RUSSIA - The Difference From '98.

In May 1998, when the world's seven powers (G7) met in Birmingham, UK, to discuss global finance, Russian President Boris Yeltsin (the eighth member of the G8) was excluded from the meeting because Russia was such a lightweight regarding international trade and finance. The next month the world price of crude oil fell below $10/b. Three months later, Russia defaulted on its US$40 bn foreign debt to the Paris Club, composed primarily of the G7. The Russian economy nearly collapsed.

By July 15, 2006, when President Putin opened G8 summit meeting in St Petersburg, Russia had changed drastically. Though still relatively poor and hardly democratic, Russia nonetheless now is a full member of the club of eight industrialised powers with WTI in the US selling for more than $75/b. Since 1998, world crude oil output has risen by 6.7m b/d. Russia now is the world's largest oil producer, surpassing Saudi Arabia's 9.3m b/d. Russia's 3.75m b/d increase since 1998 has accounted for more than half of the world's production rise during that period.

With its crude oils selling for more than $70/b and Russia exporting nearly 7m b/d of crudes and refined products, its petroleum-related hard currency income translates into about US$500m per day. No wonder the Paris Club announced in June an agreement in which Russia would soon be making an early repayment of the US$22 bn balance it owes. Exercising the prerogative of the reigning G8 president, Putin on July 15 chose "energy security" as the primary theme for this year's G8 summit.

On Jan. 1, Putin inaugurated his year as G8 president by shutting off shipments of natural gas to Ukraine over disputes involving price and control of the "Brotherhood" pipeline traversing Ukraine from Russia into the EU, whose gas shipments from Russia also plunged. Russia, which controls more than a third of the world's proved reserves of natural gas, supplies 25% of the gas consumed by the EU, including 40% of Germany's gas imports and a third of Italy's and France's. Putin has been busy trying to cartelise the natural gas producers and announcing that Russia's gas exports to Asia/Pacific will increase from 5% of Russia's total gas exports today to 25%.

Gazprom has failed to make major investments, effectively guaranteeing a major Eurasian gas shortfall and price spike as early as 2008. Clearly, Putin's idea of "energy security" is vastly different from the ideas of his fellow G8 members, which made for an interesting summit on July 15-17.

By a strategy of expanded acquisition of energy assets and markets and by the crafting of strategic co-operation agreements with other resource-rich states, the Kremlin - through its gigantic Gazprom, Transneft and Rosneft monopolies - has been working for a few years to consolidate its grip on oil and gas exports to Europe, Asia and far beyond.

Russian Finance Minister Aleksei Kudrin on July 12 was quoted as telling a meeting of the G8 finance ministers at St Petersburg: "I think we have set the right course towards resolving the range of questions increasingly being described as 'energy security'". Responding to calls to free up trade in natural gas, Kudrin said Russia hoped to boost supplies of more easily traded LNG, stating: "Taking into account the possibility of not only piping gas but also LNG, then here with joint efforts, efforts which can be turned into a concrete plan of action, we could considerably widen the scope of that market and make it global".

Energy exports helped the Russian economy grow by more than 6% in 2005. Russia's dominant energy position has emboldened Putin to take a more aggressive stance on how its economy and politics are run. The Kremlin has taken a more confrontational attitude towards NGOs, and has imposed stricter policies with respect to neighbouring pro-West countries, such as Ukraine and Georgia. Putin is much more confident about Russia's place than leaders were a decade ago. "And finally there is the topic of providing stability and sustainability in the international energy market", Putin said on Feb. 11, adding: "and annually we are witnessing 50% growth in our trade". Such confidence is visible in Russia's growing international role.

The following are APS-edited extracts from an article by Stephen Blank, a professor at the US Army War College, published on May 16, 2006. In late April, representatives of [the]...Kremlin-controlled gas conglomerate, Gazprom, threatened to reduce exports to Europe after the EU blocked the company's attempts to obtain several European energy entities. EU officials dismissed the threat, believing that the Russian energy industry could not survive without generating a hefty European cash-flow. They were right.

Behind its mighty facade, Russia's energy sector which the Kremlin has used in recent months to bully its neighbours and expand its geo-political reach, suffers from a decaying infrastructure and a dependence on Western technology and cheap Central Asian energy. Russian exporters are able to ship large quantities of energy to Europe and Asia today only because of its unique relationship to Central Asian oil and gas producers. And the future of this relationship is crucial to understanding the global energy game. The Kremlin has significantly enhanced its control over Central Asian energy in recent years, book-ended by a 25-year natural gas supply deal with Turkmenistan in 2003 and a massive oil supply agreement with Kazakhstan in April 2006.

To many outside observers, the Russian energy sector has assumed an aura of a juggernaut. Statistics seem to support this impression: Russia has been responsible for fully half of the increase in global crude oil supplies over the past five years. The image has also been fuelled by the Kremlin's use of conglomerates as instruments of geo-political policy.

