Russia's Energy Bully Takes a Fall

Just a few years ago, Gazprom had Europe eating out of its hand. But now, the energy giant -- and Putin's power base -- looks set for hard times.

After years as Eurasia's energy bully, Russia's state-controlled natural gas monopoly, Gazprom, is getting a taste of its own medicine. Even as Gazprom seeks to build the tallest skyscraper in Europe as its new headquarters in St. Petersburg, pressure from Russia's neighbors led to a 15 percent decline in the company's profits last year, eating into the state budget. Moscow's single-minded focus on gas exports in an effort to become, in the words of President Vladimir Putin, an "energy superpower" has crippled its ability to adapt to profound changes in the global energy landscape -- from the shale gas revolution in North America to the dynamism of new market players such as Azerbaijan. Having spent the last decade making enemies in Central Europe and Central Asia, Gazprom and Russian decision-makers are now reaping what they have sown.

Policymakers in European capitals could be forgiven for a little schadenfreude right now. Building on the legacy of Soviet gas exports to the Eastern Bloc and parts of Western Europe, Putin and his cohorts in the Kremlin have, for years, used Gazprom as a cudgel in Moscow's relations with European Union member states. Over the past decade, well over a third of EU gas imports have come from Russia, with a number of Eastern European states almost completely dependent on Gazprom. Bulgaria, for example, receives more than 95 percent of the natural gas it consumes from the company. Millions of European consumers shivered through the winters of 2006, 2008, and 2009 when Gazprom cut off supplies in order to squeeze middlemen in Ukraine, Belarus, Georgia, and Moldova who had had the temerity to buck Moscow's policies.

On the supply end of the network, Gazprom routinely bought cheap natural gas from producers in the Caspian region and sold it for as much as four times the price in Central Europe. To maintain the racket, Gazprom CEO Alexey Miller and Putin himself actively traveled across Eurasia threatening and cajoling European and post-Soviet leaders to quash alternative pipeline networks put forth by Western companies. Russia continues to pursue a "divide and conquer" strategy with respect to Europe that purposely undermines EU-wide energy directives, such as the Third Energy Package, intended to bring more competition to the market. Meanwhile, Gazprom seeks to isolate entire countries in "energy islands" where consumers are unable to receive gas from sources other than Russia, even during cutoffs.

But in just the last two years, the tide has started to turn. Low energy prices across the globe are allowing consumers to use Russia's "reverse dependence" on European markets against Gazprom. Russia's export options outside Europe are increasingly limited, allowing European consumer to demand better terms. Meanwhile, Central Asia is no longer Moscow's vassal, but has finally emerged as competition for cheap energy, with producers such as Turkmenistan, Uzbekistan, and Kazakhstan not only willing to give consumers (still largely in East and South Asia) a better deal, but without treating them as former colonies to be manipulated.

Gazprom's once-intimidated customers are growing increasingly bold. Last year, seemingly hapless Bulgaria was able to negotiate a 20 percent decrease in the price that it will pay Gazprom for the next 10 years. While it was still a long-term, so-called take-or-pay contract -- meaning that Bulgaria agrees to pay for a fixed amount of gas for a certain amount of time, regardless of how much gas its consumers actually require -- Sofia was able to add in a renegotiation clause, should circumstances change drastically. This would have been unthinkable in previous years.

The unexpected changes in energy markets have allowed the Bulgarians and others to play hardball with Gazprom. A glut of gas globally, due mainly to unprecedented shale gas production in North America, has driven prices down and freed up volumes around the world to be shipped as liquefied natural gas (LNG) to Europe. The United States is set to export LNG, though that will mostly go to East Asia instead of Europe. In addition, because natural gas has recently replaced coal as a fuel source throughout much of North America, EU member states, many of whom already have well-developed coal-burning infrastructure, are reaping the benefits of excess coal, which allows them to be more flexible when it comes to natural gas dependence. Thanks to this combination of factors, Gazprom has or is in the process of negotiating new contract terms with all its European customers, including the major markets of Germany and Italy.

