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Power, profits, and politics: energy security and cooperation in Eurasia

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Power, profits, and politics: energy security and cooperation in Eurasia

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Content Power, Profits, and Politics: Energy Security and Cooperation in Eurasia by Ekaterina Svyatets ______________________________________________________________ A Dissertation Presented to the Faculty of the USC Graduate School University of Southern California In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (POLITICS AND INTERNATIONAL RELATIONS) August 2013 Copyright 2013 Ekaterina Svyatets 2 Acknowledgements Writing this dissertation has been a long, exciting, and challenging process. More than a final manuscript, it gave me a unique opportunity to learn, grow, and enrich my intellectual life. First and foremost, I am very grateful to my dissertation committee -- Professors Rob English, Pat James, Saori Katada, and Najmedin Meshkati. Their mentoring, kindness, friendship, and encouragement have enabled me to complete my dissertation and to become a scholar. I thank them for their guidance and support, their countless hours with me, and generous help in every aspect of my student life. They made me feel at home at USC, and I have greatly enjoyed my graduate school years. My adviser Professor English has read dozens of my drafts, bits, and pieces, giving me feedback along the way. I am very grateful to the faculty and staff at the School of International Relations and the Department of Political Science -- Linda Cole, Cathy Ballard, Jody Battles, Karen Tang, Veri Chavarin, Wayne Glass, Carol Wise, John Odell, Laurie Brand, and all the faculty whose courses I took. The School of International Relations, the Center of International Studies, and the Politics and International Relations program have generously supported my research and studies, enabling me to present my research at major international conferences and to attend research and training courses such as the Azerbaijan Diplomatic Academy Energy School, the University of Essex Summer School (the UK), and the Consortium on Qualitative Research Methods (CQRM). I am also thankful to USC CIBER for global business dissertation awards and the Unruh Institute of Politics for the grant allowing me to intern at Global Green USC in Washington, D.C. 3 I would like to express my special thanks to Mary Ann Murphy of USC’s American Language Institute. She has helped me in the most challenging moments of my PhD, and her enthusiasm, kindness, and optimism have been an enormous boost for me when I needed them most. She has inspired me to pursue new heights. I thank my family and friends in Russia – Mikhail Mumlev, Vladimir Tilipan, Julia Kucherova, Olga Ovcharuk, Lena Studenkova, Tatyana Gubaidulina, and Olga Rybova. Your support has been my foundation and my strength. I also would like to thank my family away from home - Nathan, Ann, Terry, and Zon Mundhenk, Luda and Olga Spilewsky, Yulia Shmatkova, Victor Malychev, Brett McBride, and Molly O’Neal. I have been very fortunate to have an amazing group of friends at USC - Adele di Ruocco, Christina Wagner Faegri, Maria Armoudian, Nadia Fomina, Mikhail Zibinsky, Julian Leuthold, Jenifer Whitten-Woodring, Xiangfeng Yang, Jeffrey Fields, Jason Enia, Amy Below, Simon Radford, Nicolas De Zamaroczy, Jessica Liao, Parker Hevron, Alice Bardan, and Zlatina Sandalska. I am also grateful to Jack Matlock, Alena Egorina, Lena Latipova, Katinka Nedwed, Bob Servant, Jack Brougher, Paul Almond, and Geoffrey Garrett for their friendship. I devote this dissertation to my wonderful parents, Vladimir and Lubov Svyatets, and my sisters, Nadia and Tanya, who have encouraged me to be brave and to explore the world. 4 Table of Contents Acknowledgements......................................................................................................................2 List of Figures...............................................................................................................................6 Abstract..........................................................................................................................................7 Chapter 1. Literature Review and Unified Framework.....................................................8 1.1. Research Questions.....................................................................................................................8 1.2. Relevant Approaches in International Relations Literature..........................................12 1.2.1. Realism/Statism...................................................................................................................................12 1.2.2. Economic Liberalism and Interdependence................................................................................17 1.2.3. Domestic Interest Groups...................................................................................................................21 1.3. What Is Special About Oil?...................................................................................................27 1.4. An Integrated Framework.....................................................................................................30 1.4.1. The International Dimension...........................................................................................................32 1.4.2. The National Level................................................................................................................................35 1.4.3. The Industry Dimension.....................................................................................................................38 1.4.4. The Project Level...................................................................................................................................40 1.5. Hypotheses.................................................................................................................................44 1.6. Methods and Case Selection..................................................................................................49 Chapter 2. Russia-U.S. Energy Cooperation.......................................................................55 2.1. Introduction..................................................................................................................................55 2.2. The Russian Energy Sector and the U.S. Involvement........................................................58 2.3. Economic Potential for U.S.-Russia Energy Trade and Investments..............................72 2.3.1. Energy Resource Availability and Accessibility.........................................................................73 2.3.2. The Economic/Investment Climate in Russia.............................................................................79 2.4. International Energy Companies in Russia...........................................................................87 2.4.1. Chevron.....................................................................................................................................................87 2.4.2. ExxonMobil..............................................................................................................................................89 2.4.3. ConocoPhillips........................................................................................................................................91 2.5. Geopolitical Rivalries..................................................................................................................94 2.5.1. The Cold War Legacy...........................................................................................................................96 2.5.2. NATO Expansion....................................................................................................................................98 2.5.3. Rivalry in Eurasia and Russia’s Energy Policy in the FSU..................................................100 2.5.4. Military-Economic Relations with Third Countries..............................................................105 2.6. Domestic Interest Groups........................................................................................................108 2.6.1. Russian Political Elite.......................................................................................................................108 2.6.2. Russian Energy Lobby......................................................................................................................110 2.6.3. American Lobbies in Russia...........................................................................................................115 2.7. The Yukos Case.........................................................................................................................119 2.8. Conclusion...................................................................................................................................122 5 Chapter 3. U.S.-Azerbaijan Energy Diplomacy: BTC and Beyond.............................125 3.1. Political and Economic Transformations of the post-Soviet Azerbaijan......................128 3.2. Economic Potential....................................................................................................................132 3.2.1. Energy Resource Availability.........................................................................................................132 3.2.2. Investment Climate............................................................................................................................139 3.3. Geopolitical Rivalries in the Caspian....................................................................................150 3.4. Domestic Interest Groups........................................................................................................159 3.5. Conclusion...................................................................................................................................165 Chapter 4. Russia-Germany Energy Cooperation...........................................................168 4.1. Economic Considerations........................................................................................................171 4.1.1. Russia’s Natural Gas Resources and Economic Ties with Germany................................171 4.1.2. European Diversification Efforts..................................................................................................181 4.2. Geopolitical Rivalries................................................................................................................189 4.2.1. “Yesterday Tanks, Today Oil”........................................................................................................192 4.2.2. Geopolitical Complexities: Fluctuations in Russia-Germany Relations Since the Cold War......................................................................................................................................................................195 4.2.3. The Germany-U.S.-Russia Triangle and NATO........................................................................199 4.3. Domestic Groups.......................................................................................................................204 4.3.1. German Political Factions...............................................................................................................204 4.3.2. Energy Business Lobbies..................................................................................................................209 4.3.3. Think Tanks and Environmental NGOs.....................................................................................213 4.4. Conclusion...................................................................................................................................219 Chapter 5. Conclusions and Policy Recommendations: Away from Resource Dependency toward a Sustainable Energy Mix................................................................222 5.1. Overview......................................................................................................................................222 5.2. The U.S.-Russia Case................................................................................................................225 5.3. The U.S.-Azerbaijan Case........................................................................................................227 5.4. The Russia-Germany Case......................................................................................................229 5.5. Long-Term Lessons from the Cases......................................................................................231 5.6. Short-Term Policy Recommendations..................................................................................233 References.................................................................................................................................240 6 List of Figures Figure 1. Project Financing (Razavi, 2007) .........................................................................43 Figure 2. Shipping Costs of Oil (Drewry Shipping Consultants Ltd., 2009).......................47 Figure 3. Typology of Case Studies.....................................................................................50 Figure 4. The U.S. and Soviet Oil Production, 1945-1990..................................................59 Figure 5. Russia's Pipelines to Europe.................................................................................60 Figure 6. Oil Production in Russia (EIA) ............................................................................61 Figure 7. Russia's Oil Export to the United States (EIA).....................................................63 Figure 8. Suppliers of Oil to the United States (Dougher, 2009).........................................64 Figure 9. American Investments to Russia, 1995-1999 .......................................................65 Figure 10. FDIs in Russia: Top 5 Investing Countries (FIAC, 2008)..................................67 Figure 11. Foreign Investments in Russia's Energy Sector..................................................68 Figure 12. American Investments in Russia's Oil Production .............................................68 Figure 13. Investments in Russia's Energy Resources (By Country) ..................................69 Figure 14. Production Sharing Agreements in Sakhalin......................................................70 Figure 15. East Siberian - Pacific Ocean Pipeline Map (Thomson Reuters).......................75 Figure 16. LNG Supply Chain .............................................................................................77 Figure 17. Map of Azerbaijan ............................................................................................135 Figure 18. Oil Production in Baku, Azerbaijan .................................................................136 Figure 19. Oil Production in Azerbaijan, 1992-2010 (EIA) ..............................................138 Figure 20. Net FDIs in Azerbaijan.....................................................................................145 Figure 21. The Ease of Doing Business Ratings (the World Bank, 2012) ........................146 Figure 22. Time and Cost to Open a Business in Azerbaijan (World Bank, 2009)...........147 Figure 23. Financing Structure of the BTC pipeline (Razavi, 2007).................................148 Figure 24. Russian Gas Export to Germany, 1973-2010 ...................................................172 Figure 25. Oil and Gas Pipelines from Russia to Europe (the Economist, 2012)..............173 Figure 26. Nord Stream Pipeline Route .............................................................................175 Figure 27. Share of Russian Natural Gas in Consumption in 2004 (Gelb, 2007)..............181 Figure 28. Top 20 Natural Gas Exporters - Cubic Meters (IndexMundi, 2011)................183 Figure 29. Russia's Share in the EU Gas Import and Consumption ..................................184 Figure 30. Proposed Pipelines to the EU ...........................................................................185 Figure 31. The Price of Russian Natural Gas for Germany at the Border (USD per 1,000 cubic meters) ......................................................................................................................195 7 Abstract This study explores varying outcomes of energy cooperation, defined as diplomatic relations, bilateral trade, and investment in oil and natural gas. Tests of theories 1 pertinent to energy security – broadly speaking, realism, liberalism, and domestic politics - reveal that they alone can offer only a narrow and one-sided explanation, not embracing the complexity of energy issues. Nevertheless, using them as a starting point, this study outlined a structured framework that incorporates three variables – economic potential, geopolitical rivalry, and domestic interest groups -- that are applied to the cases of U.S.- Russia, U.S.-Azerbaijan, and Russia-Germany energy ties. This study concludes that if the economic potential (defined by geographic proximity and resource availability) is very high, such as in the case of Russia-Germany, states can overcome geopolitical rivalries and historical enmities in favor of energy cooperation. However, if the economic potential is relatively low (because of geographic obstacles or easily available alternative suppliers, as in the cases of U.S.-Russia and U.S.-Azerbaijan), then geopolitics prevails -- for example, to bypass Russia or to limit American access to contracts in Russia when U.S.-Russian relations are strained. In all the cases explored here, domestic interest groups have mixed influence: if they are united along energy issues, they usually successfully achieve their energy policy goals, although the impact of these groups often becomes intertwined with state interests. In other situations, when powerful interest groups are divided or focused on non-energy-related issues (such as ethnic priorities), their influence over energy deals is much lower. 1 In Stephen Van Evera’s classification of dissertations, this research may be categorized as theory-testing and theory application using case studies. A dissertation of this kind uses empirical evidence to evaluate existing theories. This is in the first instance a theory-testing dissertation but with the goal of finding and explaining regularities that could lead to a new, more integrated theoretical approach. (Evera 1997) 8 Chapter 1. Literature Review and Unified Framework The world’s appetite for energy in the years ahead will grow enormously. The absolute numbers are staggering. Whatever the mix in the years ahead, energy and its challenges will be defining for our future. – Daniel Yergin, 2011, the Quest, p. 8 1.1. Research Questions Energy is one of the most central issues in contemporary global politics. It is frequently at the heart of global trade issues, because energy prices are often the key factor in the differences between growth and prosperity or shortage and recession. Energy is vital for developed countries to maintain growth and living standards, and no less central to the world’s developing economies. From the OPEC embargo of the 1970s, which sprang from the conflict in the Middle East and sent Western economies into prolonged decline, to numerous confrontations of the last two decades in the Caucasus, Central Asia, Africa, and elsewhere, energy security has had a great impact on great power relations. There is scarcely a major international issue not directly or indirectly linked to energy: whether it is the “resource curse” distorting the domestic politics of individual states; resource competition provoking civil or regional conflicts; the maneuvering of major powers to secure energy independence or geopolitical dominance; and the climactic dangers of fossil- fuel use. This study of energy security and cooperation obviously cannot encompass all of these issues. Its focus is narrower, on the questions of energy relations between the West 9 and the post-Soviet regions -- the former a major consumer and importer, and the latter a major producer and exporter. Major consumers of oil (the United States, Europe) do not produce enough to ensure their self-sufficiency, and thus they have to secure supplies from other regions of the world. One important oil-and-gas-producing region is the Former Soviet Union (the FSU): Russia alone possesses 60 billion barrels out of the world’s proven reserves of 1,200 billion. Kazakhstan and Azerbaijan follow with 30 billion and 7 billion barrels (EIA 2012). The numbers are even more impressive for natural gas: the FSU, primarily Russia, possesses 40 percent of the world’s natural gas reserves. However, access to these resources has not been easy, and the FSU remains a risky area to do business in because of tight government control of resources and undeveloped domestic political and economic institutions. Post-Soviet states differ in their relations with the West. Azerbaijan, despite somewhat limited oil and gas reserves, has been active in its cooperation with the Western governments and major oil companies. Russia, on the contrary, has had complicated and limited relations with the United States, particularly in the last decade. However, Russia has closely cooperated with Germany, despite the European Union’s attempts to diversify its energy suppliers away from Russia. These puzzling developments have led to the following research questions: Why does energy cooperation (trade and investment) succeed in some cases but fail in others? What are the determinants of energy cooperation and energy security? 10 These questions contribute to the literature on energy security, which is a multidisciplinary area that borrows elements from traditional theories of international relations and political science. It also draws on economics and environmental studies, as well as geology and natural sciences (Wu et al. 2008; Aalto 2008b:5). Each body of literature provides an insight into important aspects of energy security. However, they tend to do so in isolation, to the exclusion of factors central to other approaches. In other words, the literature offers few if any integrated theoretical approaches or tests that simultaneously take account of all the important factors and systematically explain different outcomes of energy relations. This study offers such an integrated approach to energy security. An analysis of major energy deals in Eurasia over the last two decades reveals that energy cooperation between states does not necessarily happen according to the “objective” laws of economical efficiency and free trade. That is, some energy deals of “obvious” mutual benefit are not concluded, while others of more dubious nature are. Given the strategic importance of energy resources, it is not surprising that security considerations are a top priority in governments’ decisions and so can trump purely economic ones. However, an economic cost/benefit analysis is still the starting point of energy negotiations, as at the heart of any potential project investors always seek to maximize their returns. Therefore both economic and geopolitical dimensions are examined here. To explain why some energy projects, seemingly less economically justifiable, become implemented, three major approaches in the international relations literature -- realism, liberalism, and domestic politics – are applied here for the proposed unified framework. Realism argues that trade in strategic resources is strictly determined by 11 national interest, in which a state’s overriding concern for survival and power in the international system is highly prioritized. Liberalism, by contrast, stresses the benefits of cooperation, particularly economic, and therefore the promise of easing confrontation for mutual gain. Liberalism and interdependence (expressed in trade, investment, mutual benefits, norms, and institutions) can be described as an optimistic view of international relations, while realism or statism (focused on the balance of power, resource competition, energy nationalism and vulnerability) offers a more pessimistic view (Tanner 2009). Finally, the domestic politics approach highlights the influence of various lobbies and interest groups that have a stake in foreign policy issues, such as energy projects. These groups, if powerful and organized enough, can shape states’ policies in directions that contradict the “national interest” or “objective economic benefit” to the gain of their influential constituencies. The bilateral cases of U.S.-Russia, U.S.-Azerbaijan, and Russia-Germany have been chosen for several reasons. First, these cases ensure variation in independent and dependent variables. Second, each of them presents a challenging case of energy cooperation, based on resource availability and geographic determinants, domestic political institutions, or historical enmities. Finally, they include prominent consumers and producers of oil and gas, thereby ensuring policy relevance. 12 1.2. Relevant Approaches in International Relations Literature The extant literature of international relations offers several theories that are applicable to explaining energy security and cooperation. This section briefly describes these theories, which are tested in the subsequent chapters on three case studies. 1.2.1. Realism/Statism The statist approach (realism) argues that a state is a unified entity and that domestic interest groups comply with the goals of the state. Cooperation between states, including trade in strategic resources, occurs only if it advances states’ national interests, in which security considerations prevail over profit maximization. In his Defending the National Interest, a prominent representative of this approach, Stephen D. Krasner, examines how the state, as a unified and autonomous actor, builds relationships with multinational private corporations in formulating resource policies. The objectives of the state, Krasner continues, constitute the national interest, which is a “consistent set of goals” defined by policy-makers. Comparing the statist approach to interest-group liberalism and Marxism, Krasner argues that statism provides a better understanding of raw-material-relations than the other two. He defines the state as a “set of roles and institutions having peculiar drives, compulsions, and aims of their own that are separate and distinct from the interests of any particular societal group” (Krasner 1978:10). In his view, the state is a rational homogenous decision-maker, in raw material investments and in all other matters. The government defines the national interest. Krasner draws on the 13 classic realist work of Hans Morgenthau and his view of states’ national interest overwhelmingly defined in terms of power (Morgenthau 1948). While the state’s insulation from societal pressures is disputed by other theoretical approaches, Krasner’s theoretical foundations of statism have had a profound influence on other resource-policy studies. Robert Gilpin (2001) continues this line of argument and argues that “in a highly integrated global economy, states continue to use their power and to implement policies to channel economic forces in ways favorable to their own national interest and the interests of their citizenry.” Gilpin adds that free-market mechanisms are not sufficient to ensure the world economic system's smooth operation. It is especially important for the global oil market, in which oil-possessing states control oil production volume and the access to oil fields on their territory. Gilpin's definition of political economy - a “sociopolitical system composed of powerful economic actors or institutions such as giant firms, powerful labor unions, and large agribusinesses that are competing with one another to formulate goverment policies” - is highly relelant for the energy sector (2001: 21-38). Gilpin is responding to interdependence theorists, such as Keohane and Nye (1989), as well as to literature that emphasizes the growing power of global corporations. Gilpin’s argument is that states are still the ultimate actors in the world politics, and they shape even the dealings of powerful multinational’s; if states do not want a deal implemented, they will halt it. In energy-rich states, oil has played a role beyond that of a regular commodity. The oil industry has been more politically and economically influential than most other 14 industries. One of the best historic accounts of the oil industry’s development globally and its use by governments as a tool of power is Daniel Yergin’s Prize (1992). The author develops three main themes in this detailed study. The first theme is the rise of the oil industry as global business, which has the biggest impact on modern societies. The second theme focuses on how this industry is “intertwined with national strategies and global politics and power” (Yergin 1992:13). The third theme concentrates on how the mankind has developed into what some experts call the “Hydrocarbon Man.” Yergin’s volume provides knowledge and insight into how governments promote their national interests though resource diplomacy and war. Yergin’s latest book, The Quest (2011), examines more recent developments in energy power politics. One of these has been an increasing globalization of the world economy, including the energy industry. One of Yergin’s main cases is Russia, which has become a major oil and gas producer, rivaling Saudi Arabia. Prior to 1991, oil revenues helped finance the country’s imports of consumer good and the ailing economy; the oil industry was the major economic force throughout the Soviet period. Sinking oil prices in the 1980s, however, contributed to the economic collapse of the Soviet Union. Yergin provides an overview of the oil industry transformation in Russia from the Soviet model to market capitalism that has now turned again toward increased state control (Yergin 2011:31-37). During his first and second term in 2000-2008, President of Russia Vladimir Putin announced that oil and gas were the key to Russia’s economic power and its place in the world economy. Since then, energy resources (natural gas, nuclear energy, oil) have been a major “tool” of Russia’s foreign policy, especially with the neighboring states (the 15 former Soviet Union republics, Iran, China, and even the European Union). Contemporary Russia is an example of how government is intertwined with the energy industry. Both in the Soviet and post-Soviet eras, Yergin sees Russia as a quintessentially realist state in its energy politics. Russia is not the only country where the energy sector is largely in the hands of the state: out of the world’s twenty largest energy companies around the world, sixteen are state-owned. State ownership is considered by governments of oil-possessing countries – including some largely capitalist free-market countries -- as beneficial for controlling their reserves and revenues from oil and gas export. Russia, after the sweeping wave of privatization of the 1990s, quickly returned to the state-controlled model, increasing the share of government-controlled companies from 13 percent in 2004 to 40 percent in 2007 (Pleines 2009:71). The realist-statist approach views energy security as a zero-sum game and a constant rivalry. This approach relies heavily on the notion of geopolitics as “a subfield of political science and geography… [that] focuses on the relationship between territory and power, particularly the influence of geography on state behavior” (Dekmejian and Simonian 2003:5). Energy resources are often discussed as a “weapon” for geopolitical domination and manipulation. For example, analyst Vladimir Socor refers to Russia’s pipeline projects in Eurasia as a “blitzkrieg capture,” with the goal to dominate the European oil and gas market (Socor 2008). A similar theme is presented in Marshall Goldman’s Petrostate: Putin, Power, and the New Russia (2008) - a very detailed account of Russia’s energy policies since with the mid-19 th century, with a special emphasis on the 16 last decade. In his analysis, Goldman goes beyond geography and shows how oil and gas are used as a political and economic weapon, potentially able to destabilize transit countries in the Caucasus region and Central Asia (Goldman 2008:149). Many other studies have also concluded that energy resources can be a reason for conflict or outright war. Mary Kaldor, Terry Lynn Karl and Yahia Said, in their book Oil Wars assert that oil causes, exacerbates, or mitigates wars and affects the nature of a conflict (Kaldor et al. 2007). The authors analyze the cases of Angola, Azerbaijan, Colombia, Indonesia, Nigeria, and Russia/Chechnya, concluding that oil money finances these conflicts, in which domestic groups compete for oil resources in these geopolitical conflicts related to oil. Such wars can potentially happen, as some authors (Standlea 2006) argue, even in the Arctic: the area that contains enormous energy resources and becomes more accessible as the global warming progresses. Notwithstanding their many variations in subject or emphasis, these studies share realism’s consistent skepticism about the liberal assumption that trade in energy resources among states would bring more peace and stability. Other studies, such as one by Neal Adams, explore the effects of terrorism on the oil community, including special terrorist tactics, attacks methods, shocks resulting from oil supply destruction, global choke points in oil delivery, and other possible damages to the industry (Adams 2003). His in-depth analysis of potential weapons and tactics that can be used by terrorists (bombs, explosives, kidnapping, hijacking, dirty bombs, chemical weapons and others) give a valuable overview of the security dimension of various energy 17 projects, such as pipelines, tanker delivery, rail delivery, etc. In the last decade, physical security of energy projects has become an important part of their planning and execution. In sum, the realist-statist approach maintains that security considerations, the position of a state in the international system and the state’s influence in a region, consistently prevail in foreign, including energy, policy making. Energy cooperation is likely if it is in the national interest -- defined in terms of power. When it is not, economic profitability is usually sacrificed. Energy policies are considered by this approach as a tool of domination and conflict, and thus compromise is difficult to achieve. 