Appearances can be deceptive, however, at least when it comes to Russia's energy sector. There are numerous signs that Russia is in danger of over-extending itself, while dawdling on investing in its energy infrastructure. The over-extension problem is most noticeable in Moscow's dealings with Asia. Russia has made an array of commitments to China and Japan to meet those countries' voracious energy appetite. For example, President...Putin in March indicated that Russia by 2011 would be in position to deliver more than 80 BCM/year of gas to China via two pipelines. Meeting that goal will be difficult, however, as the pipeline linking China and western Siberia has yet to be built.

In general, questions continue to hover over virtually all of Russia's oil and gas-related deals with China and Japan. And even if the energy flows eastwards as anticipated, Asian officials are already expressing doubts about whether the amounts pledged by Russia are sufficient to meet projected needs. Beyond the question of Russia trying to export more than it can produce, the country will have to contend in the coming years with growing domestic demand, along with the need to repair existing infrastructure and tap into new energy fields. Both of these latter tasks are enormously expensive, given the difficulties of working in Siberia's uninviting terrain and weather conditions.

Experts say that the significant increase in Russia's energy production in recent years would not have been possible without the use of Western technology and techniques, including hydro-fracturing, a process in which steam is forced into a well to ease the production of crude oil. Likewise, Western equipment and know-how will be needed to develop new energy sources in the Arctic, as well as off the country's Pacific coast.

Despite the need for outside investment, Russian policies seem calculated to prop up closed domestic monopolies, and thus repel foreign capital and technology. In addition, foreign investors continue to face enormous risks when doing business in Russia: although foreigners can buy minority stakes in Russian energy firms, the concept of shareholder rights remains poorly developed, leaving outsiders vulnerable to the whims of a non-transparent and notoriously corrupt system.

For now, Central Asian energy is helping Russia mask both current energy problems and future dilemmas. Until recently every export pipeline for oil and gas produced in Central Asia was routed through Russia, enabling the Kremlin to import energy at exceedingly low cost. Putin sought to maximise Moscow's leverage by creating a gas cartel led by Russia.

Kremlin control over Central Asian energy reached the point that in late 2005, Russia felt secure in imposing dramatic price increases on its CIS neighbours, including Ukraine, Georgia and Armenia. A subsequent pricing dispute with Ukraine prompted Russia to temporarily halt the energy flow in early 2006.

Central Asian governments are not content with existing arrangements, however, and are turning to China in order to break Russia's pipeline monopoly. A 1,000-km pipeline linking Kazakhstan to China, opened last December, became Central Asia's first export route not to cross Russian territory. Now the authoritarian-minded leaders of Turkmenistan and Uzbekistan, along with Kazakhstan, are exploring the feasibility of building more pipelines that parallel the Kazakhstani-Chinese route. The possible construction of a trans-Caspian pipeline, which would enable Central Asian energy to hook up with Azerbaijani-Turkish routes, could further weaken Russia's grip on regional exports.

Much of Russia's neo-imperial designs in Central Asia are connected with the fact that the Kremlin's global economic strategy is dependent on Moscow's continued access to cheap Central Asian energy. Central Asian energy is far cheaper to extract than Russia's, thus the Kremlin uses it for Russian domestic consumption, which is heavily subsidised, while shipping Siberian production abroad. The ensuing price manipulation is the source of enormous revenues that helps sustain the government and overall Russian economy.

It is easy to see how the loss of control over Central Asian energy exports and production would severely damage Russia's political and economic interests. If Central Asian states start pumping oil to China and Azerbaijan, Russia would likely have to use its own production to meet domestic needs. This, in turn, would dash Moscow's export plans for Europe and Asia. At the very least, the availability of other export options would force Moscow to pay considerably higher prices for Central Asian oil and gas - a development that could have ruinous consequences for the Russian economy.

Two analysts, Vladimir Paramonov and Aleksey Strogov wrote in 2004: "should energy prices in the domestic market reach the world level, it will spell the end for virtually all Russian enterprises. Even if world fuel prices remain high, fuel production will become uneconomic in Russia".

Asian and European governments are becoming increasingly aware of Central Asia's importance in the global energy security calculus. Meanwhile, Washington is exerting pressure on Kazakhstan to make a firm commitment to a trans-Caspian pipeline. Should Central Asia achieve energy independence with outside help, Russia would quickly come under pressure to reform its domestic economy, especially the energy sector, so that it could better compete in a free trade environment.

It follows that economic liberalisation would undermine, if not reverse Putin's attempts to re-centralise political power in Russia. Of course, there is one factor that makes the Central Asian energy game extremely unpredictable - the brittle nature of the regimes in Turkmenistan and Uzbekistan. Both countries are ruled by despots - Saparmurat Niyazov in Turkmenistan and Islam Karimov in Uzbekistan - reliant on the widespread use of repression to maintain their authority. Many political observers believe Turkmenistan and Uzbekistan remain vulnerable to social explosions. In addition, the lack of a political succession mechanism in both states could spark upheaval in the event of Niyazov's and Karimov's deaths. Disorder in either country - especially in Uzbekistan, Central Asia's most populous state - could engulf the entire region. If such a scenario occurs, Central Asia's export ability could be impaired and the major energy players - the US, EU, Russia and China - would all stand to be big losers.