Meanwhile, the long-stalled efforts to connect European consumers directly to Caspian producers are finally paying off. Building on the experience of the U.S.-backed Baku-Tbilisi-Ceyhan pipeline, which since 2005 has brought oil from Azerbaijan, Kazakhstan, and Turkmenistan to the Mediterranean (avoiding Soviet-era pipeline networks through Russia), SOCAR, Azerbaijan's state energy company, is now building a natural gas pipeline network through the Caucasus and Turkey to the borders of the European Union. This network's flagship project, the Trans-Anatolian Natural Gas Pipeline (TANAP), makes SOCAR the largest foreign investor in Turkey and the arbiter of whether the gas will go from there to Austria's gas hub at Baumgarten through the Nabucco West pipeline or to the western Balkans and Italy through the Trans Adriatic Pipeline. Baku's new clout and direct negotiations with these countries mean that it is eating into traditional Gazprom territory, providing leverage for European decision-makers who in the past had no choice but to kowtow to Moscow.

Further east, Turkmenistan, long a natural gas appendage to Gazprom's network and the source of much of the gas sold in Ukraine, has in the past few years emerged as a player in its own right. With the world's fourth-largest gas reserves, it was inevitable that Turkmenistan would eventually demand the right to determine its own destiny. But Gazprom's executives were slow to read the writing on the wall when the isolated country's government started wide-ranging negotiations with Chinese energy giant CNPC to anchor a vast pipeline network through Central Asia. The pipeline project will not only bring gas to Chinese consumers but also distribute it throughout the region, undermining Gazprom's previous monopoly in energy-poor states like Kyrgyzstan and Tajikistan. The main artery of CNPC's pipeline network was completed in record time and is now being expanded to include all five post-Soviet Central Asian states, as well as Afghanistan. According to one industry source with whom I spoke, Russian officials were caught flat-footed when their Chinese counterparts told them last year in no uncertain terms that Turkmenistan's energy sector is no longer their turf.

Gazprom's response to these setbacks has long been to tout its potential export gas eastward to China and the strong economies of the Asia-Pacific, but it has not invested in the pipeline infrastructure required for this geographical shift. Although it made record profits in the previous decade's boom times, very little of those funds were reinvested, whether to repair the company's ailing infrastructure or to realize new export options. Meanwhile, CNPC built its network to Central Asian producers just south of Russia, with plans for connections to Iran and the Persian Gulf states. After years of difficult negotiations, Gazprom finally signed a preliminary export agreement with CNPC in March, but the nature of the deal revealed Gazprom's faltering clout. Neither a timeline nor volumes have been agreed upon. And where Russia once swaggered into meetings with European energy consumers, Moscow had to send several delegations to Beijing to offer very favorable prices in order for the Chinese to sign on the dotted line.

All this should be embarrassing for Putin and his close advisors -- many of them on Gazprom's board -- back in Moscow. Instead, however, Miller and Gazprom's leadership have spent millions of dollars on public relations campaigns maligning shale gas as bad for the environment and arguing that Gazprom's old-fashioned, long-term contracts provide stability in an era of market flux. This head-in-the-sand mentality could have domestic political consequences. Gazprom makes up 10 percent of Russian export revenues, so losses leave Putin with fewer resources to spread throughout his patronage network. Russia's resurgence as a great power after the shame and poverty of the tumultuous 1990s is a major pillar of Putin's popularity. But much of that rebound was based on turning Russia into a petrostate, dependent on Gazprom's profits. As the company falters, the state may not be far behind.

If Gazprom is going to continue serving as Putin's primary pawn in the great game of energy geopolitics, it will have to adapt. Acting like a real energy company would be a start. The Peterson Institute for International Economics recently estimated that Gazprom loses up to $40 billion annually due to corruption and waste. It could begin to offer spot-indexed pricing, as opposed to inefficient long-term take-or-pay contracts. It could begin to invest seriously in new technologies, such as fracking and LNG, that have boosted its global competitors. In short, it could begin to respond to the market, as opposed to trying to force its hand.