1.2.2. Economic Liberalism and Interdependence Unlike realism, liberalism argues that even in the area of strategic resources, states should be able to trade with each other for mutual benefit. The literature on economic liberalism and interdependence focuses on the economic fundamentals of trade and cooperation. Interdependence between two or more states is believed to contribute to peaceful relations among them. A pair of states does not have to “like” each other; governments are able to put their differences aside for the sake of their access to valuable resources, markets, and mutual profits. States prefer to trade instead of invade each other. 2 Realists would probably prefer to go to war to escape dependency, while liberals argue that mutual dependency reduces the chances of war. Unlike realism, that emphasizes “dangerous 2 These ideas were developed in (Keohane and Nye 1989) and in (Axelrod and Keohane 1985) 18 dependencies” and “energy supremacies” of oil and gas producers, liberalism points to interdependencies that foster cooperation (Copeland 1996). In contrast to realists who worry about Europe’s dependence on Russian oil and gas, Stacy Closson looks at Russia’s dependence on Europe’s consumption of Russian resources. She sees Russia’s dependence on Europe for oil and gas consumption as a guarantor of long-term trade and investment relations. Economic interdependence theory predicts that pipelines can be a “peace” catalyst, even in such conflicts as the Nagorno- Karabakh dispute and Georgia-Russia tensions (Closson 2009) A subset of liberalism includes energy-economics scholars who explain trade mechanisms often neglected by those focused on geopolitical rivalry. They also study the role of geography in assessing energy projects and transport routes. Landlocked countries, for example, have limited access to foreign markets. Energy political economists study how free trade influences domestic economies and political systems; a common prescription is that resource-rich countries have a greater chance to become wealthy if they commit to free trade (Sachs and Warner 1995). The energy economics literature also explores efficient exploration, trade, and depletion of global energy resources, the quantity and quality of a country’s oil, gas, uranium, and other resources, which define the feasibility of a project (trade, investment). An analysis of energy production and trade includes a study of energy resources and their distribution. Examples of such research include Ferdinand Banks’ The Political Economy of World Energy (Banks 2007) and Toyin Falola and Ann Genova’s The Politics of the Global Oil Industry (Falola and Genova 2005). Banks explores a wide range of topics, 19 including the financing of energy projects, the trends and tendencies in the world’s oil production, natural gas economics, coal and nuclear energy aspects, the economics of the electricity industry, and money markets related to energy. The distinctive feature of such research is that it more focused on economics and the laws of trade and investment (often expressed in mathematical formulas), rather than politics. Falola and Genova’s volume examines several regional energy organizations (such as OPEC), as well as several case studies. Providing an economic history of global oil, the authors take an almost encyclopedic approach, showing the numbers and key developments in every case. They conclude that economic developments in the energy industry shape global energy markets that are dominated by private and state energy companies and institutions. Their focus on trade and economic mechanisms clearly puts them in the liberalism domain. Unlike realism, however, these studies do not focus deeply on the conflict-prone nature of the oil industry, but rather they give a solid economic- historical overview of oil organizations in many important cases. Economists also study historical patterns and distortions that often persist in oil and gas trade. Former World Bank chief economist Joseph Stiglitz of the World Bank, in his Globalization and Its Discontents, touches upon economic and price distortions in the post- Soviet countries. He points to the fact that during the Soviet period, prices were dictated by the command economy, not by market mechanisms. After the end of the USSR, Russia continued to provide oil and gas at below-market prices to former Soviet countries in order to “purchase” their loyalty and support. Russia could afford these price distortions only thanks to the country’s huge energy resources (Stiglitz 2002:139). Timothy Colton also 20 explores this issue, noting that the Yeltsin administration provided oil and gas to post- Soviet states at Soviet-era discounted prices in order to keep their economies afloat and to prevent economic collapse and social unrest in those countries (Colton 2008:266). In other words, both Stiglitz and Colton indirectly counter the realist view that Russia’s energy policies were purely offensive aimed at increasing geopolitical power. Instead, they were equally “defensive” and motivated as much by domestic political and societal concerns. Both authors show how economic mechanisms are used in the post-Soviet trade space, with its distortions and path dependence since the Soviet era. Energy economics provides very detailed accounts of oil and gas reserves and energy companies’ activities. One of such volumes, Jonathan Stern’s The Future of Russian Gas and Gazprom, examines important details about Russia’s natural gas resources and how they have been explored and developed over the last two decades. This research is extremely useful for the study of the economic dimension of the Russian energy sector, including major players in the industry, geography, and a wealth of statistical knowledge (Stern 2005), providing an excellent economic analysis of a country’s energy potential. Because they are focused on economics, while not explicitly advancing liberal IR theory, their emphasis on economic potential is consistent with the liberal approach. In sum, liberalism stresses the importance of profitability, free markets, and non- state actors, searching for common interests in order to reach mutually profitable solutions. In the classic contrast with realism and its focus on relative gains, the liberal IR approach emphasizes absolute gains: if everyone profits, it is not so important who might profit more 21 and who less. 3 This is because, as explained at the outset, energy is so vital to both developed and developing economies that cooperation here has great potential to overcome conflict. Liberalism also helps explain variation among the policies of oil producing countries’ - Russia, Saudi Arabia, Nigeria, etc. 1.2.3. Domestic Interest Groups The traditional literature on domestic politics and interest groups, pioneered by the constitutional-legal and the group approaches (Baumgartner and Leech 1998), unlike broader theories of realism and liberalism, is mostly centered on American politics and influence on the U.S. Congress. Nevertheless, this literature has provided a valuable insight on how interest groups shape foreign (and energy) policies and has inspired a more generalizable theoretical variable of domestic interest groups affecting energy decision- making. Additionally, it serves as the basis for recent studies in other countries (e.g., Russia). The literature on domestic politics started in the 1960s with pluralism theories by such luminaries as David Truman, Robert Dahl, and Jack Walker. A founder of the pluralist school, David Truman, explores interest groups’ role in the political process, based on their conflicting and competing interests. Truman lists several factors that determine the power of interest groups. First, their “strategic societal stance” is determined by their status and prestige, closeness to government structures, and their access to 3 See comparisons of absolute and relative gains in (Grieco et al. 1993) See also (Keohane and Nye 1989) 22 valuable information. Second, their success is shaped by such internal features as the degree of formalization, leadership abilities, and financial resources. Finally, interest groups’ ability to exist and function is dependent on the democratic structure of the government, with its civil liberties and human rights (Truman 1951). Another theorist of domestic politics -- Elmer Schattschenider -- unlike Truman, disagrees with the pluralist school and argues that political parties, rather than other interest groups, are more important and efficient for citizens in promoting their interests. He states that "democracy is a competitive political system in which competing leaders and organizations define the alternatives of public policy in such a way that the public can participate in the decision-making process" (Schattschneider 1960:141). He asserts that only when political parties are strong and centralized, they are able to project the population’s ideas to the government. Diverging from the pluralist school, Schattschneider concludes that political parties are more than mere aggregates of interest groups, but rather they are a real political force. The next milestone of the domestic groups literature, the seminal volume The Logic of Collective Action by Mancur Olson explores what makes group work together for their collective interests. The premise of his theory is that rational and self-interested individuals join groups of common interests via either incentives or coercion. The author makes an innovative claim about the group size, finding that it is more difficult to motivate members in a larger group (Olson 1965). Unlike the traditional group theory (e.g. Leon Festinger, Harold Laski) that assumes that groups of all sizes equally attract members whose participation is voluntary and universal, Olson concludes that it is much harder to provide 23 collective/public goods and to achieve collective bargaining in a larger group due to the increasing sub-optimality, and thus larger groups are less effective to further their members’ common interests. By the early 1970s, after Olson’s breakthrough volume, the literature on domestic politics continued to focus largely on collective-action dilemmas, alongside such topics as lobbying methods, interest-group democracy, political action committees, and electoral politics. Multiple scholars of international political economy have studied how the electorate influences trade policies (Foyle and Belle 2010) -- for example, the seminal studies by Grossman and Helpman (2002) and Bueno di Mesquita (1997). These authors look at the structure of the electorate and the divisions in governments to predict trade policy outcomes: openness or protectionism. Constituents influence the government through public interest groups, labor unions, and other grassroots movements, funded by donations and grants (Wolpe and Levine 1996:2). One of the main methods used by domestic group to shape policies is lobbying. Lobbying has been in the center of multiple studies that have explored how the U.S. Congress is influenced by societal groups (Carter and Scott, 2004; Rubenzer, 2008). Still, scholars widely disagree on the definition of lobbying. One school of thought argues in favor of a narrow definition that only includes professional lobbying activities. Supporters of the narrow approach (e.g., Russian political scientists Avtonomov, Neschadin, Blokhin, Vereschagin, Grigoriev, and Ionin) assert that only non-governmental groups and businesses can be categorized as lobbyists (Tolstykh 2006:9). The other school of thought pushes a broader definition: lobbying can be done by any societal entity (including 24 government agencies) that tries to promote a particular issue and a policy (Tolstykh 2006:8). Various types of lobbying activities are systematized in the literature on domestic interest groups. First and foremost, there are contract lobbyists, hired to promote somebody else’s interest for a fee or salary. In Washington, D.C., many such firms are located on the famous K Street. They usually specialize in a certain issue-area, based on their expertise and networking. This category is different from corporate lobbyists, who are companies’ employees who represent corporate interests. Their voices are very influential, as corporations provide jobs and tax revenues in electoral districts. Yet again, corporations or industries join business and professional associations that “represent the collective interests of an industry or group of industries” and are de-facto lobbying organizations themselves (Wolpe and Levine 1996). Professional lobbying companies, by law, are required to be transparent. In the United States, their names and phone numbers are available in special reference books. Their financial contributions to political campaigns and other activities are also supposed to be publicly known, especially using new media technology and online access to government legislative documents. In countries like Russia and Azerbaijan, however, lobbying activities most often happen behind closed doors, and there are few ways to limit financial contributions to politicians or even to find out about them. Moreover, lobbying as such has a negative connotation in the post-Soviet regions, as lobbying was almost “an insulting word” in the Soviet era (Tolstykh 2006:28). 25 Multiple authors study domestic groups from the point of view of their “narratives”. Pami Aalto notes that political and economic “story-telling” is “a very common form of political activity when scientifically and technically secure information is not available, as it most often is not, and when policies nevertheless need to be developed, decisions made and funds assigned” (Aalto 2008a:29). Such “narratives” can be seen alongside (or intertwined with) the more objective political analysis and prescriptions produced by such think tanks as the Brookings Institution, the Carnegie Endowment for International Peace, the Heritage Foundation, etc. Their policy recommendations and analysis are often influential in foreign policy decisions. Ethnic lobbies also promote their interests via narratives in their lobbying mechanisms, using historical parallels and their economic interests (Foyle and Belle 2010). Of particular relevance to this study are the Armenian, Polish, and other ethnic lobbies – in the U.S. and Western Europe – whose emphasis on historic victimization is coupled with current policy positions on issues from NATO expansion to pipeline construction. Similar actors, interests, and narratives are found in the energy sector, as well. Energy projects and deals can only be implemented if domestic actors in participating countries support them (or, at a minimum, are unable to block them). Geri and McNabb (2011) categorize stakeholders in energy policy networks into four groups: energy prime movers, energy industry shapers, energy users, and energy regulators. Movers are energy producers and transportation companies. Shapers are “financial, research, social, and supporting organizations that facilitate the movement of energy from producers to users” 26 (Geri and McNabb 2011:xxix). Users are consumers -- all kinds of entities that purchase energy. Finally, regulators are government bodies, lobbied by all the remaining groups. In addition to more general studies, scholars explore regional and country-specific domestic groups. For example, Peter Rutland studies the Russian policy-making elite, analyzing rival perspectives on the country’s foreign policy. Russian energy companies in the 1990s had to decide whether they were going to continue energy export to the former Soviet countries that were unable to pay for them in order to maintain Russia’s presence and influence in the region (Rutland 2000). Scholars agree that Russia is a typical case of the corporatist model, in which certain interest groups maintain the monopoly in a specific issue-area (Tolstykh 2006:11-14), as opposed to the pluralist model that implies the diversity and competition among interest groups. In Russia, the government encourages a monopolistic domestic structure in order to establish a symbiotic relationship with interest groups by giving preferential treatment to certain groups. While this structure was relaxed in the 1990s, during privatization and the Loans-for-Shares program that “reduced state monopoly over resources” (Colton 2008:264), the structure has become again increasingly monopolistic under Vladimir Putin and Dmitry Medvedev. In sum, domestic groups, in different political systems and contexts, have powerful potential to influence states’ energy policy decision-making via lobbying the lawmakers and persuading the public. The founding theories of the 1960s and the 1970s, even though not focused on energy sector, provide us with the conceptual basis for more recent literature on domestic groups. 27 1.3. What Is Special About Oil? Oil is considered a non-renewable resource, strategically vital for every country’s survival. Production of oil is normally very oligopolistic in its nature. Crude oil has a high Energy Profit Ratio (the amount of energy produced from a certain amount of fuel) and is more efficient than that of other types of fuel, including hydrogen, oil sands, corn, and ethanol. Oil is also relatively easy to transport by pipelines and tankers. That is why oil will most probably stay a major fuel source for decades, only slowly replaced by natural gas and alternative sources. There is no consensus about how much oil is available for exploration around the globe or how long the supply will last. Competing models even disagree even on the “limitedness” of resources, from the Hubbert model that claims that resources are about to run out to the Cornucopian model that claims that the resources are unlimited (Blanchard 2005). However, the consensus is that oil and natural gas are non-renewable (i.e. limited) resources. Energy security, traditionally defined in the literature as the reliability of affordable and sustainable supply and demand (Shaffer 2009a; Bressand 2009), does not necessarily mean energy independence (i.e. a country’s possessing sufficient energy resources). Since energy independence is not always possible due to geographical determinants, energy security can be achieved through mutual investment, technology transfer, inter-government support, and trade. Trade, however, may lead to mutual dependency of energy consumers on energy producers. Although most often energy security literature focuses on the 28 vulnerability of energy consumers, energy producers face their own challenges, such as environmental problems, volatile oil prices, and dependency on consumers, as well as transit countries, which host expensive pipelines. The literature’s traditional categorization of states as consumers, producers, and transit states is also oversimplified, because most countries are, in fact, producers and consumers simultaneously (Shaffer 2009a). This study addresses this mutual dependency. Energy markets are constantly shaped by the forces of globalization and regional segmentation, and energy companies have to follow suit. On the one hand, they are becoming more integrated, combining oil and gas production, processing, and transportation. The traditional divisions between oil and natural gas production have become blurred, and many aspects of production go hand in hand (e.g., oil and associated gas production). On the other hand, energy trade is regionally oriented (North America, Eurasia, and the Middle East) in order to minimize transportation costs (Shafranik 2009). These developments are especially obvious in the natural gas trade, which is only now becoming more globalized thanks to liquefied natural gas (LNG) technology for the first time. LNG is mostly moved around the world by tankers, making natural gas a truly global commodity. Technology is steadily globalizing what traditionally has been a regional trade issue. At the same time, regular natural gas is still delivered via pipelines, such as ones from Russia to Europe. The most important global factor affecting everyone is fluctuating energy prices. Oil prices are more volatile than gas prices, the latter usually negotiated by governments (e.g. Russia and Ukraine). Oil producers can affect oil prices by reducing or increasing 29 their oil production or through direct agreements within OPEC. Non-OPEC countries sometimes coordinate their actions with OPEC: for example, in 2009, the Russian Deputy Prime Minister Igor Sechin (responsible for energy and environment) invited OPEC representatives to Moscow to discuss oil prices (Sechin: Rossiya Origlasit Predstavitelei OPEC v Moskvu 2009). State control gives producers opportunities to adjust oil and gas production volume in order to keep prices at a certain level. In the global oil market, Saudi Arabia has long played the role of a swing producer (able to quickly increase or decrease production) (Yergin 1992). As the second largest (and from time to time, the largest) producer of oil and gas, Russia possesses a more limited leverage on global oil prices because it produces oil almost at capacity (Rossiya Umen'shaet Svoi Export Nefti 2009). In addition to oil production data, oil prices are affected by information about existing oil reserves and new discoveries - whether the market believes that oil production will substantially increase in new oil fields. Leading experts in oil and gas research warn us, however, that information about global oil and gas reserves might not be accurate, even at the current level of exploratory technology. Roger Blanchard, the author of The Future of Global Oil Production: Facts, Figures, Trends and Projections, argues that data on oil reserves may be misleading and overly optimistic, partly because governments have always been motivated to inflate their numbers. First, oil and gas reserves can be calculated by different methods. In addition to that, there is often a mix-up between data on proven reserves and probable reserves (the latter are usually significantly higher than the former). Second, crude oil production is often accompanied by liquid hydrocarbons (condensate, natural gas liquids, refinery gain, and other hydrocarbon liquids) (Blanchard 2005). When 30 by-product condensate and other substances are included in the data on crude oil reserves, the figures on reserves become inflated. 1.4. An Integrated Framework From the preceding review, it is clear that an enormous amount of research has been done in various areas pertinent to energy security. But it is also clear that these are mutually exclusive approaches; they each examine a particular set of cases that support their analysis. The literature is fragmented and isolated: fragmentation leads to a narrow understanding of energy security processes and stalemates in policy-making decisions. The goal of this work is a more integrated approach that can consider multiple variables from multiple approaches through several important case studies. A more integrated approach allows examining an energy issue from several aspects in a systematic way, both for comparative analysis and for policy recommendations. In fact, it is not quite correct to say that no scholar attempted such an approach. For example, Peter Rutland, mentioned above, suggests several models for explaining Russian energy policies in the Caspian Region. First, the kuwaitization model argues that Russia’s energy resources serve as the country’s competitive advantage in the international division of labor. Second, the market forces model is based on liberalism and advocates free trade, privatization, and the prevalence of market mechanisms. Third, the rent-seeking model prioritizes rent-seeking over profit seeking: rent seeking is the extraction of benefits from 31 distortions in the economic system (such as the preeminence of the energy sector). Forth, the “Russian bear” model promotes the state’s national interest, similar to realism. Finally, the pluralist model describes competition among rival groups in a society. Rutland compared a country’s policies to a mosaic, which can be explained partly by universal economic theories, partly by geopolitics, and partly by the interests of the elite (Rutland 2000). In other words, Rutland finds that even over a short decade in the 1990s business and politics continued shifting so much that no one model emerges as the best explanation of major energy policies of that period. Another excellent volume, by editors Jeronim Perovic, Robert Orttung, and Andreas Wenger, offers a multi-aspect assessment of Russia’s energy policies in Eurasia, including Russia-EU and Russia-U.S. relations, as well as Caspian states (Perovic 2009). Assessing the case of Russia from different dimensions, the book provides a wealth of knowledge on current Russian energy ties, but it does not have the goal of creating an integrated framework or a comprehensive literature review. The authors also conclude that the field needs a multi-variable theoretical model, rather than advancing a single explanation. A recent volume by Gawdat Bahgat also offers a multidisciplinary approach to energy security. Bahgat explains why one needs to use a multidisciplinary model. First, the energy mix in most countries is diversified and includes coal, oil, natural gas, nuclear energy, and renewables. Different sources of energy require different approaches. States may be self-sufficient in some aspects, such as coal, and highly dependent on foreign suppliers for others, such as oil. This will lead to different policy decisions in terms of how 32 to ensure a stable supply of vital resources. Second, energy policies involve multiple aspects, such as investments, resource nationalism, geo-politics, and others. The diversity in these aspects requires studying appropriate literatures that generate knowledge on these particular issues. He concludes that energy security may only be explained by a combination of disciplines and areas of knowledge (Bahgat 2011). Inspired by these early efforts, this study offers an integrated framework that could simultaneously evaluate geopolitical, economic, and domestic politics variables across key cases. As detailed below, these variables have been refined to generate several hypotheses applied to the cases of U.S.-Russia, U.S.-Azerbaijan, and Russia-Germany energy ties. These energy relations unfold in the context of four key dimensions (levels). Another shortcoming of much existing literature is the oversimplified and descriptive nature of their case studies, which naturally tends to support confirmation of existing theories. But when examined in their full complexity, on the international, national, industry, and project levels, a much more fine-grained and revealing picture can emerge. Consequently, the next step is to outline these different levels as background to the case studies analyzed in the following chapters. 1.4.1. The International Dimension This dimension refers to broad conditions in the international system, affecting energy trade and investments. Examples of such factors include global business and 33 economic environments, world energy markets, oil prices, multilateral institutions, and capital movements (Razavi 2007:187-8). Over the last decade, there have been changes in the global patterns of oil supply and demand. According to BP research, the biggest oil demand in the 1990s was observed in the OECD countries, while OPEC countries provided most of the supply. Since 2000, however, oil demand was growing faster in developing countries (e.g. China), rather than in the OECD. Similarly, oil supply has shifted from traditional sources (OPEC countries) to non-OPEC countries, including states in the Caspian region, such as Azerbaijan (Khalilov 2009). Non-OPEC countries have grown in importance for global oil supply because of fewer limitations on their production volume and price-setting. The International Energy Agency (IEA), with its 28 member-countries, monitors energy supplies and provides fuel-security guidelines, designed after the oil shocks of the 1970s (Aalto and Westphal 2008). Fatih Birol, the Agency’s Chief Economist, predicts that the “era of cheap oil is over” (Tay 2011). The booming demand for human mobility (automobiles and air travel) will drive oil prices up. The number of oil producers will remain limited, and this increases the importance of conventional and unconventional natural gas in the global energy mix, since the number of natural gas-possessing countries exceeds the number of oil possessing states. LNG is becoming a globalized commodity, despite environmental concerns about shale gas production (water pollution and high water consumption) (Tay 2011). Another major factor in the international domain is multinational institutions that guide and govern cooperation in global energy resources, helping mitigate risks for 34 individual countries in energy investments. For example, the Multilateral Investment Guarantee Agency (MIGA), a part of the World Bank, provides “investment guarantees against the risks of currency transfer, expropriation, war, civil disturbances, and breach of contract by the host government” (Razavi 2007:69). Azerbaijan and Russia are now both MIGA-eligible countries (MIGA Member Countries (173) 2008). In addition to multilateral agencies, regional and national agencies also provide financial support and advice to governments: e.g., the European Investment Bank (EIB), the European Bank for Reconstruction and Development (EBRD), the OPEC Fund for International Development, the U.S. Agency for International Development (USAID), the U.S. Export-Import Bank (USExim), and OECD (Razavi 2007:105-7). Multilateral entities (such as IEA) promote sustainable development and energy independence, overarching individual governments: In a world of increasing interdependence between net exporters of energy and net importers, it is widely recognized that multilateral rules can provide a more balanced and efficient framework for international cooperation than is offered by bilateral agreements alone or by non-legislative instruments (About the Charter 2009). The following international organizations influence national energy policies: the International Energy Agency, the Asia Pacific Economic Cooperation (APEC) Energy Working Group, the North American Energy Working Group, the North American Energy Working Group, the International Energy Forum, among others. In additional to these, states often join international energy-related treaties, such as the Kyoto Protocol, cap-and- trade agreements, and the Copenhagen Accord, to name a few (Geri and McNabb 2011). 