to have grasped this too.

Gazprom chief Alexei Miller also thinks that a new stage has been reached. "The process of Gazprom's conversion from the 'national champion' into a global energy business leader has been completed," he said last year.

With the infrastructure battles pretty now settled in Russia's favour, the next phase of its strategy will be to win a greater share of downstream markets. Recent deals with OMV and Eni giving the company access to customers in Austria and Italy could be just the start. And its reported interest in the UK's Centrica suggests that some of the biggest players in the European downstream are targets. How will Brussels respond if Gazprom launches a takeover of OMV or another major company in central Europe?

Expect, then, a shift in relations with Russia as the Putin era ends. Not because of the change in personality - or because the Kremlin's rhetoric has softened lately. Rather, because the Russian strategic vision has been so expertly executed under Putin and through the activities of the state-controlled energy firms that there is little alternative but for Europe to admit its mistakes and its weakness.

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