Abu Dhabi, UAEFriday 6 December 2019

Why the pivot away from communism to a market economy is better for Berlin and Kiev, but Russia too

Eastern European energy infrastructure remains one of the most enduring legacies of the Soviet system, even 30 years on

A Russian construction worker at a ceremony in 2010 marking the start of construction of the Nord Stream pipeline. AP Photo.
A Russian construction worker at a ceremony in 2010 marking the start of construction of the Nord Stream pipeline. AP Photo.

The Berliners and tourists enjoying a cool but dry and sunny autumn day in the shadow of the Brandenburg Gate were commemorating the downfall of Communism and Soviet domination thirty years ago this Saturday.

Along with the Berlin Wall, another barrier divided the continent – between two systems of energy. The dismantling of that legacy continues even today.

The Soviet empire within eastern Europe was economic as well as military and political. Its satellites were grouped into the Council for Mutual Economic Assistance (Comecon), intended to co-ordinate economic planning and control trade between its members.

The Soviet Union provided oil and gas to the members at below-market prices, which became comparatively very cheap when world prices of oil quadrupled in the mid-1970s.

The USSR also began selling gas to Austria in 1968, and giant discoveries in western Siberia allowed it to increase supplies to Germany, Italy and elsewhere during the 1970s.

This created a massive web of costly infrastructure, including the world’s then-longest oil pipeline, Druzhba (“Friendship”), running into Hungary, Czechoslovakia and East Germany.

While the Europeans needed gas to replace expensive oil and dirty coal, the Soviets required high-spec compressors and steel pipelines. Following the declaration of martial law in response to trade union activism in Poland in 1981 – the harbinger of Communism’s collapse eight years later – US president Ronald Reagan attempted to sanction supplies of technology to a new pipeline from the giant Urengoy field, but the Europeans pressed ahead regardless.

Contrary to American fears, the gas revenue did not save the Soviet economy in the 1980s as energy prices plunged, nor did the Europeans become politically subservient to Moscow. Instead, Mikhail Gorbachev’s programme of restructuring failed in the face of dwindling oil revenue, and its eastern European empire became an unsustainable burden.

Comecon was disbanded in 1991, only six months before the Soviet Union itself disintegrated. From then on within eastern Europe, there was a sharp divide between those countries that moved rapidly to a market-based system and eventually joined the European Union, and those that did not – Belarus, Ukraine and Russia.

In the last two of these, most state energy assets were seized by “oligarchs” in the 1990s in a chaotic process of privatisation and asset-stripping. Vladimir Putin’s Russia then retook most of them from 2003 onwards. Government control over Gazprom was reasserted and the gas export monopoly became an instrument of state power and geopolitical policy.

But in Ukraine, although state firm Naftohaz retained control over the key gas pipeline system that transited Russian gas to Europe, various well-connected business figures reaped huge profits from reselling gas.

In a game of chicken, if politicians in Kiev failed to toe the line, Russia could threaten Ukraine with raising its gas prices and ruining its energy-intensive, inefficient economy. But conversely Ukraine could refuse to pay, forcing Gazprom to cut supplies through its territory to the EU. This led to a major crisis in the winter of 2008-09, when supplies to several east European states were cut off entirely.

Since then, the EU has ensured gas can flow into Ukraine from the west, removing its dependence on Russia, and has encouraged gradual reform of energy prices and improvements in efficiency. The Energy Community, established in 2006, extended EU law into Ukraine, Georgia and the rest of the Balkans, cutting pollution, boosting renewables and liberalising electricity and gas markets.

Gazprom, meanwhile, constructed two pipelines, Nord Stream 1 and 2, under the Baltic Sea, and another, Turk Stream under the Black Sea to Turkey and on to the Balkans, to eliminate most of its reliance on the Ukrainian route. This would cut the $3 billion it pays in transit fees to Kiev each year, while the two countries remain effectively at war via Moscow-backed separatists in the eastern Ukrainian region of Donbas.

As in 1981, these pipelines have attracted American opprobrium, with attempts to sanction Nord Stream 2, partly to clear the way for more US sales of liquefied natural gas. Oddly at the same time, in a subplot to the current impeachment hearings, various shady associates of Donald Trump’s reportedly attempted to push Ukraine into inserting them into Naftohaz’s management.

And vital negotiations are ongoing to extend Gazprom’s transit contract through Ukraine, which expires this winter, with Russia interested in a short-term deal until Nord Stream 2 and Turk Stream are ready, and Ukraine pushing for a long-term arrangement to guarantee continued gas flows and fees to pay for maintaining the system.

The EU has been hosting the talks, aiming to avoid another interruption in winter gas supplies. But with European gas storage at record levels, and LNG readily available, Russia’s position is much weaker than in 2009.

Eastern European energy infrastructure remains one of the most enduring legacies of the Soviet system, even thirty years on. Gas trade relations have seriously distorted Ukrainian politics, in ways that are only now being undone.

The EU’s negotiating power, and its pursuit of a common energy market, have been crucial for reform.

It was easy to tear down the Berlin Wall, but impossible to rip out Russian pipelines. East European energy security, and with it the security of the whole continent, is far from perfect. But the move from communist empire to market community is better not just for Berlin and Kiev, but Russia too.

Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis

Updated: November 13, 2019 03:55 AM

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