The Kremlin will almost certainly continue to use Gazprom as a foreign-policy tool -- it has few other options -- but going forward, the bloated behemoth will deliver diminishing returns in geopolitics, as well as business.


Democracy Lab

Four Arab Democrats and a Constitutional Scholar Walk Into a Bar

Some free advice for my MENA friends.

Barkeep! Five araks over here, please. Plus some tabouli and figs. What's that? Oh sorry, my mistake. Let's make that one arak, four iced teas ... Actually, forget the arak. Make mine a Cuba Libré. Virgin. Thanks. 

So tonight we're toasting you, Tunisia, for finally finishing your draft constitution. Sure, I realize that this is not the end of the story. You've still got some unresolved issues (and some opposition leaders crying foul about alleged changes smuggled into the text). But your constitutional process still remains the best in class. As my friend Taufiq Rahim recently put it: "[Tunisia] is the place where there is a potential for change, new ideas, and a new direction for the Arab world." 

Bottoms up! 

Okay. So guys, I'm sorry it's taken us so long to have this talk, but I just don't think we can put it off any longer. The main events of the Arab Awakening are now two years behind us, and you're all still having big problems with drafting and implementing new constitutions. Only one of you has succeeded in passing a constitution into law -- doing so in a fashion that just ensured all sorts of problems will go on simmering. (Yeah, I'm looking at you, Egypt.) As for the rest of you, you've gotten bogged down debating procedure or wrangling over language or arbitrarily extending deadlines

Now I realize that you've a lot of other stuff on your plate -- you know, trivial matters like, say, holding elections or reviving your economies. But the more time you spend dithering over constitutional specifics, the more frustrating it is to stick to the process. Just look at Nepal: They've been trying to agree on a constitution for eight years now. Nobody wants to end up like them, right? And don't even get me started on Zambia ... 

But here's the good news: These aren't the examples you should really be worrying about. If I had only one message to give you, it would be this: Chillax. 

As exasperating as this halting process might be, you may actually be better off this way. Making constitutions has always been a difficult proposition. Even Machiavelli knew that and said as much: "It should be borne in mind that there is nothing more difficult to handle, more doubtful of success, and more dangerous to carry through than initiating changes in a state's fundamental order..." That was centuries before constitutions came to be regarded a hallmark of the modern, functional state (like a good international airport or a nationwide TV network). 

The fact is that it's way better to draw up a constitution that's built to last, rather than steamrolling through some tragically flawed caretaker document simply to get the monkey off your backs. When constitutions are rushed, they often prove untenable. And if there's one thing we know about constitutions, it's that having broad-based agreement is paramount. Only when numerous groups feel a strong stake in a constitution's success will they defend it -- should the need arise. Getting there requires horse-trading, which in turn requires time. 

That's why you, Egypt, majorly screwed up by pushing your constitution through more or less on the sly (over the objections of the rather large chunk of the Egyptian citizenry that doesn't support the Muslim Brotherhood). Yeah, you got your constitution pretty fast -- but you did it by avoiding just the sort of vexing-but-necessary public discussions crucial to building democratic consensus. While constitutions seek to restrain government, they play an equally vital role in protecting democracy from its own excesses. But this can go completely wrong with unilateral shows of majoritarian force. In any case, majorities are short-lived; Constitutions shouldn't be. 

Well my friend, what's done is done -- but know that your constitution faces some stormy seas ahead. Also know that amending your way out of this mess will likely prove more traumatic on its own than the entire process should have been. 