35 The guidelines and requirements of such international entities often contradict national energy policies. Even inside the European Union, energy is the sector in which nations prefer to keep as much sovereignty in energy supplies, as possible. For example, Germany went ahead with the Nord Stream pipeline deal with Russia despite a substantial EU opposition. Despite the existence of multilateral guidelines, most decisions in energy cooperation are made bilaterally alongside such issues as asymmetry, mutual dependency, protectionism, state monopolies on energy infrastructure, and export restrictions (Barysch 2005). 1.4.2. The National Level The state dimension includes a country’s economic conditions, domestic legislation and regulations, as well as the overall business and political climate. States (both importers and exporters) introduce regulations and restrictions that affect the volume and the nature of energy trade, balancing between free-market rules and government control. Even developed economies do not always push for competitiveness among their energy industries and businesses; for example, in the European Union, nations prefer to protect their national companies rather than allowing companies from other European countries to compete on their domestic markets (Aalto and Westphal 2008). In the cases of the U.S. and Germany, both countries have carefully protected their energy markets from too much foreign influence (e.g., the U.S. government blocked the 2005 Unocal deal, when a Chinese company wanted to buy a major U.S. energy company). 36 Relations between energy consumers and energy producers are often discussed in terms of asymmetry, which means that one side is more dependent on the other and is, therefore, vulnerable. An alternative situation is when dependency is mutual. For example, according to Katinka Barysch of the Centre for European Reform, EU-Russia gas trade is a case of mutual dependency, which inspired the EU-Russia Energy Dialogue in 2000 (Barysch 2005:27). However, as the later chapter on Russia-Germany will show, EU- Russia energy trade can be also presented as a high dependency on Russia, especially from the point of view of those EU members that import almost 100 percent of their natural gas from Russia. Another problem in energy trade is protectionism that includes trade barriers and restrictions, as well as preferential conditions for domestic producers and consumers. For example, Russia has been criticized for its domestic natural gas prices that have been much lower than world market prices. The Russian government has responded that Russia’s domestic consumers would not able to pay world prices and that a plentiful supply of Russian natural gas helps keep domestic prices down (Barysch 2005:25). Such protectionism is very much supported by Russian consumers. In addition to domestic prices, state ownership of the energy infrastructure has been a debated issue since the wave of energy sector nationalization that occured in the Middle East, Latin America, and other regions in the 1970s (described in great detail in Daniel Yergin’s Prize). As a result, in Latin America we observe a similar ownership structure of the energy sector, as in the former Soviet regions. State ownership of energy industries is not a new concept in the global economy: gas pipelines, for example, “have 37 historically been undertaken by state entities” because of their long-term nature and large investments required (Razavi 2007:38). However, this issue has been an obstacle to cooperation in the U.S.-Russia case. The EU has also strongly opposed the state monopoly of Russian gas pipelines and strongly recommended that Russia open the energy sector to international competition. The Russian side did not accept these demands as realistic in the short term (Barysch 2005:25). Finally, at the country level, states with a similar (relatively low) GDP – such as Russia and Azerbaijan – have common economic problems and risks that are taken into account by decision-makers: limited domestic sources of capital, volatile legislatures, and unfavorable investment climates (Razavi 2007:19-23). Such risks are measured and evaluated by different credit rating agencies (e.g., Moody, Fitch Ratings, and Standard & Poor) and by multilateral institutions (Razavi 2007:162). One example of such evaluation is Doing Business reports published by the World Bank ("Doing Business 2009" 2008). To sum up, this dimension provides a valuable insight into the conditions in each country that affect all industries (e.g., an investment climate, political stability), as well as specific economic aspects for the energy sector (e.g., proven resources of oil and gas, government controls, and other state policies), especially in countries with almost half of the GDP revenues provided by oil and gas exports. 38 1.4.3. The Industry Dimension The importance of the energy sector can be estimated by its share in a country’s GDP, the availability of energy reserves, the institutional structure of the industry, and the volume of domestic energy supply and demand (Razavi 2007:182). Along these indicators, Russia and Azerbaijan are similar because the oil and gas industry is a major revenue generator for these states. The following two chapters will show the statistics on Russia’s and Azerbaijan’s energy production and revenues. Two types of actors exist in energy production and trade: major companies (both state-owned and private) and smaller independent enterprises. It is important to know what market strategies they use when possible opportunities for their involvement in energy projects are being evaluated. Major companies and independents have different preferences in energy-market operations. Major oil and gas companies usually prefer long- term investment due to the large volume of their operations and cost effectiveness. In the 1970s, major oil companies favored futures contracts (which obligate a seller and a buyer to implement a transaction at a fixed price on an agreed date); an alternative form - day-to- day spot trading - was not widespread. In the 1980s, the liquidity of oil as a commodity increased dramatically, and spot trading started to dominate: a “cargo of oil is bought and sold many times, as a virtual asset, before oil physically reaches a refinery” (Razavi and Fesharaki 1991:3). Since the 1990s, major oil companies use both, focusing on futures contracts and using the spot market to fill gaps in supply. Smaller independent oil companies now mostly operate on flexible spot markets (Razavi and Fesharaki 1991:22- 39 24). Therefore, bigger projects such as pipeline and oil production in remote regions with harsh climates (such as Russia’s East Siberia) can be implemented only by major oil companies, not by smaller independents. Major energy companies continually choose between long-term and short-term trade strategies. Companies react to growing operation costs of oil production and fluctuating oil prices (because of changes in global demand and supply) through adjustments in their volume of production. Oil futures are also used as investment. An example of such decision-making was a panel in 2009 by ConocoPhillips, Royal Dutch Shell PLC, Petroleo Brasilerio SA, and Total, titled “Coping with Price Volatility: How It will Affect Major Capital Projects,” in which the companies were “becoming more adept at maintaining long-term business strategy in the face of short-term uncertainty stemming from oil price cycles” (Dittrick 2009). Despite the overall volatility, the price of oil is unlikely to go down to the level of the 1990s (20 dollars per barrel) because of the increasing global demand, especially in Asian countries. That is why oil price has become a more stable factor in long-term planning in the last decade. Unlike oil prices, natural gas prices are less volatile, as natural gas trade usually involves large-scale pipelines that require substantial long-term investment, since natural gas export is technically challenging (unlike oil, a low-flammable liquid, natural gas has to be transported under pressure) (Blanchard 2005). In addition to technical challenges, gas pipelines, once built, result in a high level of commitment and dependency between a supplier and a consumer (Wu et al. 2008). This dependency is a geopolitical risk, together 40 with the need to pass transit countries, which may be unstable (e.g., Afghanistan) and make energy projects unfeasible. In sum, the industry dimension is extremely important, as it includes both the strategic and technical nature of oil and gas trade. 1.4.4. The Project Level Conditions in the energy industry influence multiple individual projects, such as pipelines, offshore production sites, and refining plants. Each project is analyzed by investors (shareholders, governments, companies, bilateral sources, multilateral institutions, export-import banks) along several criteria. One group of criteria is technical and includes design, engineering, procurement, construction, safety, maintenance, environmental assessment, auxiliary services, and technical assistance. The other group is financial and evaluates potential expenses and revenues (Razavi 2007:207). Large projects usually have multiple investors: the diversity of investors makes a project more legitimate in the eyes of the population and provides an additional source of security for investors. Depending on a company’s risk tolerance, financing can be recourse or non- recourse. In recourse investments, an investor owns a share in the whole corporation, not only in a specific energy project. Non-recourse financing means that a corporation is liable only within a specific energy project. In the latter case, the risk for investors is higher, because the rest of the corporation is not liable if the project fails. Usually both sides try to 41 find the middle ground through limited-resource financing, preferred shares, and leasing (Razavi 2007:6-9). Large-scale production in foreign countries often starts with signing a production sharing agreement (PSA) that specifies a tax structure, licenses, environmental policies, profit sharing, and other conditions of a certain project. PSAs are designed to protect an investor in a volatile business environment in which tax structures and legislatures often change (Johnson and Robinson 2005:189). However, in some cases (such as U.S.-Russia) the PSA may be revised by host governments if market conditions change in the host country’s favor. Unlike major corporations, smaller independent companies usually resort to portfolio investments, rather than PSAs, since their scope of operations is narrower, and they want to be able to easily pull out of a host country in case of adversity. The World Bank and other multinational institutions develop criteria for evaluating energy projects, when they provide loans and risk mitigation. The World Bank helps develop domestic sources of capital and invests approximately $2-3 billion per year in renewable energy projects, evaluated by the Energy Sector Management Assistance Program (ESMAP). ESMAP, together with the Global Environment Facility (GEF) and International Development Association (IDA) provides loans to low-income countries with GDP per capita of $1,065 or less on favorable terms with a low interest rate. Azerbaijan is currently eligible to borrow from IDA ("International Development Association: Borrowing Countries" 2009). Unlike the World Bank, which deals only with governments, the International Finance Corporation (IFC) provides loans directly to companies (Razavi 2007:65). The graph below (adopted from Razavi’s study) shows the 42 complexity of oil project financing, which has only increased in the era of globalization, combining commercial, government, and multilateral sources. 43 Figure 1. Project Financing (Razavi, 2007) A: Financing Oil Projects in the 1970s and 1980s B: Financing Oil Projects since the 1990s Commercial Sources Project 1 Project 2 Joint Venture Project 2 Project 1 International Oil Companies Governments Corporate Financing Internal Cash Development Budget Official Borrowing Multilaterals Bilaterals Regional (Country) National Oil Company International Oil Companies Governments Project 1 Project 2 Joint Venture Project 2 Project 1 Sources of Private Equity Other Sponsors’ Capital International Stock Markets Investment Funds International Finance Corporation Regional Development Banks Sources of Private Debt Financing International Commercial Banks Bond Markets Suppliers’ Credit Specialized Energy Funds International Finance Corporation Regional Development Banks Local Banks Corporate Financing Internal Cash Commercial Sources Development Budget Official Borrowin g Multilaterals Bilaterals Regional (Country) Company National Oil Company Commercial Borrowing 44 Participating parties take into account price forecasts, the size of reserves (proven, probable, or possible) and their productivity, taxes, royalties, a depletion premium (which is the opportunity cost of extracting the resources sooner rather than later), and environmental concerns (Razavi 2007:217-29). Environmental and social concerns may delay the implementation of a project until the investors comply with regulations and provide all necessary evidence and documentation. Considerations include “geology and geography, engineering, costs, investment, logistics, and the mastery of technological complexity” (Yergin 2011:49). The World Bank designed guidelines for an environmental assessment (EA) that includes legislative, regulatory, and policy considerations; the baseline environment; the potential impact on the environment; alternatives to the current project; environmental management and damage mitigation; and cooperation with governments and non- governmental entities (Razavi 2007:174). 1.5. Hypotheses The preceding sections outlined the complexity of energy cooperation on multiple levels. These will guide the explanation of the detailed cases under considerations: US- Russia, U.S.-Azerbaijan, and Russia-Germany energy ties. At the same time, the cases will be structured to provide revealing tests of the variables inspired by prevailing theories 45 (liberalism, realism, and domestic politics). The independent variables (explanatory factors) and the common dependent variable are as follows: Dependent Variable: Energy Cooperation (Trade and Investment) Independent Variable 1: Economic Potential (investment climate and energy resource availability) Independent Variable 2: Geopolitical Rivalries Independent Variable 3: Domestic Lobbies and Interest Groups Using these variables, the following hypotheses have been generated for application to each bilateral case. Economic Potential Hypotheses: H.1. If the economic potential of energy cooperation is high (i.e. the investment climate is favorable for foreign investors and energy resources are plentiful), the probability of cooperation will increase. This very basic hypothesis assumes that economic efficiency is the primary criterion for most projects and that corporations and governments try to maximize their profits. Investors make their decisions, based on a number of criteria: “political stability, the tax regime (rates, transparency/predictability, and enforcement/appeals), and property rights (whether shareholder rights or intellectual property rights)” (Marshall 2003:11). These together form an investment climate. Despite the obvious nature of this hypothesis, it requires testing because often seemingly profitable projects do not become implemented. H.2. If economic potential of energy cooperation is very high, it will overcome geopolitical rivalries and other political differences. This hypothesis proceeds from the first one. Such relationships can be observed in the cases of unlikely partners, such as the U.S. and Venezuela, and the U.S. and Saudi 46 Arabia, for example. In the former case, geographical circumstances are very favorable: geographic proximity and the ease of transportation by ocean routes makes energy trade between the United States and Venezuela a natural fit, despite a long-term hostility between the two governments and the differences in their domestic political systems. In the latter case, the amount of oil and gas reserves in Saudi Arabia is extremely high, and the access to these resources is of enormous importance for the U.S., putting aside the differences in political systems and human rights violations (as examined in detail by Robert Vitalis in his 2009 book America’s Kingdom). Among the cases under consideration in this dissertation (U.S.-Russia, U.S.-Azerbaijan, and Russia-Germany energy ties), Russia-Germany energy trade is a potentially “natural fit,” both in terms of geographic proximity, Russia’s enormous resources of oil and gas, and Germany’s high demand for their import. The economic potential of crude oil import-export also depends on the cost of production and the shipping costs of crude oil, since the price of oil itself is globalized. As seen below, shipping costs by cargo vessels are quite homogeneous among the continents, once oil reaches a port. The main concern in oil delivery is therefore the cost of bringing it to ports via pipelines and trains. The following graph shows examples of shipping costs for oil, taken into account by energy project decision makers. 47 Figure 2. Shipping Costs of Oil (Drewry Shipping Consultants Ltd., 2009) Shipping Costs by Vessels Source Discharge Cargo Cargo Size, Thousand Barrels Freight Costs, $/Barrel N. Europe New York Distillate 200 2.91 N. Europe Houston Crude Oil 400 2.22 West Africa N. Europe Crude Oil 910 1.60 West Africa Houston Crude Oil 910 2.27 Persian Gulf Houston Crude Oil 1,900 2.08 Persian Gulf Japan Crude Oil 1,750 1.61 Persian Gulf N. Europe Crude Oil 1,900 1.51 Geopolitical Hypotheses: H.1. The probability of energy cooperation is inversely related to the level of geopolitical rivalry between the two states. The assumption here is that geopolitical rivalry impedes cooperation. The profitability of energy projects is not the first priority here, because a geopolitical rivalry prioritizes other considerations: domination in the region, the value of the land, access to strategic resources, and economic/resource independence. The projects chosen may or may not be most cost efficient: for example, a longer pipeline may be built instead of a shorter, cheaper one, just to avoid certain countries or territories. 48 H.2. The level of a government’s geopolitical prioritization in energy policy is directly related to the level of state ownership in the country’s energy sector. As of 2009, out of the top ten oil companies (in terms of the produced petroleum volume) in the world, seven were state-owned (Saudi Aramco, National Iranian Oil Company, Pemex, Petroleos de Venezuela, Kuwait Petroleum Company, PetroChina, and Sonotrach – listed in the descending order). Only the remaining three companies (British Petroleum, ExxonMobil, and Shell) were private. If the companies are ranked according to their oil reserves, there is only one private company in the top ten list: Russia’s LUKoil (Lee 2009:63). Considering how tightly the government influences even private companies in Russia (see the U.S.-Russia and Russia-Germany chapters), even LUKoil is not completely free in its decision-making. A broad consensus in the literature that state- owned companies are operated in line with their governments’ foreign policy priorities is tested here. UDomestic Interest Groups Hypotheses: H.1. If powerful domestic groups benefit from (oppose) oil/gas cooperation, the probability of cooperation will increase (decrease). The assumption behind this basic hypothesis is that domestic groups will be interested in maximizing their own power and influence, advancing their interests. If they see that energy cooperation helps to achieve these goals, they will support cooperation. Another assumption is that groups are, in fact, able to influence government policies, both in democratic and authoritarian states, as well as in transitional political systems. 49 H.2. If such interest groups are divided, the state’s autonomy in pursuit of energy security via energy policy formations will increase. For example, in the conflict between Azerbaijan and Armenia, the powerful Armenian lobby in the U.S. has been more concerned with the issue of Nagorno-Karabakh and with Turkish recognition of the 1915 genocide than with the issue of pipelines. Pro- trade and pro-reconciliation Armenian groups exist, and thus the lobby has not been united on the issue of blocking Azerbaijan’s (and promoting Armenian’s) interests in energy deals. The Armenian lobby, as well as a growing Azerbaijani lobby in the United States, promote Armenia’s and Azerbaijan’s interests, respectively, especially on the issue of the secession conflict in Nagorno-Karabakh. At times, however, the diaspora Armenians have also differed with the foreign policy priorities of Yerevan. Here diaspora politics is examined in relation to state policies. 1.6. Methods and Case Selection These hypotheses provide a framework for analyzing the bilateral cases of U.S.- Russia, U.S.-Azerbaijan, and Russia-Germany energy ties. This dissertation employs the case study method, based on economic, political, and industry data, as well as interviews. The universe of cases in this dissertation includes all possible dyads of energy importers and exporters. Even though energy relations obviously develop in a multilateral context, most energy deals, especially in oil and natural gas still become negotiated and 50 signed between governments. This is the primary reason the bilateral cases were chosen here for analysis, as their intergovernmental bilateral relations affect energy policies. Nevertheless, each case study embraces the complexity of energy projects and takes into account relevant international and multilateral factors. A structured case study of each dyad will present a better evidence for the above- specified theoretical predictions than a large-n quantitative study, because case studies allow us to explore details and options available to decision-makers in specific economic and political contexts. The selected cases cover the variation in the independent variables, shown in the table below. The cases of U.S.-Russia, U.S.-Azerbaijan, and Russia-Germany energy ties can be categorized as follows: Figure 3. Typology of Case Studies Case Economic Potential Geopolitical Rivalry Unity of Domestic Groups The U.S.-Russia Medium High Low (governments have most power on energy issues) The U.S.- Azerbaijan Low Low Medium (some ethnic resistance; in both countries, pipeline issues are dominated by governments) Russia-Germany High Medium Strong (resistance from ethnic and environmental lobbies in both countries and in the EU) 51 In the following chapters, the unified framework is applied to explain the outcomes of energy relations in three bilateral cases: U.S.-Russia, U.S.-Azerbaijan, and Russia- Germany energy ties. The first chapter, U.S.-Russia Energy Cooperation, looks at the development of the Russian energy sector and foreign investments since the 1990s. It reveals a gradual decline in cooperation, accompanied by growing political hostilities. Based on the availability of oil and gas, one might expect a higher level of U.S.-Russia energy trade and investment, considering that the United States is the biggest consumer and Russia is the biggest producer of oil in the world. To explain this puzzle, the proposed unified framework has been applied, starting with the economic potential. Economic analysis has shown that Russia and the U.S. could significantly expand their trade and investment in oil, to their mutual benefit. However, in the area of natural gas, both countries are self-sufficient, and there is little rationale for trade here. Then U.S.-Russia geopolitical rivalries were examined, exploring the legacy of the Cold War thinking by policy-makers, contemporary military rivalries in Eurasia, security relations with third countries, and the aspiration to access the world’s energy resources. These geopolitical factors proved to be an extremely powerful factor in this case, directly affecting the outcome (a low level of trade and investment). However, all policies are ultimately decided by people. The domestic interest groups in Russia and United States, especially influential in this bilateral case, were identified: the Russian political elite, the Russian energy lobby, and American lobbies in Russia. As a specific example in which all the three variables were intertwined, the Yukos case is examined here, showing how 52 economic, geopolitical, and domestic factors led to a crash of the biggest oil company in Russia and the political annihilation of its owner Mikhail Khodorkovsky, who boldly attempted to merge his company with one of U.S. majors. As a result, Yukos was sold in pieces to state-controlled energy companies in Russia, and Khodorkovsky himself ended up in jail for challenging Vladimir Putin’s political power. The next chapter explores a case of more active and growing energy cooperation: U.S.-Azerbaijan energy ties. Following the same unifed framework (three variables), this study examines why the United States has been actively involved in Azerbaijan, despite Azerbaijan's distant, landlocked geographical position. The analysis starts with Azerbaijan’s economic and political transformation in the 1990s and an influx of foreign investments to the country, similar to Russia’s. However, unlike Russia, Azerbaijan created a very favorable investment climate for foreign investors, especially in the energy sector, working productively with very diverse countries (Russia, the United States, Iran, Turkey, etc.) As a result of investments, new oil and gas reserves were uncovered and the recovery rate was significantly improved, helping the production level soar. Azerbaijan has navigated among geopolitical rivalries in the Caspian, where great powers compete for influence and access to energy resources. Finally, domestic interest groups involved in this case show the puzzling lack of effective Armenian resistance to U.S. involvement in Azerbaijan, even though that lobby is very powerful in the United States in other issue areas. The U.S. government values Azerbaijan as one of the key partners in the Caucasus, to diversity energy sources away from the Russian domination and to ensure that NATO allies have this source of oil and gas. The Armenian 53 lobby, in its turn, is more concerned with the Nagorno-Karabakh conflict and relations with Turkey, rather than blocking Azerbaijani projects, such as the Baku-Tbilisi-Ceyhan pipeline (the main focus of this case). The next chapter addresses the third case study, Russia-Germany energy cooperation. Similar to the previous two, this is also a puzzling case that cannot be explained by one theory or one variable alone. On the one hand, there is a huge negative legacy of the Second World War, as well as recurrent hostility in Soviet-German relations during the Cold War. However, historical geopolitical-enmities aside, contemporary Russia and Germany have recently achieved an unprecedented level of cooperation in oil and gas trade and investment. This cooperation is obviously favorably conditioned by economic geography – Russian supply and German demand - but geographic proximity alone cannot account for why the two states are so friendly (other neighboring states, such as Poland or Estonia, provide striking contrary examples). Neither can it fully explain the quintessential EU member Germany's decision in this case to defy EU energy-security policy. While the economic rationale is strongest in this case, other factors - such as powerful domestic groups in Germany and Russia that favor this cooperation, and even Putin’s personal ties to Germany - have also played a significant role. The final chapter contains conclusions and policy recommendations. This unifed analysis - based on existing economic, geopolitical, and interest-group theories – offers a valuable framework for closer evaluation of each case and context-specific weighing of each theory's favored variables. 54 In each case, one variable was apparently more influential than the others. For example, in the case of U.S.-Russia, geopolitical differences were most influential, while in the case of Russia-Germany, the economic rationale prevailed over various domestic and internatioanl political obstacles. Identifying prevailing factors in each case – and especially why they prevailed in one but not the others - helps us suggest policy recommendations for advancing mutually beneficial cooperation (or for refraining from it in other cases). Narrow theories and one-variable, one dimensional hypotheses are not going to be sufficient for energy security case studies. In such a multi-faceted arena as oil/gas trade and investment, it will be nearly impossible to come up with a single-variable explanation without dangerously oversimplifying factors in play. Excessive oversimplification and one-line theorizing could, on the contrary, lead to biased conclusions and misguided policy recommendations. On the other hand, including more than three variables in this study would entail a danger of over-determined model at the expense of clear structure and would push it back into historical narrative. The proposed framework with three variables seem to offer the golden middle and to enhance our understanding of the energy sector. Finally, both theoretical and policy nature of this research provides lessons for the future, learning from past failures, and possible policy directions. 55 Chapter 2. Russia-U.S. Energy Cooperation Despite the fact that Russia is the world’s leading source of natural gas and second only to Saudi Arabia in oil production, the US has viewed Russian energy mainly through the prism of larger strategic considerations… - Peter Rutland, 2012 In our broader relationship, mutual frustration often obscures mutual interest - U.S. Ambassador William Burns about Russia, 2007 2.1. Introduction Based on energy supply and demand, it could be expected that Russia, a country with vast resources, and the United States, the biggest consumer of energy in the world, would closely cooperate in trade and investment. However, U.S.-Russia relations have fluctuated during the last two decades. In order to understand why the relations have been so volatile and why they deteriorated after the close collaboration of the 1990s, resulting in hostility in the 2000s, Russia’s economic and political context needs to be examined first. In the 1990s, Western investments were flowing to Russia, and the Clinton Administration was actively advising Boris Yeltsin’s government. Encouraged by their governments, the largest energy companies (such as Chevron, ConocoPhillips, ExxonMobil, Shell) signed production-sharing agreements and started to invest billions of 56 dollars in Russia’s energy sector, hoping for quick profits. At the time, Russia’s democratization and market reforms were praised by the West, despite the turmoil, corruption, and the overall unpredictability of the Russian economy. U.S.