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Political strategies: Securing Europe's energy


Risk managers must take a close interest in the rapidly evolving political relations between Russia and Middle Eastern states if their companies are to devise strategies to secure energy supplies

Vladimir Putin's recent visit to Saudi Arabia was significant--and not just because it was the first time a Russian president had set foot in the land of black gold, bringing together the leaders of the world's two oil-exporting giants. It also potentially marks the onset of a new era in global power broking in the Middle East region, and particularly the Gulf.

Saudi Arabia has been a staunch U.S. ally ever since the epoch-defining handshake between its founder Abd al-Aziz ibn Saud and U.S. President Franklin Roosevelt on board the USS Quincy back in 1945. That enigmatic agreement opened the way to six decades of unrivalled U.S. power in the Gulf region, with security guarantees for the ruling Al Saud dynasty ensuring a stable flow of oil.

Now, however, with U.S. power at a crossroads in the Middle East, Russia is taking the opportunity to cement political, economic and military ties, not only with U.S. adversaries such as Iran and Syria, but also U.S. allies such as Saudi Arabia and Qatar.

Europeans observing these developments are anxious that increased Russian leverage in the Middle East raises further risks of the use of energy as a political weapon. Russia already supplies over a quarter of European gas, and previous disputes involving Ukraine and the ongoing one with Belarus create significant cause for concern.

It would be a mistake, however, to characterize Gazprom's recent decision merely as ruthless political calculation; economic motives such as its need for liquidity both at home and abroad, and concerns over debt repayment to Western financial institutions, also played a part.

In this context, Mr. Putin's ambiguous position on the possibility of an Organization of the Petroleum Exporting Countries-style gas consortium--that it is an "interesting idea" worth further study--are hardly reassuring.

Although his own energy minister has dismissed the idea, Putin's comments raised the prospect of a Eurasian alliance controlling well over half the world's gas reserves at a time when growing European energy dependence faces the dual threats of rising resource nationalism and stiff Asian competition.

Collaboration between major producers such as Russia, Qatar and Algeria on investment and production activities could reduce the potential for oversupply in the global gas market and thus help them to control prices. The idea is likely to be discussed further by Russian and Qatari experts at an energy conference in Doha in April.

European countries like Germany, which relies on Russia for 40% of its energy, are very conscious of the need to diversify energy imports to incorporate Middle East and North African (MENA) sources such as Qatar, Algeria, Iran and Libya.

Qatar in particular, with the world's third-largest reserves, has its sights on being the leading global supplier of liquefied natural gas by 2010, accounting for up to 10% of European demand.

However, with European eyes on these countries as alternatives to questionable Russian gas supply, Putin's Middle East diplomacy strongly suggests he is intentionally building alliances to maintain Russian leverage over European energy security.

For example, Gazprom is cooperating with Algerian state energy firm Sonatrach in an apparent effort to maximize its access to European markets, as well as to gain much sought-after experience in global LNG trade.

The two states have also moved ahead with plans to restrain foreign investments in their lucrative energy sectors, with Moscow set to adopt a far tougher law on access to strategic economic sectors and Algiers revising its hydrocarbons law to restore a minimum 51% controlling share for Sonatrach in new energy projects.

However, the concept of a gas cartel faces inherent structural problems. Firstly, not only are there insufficient volumes of gas currently traded in global markets, but since an overwhelming majority of gas contracts function on the basis of fixed price long-term contracts, gas prices are also harder to manipulate.

There are also difficulties with transporting gas globally. For example, Qatar's LNG exports require import terminals, which are both expensive and time-consuming: Germany's first LNG terminal will not even come online before 2010.

Such a cartel could only be effective if the E.U. decided to limit or revise its current long-term contracts with gas exporters, which could create a more liquid market. A principal reason for Russia's consideration of the gas cartel is to pressurize the E.U. to not revise the current contracts it has with Gazprom. In this context, the forthcoming decision of the European Commission in March on the liberalization of the E.U.'s energy market will be a key indicator.

