The Oil Weapon On Belarus.

Russia is set to deal a double blow to the economy of Belarus - potentially making life much more difficult for the man the US has called "Europe's last dictator". As well as pressing for Belarus to pay much more for its natural gas, Moscow last week said it would slap an export duty on what are currently duty-free Russian crude oil exports to its close Slavic neighbour of $180.70 per ton from next year.

The measures could sharply reduce or wipe out the $4 bn-plus effective annual subsidy Russia provides to Belarus, which has helped Lukashenko deliver higher wages and living standards to his 10m people. That could make it harder to sustain the support that saw Lukashenko re-elected last March to a third presidential term with 82% of the vote - albeit in a poll international observers condemned as below international standards. It could also drive a wedge between countries with close cultural and historic links.

"Raising gas prices to [market] levels is equivalent to breaking off relations entirely", Lukashenko recently told Russian journalists visiting Minsk, warning: "We will survive, but you will lose the last ally".

The $46.67/000 CM price for Russian natural gas has been saving Belarus more than $3 bn per annum compared to market prices. At the same time, Belarus imports duty-free crude oil from Russia, processes it at two refineries, and sells the petroleum products to Western Europe at market prices, pocketing a healthy profit.

Russian export duties will deprive the Belarus budget of about $1.7 bn a year. This is a sharp turnaround from nine months ago, when Russian President Vladimir Putin was criticised for being one of the few world leaders to congratulate Lukashenko on his controversial election victory. It is the more surprising since Russia and Belarus signed agreements in the mid-1990s on creating a political and economic union, including a common currency and union constitution.

Analysts from both countries suggest Moscow is penalising Lukashenko for not delivering on pledges of closer integration with Russia, including the currency union and selling half of Beltransgaz, the Belarusian gas distributor, to Gazprom. Beltransgaz controls the gas export pipeline to Western Europe.

The FT on Dec. 15 quoted Yaroslav Romanchuk, head of the Mizes Research Centre, a Minsk think-tank, as saying: "Mr Lukashenko monetised his rhetoric. He sold his integration pledges for a high price, but now Putin feels he was cheated".

Analysts attribute Lukashenko's support for the union state in the 1990s to his belief that it could lead to a senior position for him in Moscow - even president of the union. His enthusiasm waned after the Kremlin made it clear there was no prospect of that.

Lukashenko says there can be no talk of further integration with Russia in a pre-election period. That would postpone matters until after Russia's presidential elections in 2008.

The Belarus president now has a difficult choice. He is loath to cede a half-share to Gazprom in Beltransgaz, which a Western diplomat describes as Belarus' "sacred cow", according to the FT. But even a limited gas price increase could render much of the country's largely state-owned industry uncompetitive - and handing over the Beltransgaz stake would probably only delay Russia's demands for a higher gas price.

Stanislav Bogdankevich, a former Belarus central bank governor, estimates that 60% of Belarusian industry is barely profitable or loss-making. Independent economists suggest Lukashenko may be forced to introduce market reforms into the economy. That could mean privatising some of its more attractive industrial assets - with Russian companies the most likely buyers.