-Russia relations stayed productive even during the crisis of 1998, when the ruble collapsed and the country defaulted on its debts. The economic chaos and domestic instability in the 1990s, aggravated by extremely low oil prices, helped Vladimir Putin build legitimacy and influence when he was appointed prime minister by Boris Yeltsin and later elected president. Putin started to reform the extremely inefficient taxation system and promised to establish the “rule of law.” Initially, these reforms paid off and stabilized the economy, bringing down the rule of the oligarchs, who had to either comply with Putin’s demands or leave the country. In foreign affairs during the last decade, Putin and George W. Bush started their relationship on a positive note, especially after Russia offered sincere condolences and concrete assistance to the United States after September 11, 2001. The growth of U.S.-Russia trade and investment during this period may be explained by high economic potential and low geopolitical tensions. This falls in line with the proposed integrated framework and hypotheses. Indeed, the U.S. government strongly encouraged American companies to do business in Russia, providing them with informational support and financial incentives. On the other hand, post-Soviet Russia had enormous need for foreign capital and advanced technology to revive its oil and gas industries. 57 Since 2002, as global oil prices started to rise and Russia substantially increased its oil and gas revenues, the Russian government became more assertive internationally and defiant towards the West. Driven by nationalism, Putin wanted to restore Russia’s great power status. As a result, U.S.-Russia relations quickly turned into mutual distrust and severe hostility over such issues as NATO expansion, the Iraq war of 2003, and the U.S. missile defense in Europe. Russia’s anti-U.S. stance led to decreased American access to new energy projects, while some of the projects that had been initiated in the 1990s were suspended or blocked. The hostilities between the two states rose again almost to the Cold War level, especially during the Russia-Georgia War of 2008. During this period, geopolitical rivalries, for the most part, have prevailed in U.S.-Russia relations, hurting energy cooperation, especially as the Russian government has continued to increase state control over the energy sector, taking over decision-making in energy deals. U.S.-Russia relations temporarily improved during Dmitry Medvedev’s presidency in 2008-2012, when Barack Obama initiated the U.S.-Russia “reset.” During this time, some American companies had an opportunity to sign several multi-billion deals with Russia. However, these deals were selected by the Russian government based on geopolitical and economic calculations. Western companies received access only to the most challenging areas in the Arctic and East Siberia, where Russian companies did not have enough expertise to produce oil and gas. Most recently, as Vladimir Putin was reelected to presidency for his third (6-year) term in 2012, U.S.-Russia relations returned to the pre-reset levels. Such recent laws as the adoption ban and the Magnitsky Act further complicated a hostile business environment, 58 while Russia continues slipping in the ease of doing business and democracy indices. As a result, some Western energy companies have been forced to sell their stakes in Russia, leaving the Russian market and reorienting themselves to the newly discovered shale reserves in Europe and the United States, as well as new production in the Gulf of Mexico and Alaska. 2.2. The Russian Energy Sector and the U.S. Involvement U. The Soviet Union had become the biggest producer of oil in the world by 1975, at the level of 12 million barrels per day in the 1980s. Oil and gas were mostly exported to Europe via about 50,000 km of oil pipelines and 150,000 km of natural gas pipelines. Oil and gas exports were both the biggest source of revenue for the Soviet Union and the way to exercise control over the Eastern European countries. Major pipelines included Druzhba, the Baltic Pipeline System, the North-Western Pipeline System, Tengiz-Novorossiisk, and Baku-Novorossiisk. The two routes of the 2,300-mile, 1.4 million bbl/d Druzhba pipeline, which is the largest among them, delivers oil to Europe via Belarus, Poland, and Germany, and via Belarus, Ukraine, Slovakia, Czech Republic, and Hungary (EIA 2010). 59 Figure 4. The U.S. and Soviet Oil Production, 1945-1990 Russia inherited the majority of Soviet pipelines after the collapse of the USSR (the graph below shows the current pipelines from Russia to Europe). The political and economic chaos of the early 1990s led to a decline in Russia’s oil production, compared to the level of 1990 (Goldman 2008:11). The energy industry, extremely outdated and lacking modern technologies, survived in the 1990s only on the platform of the Soviet technological legacy. Newly independent Russia tried to keep production going, amidst shock-therapy economic reforms, sweeping privatization, asset stripping, and low oil prices (around 20 dollars per barrel, compared to 140 dollars a decade later). The industry badly needed Western expertise, financial resources, and technology: the Yeltsin administration invited Western investors and foreign advisors with open arms. 60 Figure 5. Russia's Pipelines to Europe Source: EIA, http://www.eia.gov/cabs/russia/full.html Experiencing the enormous state budget deficit while the taxation and domestic production (outside of raw materials) plummeted, oil and gas remained the main means of survival for the democratizing state. What Russia could offer to the world market in abundance was oil. Both Western investments and rising oil prices contributed to the fact that by the end of the 1990s Russia bounced back in its oil production volume. 61 Figure 6. Oil Production in Russia (EIA) This was achieved via economic and institutional reforms of all the sectors of the economy, including the energy sector (Frye 2010). In September 1991, the Ministry of Fuel and Energy was transformed into the Ministry of the Petroleum Industry (with Vagit Alekperov in charge). The Ministry established the Rosneftegaz energy company that was later divided into several independent entities. In November 1991, another major company, LUKoil was formed by combining assets located in the Langepaz, Urengoi, and Kogalym oil fields. A year later, Rosneftegaz was transformed into Rosneft. In 1993, Yukos and Surgutneftegaz came into existence (Goldman 2008:61). In 1995, the Russian government badly needed financial resources and started the Loans for Shares (LFS) initiative, under which national resource companies were auctioned off for a small fraction of their costs to oligarchs’ banks that had lent money to the government (Frye 2000:4). 62 Simultaneously, foreign capital was flowing to Russia. In the early 1990s, several international energy companies signed production sharing agreements. ARCO bought $250 million worth of shares of LUKoil, acquiring access to Siberian oil reserves (Yergin 2011:29). Total (France) invested $800 million in a project to develop the Kharyaga field in Timan-Pechora and eventually to produce 30,000 b/d of oil. Royal Dutch Shell and ExxonMobil started their investments in oil and gas production in Sakhalin (Goldman 2008:63). Currently, Shell’s accumulated investments in Sakhalin have been estimated at 20 billion dollars over the course of the project. ExxonMobil and its partners in the Sakhalin-1 project expect to invest overall $10-12 billion dollars. In the second half of the 1990s, the redistribution of assets and the Loans for Shares Initiatives in the resource sector continued, as well as an increased participation of foreign companies. In 1997, Mikhail Fridman’s Alfa Bank and in cooperation with the American- based Access Industries (chaired by Leonard Blavatnik), acquired 40 percent of the Tyumen Oil Company. Vladimir Potanin acquired Sidanko, along with dozens of other companies. He established a partnership with BP and bought the Cleveland-based nickel producer QM Group, as well as the Montana-based palladium and platinum producer Stillwater Mining. Amoco (USA) bought a 10-percent stake of Sidanco, which later was sold to BP. Another major Russian oil company, TNK, signed a $198-mln contract for oil services with Halliburton, through a loan from the U.S. ExIm Bank. The American service company Schlumberger started to work with Rosneft in the Yuganskneftegaz Priobskaia oil field (Goldman 2008:66-79). 63 In turn, some Russian companies attempted to enter the American market. The most remarkable case was LUKoil, which in 2003 bought a number of gas stations in the U.S. on the East coast from Getty Petroleum Marketing Limited. The opening ceremony of a LUKoil gas station in New York was attended by President Vladimir Putin and Senator Charles Schumer (Maass 2009:185). In addition to its American assets, LUKoil purchased 376 Jetts gas stations in Europe from ConocoPhillips. At home, in 2004, LUKoil formed a joint venture with ConocoPhillips, which bought 20 percent of LUKoil stock for $7 billion dollars (Goldman 2008:126). As Russia’s oil production was recovering after the economic turmoil of the 1990s, Russia’s export of oil to the United States started to grow. Figure 7. Russia's Oil Export to the United States (EIA) 64 The United States is an important buyer of Russian oil. By 2010, the United States had become the 7 th largest importer of Russian crude oil (about 250-300 thousands barrels per day), after Germany, Netherlands, Poland, China, France, and Italy (EIA 2010). However, for the United States, Russia is not of equal importance. The American Petroleum Institute reported in 2009 that Russia’s share in overall American oil imports was just 3 percent, which was the same as Iraq’s and Nigeria’s (Dougher 2009). Figure 8. Suppliers of Oil to the United States (Dougher, 2009) American investments in Russia’s production of oil have fluctuated. In the 1990s, Russian companies did not have enough capital to invest in new production and were struggling to maintain existing facilities (Hueper 2003:177). Russia needed Western capital and technology. As a result, by the mid-1990s, major international companies signed PSAs, creating more than one hundred joint ventures in the Russian energy sector (Blanchard 65 2005:205). A standard PSA -- a contract for 20-40 years, under which a foreign company provides capital, and the government receives its share of profits only after the company returns its capital expenses -- serves as a guarantee that the investing company returns its expenses. American investments were steadily growing through the 1990s, with a temporary decline during the 1998 financial crisis (Frye 2000:200). Between 1995 and 1999, American investments accounted for up to half of all foreign investments in Russia Figure 9. American Investments to Russia, 1995-1999 Source: 'Financy Rossii 2000,' 'Sotsial'no-Economicheskoe Polozhenie Rossii 2001.1,' Goskomstat (Arai) Foreign businesses were optimistic about investing in the country before 2001, as political risks in Russia were considered low. International companies in Russia were expanding their staff, receiving profits, and praising the stabilized tax system, reformed by the first Putin administration (Marshall 2003:10). 0 500 1000 1500 2000 2500 3000 3500 1995 1996 1997 1998 1999 American Investments to Russia (million USD) 66 Russia’s foreign policy was also oriented to the West. In the beginning of their presidential terms, Presidents Vladimir Putin and George W. Bush started the Russian- American Business Dialogue, promoted by such business groups as the U.S.-Russia Business Council (USRBC), the American Chamber of Commerce (AmCham), the Russian-American Business Council (RABC), and the Russian Union of Industrialists and Entrepreneurs (Russian-American Business Dialogue 2003). The Dialogue was “a business-to-business mechanism intended to expand contact between the two private sectors; to identify areas where laws, regulations, and practices impede trade and investment; and to provide a forum where business interests can be raised with the respective governments…” (Russian-American Business Dialogue 2003). After 2001, as oil prices were rising and the Russian economy was growing, the Putin Administration became more assertive in geopolitical issues. It coincided with the “erosion of democracy” domestically (Frye 2010). Simultaneously, Russian companies enjoyed growing revenues, and the need for foreign investment became less urgent (Hueper 2003:178). The Russian government has tightened state control over energy resources, limiting foreign energy companies’ access to them. The government started to revise the existing PSAs and modified its policy for signing new ones. High oil prices made the old PSAs much less profitable for the government: Vladimir Putin called them “a colonial treaty,” adding that those who had signed them should be “put in prison” (Goldman 2008:86). American companies were affected much more than companies than companies from other countries. According to the Foreign Investment Advisory Council to the 67 Russian government (FIAC), the overall share of American foreign investments in Russia (in all sectors of the economy) experienced the biggest drop among major investing countries (Johansson 2008). Figure 10. FDIs in Russia: Top 5 Investing Countries (FIAC, 2008) In absolute numbers, the following table shows a clear gap between the total foreign investments in the Russian energy sector and the American investments. It is clear that, as many experts noted, the U.S. was excluded from major oil and gas deals. The Guardian newspaper captured the essence of those developments in the line “President Vladimir Putin is set to keep US oil companies out of a lucrative gas field in the latest sign of the deteriorating relationship between Moscow and Washington,” published on July 22, 2006, when U.S.-Russia relations were at an extremely low point. 0 5 10 15 20 25 30 USA UK Cyprus Luxemburg France Germany 68 Figure 11. Foreign Investments in Russia's Energy Sector Source: The Russian Federation Federal State Statistics Service, http://www.gks.ru/dbscripts/Cbsd/DBInet.cgi, accessed on January 27, 2011. Figure 12. American Investments in Russia's Oil Production 2005 2006 2007 2008 2009 U.S. Investments in Russia’s crude oil production, in thousands USD 433741 425695 570445 1052781 16602 Source: The Russian Federation Federal State Statistics Service, http://www.gks.ru/dbscripts/Cbsd/DBInet.cgi, accessed on January 27, 2011. In some years, American investments were much lower than investments from other countries (in thousand USD), presented in Figure 13. 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000 14,000,000 16,000,000 18,000,000 2005 2006 2007 2008 2009 Total USA 69 Figure 13. Investments in Russia's Energy Resources (By Country) Investments in Russia’s Energy Resources 2005 2006 2007 2008 2009 Total 5164126.5 7772411.5 15859589.52 9867699.42 8293878.99 Austria 5914.9 83566.49 15509.99 103847.14 20462.92 The Bahamas 131392.5 518935.7 328727.7 467333.34 592782 Great Britain 216519 15250.23 48339.85 56361.92 11276.47 British Virgin Islands 212913.6 158503.59 66071.95 161005.45 38766.89 Germany 399.2 5122.3 24608.11 43651.92 251123.67 India 464503.1 219153 311538.7 395188.1 Ireland 7500.9 216003.31 38795.52 32272.62 Italy 2.58 1.37 Canada 21.2 3467.19 19705.28 22422.08 11940.76 Cyprus 188562.2 430671.06 1042238.31 1524531.67 674671.12 China 1238.83 3005.39 1700 16215.13 South Korea 2271.5 8582.8 22768.51 10046.43 Luxemburg 12800.1 119236.71 43845 17010 2460.48 The Netherlands 3799207.9 3641641.29 12587010.11 4808534.34 2647305.49 Norway 31.1 24884.62 16302.44 USA 439036.5 430667.11 582909.62 1058185.51 18610.58 France 78500 1247206.4 169210.27 286392.03 395423.1 Czech Republic 11580 11068.86 4811.51 Switzerland 7452.8 113130.58 78804.9 357156.29 230606 Japan 54749.4 521291.1 328727.6 474146.5 2608628.54 CIS countries 1019.69 36453.95 10560.67 12216.8 Source: The Russian Federation Federal State Statistics Service, http://www.gks.ru/dbscripts/Cbsd/DBInet.cgi, accessed on January 27, 2011. One way to limit access to oil fields for foreign companies has been to grant the status of strategic importance to these fields. The table below shows an example of Sakhalin Island projects, in which foreign companies experienced changes in the Russian legislation and a partial loss of exploration rights. One of them, $20-billion Sakhalin-2, initially did not include even Russian companies at all. However, by 2006 foreign participants were charged with environmental violations, after Russia’s Gazprom became the project’s majority shareholder (Yergin 2011:35-40). 70 Figure 14. Production Sharing Agreements in Sakhalin Project Participants Notes Sakhalin-1 Chayvo, Odupto, Arktun-Dagi Exxon Neftegaz Ltd (US) 30% SODECO Ltd. (Japan) 30% ONGC Videsh Ltd (India) 20% SMNG-Shelf (Rus) 11.5% Rosneft-Astra (Rus) 8.5% Phase 1: First oil October 2005. Sakhalin-2 Piltun- Astokhskoye (oil), Lunskoye (gas) Operator: Sakhalin Energy Investment Co. Gazprom (Rus) 50% Royal Dutch Shell (Ned) 25% Mitsui (Japan) 12.5% Mitsubishi (Japan) 12.5% Phase 1: early oil 1999 Phase 2: Gas/LNG in 2007/8. Sakhalin-3 Krinskii Operator: Pegastar Exxon Mobil (US) 33.3% Chevron Texaco (US) 33.3% Rosneft (Rus) 22.2% Suspended in 2007 due to loss of exploration rights Sakhalin-3 Vostochno Odoptinski, Ayashski Exxon Mobil (US) 66.6% Rosneft (Rus) 33.3% Idle, now suspended. Sakhalin-3 Veninski Rosneft (Rus) 51% Sakhalin Oil Co. (Rus) 24% Sinopec (China) 24% First drilling summer 2006 Sakhalin-4 Astrakhanovskii Offshore Rosneft (Rus) 51% BP (UK) 49% Project stopped by Rosneft Sakhalin-5 Vostochno- Schmidtovski, Kaigan/Vasukan & Zapadno- Schmidovski JV Co "Elvary Neftegas": Rosneft (Rus) 51% BP (UK) 49% Phase 1: Exploration. Sakhalin-5 Lopukhovski Gazpromneft (Rus) 100% (originally Sibneft) Sibneft acquired block from TNK-BP Sakhalin-6 Pogranichnii Urals Energy Originally held by Alfa- Echo Source: Russia Profile.Org, http://www.russiaprofile.org/resources/territory/districts/sakhalin/economy Russia’s energy strategy for 2010-2030, developed by the Ministry of Energy, still defines the energy sector as the “most strategically important industry in the Russian 71 economy,” which “consolidates the regions of the Russian Federation and determines main economic indicators” (Ivanitskaya 2009:11). Limited access by foreign companies to Russian oil and gas contracts has been further complicated by the lack of intellectual property protection, the underdeveloped financial and judicial systems, and high bureaucratic obstacles to business. This challenging business environment has been exacerbated by excessive protectionism and discriminatory provisions in trade laws (Donohue and Shokhin 2008). On the other hand, during the last decade, Russian companies that tried to enter American markets experienced such obstacles as the Jackson-Vanik law, limiting Russia’s trade in the U.S., and a delay in Russia’s accession to the World Trade Organization (Russian-American Business Dialogue 2003). To sum up, Russia inherited an extensive system of Soviet pipeline and the aging oil and gas sector that needs renovations, new oil wells, and massive investment. Yeltsin’s domestic reforms of the 1990s (privatization, the loans-for-shares program, democratization, and market mechanisms) were plagued by high unemployment, inflation, corruption, and overall economic turmoil. Nevertheless, it was an optimistic time for American investments in Russia, which comprised about half of all investments coming to the country. The 1990s were also a period when major Russian private oil and gas companies signed multiple production sharing agreements and other joint projects with foreign energy companies. After the economic crisis of 1998, which helped elect Vladimir Putin in 2000 in search of stability and the rule of law, the U.S. involvement in Russia has 72 been steady until the beginning of the 2000s, when Putin and Bush started what at an energy dialogue. However, as Russia was gaining strength economically and geopolitically thanks to growing oil revenues, disagreements with the United States started to affect opportunities for American companies. Such issues as NATO expansion, Kosovo, the Iraq war, and others indirectly shut the door for U.S. businesses, and the U.S. share of foreign investments in Russia plummeted -- in the energy sector in particular. Dmitry Medvedev and Barak Obama’s “reset” re-opened some opportunities for American companies, but strictly under the Russian government control -- geopolitical considerations were affecting economic calculations. 2.3. Economic Potential for U.S.-Russia Energy Trade and Investments The economic component of trade and investment in oil and gas includes several factors, such as availability of oil and gas reserves and the prevailing investment climate. The starting point of analysis - oil and gas reserves, opportunities for their production, and possible methods of their transportation - are determined largely by countries’ geographic positions. 73 2.3.1. Energy Resource Availability and Accessibility Oil Russia possesses enormous oil and natural gas resources. Some of the largest oil fields in the world (Samotlor, Romashkino, Tevlin-Russkin, Vatyegan, Lyantor, Fedorov, Mamontov, Sutormin, and Povkhov) are located in the East and West Siberia regions, where a harsh climate and remoteness make oil extraction and transportation especially costly and require significant investment (Blanchard 2005). Since many of Russia’s oil fields have been in use for several decades (some of which go back to the 1950s), oil companies have to discover new ones, in order to maintain the production volume constant (Gimbel 2009:92). However, industry experts admit that the substitution of depleted wells with new oil discoveries has not been happening fast enough. Oil is transported from in-land fields to seaports by pipelines, to be then exported by tankers. Due to the landlocked geographical position of Siberia and its remoteness from navigational waters, it is a problem to deliver oil to international markets. The Arctic waterways freeze for several months a year, closing this transportation route. As older wells are depleted, new discoveries happen in ever more challenging areas in East Siberia. Additionally, Russia has had disagreements with transit countries (the Baltic and Ukraine), because of high transit fees. Unitl the 1990s, a major part of Russia’s oil imports had been directed toward Europe via the Latvian port Ventspils (since then the two countries have had disputes of the use of this port). To circumvent the problematic Latvian port, in 2001 Russia built Primorsk that became the largest oil terminal in the Baltic region of Russia. Bloomberg 74 reported in 2012 that Primorsk had exported 70 million tons (490 million barrels) of oil per year – twice the volume exported by another major Russian port Novorossiysk (43 million tons, or 301 million barrels). Out of 1,400 million barrels of oil, which Russia exports yearly, these two ports handle about 35% and 20% of the export volume, without dependency on transit countries (Bloomberg, 2012). However, these two ports, together with the Black Sea ports, are mostly relevant for the EU markets. They are too far from the United States and Asian markets for tanker delivery. It is more justifiable economically to deliver oil from the Russian East coast to the United States, mainly Alaska and California, especially that Alaska has all available infrastructure for accepting oil deliveries and California has multiple refineries. To deliver oil to Asian markets, in the last decade the Russian government started to focus on the Pacific Ocean basin -- the key destination for future energy export routes. The government built a new pipeline from Siberia to the Pacific Ocean, called the East Siberia-Pacific Ocean (ESPO), with the planned capacity of 1,600 thousand barrels per day (Watkins 2009). The new pipeline, logistically increasing export opportunities to Pacific Rim, including the United States, was unveiled by Prime-Minister Putin in 2009. It connects East Siberia with the Kozmino terminal on the Pacific Ocean. The opening of the pipeline was followed by oil export contracts with Asian countries (such as Vietnam). The first shipment of 700,000 barrels of crude oil to Vietnam was made by TNK-BP 4 in 2010. Deputy Chairman of TNK-BP Maxim Barsky described it as the “first and important step towards broad-based cooperation between TNK-BP and 4 TNK-BP, which produces about 16% of Russia's crude oil, is the third largest oil company in the country. BP and the AAR Consortium (Alfa Group, Access Industries and Renova) own equal shares (50% and 50%). TNK-BP also owns close to 50% of another Russian oil and gas company, Slavneft (Interfax 2010). 75 PetroVietnam.” He continued that the company’s goal was to establish a long-term presence in Vietnam and to pursue joint projects in the upstream and refining sectors (Interfax 2010). Oil export to Vietnam is a very typical example of Russia’s current turn to Asia. Figure 15. East Siberian - Pacific Ocean Pipeline Map (Thomson Reuters) The ESPO oil blend has been in demand in North America: “ESPO Blend's good quality is attracting the attention of American refiners. While Alaskan crude currently accounts for 30 percent of their loading, in the future Alaskan oil is likely to feel pressure from ESPO Blend” (Besedovskiy 2010). With its 34.7 degree API density and 0.53 percent sulphur, the blend has been evaluated by American refineries as high-quality oil, even 76 superior to the popular Oman blend. In 2010, Tesoro Corp.’s CEO Bruce Smith expressed a strong interest in using the ESPO oil in the company’s production of gasoline, diesel, and jet fuel (Malik and Henshall 2010). The import of Russian oil by the West Coast of the United States soared from zero in 2009 to 100,000 barrels a day in 2010. Oil analysts estimate that the ESPO's share could reach up to 15 percent in the U.S. West Coast's oil import (Besedovskiy 2010). In addition to its high quality, the ESPO blend has been cheaper than Alaskan, BP’s and Chevron’s oil (Malik and Henshall 2010). The Wall Street Journal reported in 2010 that ESPO oil helped keep California’s gasoline prices low during the summer of 2010, providing an alternative to OPEC oil and increasing the energy supply of the U.S. West coast (Malik and Henshall 2010). As noted in Chapter 1, the cost of shipping crude oil from Northern Europe to East Coast of the U.S. is between $2.5 and $3 a barrel. The distance to ship oil from the Baltic Sea (Primorsk) to the U.S. East Coast is roughly 40% longer than the distance from Sakhalin to Alaskan ports and to California. Therefore, one might expect that the cost of shipping over the Pacific is about 30-40% lower, which is a huge cost advantage. 5 Natural Gas Russia has the biggest reserves of natural gas in the world – 1,680 trillion cubic feet (Goldman 2008) -- often being called the “Saudi Arabia of natural gas.” However, unlike oil trade, which is global, the feasibility of natural gas trade depends on technology and infrastructure. Unlike oil, natural gas has not been a global commodity and has depended 5 Of course, it is a rough calculation, because the shipping costs depend on so many factors, but it is enough to show that the economic advantage is strong, and the Pacific Coast of Russia opens opportunities for cooperation, comparing to the situation in the 1990s, when there was no such outlet. 77 instead on local pipelines. Only recently, developments in liquefied natural gas technologies, as well as notable pipeline projects, have made it possible to ship natural gas by tankers, as it has been done for decades for oil. The graph blow shows an LNG supply chain. Figure 16. LNG Supply Chain Source: Hydrocarbon Processing, http://www.hydrocarbonprocessing.com/Article/2598478/Natural-gas-and-LNG-trade-a- global-perspective.html, accessed on January 28, 2012 Assisted by major energy companies, Russia has already built expensive LNG facilities on the Sakhalin Island. The first LNG plant was open on the Sakhalin Island in 2009 as a part of the Sakhalin-2 joint venture. At its full capacity, the plant is be able to produce up to 5 percent of the world’s LNG output (Kramer 2009b). The Sakhalin-1 and Sakhalin-2 projects have cost their participants up to $20 billion each – the same amount as the Shtokman field in the Arctic (another major Russia’s project) is estimated to cost. This expensive infrastructure often makes LNG more expensive for consumers (e.g. in the 78 United States) than locally produced natural gas. Thus, LNG can be competitive only if consumers do not have enough natural gas domestically, or if other types of fuel (gasoline, ethanol, etc.) are more expensive than LNG. Currently, domestic natural gas production in the United States meets the domestic demand, thanks to shale gas technology, and LNG import from Russia is not economically feasible. Shale gas became a break-through in the United States energy mix, and experts now estimate that the country has the “100 years worth” of natural gas reserves. The Marcellus Shale and other shale gas sites are experiencing a new boom, similar to the oil boom a century ago. The daily production of shale gas in the United States has increased twenty-fold and reached 20 bcfd. The U.S. Department of Energy estimated in 2012 that the country has 482 trillion cubic feet of shale gas reserves. Even considering that the reserve estimates differ widely in different reports, depending on technological projections, it is obvious that the shale gas revolution has made LNG exports from Russia to the United States much less relevant. In its turn, Russia has diversified its consumer base and started to export LNG to Japan, South Korea, Taiwan, Vietnam, and China. In sum, Russia’s enormous oil and gas resources until recently were exported mostly to Europe via an extensive system of pipelines (left from the Soviet period and new ones), as well as by tankers around the world. To bypass transit countries and to ensure new outlets for the country’s energy resources, Russia built new European terminals – e.g., the port of Primorsk, as well as a massive pipeline from East Siberia to the Pacific Ocean. The ESPO pipeline has also become a route that made Russian oil available to Asian consumers and the West Coast of the United States. This oil is highly competitive on the 79 global market thanks to its low sulfur content and its moderate price, as well as low shipping costs via the Pacific Ocean. In the natural gas trade, despite technological breakthroughs and multi-billion dollar facilities, Russia’s LNG cannot compete with shale gas in the United States, which made the United States self-sufficient in natural gas production for many decades ahead. Russia’s projects in the harsh climate conditions of Sakhalin and the Arctic (the Shtokman field) potentially will pay off when LNG becomes a truly global commodity transported by tankers around the world. Currently, LNG is in demand by well-to-do Asian countries (Japan, Korea, Taiwan, etc.), where Russian gas competes with Australian and even potentially American LNG. All in all, the economic potential of U.S.-Russia cooperation is much higher in oil trade and investment, and it has been puzzling why this potential remains to the great extent unfulfilled, despite geographic and technological advantages. A worsening investment climate in Russia sheds light on what it takes for foreign investors to do business in Russia. 2.3.2. The Economic/Investment Climate in Russia Given the availability of energy resources, the manageability of transportation challenges and the viability based on cost to product and supply and demand, the next economic factor to consider in the development of energy cooperation is the prevailing investment climate. 