Such revision of contracts might, indeed, endanger the security of the flow of energy resources from Russia and have serious adverse effects on any insurers who underwrote those deals in the past. Inadequate gas production levels by Gazprom inside Russia itself will become much more of a problem as we advance into 2007. It means that European energy companies will have to reorganize their operational processes gradually, and invest in research and development of alternative energy sources. This lack of supply will lead, one way or another, to further price increases of Russian natural gas for European customers.

The major battle within Europe still clearly lies ahead. Key controversial issues include the planned reorganization of energy distribution assets in Europe which would directly affect the vertically integrated energy giants such as EON and Gaz de France, and proposals to increase the share of renewable energy to 20% of overall production by 2020.

A further problem with the gas cartel idea lies with Iran. As the country with the second-biggest gas reserves, it would be a key player and currently openly advocates the concept.

However, its energy industry faces severe problems. Skyrocketing domestic fuel demands are forcing it to import 170,000 barrels of gasoline a day at an estimated cost of $4 billion (€3 billion) a year, while its deepening international isolation is hindering vital investment in its energy infrastructure. Despite its enormous reserves, Iran's export pipelines have fallen foul of U.S. sanctions pressure, mistrust and hostility with neighboring countries, and labyrinthine decision-making processes in Tehran. Its export problems were illustrated late last year when it was obliged to temporarily cut gas supplies to Turkey.

Furthermore, the cartel would be undermined by the national interests of its constituent members. As a major gas exporter, Algeria is likely to be wary of jeopardizing good relationships with European consumers by cooperating too strongly with Russia, despite the fact that they each supply to different parts of Europe.

Similarly, OPEC is subject to the competing interests of swing-producer--a supplier which has the power through its output decisions to control the global price of oil Saudi Arabia, which favors a "moderate" oil price of around $50/barrel, and Iran and Venezuela, who strongly favor higher prices.

In any case, energy concerns are only one part of Russia's drive to re-exert its historical Cold War role as alternative global powerbroker in the Middle East. Its strategic obstruction of U.S. objectives, and its ongoing relationships with all regional players, is part of an effort to deepen political and economic ties, particularly in the military, nuclear energy and infrastructure spheres.

While Russia does not want an Iranian nuclear bomb, it is happy to support both sides in the burgeoning regional power struggle between U.S.-allied largely Sunni states and the Iran-Syria alliance. In particular, discussions with Saudi King Abdullah, Egyptian President Mubarak and the Iranian regime suggest Russia will provide the hardware for a prospective regional nuclear energy race.

From the Arab states' perspective, Russia's more active involvement helps them to diversify their own security and economic strategies away from their domestically unpopular U.S. dependency.

While an official Organization of the Gas Exporting Countries may not be a realistic possibility, then, informal collaboration is a more likely scenario, buttressed by an integral Russian role in assisting the Middle East states' nuclear aspirations. Increased Russian-MENA cooperation could eventually lead to more than 50% non-European control of Europe's gas supply, but the evidence suggests there is a long way to go before Russia can really challenge U.S. dominance in the Middle East and secure an energy stranglehold over Europe.

    James Howarth is the deputy head of the Middle East and North Africa division at Exclusive Analysis. Prior to joining Exclusive Analysis, he was senior researcher and speechwriter for Jordan's Prince Hassan bin Talal. Mr. Howarth has an extensive background in Middle Eastern studies and is an energy specialist. He holds a Masters degree and PhD from the School of Oriental and African Studies, and has served in a variety of research capacities, both in London and abroad.

    Teymur Huseynov, is head of the Eurasia division at Exclusive Analysis. He is an energy specialist and has worked in a variety of analytical positions in Eurasia, including for government, banking and research sectors. His analysis has been published by "The Wall Street Journal," "Global Politician" and "Caucasus-Central Asia Analyst." Mr. Huseynov holds a Masters degree from Oxford University, where he was awarded the Overseas Research Award, as well as the prestigious Clarendon Fund Scholarship.