That's why writing a constitution is not something to be taken lightly. Someone should have told you about the Locrian Code. This ancient Greek law system (one of the world's most ancient) required that anyone proposing a modification to it had to do so with a noose around their neck, so as to facilitate their immediate execution should the measure be defeated. That may sound harsh, but it's not far off. Rewriting a constitution is not free: it's an investment, and a very risky and expensive one at that. Whenever a government decides to redesign the constitution in accordance with its own specifications, previously established procedural and institutional norms will rarely carry over. These are crucial to successful governance, and can take decades to develop. The resulting vacuum is itself destabilizing. Worst yet, such changes can trigger vicious cycles. Woe betide the state whose constitutional ADHD becomes habitual. (My own, Venezuela, has endured 26 different constitutions since its founding. You can judge for yourselves how good it's been for the country.) 

All this goes to show you, Tunisia, why you were so lucky to have Rachid Ghannouchi, a singular figure who acted as the voice of reason during the chaotic post-revolutionary period. Ghannouchi's influence and willingness to seek consensus with the opposition, even though his Ennahda party could have hijacked the process -- just as Egypt's Islamists did -- have been vital. There's no question that this strategy has drawn out the whole process, but that was the right choice. 

Now you just have to avoid falling apart just as you reach the goal line. Recently some of the members of your National Constituent Assembly (NCA) have been talking about sending especially thorny issues to a national referendum if they can't arrive at consensus on their own. That is a really, really bad idea. Popular majoritarian sentiment, particularly of the post-revolutionary variety, doesn't usually lend itself to dispassionate compromise. But that's exactly what you'll need to drive a successful constitutional project home. 

Which brings me to you, Libya and Yemen. I know you want to jump in. And I hope you won't mind if I'm frank. 

Now don't take this personally, Libya, but right now you're still kind of a mess. Sure, you managed to pull off a remarkably inspiring election, and there are promising signs your economy may be rebounding. But the constitutional project hasn't even entered the drafting stages, while the largely unelected National Transition Council (NTC) and your legislature are still butting heads over who the drafters will be. Meanwhile, the security situation has been going steadily downhill. Just look at the recent efforts by militias to take over government ministries in Tripoli. That certainly doesn't bode well. 

Nor, for that matter, does tightening social controls that have forced many of your more progressive voices on issues like personal rights and minority protections to flee the country. Honestly, any constitution that emerged from such conditions would already be born on life support. 

It's important to remember, that drawing up a constitution isn't an end unto itself. It's supposed to serve the aim of establishing stable ground rules for a functioning polity. But you can't just charm that into existence if the conditions aren't right. How are you going to draft a viable constitution while there are still armed gangs running the place? 

After all, the Spanish transition from Franco-era dictatorship to democracy, a model that you've looked to for inspiration, took several years to reach the point where establishing a new constitution seemed appropriate. The drafters didn't force themselves into onerous timetables. Here's a thought: Why not just extend the provisional constitution for two or three years at a stroke (rather than a few months at a time) to allow you some space to get back on track? Like Tunisia, you've still got some of the institutional structures from the old regime to keep you going in the interim. Think about the fact that you're following a thirty-year period in which you essentially had no constitution at all. (It was replaced by Qaddafi's Green Book.) So why not give yourself the chance to get it right? 

Or, to phrase it differently: Why put the catharsis before the horse? (Ahem.) 

Same goes for you, Yemen. It's hard to know precisely what's going on with you, but it's clear enough that you're going through a phase of violence and instability comparable to Libya's -- but without the benefit of those inherited institutions. But your situation is even more complicated because of all the outside powers that are now involved. I know that you actually asked the French to come in and advise you on your constitutional transition. But both Russia and Iran simply invited themselves to the party -- as has the United States. You need to get some of these guys out of your house. 

I know. None of this is easy. It's one of the sad ironies of the business that the very countries most desperate to write new constitutions are usually in the worst positions to do so. Revolutions or changes in regime are almost invariably followed by periods rife with chaos, economic turbulence, power struggles -- not exactly the right environment for cool heads and brokered compromise. But it is what it is. 

Which reminds me: It's getting late. How about I spring for the check?

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