80 Foreign investors are very concerned about the economic climate in a host country that includes «natural conditions and resources; infrastructure; human resources and expectations; and governmental and legal conditions» (Starr 2003). Investors in the energy sector also take into account political risks, especially if oil reserves are often located in countries with unstable regimes and a low level of democracy and market economy (Gati and Christiansen 2003:449). Roughly, Russia’s economic climate for foreign investments can be broken down in several phases. The first phase, in the early 1990s under President Yeltsin, was favorable for foreign investors who enjoyed large profits amidst chaotic economic domestic reforms. The second phase came with the default and economic collapse of 1998, caused by inefficient taxation system and the downfall of domestic production. The “grey economy” was dominating the market, and most foreign investors downsized their presence in Russia for several years. The early Putin administration briefly improved the investment climate in 1999-2002, when the economy started to rise and the raging inflation of the 1990s was brought to manageable levels. Phases 3 and 4 stand for the rest of the Putin’s presidency in 2002-2008 and Medvedev’s presidency in 2008-2012. These phases were overwhelmingly dominated by ever-increasing state control over domestic resources and by geopolitical disagreements with the United States and the West, anemically improved during the Obama-Medvedev “reset.” Putin’s coming back to presidency marks not only Phase 5, but also it remains to be seen if Russia slides back to the authoritarian model in which the investment climate is nothing more than direct deals with the government, especially in the energy sector. 81 The economic climate in Russia has been monitored and analyzed by foreign governments that provide recommendations and guidance to their businesses. The U.S. government provides informational support for American companies to navigate in Russia’s business environment. In 1994, the Doing Business in the New Independent States guide encouraged companies to take advantage of well-educated workforce in post-Soviet states and vast natural resources, as Russia was on its way to the market system: The emergence of a prosperous Russia as well as the other states will add billions of dollars of new growth to the global economy, which in turn will create exports, jobs, and investment opportunities in America ("Doing Business in the New Independent States -- A Resource Guide" 1994:497). Similar assessments were offered by other reports on Russia's economic conditions: the Doing Business database and enterprise surveys by the World Bank's, the Business Environment and Enterprise Performance survey, and the Russian Competitiveness and Investment Climate Assessment survey (Desai and Goldberg 2008:10). In addition to informational support, the U.S. government-sponsored loans helped American companies to start joint projects in Russia. Examples include a $240-million loan from the U.S. Export-Import Bank; a $2-billion U.S.-Russia oil and gas framework agreement; and a $150-million U.S.-Russian joint venture, Polar Lights, sponsored by the Overseas Private Investment Corporation. In the 1990s, the U.S. Trade and Development Agency funded feasibility studies in the Russian oil and gas industry and provided training for Russian specialists ("Doing Business in the New Independent States -- A Resource Guide" 1994). To reduce risk for investors, to guarantee profit repatriation, and to protect property rights, Russia and the United States signed a number of bilateral treaties. The first 82 of them was based on the 1990 Trade Agreement with the Soviet Union and covered market access, tariffs, property rights, and other aspects (Novelli 2003:431). Shortly after that, the 1993 Oil and Gas Agreement provided the foundation for energy trade and investment. Nevertheless, even in the amicable 1990s, the Clinton Administration had policies to reduce Russia’s strategic influence as an energy exporter to Europe, through such initiatives as the policy of multiple pipelines (implemented by Richard Morningstar), the East-West energy corridor, and the Baku-Tbilisi-Ceyhan pipeline. The domestic economic situation, at the time, was chaotic: energy deals were arbitrary and did not have a strong legal foundation, and investors were frustrated by corruption, multiple taxes, and the absence of clear laws, complicated by an unclear PSA regime. During the economic crisis of 1998, the amount of overall FDIs in Russia fell sharply from $5 billion in 1997 to $3 billion in 1998; the amount of American FDIs fell from $3 billion to almost $2 billion over the same period. These economic difficulties of the late 1990s were conducive to Vladimir Putin’s coming to power with a promise to double the country’s GDP and to restore “the rule of law.” Vladimir Putin’s first presidential term (2000-2004) coincided with an unprecedented growth of the Russian economy (4-6% per year) and substantially decreased inflation and external debt. In contrast to the budget deficit of the 1990s, by 2001 Russia had managed to achieve a $7-billion budget surplus through the tax reform and increased tax collection. Other reforms by the Putin administration included a customs reform (aimed at simplifying and systematizing customs processes and to reducing red tape), a land reform (to strengthen property rights), and a currency control reform (for mandatory 83 currency conversion requirements) (Marshall 2003). Russia was even referred to as the economic “tiger” of the post-Soviet region, as it became one of the world’s top three performing countries in stock value gains (Kalicki and Lawson 2003:473). Experts debate whether it was Putin’s reforms or simply soaring oil income that brought Russia’s stability and growth. Russia’s economic rise coincided with an unprecedented oil prices (which went from $20 to $140 per barrel) in the last decade. Marshall Goldman (2008), as well as Putin’s economic adviser Andrei Illarionov (Maass 2009) argue that oil wealth was crucial for the country’s progress, regardless of Putin’s leadership. Hillary Appel, on the contrary, argues that Vladimir Putin’s presidency, in which he reduced the influence of the key oligarchs and increased the state ownership of major industries, was the underlying condition for the domestic reforms. Putin consolidated the state’s fiscal power and removed Yeltsin-era tax evasion schemes. However, he also restricted the influence of international institutions and foreign advisors (Appel 2008). Most likely, both factors (high oil prices and Putin’s reforms) contributed to the growth in the Russian economy. Interestingly enough, many of these reforms were introduced back in 2000, when oil prices were still low (about $18 dollars per barrel). At the time, few analysts could predict that oil prices would soar to $140: “[o]ne could argue that oil prices zooming above $20 per barrel contributed to a false sense of economic security and, if taken to the extreme, acted as a disincentive to bolster the reform process” (Marshall 2003:17). This “sense of security” skyrocketed when oil prices rose not to $20 84 but to $140 per barrel, bringing vast revenues to Russia and reducing incentives for further reforms. Not surprisingly, the Russian government has focused on developing its energy sector, including new oil fields, in order to increase oil production (Mankoff 2009), as well as diversifying oil and gas export routes, from Europe to the Pacific Rim (Hueper 2003). Growing oil wealth increased Russia’s income inequality: the high-paying oil and gas sector employs only 1% of Russia's workforce, compared to 15% in manufacturing and 28.4% in the service sector (Shaffer and Kuznetsov 2008). In the fast growing Russian economy, foreign investors were able to get higher profits than in many other countries. Even the goal to double the country’s GDP, announced by Putin, did not seem impossible at the time (although it was never achieved) (Mankoff 2009). Since oil wealth “often creates powerful incentives to capture and control the power and wealth that resource abundance provides,” (Talbott and Montes-Negret 2008:viii), the government increasingly blended with oil oligarchy. For example, Igor Sechin simultaneously held the positions of Rosneft’s Chairman and Vice Prime Minister of Russia. Nevertheless, foreign investors welcomed the newly established stability. In 2009, the U.S. Embassy in Moscow stated: “Russia today is fundamentally a different country from what it was 10 years ago. The country's macro-economic indicators are stronger and healthier than at any time during the last 10 years” (U.S. Commercial Services in Russia 2009). Trade between Russia and the United States has remained asymmetrical, however, with Russia being more dependent on American technology. The United States is the third 85 biggest importer for Russia (8% of Russian import comes from the U.S.) and the seventh biggest destination for Russian export (4% of Russian export goes to the U.S.) Russia, in its turn, has been only the 30th on the list of U.S. main trading partners (Lotarski 2003). 6 These rankings have not changed much for the last ten years, since Russia has remained a resource-oriented exporter. As a result, the oil revenue bonanza has not been conducive for developing other sectors of the economy and reducing Russia’s overwhelming dependence on oil and natural gas. In line with the resource curse predictions, democratic institutions also started to deteriorate (Ross 1999). President Medvedev in 2008-2012 tried to diversify the economy, at least in his declarations. One of these attempts – Skolkovo -- has been designed to create a modernized high-tech Silicon Valley in Russia, in hopes to give a boost to industries outside of the energy sector, promoting innovative development. To push this cause, Medvedev established the Modernization Commission, the Skolkovo Council, and the Skolkovo Foundation, channeling billions of dollars into Skolkovo with special attention to nanotechnology. Medvedev’s aspirations to revitalize the Russian economy seem quite genuine, accompanied by his affinity for modern technology and social media, but it has not yet brought results. The future of this modernization trend remains unclear after Vladimir Putin came back to presidency for the third, 6-year, term. The Russian government has seen the country’s unique strength and advantage in its energy sector. First, the oligarchy has been in charge of the whole Skolkovo project, led by billionaire Viktor Vekselberg and his 6 In addition to oil, top exports to the U.S. from Russia include palladium, enriched uranium, oil, diamonds, and vodka. Top American exports to Russia include tobacco, high-tech equipment, automobiles, and other high-tech goods. (Lotarski 2003) 86 family. Some experts, such as Vivek Wadhwa, doubt that the usual Russian top-down approach can inject the entrepreneurial culture of Silicon Valley into Russia’s technology domain. The author argues that such a model of a forced start-up culture is destined to fail (Wadhwa 2010). Start-up technology requires an open free business culture. However, by the end of Medvedev’s presidential term, the conditions for businesses had not improved. In its Doing Business report, the World Bank ranked Russia #112 in 2008, 7 #120 in 2009, #124 in 2010, and #120 in 2011 (out of 181 countries), according to the “easiness” of doing business. Foreign investors continue to complain about such problems as inconsistencies in regional and national tax procedures, difficulties with value-added-tax refunds, lacking tax dispute procedures, slow depreciation schedules (meaning a higher tax base), corruption, and asset stripping (Marshall 2003). Still, foreign investors admitted that despite these difficulties, they were received high returns on their investments (600 percent and higher) because the Russian economy was quickly expanding (Seib 2008). Investors would not have been able to receive this rate of return on their investments in the United States or other developed markets (Fennell 2008). One of Putin's reforms was the rule that a foreign share in joint energy enterprises could not acceed 50 percent, giving Russian partners the controlling stake. Contracts from the 1990s with the foreign share of more than 50 percent were revised, and partial ownership rights were transferred to Russian companies. For example, in 2007, Shell sold a share in Sakhalin-II to Gazprom for $7.45 billion (Simonov 2011). These revisions 7 The earliest year this data is measured by the World Bank, available at http://data.worldbank.org/indicator/IC.BUS.EASE.XQ 87 brought additional risks for foreign investors. In 2010, CEO of Chevron Neftegaz 8 Darrell Cordry said that this “strategic assessment appraisal process should be done up front, before the exploration period commences, and national security issues should be considered at the time” ("Chevron concern about Russian law on foreign investment and its impact on oil exploration" 2010). The next section shows how major energy companies have maneuvered in the Russian unstable investment climate. 2.4. International Energy Companies in Russia In the 1990s, international energy companies, such as Chevron, ExxonMobil, and ConocoPhillips started to work in Russia, signing PSAs with the Russian government (Darmin 2010:31). However, since Vladimir Putin initiated his reforms in the 2000s, PSAs have become less common, and foreign companies have participated mostly in technologically and financially challenging oil and gas projects in the Arctic. For more than two decades, the companies have been navigating in Russia’s changing business environment. 2.4.1. Chevron Chevron has participated mostly in oil transportation, rather than production, in the Caspian region, the Sakhalin Island, the Shtokman field, and Yamal. In 1996, Chevron 8 The Russian branch of Chevron 88 signed its first major contract in Russia, acquiring one third of the Caspian Pipeline Consortium (CPC) - a 935-mile pipeline that connects the Tengiz oil field in Kazakhstan and the port of Novorossiysk (Chevron Neftegaz. Inc 2000). A decade later, Chevron’s investments in CPC reached $2.2 billion (15% of the consortium). In 2001, the Consortium built the CPS oil pipeline that started to transport 700,000 barrels of oil per day. Chevron continued to increase its participation in the Consortium, investing $710 million in Tengizchevroil and bringing its total investments in CPC to $4.3 billion in 2010 (Chevron 2010). In addition to crude oil transportation, Chevron has operated on the Russian market of oil lubricants (production, licensing, and technology transfer), cooperating with LUKoil, OAO Gazprom Neft, TNK-BP and other Russian producers of lubricating oil. Chevron licensed its lubricant, diesel, and jet fuel production technologies to a number of Russian companies -- Kirishi Nefteorgsyntez (Surgutneftegaz), LUKoil- Volgogradneftepererabotka, Taftneft, Rosneft, as well as several refineries (in Tuapse, Komsomolsk, Achinsk, Novokuibyshevk, and Ryazan) (Chevron 2010). In the 1990s, Chevron joined Gazprom Neft in the Severnaya Taiga Neftegaz LNG project in the Arctic but had to withdraw from the project, because the output of natural gas turned out to be lower than predicted (Interfax 2009). The company's CEO, Darrell Cordry, reiterated on several occasions that Chevron was still interested in future LNG production in the Arctic, such as the Yamal LNG project in the South Tambeyskoye field, jointly with Gazprom and Novatek (Bloomberg 2009). 89 However, during Putin's presidency in 2000-2008, because of restrictions on foreign participation in the Russian energy sector, Chevron was not able to start new major large-scale projects. Only during the “reset” in U.S.-Russia relations in 2010, did Chevron manage to sign a major deal with Rosneft. The two companies agreed to jointly develop an offshore 860-mln-ton oil field in the Black Sea. Initially, they invested $1 billion each and further committed to invest up to $32 billion for the project implementation (Research 2010). As a condition, the Russian government requires that Chevron and other companies invest in local infrastructures and communities (medical, educational, and recreational facilities). In addition to that, to boost its public image in Russia, Chevron spent about $4 million from 1994 to 2010 on cultural projects, sponsoring the Russian National Orchestra, the State Tretyakov Gallery, the State Pushkin Museum, the State Literary Museum, the Moscow Zoo, and the Moscow Kremlin museums. Chevron also maintains long-term partnerships such Russian universities as the Moscow State University, VNIIUS (Kazan), Gubkin State Oil and Gas University, VNIGNI, and VNIIGAZ, providing financial help to students and sponsoring conferences (Chevron 2010). Thanks to such initiatives, the company has maintained a stable position in Russia. 2.4.2. ExxonMobil Exxon Mobil followed a similar path. In 1995, ExxonMobil signed a PSA for oil and natural gas production in the Sakhalin Island, investing $4.7 billion over several years. 90 This project, known as Sakhalin-1, started as a Russian-American-Japanese joint venture. Currently, it is co-owned by Exxon Neftegas Limited 9 (30 %, USA), the Sakhalin Oil and Gas Development Co. Ltd. (30%, Japan), Rosneft RN-Astra (8.5%, Russia), Sakhalinmorneftegas-Shelf (11.5%, Russia), and ONGC Videsh Ltd. (20%, India) (Taylor 2010). Sakhalin-1 develops the Chayvo, Odoptu, and Arkutun-Dagi oil fields, which possess 2.3 bln barrels of oil and 17.1 trillion cubic feet of natural gas in reserves, first discovered in the 1970s but undeveloped for several decades due lacking technology and investment (ExxonMobil, 2010). Sakhalin-1 was the first step in ExxonMobil's planned $12-billion investment in the Russian energy sector (Marshall 2003:15). Production of oil and gas in Sakhalin has required ExxonMobil to use its best technologies, in order to overcome harsh climate conditions (pack ice, waves, earthquakes) and seismic activity (ExxonMobil 2010): Oil production in the Chayvo field started in 2005, followed by a new onshore processing facility in 2006. By 2010, this field alone had produced 270 million barrels of oil (250,000 barrels per day, shipped by a fleet of 350 tankers from the De-Kastri terminal) and 210 billion cubic feet of natural gas. The project passed the cost recovery point in 2008 and brought in about $4 billion of royalties and taxes to the Russian state budget. The next step by ExxonMobil was to expand oil production into the Odoptu and Arkutun-Dagi fields and to start producing natural gas (Taylor 2010). Like Chevron, ExxonMobil has to comply with Russian labor safety regulations, environmental protection measures, and indigenous populations’ concerns. One of the requirements by the Russian government has been a condition that two thirds of the 9 The Russian branch of ExxonMobil 91 company’s employees (13,000 staff) should be local staff. Since Sakhalin-1 is located in an underdeveloped region, the company has to contribute to new local infrastructures (roads, bridges, airports, sea ports, education, medical, and community facilities). Assisted by USAID, the company has provided training and microloans (about $1 million in total) to local entrepreneurs who open their own small businesses in the area (Taylor 2010). President of Exxon Neftegaz James Taylor underscored in 2010 that Sakhalin-1 provided “more jobs for locals and new contracting opportunities,” as well as revenues for the Russian budget from oil and gas export and taxes. He also stated that the project had helped to expand a natural gas network for the Russian consumers in the Russian Far East (most of whom up to now had to rely on expensive electricity for heating and cooking) (Taylor 2010) Similar to other major companies, ExxonMobil was not able to sign major new contracts for almost a decade during the first and second Putin’s presidential terms. In 2011, a major breakthrough happened for the company, when it signed a multi-billion- dollar deal with Rosneft to produce oil offshore in the Arctic (the Kara Sea) and in the Black Sea. The deal would also allow Rosneft some access to oil fields in the United States (in the Gulf of Mexico) through ExxonMobil ("Rosneft Teams Up with Exxon Mobil in Arctic Deal" 2011). 2.4.3. ConocoPhillips ConocoPhillips came to Russia in the 1990s and invested about $11 billion by 2010 in such joint projects as Polar Lights Company (with Rosneft in the Timan Pechora), 92 ConocoPhillips-ConocoPhillips Alliance, and Naryanmarneftegaz (NMNG) 10 (ConocoPhillips 2010). Like Chevron and ExxonMobil, ConocoPhillips emphasizes its strong adherence to Russia’s environmental and safety regulations in its production processes, “aimed at zero-incident operation of hazardous oil and gas production facilities in the extreme climatic conditions of the North” (ConocoPhillips 2010). ConocoPhillips has closely cooperated with LUKoil, buying 20 percent of LUKoil’s shares. In addition to domestic production in Russia, ConocoPhillips, jointly with LUKoil, participated in international bids, such as West Qurna-1 in Iraq. The Iraqi government did not accept the bid, instead awarding the contract to ExxonMobil and Royal Dutch Shell. In 2009, ConocoPhillips was again supposed to be LUKoil’s partner in a bid to develop Iraq’s West Qurna-2, but LUKoil partnered instead with Statoil (Tutushkin and Vasilyev 2009). This marked growing difficulties between ConocoPhillips and LUKoil. In 2010, ConocoPhillips announced that it was selling 10 percent of LUKoil shares, worth $4.7 billion, explaining it by the unfavorable investment climate in Russia, in which state-owned companies (Rosneft, Gazprom) receive the most lucrative contracts and oil fields. Conoco had its taxation increased without notice and its license revoked periodically in its Polar Lights joint venture. Profits after taxes, fees, and informal “payments” to local officials were lower than expected (Goldman 2008:84-85). Another reason that Conoco announced about the sale of its LUKoil shares was the global recession, in which the company lost $17 billion 11 (Ryabova 2010). 10 a limited liability company established in 2005 between LUKoil (70 %) and ConocoPhillips (30 %). 11 In addition to the Russian assets, ConocoPhillips sold shares in a Canadian energy business and a pipeline in the United States 93 Overall the economic evidence has shown that in Russia’s economic development and foreign investments in the country, there were several distinctive periods. In the early 1990s, despite the chaos of economic reforms, the economic potential for foreign companies was considered enormous and the political risk was viewed as very low. This period conforms well to our economic efficiency hypotheses that state that if the economic potential of cooperation is high, the probability of cooperation will increase. If the economic potential is considered very high, as it was in the Yeltsin period, geopolitical differences, such as the legacy of the Cold War, are overcome and put aside for the sake of mutual profits. During the crisis of 1998, still in line with the economic potential hypotheses, foreign businesses fled Russia, and the foreign direct investments dropped dramatically by about one third. Therefore, in the 1990s, the case of U.S.-Russia cooperation is explained best by the economic potential hypotheses both in the energy sector and beyond. In the same period, energy companies had more independence in selecting their projects: this study examines their influence via the domestic interest group hypotheses. However, in the 2000s, under the Putin Administration, the energy cooperation between the two countries went down, despite obvious economic benefits of oil trade and joint projects in oil and gas production in Russia. Previously arranged deals with foreign companies started to fall apart. Back in 1995, Total (France), Conoco (USA), Hydro (Norway), and Fortum (Finland) established an international consortium to develop the Shtokman gas field. In 2002, their license for this project expired and the contract was instead awarded to Rosneft and Gazprom (Stern 2005). Plans for a private oil pipeline to 94 Murmansk, actively promoted by the United States, were also abandoned, as well as the plan to increase the CPC project (Nanay 2009). In 2008, at the lowest point in the U.S.- Russia relations, a CSIS report outlined main strategic disagreements in energy policies between Russia and the United States. The report emphasized that Vladimir Putin used anti-Americanism for creating a rift between the “old” and the “new” Europe, as well as reducing the American influence in the European Union. Since the level of the American involvement fell even more drastically than the investments from other Western countries, the main explanation of why this happened is within the realm of geopolitics. The geopolitical hypotheses state and when geopolitical differences are large, the economic advantages are neglected in favor of promoting geopolitical goals. Also, an increase in state ownership of the energy sector leads to governments’ geopolitical calculations being dominant in decision-making. This is exactly what happened in Russia, and the next section will address these developments in more detail. Energy companies are also influenced by opportunities in other countries, pulling their investments from Russia. 2.5. Geopolitical Rivalries As the above overview of economic and business trends showed, the period of 2001-2009 saw a slump in the share of American investments and other activities of major energy companies in Russia. The most proximate cause seems to have been the 95 deterioration in the investment climate. But it would be premature or simplistic to describe these difficulties by simply economic factors. It is impossible to ignore the development that Putin was motivated by geopolitical concerns as much as by desire to capture the economic benefits. The 2000s was also a period aggravated by difficulties and disagreements between the Russian and American governments, such as the NATO’s expansion, the war in Iraq, discontinued international treaties (ABM), the U.S. missile defense in Europe, the Iranian nuclear issue, and the Russia-Georgia War of 2008, among others. For the first time since the end of the Cold War, relations between the Putin administration and the Bush administration hit such a low point that most analysts started to fear that it was the beginning of a new Cold War. Since the energy sector in Russia is tightly controlled by the government, these disagreements soured the business environment, stifling business opportunities for American companies. Only during the U.S.-Russia “reset” of 2008-2012, American oil companies were able to sign new multi-billion investment deals. The geopolitical hypothesis in Chapter 1 predicts that energy cooperation (trade and investment) will be negatively affected by disagreements between the participating governments in the military and geopolitical spheres. More specifically, the level of a government’s geopolitical concerns is directly related to the level of state ownership in the country’s energy sector. If the government becomes the main decision-maker, the geopolitical considerations will prevail. Some geopolitical issues are very specific short- term problems, such a dispute over a treaty to a particular economic deal with rival states. 96 Other problems have a more long-term character, such as ongoing rivalry in some regions or the institutions and attitudes of persistent Cold-War advocates. 2.5.1. The Cold War Legacy In the first place, in addition to the institutions and individuals that have help over since the Cold War, the perceptions of how the Cold War ended also matter. While Russia prefers to see the end of the Cold War as a “negotiated outcome that benefited both sides,” in the United States it is commonly viewed as a “necessary struggle … that culminated in a decisive, final victory of American moral and political principles…” (Foglesong 2007:4). A similar debate has been going on about the end of the Soviet Union. One school of thought (e.g. Robert English in Russia and the Idea of the West) convincingly argues that the Soviet Union ended as a result of new ideas originating from within the country (English 2000); others insist that the Soviet Union fell as a result of external military and economic pressures. Jack F. Matlock, the U.S. Ambassador to the USSR in 1987-1991, agrees with the former argument: “pressure from government outside the Soviet Union, whether from American or Europe or anywhere else, had nothing to do with it” (Jack F. Matlock 2010:89). In his view, the end of the Cold War resulted from extensive negotiations and mutual compromises. Mikhail Gorbachev was willing to reform his country, to unify Germany, and to cooperate with the United States; in return, the U.S. government promised not to expand NATO to the East. Matlock maintains that referring to Russia as the defeated enemy is detrimental to U.S.-Russia cooperation. 97 The Cold War legacy still affects the political rhetoric on both sides. Experts on Russia, such as Stephen Cohen in his Failed Crusade and Anatol Lieven in his Against Russophobia give examples of how this Cold War thinking has altered U.S.-Russia relations in the 1990s and up to today and has led to unnecessary confrontation. Cohen shows the difference in the American view of the Russian reforms in the 1990s, considered by the United States a “crusade” to build democracy and a market economy for Russia, and the Russian view that predominantly views the shock therapy reforms of the 1990s as a humanity crime that pushed the majority of the Russian population into poverty and despair. Cohen concludes that the United States viewed the newly independent Russia as a modernization project and a follow-up to the U.S. victory in the Cold War, while this view was almost the opposite to the Russian sentiment at the time (Cohen 2001). Along similar lines, Lieven goes further back in history and explores how the "Russian autocratic tradition" was used in the Cold War and post-Cold War rhetoric against Russia (Lieven 2000). Both authors convincingly show that such views were very detrimental to U.S.- Russia relations in the 1990s and lingered into the 2000s, when Putin’s KGB background and KGB “instincts” were brought up by multiple commentators in the West, based on the deterioration of human rights in Russia. The Cold War references were also used to justify “new” European countries’ joining NATO, in search of protection against Russia. 98 2.5.2. NATO Expansion The expansion of NATO to the East, directly to the Russian borders, vastly added to Russia’s anti-American sentiments. Elena Khalevinskaia of the Russian Institute of World Economy asserted that the United States used NATO expansion as a method to “belittle the role of Russia as one of the influential centers of the budding multi-polar world.” Another analyst, Vladimir Podoprigora, argued that NATO expansion was a method of arms race aimed at tying NATO members to American weapon standards and creating a dependency on U.S. military supplies and maintenance (Piadyshev 2006:21-25). NATO’s expansion made Russian people “rally around the flag” and turn their attention away from domestic problems, such as the inadequacy of infrastructures and corruption (Bazhanov 2010). Some Russian analysts, however, take a pro-NATO stance. Vice Chancellor of Research and International Relations at the Russian Foreign Ministry’s Diplomatic Academy Yevgeny Bazhanov argues that Russia benefits from a strong NATO: the alliance brings peace and stability to Europe. He humorously continues that many of those in Russia who call NATO “enemy” are “the same people who gladly take vacations in NATO countries, buy real estate there, send their children there to study and even root for those countries’ football teams” (Bazhanov 2010). He concludes that NATO, as a European common security mechanism, reduces rivalries and builds trust among European countries (Bazhanov 2010). 99 NATO’s expansion is closely connected to another contentious issue - the U.S. missile defense system in Eastern Europe, which has been perceived extremely negatively in Russia as a system that would radar Russia, rather than protect Europe against “rouge states.” In response to the U.S. missile system plans, Russia has repeatedly announce plans to increase the country’s missile capabilities, including new missile installation and possibly the antimissile system of their own (Piadyshev 2006:19). Some analysts, however, argue that Russia uses the U.S. missile defense system as a negotiation tool, understanding that the system is not a threat to Russia’s defense and deterrence capabilities. Alejandro Sueldo states that “Russia privately recognizes that missile defense as planned does not currently pose a challenge mainly because the location, range and number of planned interceptors are too far, too short and too few to undermine Russia’s strategic nuclear forces” (Sueldo 2011). Whether or not the U.S. missile shield is a real threat for Russia, this issue has been very contentious and may even lead to a new arms race between the United States and Russia. Subsequently, the idea of any reduction of defense spending is not popular in Russia. The conversion of military industries for civilian use, implemented broadly in the 1990s, is now considered costly and not benefitial for Russia's interests. The cost of Russia's demilitarization is estimated at $150 billion since it started in the 1990s (MacLean 2006:29). Demilitarization is especially unpopular in regions heavily dependent on military industries. Governor of one of them, the Saratov oblast, stated in 2006 that the geopolitical situation had not changed much since the Cold War. Echoing the common sentiment in the Russian military industry, he maintained that military research and development would 100 encourage Russia’s technological progress in other sectors of the economy (Piadyshev 2006:22). 2.5.3. Rivalry in Eurasia and Russia’s Energy Policy in the FSU U.S.-Russia relations have experience several ups and downs, based on military and economic rivalries. Nowhere have these rivalries been stronger than in Eurasia, which is simultaneously Russia’s “backyard” and the area of the utmost strategic importance for the United States. Here – in the Middle East, Russia’s Near Abroad, and Europe –Russia has a strong sense of geopolitical urgency and insecurity, often challenged by other great powers. U.S.-Russia rivalry in Eurasia is not only military but also political and economic, in the context of other, smaller powers juggling for influence in the region, such as Turkey and Iran. This juggling has made Russia extremely nervous about the country’s position in the region. In the 1990s, to diversify energy supplies for the West and to ease the dependency on Russia, the United States started the policy of multiple pipelines. These developments culminated in the 1990s in the signing of the Contract of the Century, to build the Baku- Tbilisi-Ceyhan pipeline from Azerbaijan to Turkey via Georgia. BTC was a blow in Russia’s interests, snatching away Russia’s monopoly for transportation routes in the Former Soviet Union. This pipeline, as well as the Pipeline Consortium from Kazakhstan were the great powers’ methods to push for their “Great Game” for the influence in the Central Asia and the Caucasus (Starr 2003). In addition to trying to control as many transport routes for oil and gas as possible, Russia has continued to supply the former 101 Soviet republics – Armenia, Belarus, Ukraine – with subsidized energy resources, in order to exert Russia’s influence. These developments will be addressed in greater detail in the subsequent chapters on U.S.-Azerbaijan and Russia-Germany cooperation. The U.S. policy of multiple pipelines continued under the Bush Administration in the National Energy Policy, announce in 2001 by Vice President Dick Cheney. The goals of the policy were to establish relations with various producers of energy, to diversify energy sources for the United States, and to reduce the influence of Russia and OPEC (Mortished 2008). South Caucasus became a strategically important region for such a diversification, in an attempt to break the «Russian transport monopoly» (Mann 2003). After the terrorist attack of 9/11, Russia and the Central Asian states supported the U.S. military operation in Afghanistan, providing intelligence and air space access. However, the presence of American military bases in Russia’s backyard made the Russian government worry about long-term strategic and economic implications and a possible shift in the balance of power in this important region, affecting energy resources and transit routes (Gati and Christiansen 2003:453). When Russia opposed the war in Iraq in 2003, American policymakers stressed that Russia was not providing enough support for the U.S. goals: to fight the war on terror, to promote democracy, and to stop nuclear proliferation. By 2006, U.S. -Russia relations hit the lowest point since the end of the Cold War, and cooperation became the “exception, not the norm” (Mankoff 2009:6). In the Western political rhetoric, Russia has been often described as a rival to the U.S. and the EU and as trying “to subvert its neighbors and prevent the expansion of free-market democracy around its borders” (Mankoff 2009:6). On 102 the other hand, the Russian government accused the United States of unilateralism and had to “swallow” the U.S. withdrawal from the ABM Treaty (Goldgeier and McFaul 2005:45). Other Russian analysts, such as Andrei Bobrov, criticized the United States as a “world overlord,” praising Russia’s desire to resist a one-polar world (Piadyshev 2006:31). Vladimir Putin set a goal to restore Russia’s great power status after the weak 1990s, when, as Deputy Foreign Minister Andrei Denisov put it, “under various pretexts, democratization being one of them, our international partners and rivals” were “pursuing their own obvious and selfish aims” (Piadyshev 2006:18-19). To many in the West, Russia’s recovery after the 1990s was “shocking mostly for its rapidity” (Mankoff 2009:2). The West saw a newly “resurgent” and assertive Russia, which wanted to be a great power again and whose “integration with the West and its institutions was neither possible nor desirable” (Mankoff 2009:4). A major theme in Russian rhetoric was “[s]trong states are loved, strong states are respected.” Energy resources were considered a possible source of conflict, as Aleksandr Lebedev of the State Duma stated in 2006: [t]ensions will grow together with the world’s population while the energy resources, an object of uncompromising rivalry, will decrease. Russia that controls a large part of the world’s natural resources will, therefore, be challenged and should be prepared to use its military shield to survive [sic] (Piadyshev 2006). Access to energy resources around the world has been a contentious issue between Russia and the United States. On the one hand, Russian experts, such as Vagif Guseinov, argue that the United States wants to control world resources through the unipolar system and “color” revolutions, calling it the “resource imperialism.” He argues that the “world democratic revolution,” promoted by the United States, is in fact designed to “cement” the 103 new imperialism, backed by the technological, military, and economic superiority of the United States (Guseinov 2008:438-40). In the West, on the contrary, Russia is viewed as an energy supplier that has exploited its “energy weapon,” creating dangerous dependencies on Russian oil and gas in Europe. Russia’s military and energy might were “tested” in 2008 during a war with Georgia: “Georgia was a stunning announcement that Russia had again become a force to be reckoned with” (Mankoff 2009:1). This was has showed that the nuclear arsenal alone is not able to deter smaller military conflicts: “…these weapons will not be much use in dealing with problems such as the situation in the North Caucasus” (Friedman 2011). During and immediately after the war, which was the lowest point in the U.S.-Russia relations since the end of the USSR, most American and East European politicians, such as John McCain, called for cutting off all relations with Russia and for excluding the country from international organizations. Others, such as John Matlock, insisted that negotiations should be continued (Jack F. Matlock 2010). Russia’s own reputation as an energy supplier was tainted during natural gas transit disputes with Ukraine and Belarus: “Demanding market prices from Kyiv and other post- Soviet capitals allowed Gazprom to realize higher revenues and to sow political chaos in countries seen as turning their backs on Russia” (Mankoff 2009:37). Other analysts argue that both sides (Russia and Ukraine) were to blame for the interruption of gas transit: Rather than Russia exploiting its uniqueness as the original source of this energy, Belarus and Ukraine may have been conversely exploiting their unique geographic position as transit countries (as well as exploiting the simple inertia of paying lower prices since the Soviet Union collapsed and the world’s sympathy for anyone suddenly cut off from such a subsidy), with Western receivers being 104 inconvenienced by this contest of wills between Moscow and Kyiv (Quester 2007:448). The mainstream Western commentators agree that such actions are a form of Russia’s energy blackmail of the European Union and the West and Russia’s method to recreate the Soviet style of domination. Others maintain that Russia is acting as a “normal” great power, using carrots and sticks in negotiations post-Soviet states, but no designs to question their sovereignty or to establish “an empire” (Tsygankov 2005). This aspect will be explored in Chapter 4 on Russia-Germany relations. Russia’s export of oil and natural gas has largely dependent on transit countries (Ukraine, Poland, Belarus), and the new Nord Stream pipeline form Russia to Germany on the bottom of the Baltic Sea has changed this balance in Russia’s and Germany’s favor. Not all countries in the West have been in favor of Nord Stream, including the United States that has viewed it as the deepening of dependency on Russia. The United States has also been concerned with Russia's energy policies in the Middle East, especially in Iran (in nuclear energy) and Iraq (in oil and gas). Russia's divergence from the U.S. position on nuclear cooperation with Iran and economic sanctions has been an obstacle in U.S.-Russia cooperation. In Iraq, however, Russia has followed the U.S. leadership. In 2009, Russia agreed to forgive $12 bln of the Iraqi debt in order to secure the West Qurna project. Amidst concerns about the access to Iraq's oil and gas, Russian senator Margelov praised the fact that the United States allowed thirty-five other countries to participate in tenders for oil and gas development (Anishyuk 2009). 105 2.5.4. Military-Economic Relations with Third Countries Russia’s relations with third countries have had serious repercussions for U.S.- Russia relations, as well, since Russia’s and U.S. policies toward such countries as Iran, Syria, Libya, and others have often been opposite to each other. On of them, the Iranian nuclear problem has been a major stumbling block between the United States and Russia. Although the United States and Russia have repeatedly negotiated on the Iranian issue, it has remained unsolved, and Iran has continued its uranium enrichment activities. Russia’s long-time cooperation with Iran and resistance to Western initiatives is especially puzzling, considering Russia’s desire to be an equal partner in the G-8 club of states and Iran’s defiance of the international community. For two decades, Russia has participated in the Iranian nuclear program, opposing Western sanctions. Russia’s support of Iran seems to contradict Russia’s other goals. Russia has repeatedly stated that it is not interested in another nuclear state in the Middle East, Russia’s “backyard.” Nor is Russia-Iran cooperation simply revenue-driven, because other sources (oil and natural gas exports) in Russia’s state budget are much more substantial. Most importantly, the cooperation with Iran alienates the United States and Europe. This issue is also related to U.S.-India nuclear trade that gives India the right to develop the civilian nuclear program, despite India’s nuclear weapons. Russia has disagreed with the United States on what Russia has considered as double standard, because Iran has not been given this right, based on the Iranian nuclear activities that the international community does not believe to be peaceful. 106 Another issue that has been very problematic in U.S.-Russia relations is Russia- Syria arms trade. The Syrian regime has cracked down on its own citizens, killing thousands of people. Despite this brutality, Russia has refused to support the regime change in Syria and to stop arms sales to this country. Russia’s position on this issue has been opposite to that of the United States and other Western countries. The U.S. government has also carefully monitored Russia’s puzzling technology transfer and arms in Asia with China and Japan (Trenin 2002:204), considering that China is Russia's potential geopolitical rival. Robert Donaldson and John Donaldson explained this military cooperation by Russia’s declining relative structural position, domestic politics factors, and pursuit of short-term revenues (Donaldson and Donaldson 2003). More importantly, China has been increasingly interested in buying oil and natural gas from Russia, substantially reducing Russia's dependency on Western consumers (Mortished 2008). Japan is also a consumer of Russian oil, despite the fact that Russia and Japan have had a half-century dispute over the Kuril Islands and the 196,000-square-km economic zone around them, which has even prevented Russia and Japan from signing a peace treaty. The Kuril Islands became an issue of national pride for the Russians, and it is unlikely that Russia would make concessions to Japan (Trenin 2002:218). As Russia has balanced between its integration into the world economy and its “ability to project hard power” (Mankoff 2009:2), the U.S. government has often disagreed with how NATO members deal with Russia, especially in the military sector. In 2010, the United States strongly objected when France sold to Russia Mistral-class warships, able to carry helicopters. American analysts indicated that the ships would give Russia “additional 107 capabilities to threaten Georgia” (Socor 2010). Analyst Vladimir Socor stressed that such deals undermine NATO, “enhancing Russia's capacity to pressure NATO allies and partners in Europe's East” (Socor 2010). Overall, U.S.-Russia relations are based on geopolitical concerns. The geopolitical hypotheses state that geopolitical rivalry inversely relates to opportunities in oil and gas trade and investment, and as government control of the energy sector increases, economic considerations become sacrificed for geopolitical calculations. Energy cooperation between the United States and Russia has followed the ups and downs in the relations between the two governments. After the optimistic early 1990s, when President Clinton and his advisers were extremely welcome in Russia and helped shape Russian domestic institutions, in the late 1990s and 2000s the relations between the two countries started to increasingly deteriorate. As Russia was becoming stronger economically and militarily, the competition between the United States and Russia and disagreements on major international issues listed above started to dominate. From the economic efficiency section above, it is possible to conclude that the potential for oil cooperation has become greater in the 2000s, thanks to the ESPO pipeline and advances in technology of production. However, at the same time American involvement in Russia dramatically fell, while other Western countries, such as Germany and France, kept their investments stable. At the lowest point in the U.S.-Russia relations, during the Russia-Georgia war, U.S. companies were basically excluded from energy deals. Opportunities were open for them again only during Obama-Medvedev’s “reset.” 108 Nevertheless, one needs to explore domestic interest groups that could potentially influence and shape the Russian government’s decision to give American companies access to energy deals, testing the domestic interest groups hypotheses. 2.6. Domestic Interest Groups Domestic groups hypothesis stipulated in the previous chapter suggests that energy trade and investment takes place only if powerful domestic group (in a broad sense) benefit from them and promote them. More specifically, if interest groups are divided, the state’s autonomy in pursuit of energy security via energy policy formations will increase. To test this hypothesis, domestic interest groups in the U.S.-Russia case (Russian political elite groups, Russian energy lobbies, and American business lobbies in Russia) have been studied here. Even though there is an obvious degree of overlap among these groups and the governments, the following classification will provide a necessary insight into their specific influence. 2.6.1. Russian Political Elite The Russian elite circles can be further categorized along several dimensions according to their attitude to the West. Foreign policy of Russia has greatly dependent on the type of the political elite in charge. 109 First, integrationists view Russia as a European power, a part of the West, with minimum divergence from Western values and ideas. The radical wing of the Russian “Westernizers” of the early 1990s symbolized the period of an unconditional pro-Western orientation (Melville and Shakleina 2005:x). Among them were Mikhail Gorbachev, Foreign Minister Andrei Kozyrev, and Deputy Foreign Minister Anatoliy Adamishin. This set of ideas was essentially led by Boris Yeltsin, who “dampened Russian revanchism, jingoism, and nostalgia for the Soviet Union” (Colton 2008:266). In the 2000s, influential voices in this branch include Andrey Piontkovsky and Pavel Felgenhauer. While being very progressive in line Western philosophical thought, they only influence a small circle of public elite with the public elite and have little influence on Vladimir Putin’s policymaking. The second category is balancers who emphasize Russia’s role as a great power, a “geopolitically and culturally distinct entity”, which needs to balance the United States in the world, nevertheless pursuing limited cooperation. Yevgeniy Primakov (Foreign Minister in the second half of the 1990s) may be put in this category (Tsygankov 2005). This category has morphed with the forth one, great-power normalizers, in the 2000s. Third, neo-imperialists, such as Gennadiy Zyuganov, the Communist Party leader since the beginning of the 1990s, argue for the restoration of the lost power and independence from the “alien” West (Tsygankov 2005:136). Even though the Communist Party still receives about 30% of votes in national elections, the party is quite in line with the Putin government in terms of Russia’s foreign policy making. The differences in 110 ideologies are not substantial and only concern domestic issues, such as pensions and prices for staple food items, among others. Finally, great-power normalizers have became the mainstream sentiment in the last decade. They are driven by moderately nationalistic ideas, a selective engagement in the post-Soviet space, with a strong emphasis on Russia's great power status. Such thinkers as Andranik Migranyan and Alexei Arbatov can categorized as normalizers, but most importantly, this philosophy became the basis of Vladimir Putin’s presidency in 2000-2008 (Tsygankov 2005:138). This is the dominant ideology that prevails in domestic and foreign policy issues. This domination makes this ideological aspect morph into the geopolitical hypothesis addressed in the sections above, as the interests of this elite circle become presented the interests of the state. 2.6.2. Russian Energy Lobby As such, the energy policy in Russia is decided by a small elite circle (Mankoff 2009:9). The energy business is tightly intertwined with the government: government members are also board members of major state-run energy companies. As Peter Maas put it, “crude oil and political power are umbilically connected in Russia” (Maass 2009:190). For example, Valery Yazev is a policymaker who has held leadership positions in energy businesses, the Russian legislature, and professional organizations (e.g., the Russian Gas Society) (Yazev 2010). Scholars have defined the Russian political system as the oligarchic capitalism, as a “system in which prominent businessmen command political 111 power, and powerful politicians are able to arbitrarily choose winners and losers” (Hoffman 2003:372). President Putin consolidated the power of the state during his two presidential terms, and several major oligarchs (e.g. Gusinsky and Berezovsky) had to flee the country as a result of Kremlin campaigns. Others had to modify their behavior in line with the Kremlin’s preferences (Hoffman 2003:383-4). In addition to oligarchs, several influential professional organizations lobby for the Russian energy sector at the domestic and international levels: among them, the Energy Committee at the Russian Union of Industrialists and Entrepreneurs, the Russian Fuel Union, and the Russian Gas Society (Makhortov and Tolstykh 2008:59). These groups promote their vision of Russia’s energy future as, for example, in the Russian Gas Society’s monograph titled “Russia and the International Energy Cooperation in the XXI Century” (Yazev 2010). Another powerful group is the Russian Union of Oil and Gas Producers that serves as a liaison between market forces and government control of the oil and gas sector (Shmal 2009:22). In 2009, its president Gennadiy Shmal stressed that the Union’s main focus was to increase investments in the oil and gas industry up to minimum $40 billion per year. He added that just to maintain the industry’s output at the current level, Russian producers use costly water injections in oil wells, negatively affecting the quality of oil. As a result, the extracted liquid contains up to 80 percent of water that needs to be separated from oil. The effectiveness of this outdated extraction technology is very low: the percentage of pure oil separated from water is only 28%. Shmal stated that Russia’s current level of oil production is maintained only thanks to the country’s vast reserves and 112 new oil fields, not because of advanced methods of oil extraction. In addition to that, new production sites in the harsh climate conditions of East Siberia have no necessary infrastructure and require substantial investment. In order to improve this situation for domestic producers, the Union lobbies for such measures as reduced taxation, government investments, new favorable laws and regulations, the national project status and other preferential treatment from the government (Shmal 2009:22-4). Discussing global oil trends and Russia’s place in them, the chairman of the same organization, Yury Shafranik, asserted that the global era of cheap oil and easy profits for energy businesses is over because new fields require more expensive technology for oil extraction, and consumers dominate energy markets and determine prices (Shafranik 2009:26). This trend presents a significant challenge for Russia’s oil and gas producers that use the Union for domestic lobbying and negotiating with government agencies 12 that regulate various aspects of energy exploration and trade 13 (Makhortov and Tolstykh 2008). 12 Government Commission on the Fuel and Energy Complex and Regeneration of the Mineral and Raw Materials Base (Igor Sechin) President’s Expert Group (Arkadiy Dvorkovich) Presidential State-Legal Directorate (Larisa Igorevna Brychyova) Presidential Domestic Policy Directorate (Oleg Markovich Govorun) Government commission on Legislative Activities (Sergei Sobyanin) Ministry of Finance (Alexei Kudrin) (http://www.government.ru/eng/power/69/) Government Department of Branch Development (Olga Pushkaryova) Ministry of Natural Resources and Environmental Protection of the Russian Federation (Yury Trutnev) (http://www.government.ru/eng/power/48/) Ministry of Energy (Sergei Shmatko) (http://www.government.ru/eng/power/85/) Federal Anti-Monopoly Service (Igor Artemyev) (http://www.government.ru/eng/power/89/) Federal Taxation Service (Mikhail Mokretsov, Mikhail Mishustin) (http://www.government.ru/eng/power/70/) Federal Service for the Oversight of Natural Resources (Vladimir Kirillov) (http://www.government.ru/eng/power/50/) Federal Agency on Mineral Resources (Anatoly Ledovskikh) (http://www.government.ru/eng/power/53/) Federal Tariff Service (Sergei Novikov) (http://www.government.ru/eng/power/103/) State Duma Committee for Natural Resources, Environmental Management and Ecology (Natalia Komarova) State Duma Committee for Budget and Taxes (Yuri Vasiliev) State Duma Committee for Energy (Yuri Lipatov) 113 Most recently, in 2010, at the Russian Petroleum and Gas Congress, the Russian energy sector representatives expressed their own concerns. Valery Yazev spoke of inevitable competition and struggle for global resources and predicted that the United States would try to keep its presence everywhere around the globe, using American military might. Sergey Kudryashov, vice president of Rosneft, outlined the main tasks for Russia’s immediate energy policies. Among them, he mentioned the exploration of the Vankor field by Rosneft, Sakhalin-2 (an LNG plant), the ESPO pipeline, more thorough oil processing technology, Nord Stream and South Stream pipelines, the Sakhalin- Khabarovsk-Vladivostok gas pipeline, as well as deals with China. He mentioned the need to overcome such challenges facing the energy sector as new transportation routes for oil and gas resources and a low economic efficiency of the existing projects under the current tax law. To overcome these challenges, the main goals he presented were are the maximum economic efficiency, new infrustructures, the diversification of markets, exploration cites, and products. Vladimir Kushanryov of Transneft continued these statements by emphasizing the importance of oil pipeline systems, in order to diversify the oil routes, including the ESPO pipeline. Unlike the Union of Oil and Gas Producers, which promotes the interests of Russian companies, other associations lobby for all energy producers. One of them, the Moscow International Petroleum Club (MMNK), was started in 1994 under the auspices of The Council of the Federation Committee on Natural Resources and Environmental Protection (Victor Orlov) The Council of the Federation Committee on Economic Policy, Business and Ownership 13 The Federal Energy Commission (Federalnaya Energeticheskaya Komissiya) regulates and oversees the energy sector, including nuclear power, oil and gas, and utilities. Foreign policies are regulated by the Ministry of Foreign Affairs (Ministerstvo Inostrannikh Del) (p. xv). Environmental aspects of energy resource extraction and transportation are regulated by the Ministry of Natural Resources and Ecology (Ministerstvo Prirodnikh Resursov i Ecologii), which is also responsible for an environmental assessment of resource projects (p. xvi) (Newell 2004). 114 the Gore-Chernomyrdin Commission and the Russian Duma-U.S. Congress Energy Working Group (Bagirov 2010). The club has been recognized by the United Nations as an expert group at the Economic Commission for Europe and now includes more than two dozen energy companies based in Russia, Europe, and the United States (e.g., ExxonMobil, ChevronTexaco, Shell, Total, E.ON Ruhrgas, with CNPC and Sinopec as observers) (MIPC 2006). Co-chairmen of the club at different times have been Sergey Bogdanchikov of Rosneft, Ben Haynes of ExxonMobil, Vagit Alekperov of LUKoil, Rein Tamboezer of Shell, Alexei Miller of Gazprom, and Menno Grouvel of TotalFinaElf (MIPC 2006). The priorities of the club evolved with the changes in the Russian energy business climate (Bagirov 2010). Since members of the club are essentially competitors, the organization has focused on issues beneficial for all of them, such as export legislation, reduction in taxes and royalties, and networking with Russian businesses (Bagirov 2010). When Russian companies go to foreign market, they want to influence host governments through their lobbying. However, Russian lobbies in the United States are very limited: among them, LUKoil, Itera, Foundation for Russian American Economic Cooperation and Russian American Pacific Partnership, the U.S.-Russia World Forum in Washington D.C. by Edward Lozansky. Eduard Lozansky, a major expert on Russian lobbying in the United States, stated in 2006 that “there is no pro-Russian lobby in Washington, D.C.” (Verlin 2006). To fill this void, since 1981 he has annually organized the so-called World Russia Forum in D.C, which brings together top officials, academics, and others interested in the U.S.-Russia relations. Support of the forum comes from both republican and democrat members of 115 Congress (Bob Doul and Jack Kemp in the 1980s and the 1990s; Kurt Waldon, Dana Rorarbakher, and Ralph Hall, among others in the last decade). Lozansky observes that the republican and the democrat positions on Russia are historically similar. The Russian diaspora in the United States is not united in its support of the native land. Moscow has been slow and reluctant to hire professional lobbying firms in Washington, D.C. (Verlin 2006). Again, to sum up, the energy industry decision-makers in Russia are the same personalities who are responsible for the foreign policy. Normally, they are united around the President and promote the government line. If they distance themselves from the government or, worse, challenge them, they are removed regardless of their level of wealth and power. The Yukos case explored in detail below shows exactly such a situation with Mikhail Khodorkovsky, who was the richest man in Russia and the owner of the biggest Russian oil company in the 1990s. 2.6.3. American Lobbies in Russia Energy companies usually position themselves as pragmatic entities that follow profit opportunities and available natural resources around the world, using their governments’ guidelines and informational support. In Russia, foreign companies join international business associations, such as the American Chamber of Commerce or the European Business Association (Makhortov and Tolstykh 2008:39). In addition to that, each corporation usually has a government relations department that directly deals with the 116 host government, partners, and trade unions. However, it has been increasingly difficult for international companies to join projects in strategically important Russian industries (Donohue and Shokhin 2008). One of the main areas where these changes have occured has been the limited access to PSA. PSAs were introduced in Russia in the 1990s, when oil prices were low ($20-$30 per barrel) and the government badly needed foreign capital and expertise, as a way to attract foreign investments and to increase oil and gas production without additional government spending. PSAs, promoted by the International Tax and Investment Center (ITIC), 14 were supposed to have the status above state laws and ensure a constant level of taxation (Darmin 2010:31). However, when oil prices soared to $100 per barrel, the Russian government started to consolidate control over major oil and gas companies, so that “the whole nation gets benefits, not just a small group of oligarchs.” Russia still needs foreign technology and expertise, especially for production in the harsh conditions of Yamal and Shtokman, but now the state control in joint ventures is set up as not less than 51%. Under favorable market conditions and high oil revenues, Russian also started to quickly accumulate expertise and capital (Bagirov 2010). Western companies now often accept the role of consultants and service providers (Darmin 2010:31). After the initial shock, multinationals have adjusted to the changes in the Russian business climate, and to the lack of PSAs in particular. Their lobbying organizations, such 14 a special lobbying association sponsored by major multinational companies, such as BP, Chevron, ExxonMobil, and ConocoPhillips. 117 as the Petroleum Advisory Forum (PAF) 15 started to reshape their strategies, since signing PSAs with the Russian government became close to impossible. After the challenging period in U.S.-Russia relations during the second term of the Bush Administration, the U.S.-Russia business relations became more amicable when President Obama offered the “reset” in 2008 (Obama 2010). American companies have benefited from informational support by the U.S. Embassy in Moscow and the U.S. Department of Energy, whose missions have been to “advance the national, economic, and energy security of the United States” (Embassy 2010). Another link to the U.S. government - the American Chamber of Commerce – also provides informational and lobbying support: “Through AmCham’s effective advocacy and high credibility, member companies are assured of having their concerns heard by decision-makers in both Washington and Moscow” (AmCham 2010). AmCham’s Energy Committee, co-chaired by Darrell Cordry, the president of Chevron Neftegaz, has been actively working to help American businesses secure contracts in Russia (Committee 2010). Currently, major American oil companies can sign multibillion-dollar deals with Russian energy companies only with the Kremlin’s approval. AmCham was an active proponent of Russia’s joining WTO, even though the energy sector is not regulated by WTO. Russia expert Sergey Kostyaev suggests that AmCham is active in this sphere of lobbying because it will make Russia’s market more available for foreign capital overall, which will be positive for the energy sector, as well (Kostyaev 2011). U.S.-Russia trade and investment had been affected by Russia’s delayed WTO membership that Russia acquired only recently: Russia joined WTO on August, 22, 2012 15 registered in 1993 in Texas, USA, but headquartered in Moscow, Russia 118 as its 156th member. One of the conditions set by Western countries for Russia to join WTO has been the liberalization of Russia’s domestic energy prices and the establishment of free trade institutions. Potentially, Russia could utilize WTO functions – as a the conference organization for multilateral trade issues; the depositary of binding international trade conventions; and conflict resolution, arbitration, and trade dispute mechanisms -- to diversify the country’s resource-based economy and move towards the knowledge-based development (Aslund 2010). Kostyaev gives further examples of American lobbying in Russia. American law firms that practice lobbying and public relations, such as Akin Gump Strauss Hauer & Help; Hogan & Hartson, Cassidy & Associates, and Fleishman-Hillard, came to the Russian market (Kostyaev 2011). American lobbying organizations perform a supporting function, promoting the interests of American companies and the American government. This is in line with our domestic interest group hypotheses that state that if powerful domestic groups benefit from energy cooperation, the probability of cooperation will increase. Also, ethnic lobbies abroad tend to align their interests with their respective governments. In the 1990s, energy lobbies had more independent power and decision-making influence. In 2000s, however, in the case of U.S.-Russia, oil and gas investments in Russia are tightly controled by the Russian government, and the activities of domestic groups as such have been mostly alighned with government policies, leaving little freedom for diversion. The next section explores one example – Yukos -- that is especially revealing about how the three factors – 119 economic, geopolitical, and domestic politics – played the role in an attempt for U.S.- Russia energy cooperation. 2.7. The Yukos Case The case of Yukos’s rise and demise is a culminating example of the overall Russia’s economic development in such stages as the Loans-for-Shares program of the 1990s; 16 the economic crisis of the 1998, partly due to the dysfunctional tax system (from which Yukos benefited via low taxation of its revenues), and the strengthening of state control during the first two terms of Putin’s presidency. The Yukos trial is the most prominent case in which economic, political, and geo-strategic aspirations of an oil company and its leader clashed with the government, destroying the company (Frye 2010). Emerging out of the Loans-for-Shares program of the 1990s and a number of consolidations, by 2000 Yukos had become the biggest and the richest oil company in Russia. Its owner Mikhail Khodorkovsky felt very confident not only in his business sector but also in de facto foreign policy making, signing contracts directly with foreign companies and foreign governments for oil and gas trade. He was becoming a real political 16 The program was implemented in the mid-1990s by the Russian government that badly needed financial resources to cover the state budget deficit. During the program, major state enterprises were leased out in exchange for monetary loans in the process of auctions. The access to the auctions was limited to an internal circle of individuals. The program implied that if the government does not repay the loans, the enterprises become de facto sold to their new owners at a fraction of their real costs, which is exactly what happened to major state assets. 120 force, clearly challenging Putin’s consolidation of the state power and de-nationalization tendencies in the Russian energy sector. In 2003, Mikhail Khodorkovsky visited the United States and presented Russia as a supplier of energy resources that would provide the West with an alternative to the unstable Middle East (Hoffman 2003:382). Acting independently and pursuing its own deals while President Putin was strengthening the government’s control over the Russian upstream, Yukos’ rift with the government worsened when Yukos decided to sell a big share of its assets to ExxonMobil and Chevron (Mankoff 2009:25). The Kremlin was concerned about Yukos’s plans to increase this percentage even further by selling a part of the company to Exxon-Mobil and Chevron. Khodorkovsky appointed Bruce Misamore of Marathon Oil and PennzEnergy as Chief Financial Officer and Steven Theede of ConocoPhillips as his Chief Operating Officer. Americans Sarah Carey, Rai Kumar Gupta of Philips, Bernard Loze of France, Jacques Kosciusko-Morizet of Credit Lyonnais and Michel Soublin of Schlumberger in Yukos’ board of directors. Khodorkovsky set up a philanthropic foundation and provided grants and sponsorship even to the U.S. Library of Congress. By 2004, Yukos became Russia’s largest oil producer, exported oil by tankers to the United States and had plans to sign a 20-year oil delivery contract with China. Yukos was acting as a sovereign power, making foreign policy, rather than following the government’s instructions. Yukos signed a protocol of understanding with Exxon in 2003, just before Khodorkovsky’s arrest. Neither company consulted President Putin. Through the “removal of Khodorkovsky from the economic and political stage, the dismemberment of Yukos, and its effective renationalization and redistribution 121 to state-controlled entities like Rosneft”, the plans to sell a part of Yukos to Exxon-Mobil and Chevron were also blocked by the Russian state (Goldman 2008:123). Shortly after, Yukos was charged with tax fraud and ordered to pay back millions of dollars to the government. The company’s assets were frozen and ended up in Rosneft’s possession (Volkov 2008:241). Foreign companies were not allowed to buy parts of Yukos (Mankoff 2009:37). Some scholars compared Yukos to the American conglomerate Standard Oil, which was broken apart in 1911. Both companies were in existence in the “wild capitalism” stages in their respective countries. Like Roosevelt, Putin was strengthening his personal power and that of his apparatus by limiting the activities of leading tycoons (Volkov 2008:241). Around the same time, Roman Abramovich also contemplated selling a part of his company Sibneft to Chevron-Texaco, Shell, and Total. Similar to Yukos, Sibneft faced a charge of tax fraud. Abramovich quickly sold his 72 shares in Sibneft to Gazprom, which formed the entity called Gazpromneft. After this deal, the Russian state owned 30 percent of the overall oil production in Russia (Goldman 2008:123). Another energy player, ITERA - the second largest Russian producer of natural gas in the 1990s (headquartered in Jacksonville, Florida) - also lost most of its contracts during Putin’s presidency (Goldman 2008). In 1990, ITERA and its owner Igor Makarov started to deliver natural gas from Turkmenistan to Ukraine via Gazprom’s pipeline system. During the Loans for Shares initiative, ITERA acquired substantial assets from Gazprom at a sub-market cost. When Rem Vyakhirev, the head of Gazprom who was favorable to 122 ITERA, lost his position as Gazprom’s CEO, ITERA had to return Gazprom assets and also lost the Turkmenistan-Ukraine gas trade opportunity in 2002 (Goldman 2008:123). Even now, in 2013, the case of Yukos remains a source of contention between the United States and Russia. Both the United States government and human rights organizations (such as Amnesty International) expressed their disagreement with the Russian government’s treatment of Mikhail Khodorkovsky who is still in jail. Human rights activists, such as Khodorkovsky’s lawyer Robert Amsterdam, work to increase the public’s awareness about this case. A similar case of lawyer Sergei Magnitsky who died in custody in Russia before the trial is now a topic of debate in the U.S. Congress in their discussions of a new law that would limit visas and assets in the U.S. to those who were responsible for his death. 2.8. Conclusion The case of U.S.-Russia energy ties is a puzzling, multi-faceted case that requires a multi-aspect explanation. Russia, as a largest oil producer in the world (competing with Saudi Arabia), and the United States, the largest oil consumer, could potentially increase oil and gas trade and investments. Initally, the early 1990s were an optimistic start, when Russia opened its doors to American advisors and businesses. President Clinton and his team (Warren Christopher, Madeleine Albright, Les Aspin, William Perry, Colin Powell, Anthony Lake, and Strobe Talbott) promoted economic liberalization as Russia's future course of development (MacLean 2006:4): … the United States treated Russia as a kind of pet project for the contemporaneous creation of capitalism and democracy, in which American lawyers, academics, and 123 newly minted MBAs descended on Moscow to rewrite tax laws, design institutions, and peddle advice (Appel 2008). In this first stage of U.S.-Russia relations after the end of the Soviet Union, the economic potential of cooperation was considered by both governments very high, and they encouraged businesses open joint ventures and sign production sharing agreements. This period of the 1990s is best explained by the economic potentical hypothesis that stresses that if economic considerations are favorable, decision-makers will overcome geopolitical rivalries and other political difficulties. Indeed, despite the chaos and instability of Boris Yeltsin's reforms, the American government focused only on opportunities presented by a newly open Russia. Major energy companies followed suit. The economic crisis of 1998, caused both by domestic (inflation, tax evasion, corruption) and international (the Asian crisis contagion) factors, became a watershed in that initial optimistic stage, bringing Vladimir Putin to power and creating favorable conditions for his strengthening of state power and Russia's international stance. While the early years of the Putin Administration and the George W. Bush Administration were relatively cooperative and productive, especially after the 9/11 terrorist attack when Russia opened its air space and territory for U.S. military cargoes and shared intelligence, the U.S.-Russia relations nevertheless started to quickly deteriorate, plagued by such issues as NATO expansion, Iran, U.S. missile defense and especially by the Iraq War of 2003 that Russia strongly opposed. The lowest point of the relations between the two countries was reached during the Russia-Georgia War of 2008, when the United States, in rhetoric, took Georgia's side and hawkish voices in the United States even suggested to start a military 124 intervention, which might have led to a full-scale U.S.-Russia war. All of this as overshadowed by the lingering Cold War legacy and concervative voices on both sides. The 2000s, overall, were the period when the share of American investments in the Russian economy and in the energy sector in particular fell drastically. For almost a decade, major U.S. companies (Chevron, ExxonMobil, ConocoPhillips) could join no new projects and were struggling to keep the exisisting ones (Sakhalin, Shtokman, Black Sea, etc.) The Putin government reversed the trends of the 1990s and worked on increasing state ownership and control over Russia's energy resources. Oil and gas became not just a mere source of revenue for the state budget, but a tool of foreign policy, geopolitical advantage, and Russia's national pride. As a result, this stage of 2000-2008 is best explained by the geopolitical hypothesis that stresses the importance of geopolitical considerations and state control over energy resources. In this period, energy lobbies and main domestic interest groups were either merged with the government (in case of Russia) or highly depended on government arrangements and agreements (in case of American energy companies). In the 1990s, on the contrary, energy companies were more autonomous in their decisions to invest in Russia, although not completely independent from the influence of their governments. 125 Chapter 3. U.S.-Azerbaijan Energy Diplomacy: BTC and Beyond BTC was preferable to others from the geo- strategic and geopolitical standpoints. - Nasib Nassibli, former Ambassador of Azerbaijan to Iran, 2004 The Baku-Tbilisi-Ceyhan (BTC) pipeline brushed aside shorter, cheaper and environmentally better routes via Armenia or Iran. - K. Gajendra Singh, former Indian ambassador toTurkey and Azerbaijan, 2005 The U.S. government has continuously invested in key multi-billion dollar projects in the Caspian region – the Baku-Tbilisi-Ceyhan pipeline, the Shah-Deniz natural gas field, the Baku-Supsa pipeline and others – providing strong diplomatic support. However, a high level of U.S. involvement in Azerbaijan is puzzling for several reasons. First, relatively little oil is exported directly from Azerbaijan to the United States, and Azerbaijan’s oil reserves are smaller than other oil-producing states. Azerbaijan's oil production goes back to the oil boom of the mid-19th century, when the country was one of the leading oil states, introducing the world's first oil tanker and other technologies. At the time, its oil production was controlled by oil barons such as the Nobel brothers and the Rothschilds. This first oil boom saw an influx of foreing investors and the blooming of Baku. By the beginning of the 20th century, Azerbaijan was the biggest oil producer in the 126 world that provided half of the world's oil output. During the pre-WWII period, Azerbaijan produced 75 percent of the overall Soviet oil output. After the end of the Soviet Union, Azerbaijan opened its resource-based economy and embraced investments and guidance from the West and especially from the United States. Despite Azerbaijan's historical importance and openness to the West, objective geographic obstacles for delivering oil to the U.S. soil are even greater than in the previously discussed case of U.S.-Russia energy ties: Azerbaijan is practically landlocked and has to rely on transit countries for oil and gas transportation. Experts also debate on how much oil the country possesses, and whether it will be able to fill the pipelines to capacity. Second, Azerbaijan, as does Russia, has substantial problems with democratic institutions and civil freedoms. The Aliyev family has been in power since 1969 (with a brief interruption in the 1990s). Heydar Aliyev was the party leader of Soviet Azerbaijan and then became president after the end of the USSR. His son Ilham Aliyev was prime minister and then became president of Azerbaijan after his father’s death. The lack of democratic institutions has not prevented the government from close ties with the West. Third, one might expect that the powerful Armenian lobby in the United States would block American energy contracts in Azerbaijan, as well as in Turkey. Since the 1980s, Azerbaijan and Armenia have been in a prolonged territorial military dispute over Nagorno-Karabakh, which left hundreds of thousands refugees and is still the focal point of both countries’ foreign policies. In addition to that, Armenia has been in a complicated relation with Turkey because of the disagreement about mass killings of Armenians in 1915-1923. 127 Forth, Azerbaijan has close ties with Iran, in which the ethnically Azeri community comprises 16% of the population. Given that the United States has serious disagreements on multiple issues with Iran, it is puzzling how Azerbaijan has been able to keep close relations with both. Nevertheless, Azerbaijan and the United States have overcome all these serious obstacles and created a close energy and military partnership. Post-Soviet Azerbaijan quickly emerged as an attractive point for foreign investments: from the 1990s, major companies poured billions of dollars into the country’s projects. One of them was the 1,099-mile Baku Tbilisi Ceyhan (BTC) pipeline, finished in 2006, which cost $4 billion to build. Another major project that is underway is the $25- billion Shah Deniz-II (natural gas production and transportation). As the following analysis will show, geopolitical calculations are the main reason for the relatively quick implementation of these multi-billion projects, backed by the United States government and other Western countries. The United States and other NATO allies had a strong interest in building pipelines that bypass Russia and provide an alternative source of oil and gas for Western Europe. Azerbaijan has also been building up the cooperation with Israel: this move strengthened Azerbaijan’s geopolitical position in the region and provided support by the Israeli lobby in the United States. In addition to energy supplies, the United States has been interested in an independent Azerbaijan and in curtailing Russia’s dominance in the post-Soviet regions. The evidence supports our geopolitical hypothesis, which stresses the influence of geopolitical interests and government control in the energy sector. 128 T 3.1. Political and Economic Transformations of the post-Soviet Azerbaijan Azerbaijan’s productive relations with Western investors and governments, compared to other post-Soviet states (e.g. Russia, Belarus), is especially puzzling, taking into account that political and economic transformations in the post-Soviet Azerbaijan have been similar to other post-Soviet states but have led to a more favorable outcome in the country’s relations with the West. The resulting political and economic system is similar to the other states, too: it is based on a narrow circle of ruling elite and limited democratic processes. Azerbaijan announced its independence on October 18, 1991, which was confirmed by a national referendum on December 29, 1991 (18 October - The National Independence Day 2009). A former Soviet leader, Ayaz Mutallibov, became the first in a quick succession of presidents, some of whom stayed in power for as little as two months. 17 The post-Soviet nation started to use national symbols and national currency, similar to those of the pre-Soviet Azerbaijani Republic that existed in 1918-1920 (Finn 2009) that was a brief period of independence in the whole pre-1991 history of Azerbaijan. Other than these two years, Azerbaijan was never independent before 1991. Even the independent post-Soviet Azerbaijan had to juggle influences from other major players in the region, such as Iran, 17 Ayaz Mutallibov became the first president of Azerbaijan for the period of 1990-1992. His presidency was followed by Yagub Cavad oglu Mammadov (6 March - 14 May 1992); Isa Yunus oglu Gambarov (19 May - 16 June 1992); Abulfaz Gadirgulu oglu Elchibey (16 June 1992 - 1 September 1993); Heydar Alirza oglu Aliyev (24 June 1993 - 31 October 2003); and current President Ilham Heydar oglu Aliyev (31 October 2003 - present). 129 which has about 16% of ethnic Azeri population, and Russia, which is home to 3 million Azerbaijan people. Such interconnections are a source of potential frictions, as well as opportunities, between Azerbaijan and these states. The government started to reorganize the economy and the oil sector in particular, merging two major state oil enterprises, Azneft and Azerneftkimya, into the State Oil Company of Azerbaijan Republic (SOCAR). SOCAR became a vertically integrated oil and gas company that explores, produces and trades the country’s energy resources (Azerbaijan.az 2009). The company remained in the government’s hands but went through a major redistribution of assets and reformulation of business processes. Shortly after Azerbaijan became independent, Heydar Aliyev came back to power in 1993. He had been a prominent figure on Azerbaijan’s political arena for several decades, starting with his position as a KGB officer in the 1940s and the 1950s and the head of the country’s KGB in 1967. Two years later, in 1969, Aliyev became the First Secretary of the Central Committee of the country’s Communist Party and stated in power until 1987. After a brief service as the Nakhchivan province’s Chairman of the Supreme Soviet, Aliyev became the president of Azerbaijan in 1993. His way to the presidency of the independent Azerbaijan is debated in the literature: according to the Heydar Aliyev Heritage Research Center, he became the president of Azerbaijan because the nation wanted him to “lead the country” (Heydar Alirza oglu Aliyev 2009). However, other sources, such as NATO archives, point to a military coup against his predecessor, President Abulfaz Elcibey (Visit to Baku, Azerbaijan, Jan 22 - 24 October 1998 1999). 130 President Aliyev stabilized the domestic political situation and started to focus on economic issues, especially on the country’s production and trade in energy resources. Novruz Mammadov, Head of Foreign Relations Department at the Administration of the President, compares Heydar Aliyev’s policies to his predecessor Abulfaz Elchibey’s. Mammadov describes Elchibey’s strategy as “self-isolation,” while Aliyev pursued openness to the West and productive relationships with Russia, Iran, and other neighbors (Mammadov 2009:150). The critics, however, argue that Aliyev created a semi-tribe state system, close to a neo-monarchy. Vagif Guseinov of Russia’s Institute of Strategic Assessment and Analysis maintains that a stable state “machine”, created by Heydar Aliyev, allowed painlessly transferring the power from the father to the son, through the prime-minister position to the presidency. The president concentrated an unprecedented power and wealth in the hands of his family (Guseinov 2008:40). In his foreign policy, Heydar Aliyev was successful in balancing between Moscow and Washington, ensuring lucrative oil and gas contracts and a stable inflow of petro- dollars. His son Ilham Aliyev continues his legacy. Even before becoming President of the country, Ilham Aliyev was an influential figure since 1994 when he became vice-president of SOCAR, as well as holding a number of other key government positions in Azerbaijan. He later became the Prime Minister, when Heydar Aliyev was already terminally ill and ready to pass on his power. Just two months after his appointment as the Prime Minister, Ilham Aliyev won presidential elections, replacing his father as the President of Azerbaijan in 2003. Despite protests by the opposition and their claims that the elections were unfair, the governments of the United States, Russia, Turkey, and other states recognized the 131 election of Ilham Aliyev as fair and praised the “successful choice of leadership” (Guseinov 2008:40). Ilham committed to continue implementing the existing and new energy deals for foreign investors. In 1992, the U.S. government established bilateral economic relations with a newly independent Azerbaijan, starting with Secretary of State Cyrus Vance’s visit to a newly opened U.S. embassy in Baku. During that visit, Azerbaijan became accepted to the NATO Partnership for Peace program. Robert Finn, the first Charge d'Affaires of the U.S. Embassy, recalls that his job was quite challenging: the Azeri nationalism was on the rise, the country was involved in a bloody war with Armenia, and whole communities were displaced because of the violence (Finn 2009:102). Despite these challenges, high-profile foreign visitors, such as the U.S. Secretary of Energy Hazel O’Leary and Undersecretary of State Strobe Talbott, visited Baku in order to explore opportunities for energy cooperation (Finn 2009). The United States has been very interested in Azerbaijan’s oil export to the U.S. and NATO partners, the demand for oil was growing, mostly in the transportation sector (Sabonis-Helf 2009). The U.S. Department of Commerce saw potential opportunities for American companies in the energy sector of Azerbaijan, especially in project management, engineering, drilling, and other extraction activities ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008). The former Soviet republics were considered the «safe haven» for energy supplies to the West (Mortished 2008). 132 3.2. Economic Potential The integrated framework outlined in Chapter 1 states that the first consideration for energy cooperation is economic potential. When governments and energy companies consider opportunities for energy trade and investment abroad, an analysis usually starts with the availability of energy resources in a chosen country and its investment climate. Applying this framework, it is possible to conclude that Azerbaijan’s oil and gas resources, even though substantial, might not be sufficient to fill the pipelines that have been built recently (e.g. BTC) and those that are still planned (e.g. Nabucco). However, the investment climate in the country has been increasingly favorable and stable for foreign investors, even despite domestic human rights problems and the narrow resource focus of the economy. 3.2.1. Energy Resource Availability Data on how much oil Azerbaijan possesses vary dramatically in different sources. The U.S. Department of Energy (the Energy Information Administration - US DOE/EIA) initially assessed the overall Caspian oil reserves at 233 billion barrels but later drastically reduced the estimates to 17- 33 billion barrels. In 2002, Chairman of ENI (Italy) Gian Maria Gros-Pietro announced that the region possessed only 7.8 billion barrels of recoverable oil, with one third of it located in Azerbaijan (Blanchard 2005:206). Energy analysts warn that host governments are often interested in inflating the estimates of their 133 reserves, and modern technology is not advanced enough to measure them with precision (Shaffer 2009a). For example, the Kashagan field was initially rated as supergiant, but the actual drilling uncovered dry wells, and the estimates were lowered (Blanchard 2005:14). Despite the fact that Azerbaijan produces one million barrels per day (only about 1 percent of the world’s oil production output), the country’s leadership uses every chance to promote their country’s oil wealth and to secure Western investment. President of the State Oil Company of the Republic of Azerbaijan (SOCAR) Rovnag Abdullayev stressed in 2009 that Azerbaijan had been the first onshore and offshore oil producer in the world and even the first to use oil tankers for oil transportation (Abdullayev 2009). The world’s first oil tanker was designed and built in Baku by Ludwig Nobel in the late 19 th century (Yergin 2011:50). First industrial-scale oil production in Baku started in 1847 on the Ramany, Balakhany, Sabunchu, and Bibi-Heybat oil fields. The Nobel brothers’ company became the largest oil producer at the time, operating alongside local oil barons (Taghiyev, Naghiyev, Mukhtarov, Hajinsky). In 1901, Azerbaijan’s oil production (80.5 million barrels) exceeded American output (63.7 million barrels) and comprised more than a half of the world’s oil production. During the Soviet years, oil production in Azerbaijan continued to grow (Mammadov 2010). Azerbaijan’s current challenges are somewhat similar to those in the 19 th century: the country’s export routes are limited to the Caspian Sea; the Caspian region is an area of a strong competition among great powers; the region is plagued by ethnic and secessionist conflicts (Shaffer 2009b:68-9). On the other hand, new technology in transportation and 134 drilling open new opportunities for Azerbaijan to be not only a producer of oil but also a transit state for resources from Turkmenistan and Kazakhstan (Pashayev 2009:110). To deliver oil to the Western market, several routes were considered by the Azerbaijani government for what eventually became the Baku-Tbilisi-Ceyhan pipeline. The first route would have gone north from Azerbaijan, through Russia. Since the main idea of the policy of multiple pipelines was to bypass Russia, this option was unfeasible. The second option would have been to go south, to Northern Iran, in which oil would be delivered to Iranian refineries and swapped with Iranian oil in southern Iran. This option was also unfeasible, as both the United States and Azerbaijan did not want to depend on Iran’s will to fulfill Iranian obligations to swap the oil. In addition to that, oil would have to be delivered to world markets through the Persian Gulf, already overcrowded. The third option was the BTC itself, ardently supported by they United States, even though it was the most expensive and technologically challenging of all the options (Yergin 2011). Nevertheless, this route was selected, mostly on geopolitical grounds, as the following sections will show. 135 Figure 17. Map of Azerbaijan Source: Lonely Planet, http://www.lonelyplanet.com/maps/europe/azerbaijan/ Oil and gas development in the Caspian is complicated by an ongoing dispute among the littoral states over the status of the Caspian Sea. They disagree whether the Caspian Sea is a sea or a lake (inter-state divisions of seas and lakes are governed by different international laws). Azerbaijan and Kazakhstan view the Caspian Sea as a lake and argue that it should be divided into sectors. Turkmenistan agrees that the Caspian Sea is a lake but disagrees with Azerbaijan on the median line dividing the body of water into national sectors. Russia offers an alternative solution: to divide the seabed, while treating the water surface as an area of common use. Iran has made several propositions, from a condominium regime to join exploration of resources. These disagreements among states have created uncertainties for future oil and gas contracts (Mammadov 2010). In 2003, Russia, Azerbaijan, and Kazakhstan reached an agreement to divide the oil-rich northern part of the Caspian Sea into 3 parts (Kazakhstan - 27 %, Russia - 19 % and Azerbaijan - 136 18 %). Based on these borders, the US DOE/EIA estimates Azerbaijan’s proven oil reserves at 7-13 billion barrels (Blanchard 2005:206-8). Figure 18. Oil Production in Baku, Azerbaijan Source: Ekaterina Svyatets, field research, 2009, Azerbaijan Based on these limitations, analysts warn that Azerbaijan’s current reserves may not be sufficient to fill all the planned pipelines (BTC, Nabucco). Theresa Sabonis-Helf of the National War College argues that Azerbaijan’s oil has already passed its peak and that building new pipelines bears a substantial economic risk. BTC, for example, was designed to transport oil not only from Azerbaijan but also from Kazakhstan, in order to ensure the promised volume of exports. Kazakhstan, however, might divert its resources to other projects in the future, including oil swaps with Iran (Sabonis-Helf 2009). Taking advantage of its resources and geographical closeness to Western Europe, Azerbaijan turned to the West shortly after the country’s independence. President Heydar Aliyev’s decision to invite foreign investors to participate in the energy sector in 1994 had 137 very positive results. Azerbaijan, which had been a natural gas importer before the 1990s, recently developed the Shah-Deniz gas field and became a gas exporter to Turkey, Russia, Georgia and Europe, contributing to the European energy security (Abdullayev 2009). The government often underscores that energy trade helps to achieve other policy priorities, such as the country’s economic development and military sector expansion, especially in light of its conflict with Armenia over Nagorno-Karabakh (Abdullayev 2009). Despite cautious evaluations of the country’s oil reserves, Western energy companies and governments, attracted by political stability and an improved business climate, continue to come to Azerbaijan for new contracts. Oil production has steadily grown with foreign capital and technology, comprising half of the GDP. The U.S. Energy Information Administration (EIA) reported that in just one year, Azerbaijan’s oil output grew from 150,000 b/d (in 2008) to 1.04m b/d (in 2009) ("News in brief" 2009). The ACG oil field alone is estimated to be able to produce 1,000,000 b/d at its peak (Blanchard 2005:7). 138 Figure 19. Oil Production in Azerbaijan, 1992-2010 (EIA) Foreign Minister of Azerbaijan Elmar Mammadyarov stressed that Azerbaijan must expand the number of its consumers of oil and gas, in order to strengthen the country’s sovereignty, simultaneously making sure that the projects are profitable. He continued that it is much easier to diversify oil trade because oil is easily transportable, as opposed to natural gas, which requires pipelines or LNG facilities for its transportation (Mammadyarov 2009a). In sum, oil and gas resources and production volume in Azerbaijan are substantial and are within top twenty world producers, which provides a partial support of the economic potential hypothesis that states that abundant energy resources are conducive to 139 energy cooperation. However, the geographic challenges to deliver oil and gas to Western consumers (via expensive pipelines and transit countries) and to rely on other Caspian states for the sea status settlement point to other, economic and non-economic reasons for why Western countries, including the United States, are so heavily invested in Azerbaijan. 3.2.2. Investment Climate The second economic aspect of our integrated framework is the country’s investment climate. Oil and gas reserves alone are not sufficient to determine the opportunities for foreign companies. To invest and operate in a host country, they consider a set of conditions that is usually defined as an investment climate, i.e. regulations enhancing or constraining business activity. The investment climate reflects to the ease of doing business in a country. According to the World Bank’s Doing Business ranking, Azerbaijan became one of the top ten reformers in Eastern Europe and Central Asia in 2008. Its ranking increased from the 97 th place in the world in 2008 to the 33 rd in 2009 ("Doing Business 2009" 2008:18). It does not mean, however, that barriers and challenges have been completely removed: in 2008, a report by the U.S. Department of State asserted that Azerbaijan remains “a challenging market in which to do business” ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008:41). Like Russia, Azerbaijan experienced a substantial decline of its economy in the very beginning of 1990s. The country’s GDP in 1994 was only 44 percent of the GDP in 1990. An armed conflict with Armenia over Nagorno-Karabakh and the internal 140 displacement of more than half a million people created an additional burden on Azerbaijan’s economy (Maharramov 2010). Similar to Russia, Azerbaijan’s oil industry suffered the lack of investment and modern technologies after the end of the Soviet Union. The U.S. government has monitored Azerbaijan’s economy since the early 1990s. In 1994, a resource guide for U.S. businesses described Azerbaijan as a country with substantial energy resources, moving “cautiously” towards a market economy, but still struggling with an underdeveloped infrastructure, the lack of hard currency reserves, and profit expatriation barriers ("Doing Business in the New Independent States -- A Resource Guide" 1994). On September 20, 1994, in response to the newly acquired political stability, several governments and international oil companies signed the pivotal Contract of the Century with SOCAR, which terms and conditions of energy production and trade with Azerbaijan. This “deal of the century,” aimed at exploration of the ACG oil and gas field, was the first in the Caspian to bring together a diverse group of governments and companies (Yergin 2011:54). The dignitaries and signatories included Tim Eggar, UK Energy Minister; President of Azerbaijan Heydar Aliyev; Bill White, US Energy Deputy Secretary; Usam Jafari, Islamic Bank of Development; Stanislav Pugach, Russian Ministry of Fuel and Energy; Thomas Young, UK Ambassador; Richard Kauzlerich, US Ambassador; Eldar Namazov, Presidential Advisor; Hasan Hasanov, Foreign Minister of Azerbaijan; as well as executives of the energy companies participating in the deals (Sagheb and Javadi 1994). 141 The Contract stipulated stakes and profit divisions. SOCAR was entitled to 80% of all profits, with the remaining 20% to be allocated as follows: SOCAR (Azerbaijan) 20%; British Petroleum (UK) 17.127%; Amoco (USA) 17.01%; LUKoil (Russia) 10%; Pennzoil (USA) 9.82%; Unocal (USA) 9.52%; Statoil (Norway) 8.563%; McDermott International (USA) 2.45%; Ramco (Scotland) 2.08%; Turkish State Oil Company (Turkey) 1.75%; Delta-Nimir (Saudi Arabia) 1.68%. It was expected that Azerbaijan would receive $81 billion over 30 years from this deal (Sagheb and Javadi 1994). The Contract of the Century was followed by other international contracts between Azerbaijan and major energy companies. In September 1994, a number of oil companies - BP (UK), Chevron, Devon Energy, Amerada Hess, and ExxonMobil (USA); StatoilHydro (Norway); Türkiye Petrolleri Anonim Ortaklığı (TPAO; Turkey); SOCAR (Azerbaijan); Inpex and Itochu (Japan) 18 – formed a consortium called the Azerbaijan International Operating Company (AIOC), to develop the Azeri, Chirag, and Gunashli fields ("Shah Deniz Signed: Third Major Contract in Caspian" 1996). In 1995, the Karabakh Prospect oil field started to be developed by the Caspian International Petroleum Company (CIPCO) that included Pennzoil Caspian Development Corporation (30%), LUKoil International Ltd. (12.5%), a SOCAR commercial affiliate (7.5%), Agip Azerbaijan (5%), and LUKAgip (45%) ("Shah Deniz Signed: Third Major Contract in Caspian" 1996). In 1996, the Azeri government started an international project to develop another major oil and gas field - Shah Deniz. The participating companies included British 18 The contract on the development of the ACG fields was signed on September 20, 1994. The project participants are project operator BP (34.1367% interest), Chevron (10.2814%), ExxonMobil (8.0006%), Devon Energy (5.6262%), Amerada Hess (2.7213%), State Oil Company of the Azerbaijani Republic (SOCAR) (10%), Inpex Corp. (10%), ITOCHU Oil (3.9205%), Statoil (8.5633%) and TPAO (6.75%) (Interfax 2010) 142 Petroleum (25.5%); Statoil (25.5%); LUKoil (10%); ELF (10%); National Oil Company Iran (10%); Turkish Petroleum (10%), and SOCAR (9%). The signatories and attendees 19 of this deal, as with the Contract of the Century, included many prominent government and business representatives, brought together to secure a stable supply of energy resources from Azerbaijan ("Shah Deniz Signed: Third Major Contract in Caspian" 1996). As oil production was increasing, a crucial issue to solve was the transportation of energy resources from Azerbaijan to the West. On October 29, 1998, the governments of Georgia, Turkey, Kazakhstan, and Uzbekistan signed the Ankara Declaration, which defined the route of the Baku-Tbilisi-Ceyhan pipeline. Among major energy companies, one of the most active in the region was British Petroleum, which came to Azerbaijan in the 1990s and quickly became a leader in production and transportation of energy resources from Azerbaijan. BP’s current interests in the region include the ACG oil field (in the Caspian Sea) and the Shah Deniz gas field. A BP vice president Khalilov described Azerbaijan as a country with low political risk but full of technological challenges (Khalilov 2009). Russia has participated in some Caspian energy projects. Russia’s Blue Stream gas pipeline on the bottom of the Black Sea delivers natural gas from Azerbaijan’s Shah Deniz field to Turkey. Baku-born Vagit Alekperov and his company LUKoil has held a partial 19 Guy Arlette, Deputy Minister of Energy and Industry (France); Vladimir Kostyushin, First Deputy Minister of Energy (Russia); Heydar Aliyev, President (Azerbaijan); Tim Eggar, Minister of Energy (UK); Seyid Ali Akbar Hashimi, President of Iranian Oil Company; Thomas Young, Ambassador (UK); Ömür Orhun, Ambassador (Turkey); Sidgi Süncär, President of Turkish Petroleum Company; Ravin Maganov, VP of LUKoil (Russia); Philippe Jaffre, President of ELF Aquitane (France); Bayron Grodini, VP of BP (UK); Natig Aliyev, President of SOCAR (Azerbaijan); Jon Nic Vold, Executive VP of Statoil (Norway); Anwar Saifullah Khan, Minister of Oil & Natural Resources (Pakistan); Guy Arlette, Deputy Minister of Energy and Industry (France); Lucian Motiu, State Secretary responsible for Oil and Gas, Ministry of Industry (Romania); Baltabay Kuandykov, President of State Oil Company (Kazakhstan); K. Saldastanishvili, Minister for Economic Relations (Georgia); and Jens Stoltenberg, Minister of Industry and Energy (Norway) 143 ownership of upstream projects in Azerbaijan and Kazakhstan. However, LUKoil decided not to join the BTC project and later in 2002 sold LUKoil’s share in the ACG field (Nanay 2009). Oil and gas wealth from these international projects has been accumulated by Azerbaijan in the State Oil Fund (SOFAZ). Using this fund, the government substantially invests in social and economic infrastructures, such as housing, education, and transportation. As a result, the Word Bank and the IMF regularly evaluate Azerbaijan as one of the fastest growing economies in the Caspian region (Mammadov 2010). Azerbaijan has been praised by international organizations and foreign companies for staying resilient in the global economic downturn of 2008 (Khalilov 2009). According to BP’s experts, several factors have contributed to this resiliency. First, the Azeri manat has been pegged to the U.S. dollar since 1994, stabilizing the Azeri economy (although making Azeri oil production more expensive because of the rising value of the dollar) ("Azerbaijan" 2006). Second, the Azeri government adopted conservative fiscal and investment policies, avoiding profitable but volatile financial instruments (Khalilov 2009). In 2009, Azerbaijan was the only state in the region with an economic growth of 4.8% (9% in the energy sector alone) (Ibadoglu 2011:4). However, similar to other oil-depenent countries, Azerbaijan has been a natural resource economy. Companies in other sectors (steel, metal-rolling, etc.), which Vladimer Papava called «necroeconomic enterprises», have worked at the lowest possible capacity or been idle (Papava 2011:22-3). In spending oil revenues, the Azerbaijani government has kept the balance between short-term 144 spending and long-term country development, to prevent a decline in the standard of living and a social unrest that may endanger the regime (Kendall-Taylor 2010:16). In addition to the overall domestic stability, Azerbaijan took special measures to attract foreign investors. In an attempt to improve the country’s investment climate, promote transparency, and decrease corruption, the government launched several initiatives, such as the 2007 Extractive Industries Transparency Initiative (EITI) and the Law on Protection of Foreign Investments. The law stipulated that if the government adopts new regulations unfavorable for foreign investors, the investors are protected by a 10-year grandfather clause (with the exception of tax policies) from any nationalization and property requisitions (except for emergency situations). If such requisitions have to happen, the foreign companies are entitled to fair compensation ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008:42). These initiatives helped to build foreign investors’ trust, and FDIs continued to flow ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008:45). 145 Figure 20. Net FDIs in Azerbaijan Year Net FDIs in Azerbaijan, in USD 1995 330,050,000.00 1996 627,277,000.00 1997 1,114,834,000.00 1998 1,022,947,000.00 1999 510,317,000.00 2000 129,177,000.00 2001 226,513,000.00 2002 1,066,821,000.00 2003 2,351,747,000.00 2004 2,351,283,000.00 2005 459,151,000.00 2006 -1,289,475,000.00 2007 -5,034,521,000.00 2008 -540,824,000.00 2009 147,181,000.00 2010 331,155,000.0 Source: Index Mundi, http://www.indexmundi.com/facts/azerbaijan/foreign-direct- investment Foreign companies and the Ministry of Energy and Industry signed PSAs, which were granted the status of national laws. In 2000, to encourage and protect their mutual investments, the U.S. and Azerbaijan signed and ratified the Bilateral Investment Treaty. The government also simplified business registration procedures, reducing red tape required to open a new business ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008:40-1). 146 Figure 21. The Ease of Doing Business Ratings (the World Bank, 2012) The graph above provided by the World Bank shows that the ease of doing business in Azerbaijan is better than in Russia or than even in Turkey. Another graph below shows the elements of Azerbaijan’s evolution in business practices in the last decade in such aspects as the time and cost of opening a new business. 147 Figure 22. Time and Cost to Open a Business in Azerbaijan (World Bank, 2009) Simplified procedures made it easy to finance large-scale projects, in which governments, energy companies, and international institutions combined their resources. An example of financing the $3.3-billion Baku-Tbilisi-Ceyhan pipeline shows that it was necessary to attract multiple investors and to reach a compromise on costs and profit- sharing among them (Razavi 2007:278). 148 Figure 23. Financing Structure of the BTC pipeline (Razavi, 2007) The Azerbaijani government has worked closely with international institutions, such as the International and the European Bank for Reconstruction and Development (IBRD and EBRD), the International Monetary Fund (IMF), and the Asian Development Bank (ADB). For the last several years, Azerbaijan has worked on joining the WTO ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008:2). Under the guidance of these international institutions, Azerbaijan invests in its domestic economy (education, health care, as foreign debt repayment) (Sadigov 2009:140). 149 Public spending has contributed to a higher rate of employment and better education, which are favorable factors for foreign companies who come to Azerbaijan (Maharramov 2010:38). An important aspect of government control and regulation is ecology, which has been a challenge in Azerbaijan. Baku has become heavily polluted since oil production started in the 19 th century. According to Azerbaijan’s Minister of Ecology Huseynguly Bagirov, the Caspian Sea bed contains from 3 to 10 meters of oxidized oil products, accumulated during the decades of oil production, on its bottom. Talking about the BTC pipeline, Bagirov indicated that the pipeline is not an ecological “disaster,” but British Petroleum has not cooperated with the government enough. Bagirov continued that BP has not been willing to join a government-led environmental coalition of NGOs and businesses, to make oil companies fully comply with the environmental law and pay multi-million environmental penalties (Bagirov 2009). To cooperate with the government, oil companies started various initiatives to make their business “greener.” BP-Azerbaijan’s vice-president for environment at Greg Mattson maintained that the company’s “holly trinity” (energy, technology, and policy) brought new technology to Azerbaijan, ensured stable oil revenues for the government, and promoted sustainable development. He positively evaluated Azerbaijan’s business environment that granted a status of law to PSAs and ensured the stability of contracts (Mattson 2009). 20 20 For comparison, BP has had more problematic relations with the government and major energy companies in Russia. In 2010, CEO Tony Hayward was nominated to the position of nonexecutive director of TNK-BP, while TNK-BP CEO Robert Dudley was appointed 150 In sum, the investment climate in Azerbaijan has been favorable for foreign companies, which were provided certain guarantees by the government. This supports the investment climate aspect of the economic potential hypothesis. However, the favorable investment climate explains why foreign investors are attracted to the country. When it comes down to the specific details of energy deals, such as a pipeline’s route selection, these economic indicators matter much less. The choice therefore becomes determined by geopolitical factors, especially by the U.S.-Russia rivalry in the region and by the U.S. and other NATO countries’ desire to bypass Russia and to prevent the Russian energy monopoly in Europe. 3.3. Geopolitical Rivalries in the Caspian As a small state, Azerbaijan has worked to keep its independence from the surrounding states (Russia, Israel, Iran, Turkey). Normally, the literature categorizes four options available for small states in such situations: international organizations, self- reliance, alliance-building and strategic maneuvering (Mehdiyeva 2011:18). Azerbaijan as BP’s CEO. Deputy Prime Minister Igor Sechin commented on this appointment: "We have developed good and warm relations during [Dudley's] time in Russia. He knows the Russian market well." Earlier in 2008, Dudley had to leave Russia after he was accused by the AAR company (Mikhail Fridman, Len Blavatnik, and Viktor Vekselberg) of acting in the interest of the British shareholders. Currently, in 2012, BP is in the process of selling its stake in TNK-BP, which will most likely be bought out by the Russian side of the joint venture.(Razumovskaya 2010) 151 has clearly taken the fourth path – the strategic maneuvering, both in energy policy and military strategies. Energy security has always been at the center of Azerbaijan’s geopolitical priorities and national interests. Elin Suleymanov, then the Consul General in Los Angeles, emphasized in 2009 that Azerbaijan is a pragmatic state that has followed Heydar Aliyev’s strategic vision and promoted the country’s national interest (Suleymanov 2009). These strategic interests were especially obvious for all participants in the $4-billion, 1,099-mile BTC pipeline route selection. Built in 2006 by major energy companies that were “keen to get energy to market through private pipelines bypassing Russia,” BTC enjoyed “enormous U.S. government political backing” (Nanay 2009:117). Parallel to BTC, there is a gas pipeline (the South Caucasus pipeline) that brings natural gas from the Shah Deniz field to Ceyhan (Yergin 2011:63). In 1997, the US Department of State issued a report titled Energy Development in the Caspian Region, analyzing the expansion of the world’s energy supply and demand, the sovereignty and independence of the Caspian Basin countries, and the need to isolate Iran (Nassibli 2004:167). Nasib Nassibli, an Azerbaijani politician and former ambassador of Azerbaijan to Iran, argues that the report was focused on Azerbaijan’s independence from other Caspian states’ influence. In order to keep Russia and Iran in check, a prominent role in energy transportation (the BTC pipeline) was given to Turkey as a key NATO ally in the region (Nassibli 2004). The U.S. government opposed the Iranian route for the pipeline. Initially the United States tried to urge Baku and Ankara to select the Armenian route, as an attempt to solve the Armenia-Azerbaijan conflict. The Armenian 152 route, however, was rejected by Baku, it was decided that the pipeline would go through Georgia. Nassibli recalls that fifteen American oil companies were invited to the White House for a special meeting, in which they were persuaded that the BTC route “was preferable to others from the geo-strategic and geopolitical standpoints” (Nassibli 2004:168). According to Azerbaijan’s Foreign Minister Elmar Mammadyarov, decisions on energy projects are highly politicized at all the stages of energy projects, including planning and implementation, pointing to the Baku-Tbilisi-Ceyhan pipeline as an example. He also added that the U.S. government strongly supported the pipeline at all levels (Mammadyarov 2009b). However, “Russians saw Western influence in the Near Abroad as an attempt to further undermine Russia and retard the restoration of its Great Power status” (Yergin 2011:47). The Ankara Declaration, signed by U.S. Energy Secretary Bill Richardson on behalf of the U.S., finalized the BTC pipeline route. In 1998, the U.S. government created a special position for Caspian energy diplomacy and appointed Richard Morningstar as the U.S. Special Counselor (Nassibli 2004). Energy ties were accompanied by a joint regional military exercise, in which the United States participated along the troops from Azerbaijan, Georgia, Turkey, Russia, Uzbekistan, and Kyrgyzstan (Nassibli 2004:168). Just as the U.S. government has pursued the policy of multiple pipelines, Azerbaijan has worked to avoid dependency on a single consumer or a single pipeline, keeping its options open and periodically selecting new commercially and strategically viable projects (Mammadyarov 2009b). Potential customers of Azerbaijani gas (Poland, Italy, Russia, and Greece, among others) regularly negotiate with Azerbaijan. In addition 153 to BTC and oil Soviet-era pipelines, which cannot handle an increased volume of trade, Azerbaijan has considered options for new routes, such as the Trans Adriatic pipeline (through Georgia and Turkey to Italy); Nabucco (bypassing Russia); South Stream (through Russia to Bulgaria); and the Ukrainian-Polish Sarmatia (on the basis of the Odessa-Brody oil pipeline) (Sarmatia Likely to Endorse Feasibility Report on Euro-Asian Oil Transportation Corridor on April 24 2009). In 2009, Azerbaijan signed a substantial deal with Russia for natural gas export, which caused concerns in the West. Foreign Minister Mammadyarov allayed these fears about the deal between Russia and Azerbaijan, emphasizing that the deal came through only because Gazprom had offered “a very attractive price” for one billion cubic meters of natural gas (still a small fraction of Azerbaijan’s overall export). He responded to the critics by saying that the European partners had not yet fully committed to buying Azeri natural gas because of the internal disagreements in the European Union (Mammadyarov 2009b). Implicitly, Azerbaijan has shown to the European partners that Europe is not the only customer for Azeri energy resources, increasing competition among consumers and, therefore, increasing the importance of Azerbaijan. Simultaneously, Russian was showing support to Azerbaijan, referring to it as a focal point for peace and stability in the Caucasus region. Russia’s former special envoy Victor Kalyuzhniy in his speech called Azerbaijan a young, quickly developing sovereign nation, praising Ilham Aliyev’s focus on oil and gas resources, rather than “costly and unreliable” alternative energy (Kalyuzhny 2009). In the Western view, by praising Azerbaijan, Russia pursues its own interests, such as the South Stream pipeline, in order to 154 undermine Nabucco, which could substantially reduce Russia’s energy influence (Larrabee 2009). Azerbaijan could potentially divert its oil and gas from Nabucco to pro-Russia and pro-Iran projects. Iran was also avoided for geopolitical reasons during the selection of the pipeline route. For years, Iran had tried to enter the Caspian gas market. Mahmood Khaghani, Chief of the Caspian department in the Iranian Oil Ministry, stressed that Nabucco would be more cost efficient and economically justifiable if Iranian natural gas were allowed in. He also claimed that BTC was not economically feasible but only politically justified to bypass Russia. Disagreements between Iran and the West on everything from nuclear issues to oil export have prevented Iran from entering Caspian projects. Back in 2009, Iran attempted to shift focus from inter-governmental hostility between, suggesting a new energy project model that would increase the decision-making power or private companies and reduce the role of governments that would become project custodians (Khaghani 2009). Nevertheless, Azerbaijan has skillfully maneuvered among the interests of the West, Russia, Iran, Israel, and China, keeping friendly relations and increasing the country’s bargaining power. The government has underscored that Azerbaijan is “not committed to Nabucco but supports the project,” and that the Azeri leadership has been waiting for potential European partners in Nabucco to solve multiple disagreements among themselves before asking the Azerbaijan to commit (Abdullayev 2009). Minister Mammadyarov has evaluated US-Azerbaijan relations as stable and productive. Azerbaijan has cooperated with the United States in the Memorandum of Understanding on Energy Security Cooperation in the Caspian Region (2007) and even 155 sent troops to Afghanistan and Iraq. Mammadyarov praised a recent re-appointment of Ambassador Richard L. Morningstar as Special Envoy for Eurasian Energy (who had already held this position in the 1990s), as a sign that Azerbaijan is again on the U.S. foreign policy and trade agenda (Mammadyarov 2009b). The U.S. government has provided informational support and guidance to American companies in the Caspian through the U.S. Commercial Service and the Overseas Private Investment Corporation (OPIC), among other means ("Export.Gov: Helping U.S. Companies to Export" 2009): OPIC provided USD 100 million in political risk insurance to U.S.-based financial institutions and U.S. equity partners in the Baku-Tbilisi-Ceyhan oil pipeline. In 2002, OPIC invested USD 50 million in Soros Investment Capital for projects targeted to all three Caucasus countries. OPIC also disbursed a USD 4.6 million loan to Caucasus Airlines, a regional air carrier based in Tbilisi. Caucasus Airlines ceased operations in late 2004 after a dispute arose with Azerbaijan's state air carrier AZAL over terms on the Baku-Tbilisi route. In 2005, OPIC provided financing to Baku Oil Tools for a joint venture with the State Oil Company, SOCAR. In 2006, OPIC provided USD 7.5 million to ShoreBank International Ltd for SME and mortgage loan portfolio expansion in Azerbaijan ("Doing Business In Azerbaijan: A Country Commercial Guide for U.S. Companies" 2008:47). As Ambassador Pashayev’s put it, “[t]he stars and stripes do indeed follow the U.S. dollar” (Pashayev 2009:113). The president of SOCAR Rovnag Abdullayev and other Azeri leaders have repeatedly underscored the importance of the American support for regional project implementation (Abdullayev 2009). The Azeri government have described the regional pipelines (BTC and the South Caucasus pipeline) as a guarantor of stable U.S.-Azerbaijan relations, Azerbaijan’s energy independence from Russia, and the country’s commitment to cooperate with the West (Pashayev 2009:115). 156 One issue that remains unsolved by U.S.-Azerbaijan energy ties is the Azerbaijan- Armenia conflict in Nagorno-Karabakh. The U.S. government has “shied away” from solving the issue, and Azerbaijan has not received as much support from the United States as the Azeri government expected (Pashayev 2009:111). On the contrary, a U.S. representative to the United Nations voted against Azerbaijan’s attempt to bring Nagorno- Karabakh back to Azerbaijan. Ambassador Pashaev also pointed in 2009 that the U.S. government was more critical about democracy flaws and human rights abuse in Azerbaijan than about similar problems in Armenia (Pashayev 2009:123). Nevertheless, the Nagorno-Karabakh conflict was one of the main reasons why Azerbaijan and the Western partners chose Georgia over Armenia for the BTC route. According to some analysts, Russia supports of Armenia, to use Nagorno-Karabakh as a “divide and rule” policy in the region. However, this support is different from Russia’s relations with South Ossetia, because Nagorno-Karabakh does not share a border with Russia (Kjaernet 2010:154). Georgia, which has had friendly relations with Azerbaijan and the United States, was considered a low-risk country, despite domestic political instability in the 1990s and tense relations with Russia (Shaffer 2009a). Although Georgia’s domestic situation was complicated by the South Ossetia and Abkhazia separatism movements, the need by bypass Russia and pro-Russian Armenia prevailed over potential dangers of the Georgian route. As a result, the BTC pipeline strengthened Georgia’s and Turkey’s position as a transit state, increasing their geopolitical significance, transit revenues, and a stable access to energy resources (Nassibli 2004:168). 157 During the war between Russia and Georgia in August 2008, the physical security of BTC was the main concern for Azerbaijan and Western companies. Russia might have damaged the pipeline to disrupt the flow of oil from the region. However, these fears did not materialize, and a vice-president of BP Khalilov stated in 2009 that the Russian forces had not attacked the pipeline or other BP facilities. Although the pipeline was indeed non- operational for several days during the war, it happened because of a terrorist attack by Kurdish separatists on the Turkish side. After the damage from this explosion was repaired, the pipeline operated normally even during the war (Khalilov 2009). This was the lowest point in U.S.-Russia relations, and American critics were very vocal about Russia's policies in the Caspian. Edward Lucas in New Cold War stressed that Azerbaijan built the BTC pipeline to avoid the Kremlin's «imperial embrace» and control. As previously with BTC, the United States strongly supported the planned Nabucco pipeline. In 2003, a senior adviser for Caspian Basin Energy Diplomacy Steven Mann stated that the choice of pipeline routes and trade partners was a matter of sovereignty for Caspian states (Mann 2003:153). In 2008, U.S. interest was more direct: Vice President Cheney, visiting Azerbaijan, Ukraine, and Georgia, expressed disappointment about Azerbaijan's decistion to export natural gas to Russia, which in his view was made out of fear of a Russian invasion after the Georgia war (Lucas 2008). Azerbaijani representatives, in unofficial discussions, expressed concern that the “reset” in U.S.-Russia relations and newly achieved closeness between the United States and Russia meant turning away from the Caspian region, undermining U.S.-Azerbaijan relations. One official lamented that the “U.S. foreign policy is inconsistent” - by “giving 158 in” to Russia, the United States is losing its strategic “game,” while Russia is working on its strategic dominance in the region. On the other hand, Azerbaijani decision-makers admitted that Turkey charged a high price for its transit services to Azerbaijan, and the diversification of energy routes now almost means including Russia, rather than bypassing it. In 2011, during his visit to Moscow, Foreign Minister Elmar Mammadyarov underscored that economic relations and trade between Azerbaijan and Russia have improved. He negotiated with his Russian counterpart Sergey Lavrov on increasing export of Azeri oil (via the Baku-Novorossiysk pipeline) and natural gas. After the initial natural gas export contract between SOCAR and Gazprom (which stirred concerns in the West), the two countries signed an additional agreement that allows Gazprom to import 2 billion cubic meters of Azeri natural gas per year ("Azerbaijan, Russia Discuss Increasing Oil and Gas Export" 2011). Some experts described energy ties between Russia and Azerbaijan as “economization,” i.e. a policy that prioritizes economic and business factors in decision- making (Kjaernet 2010:151). All this geopolitical maneuvering by Azerbaijan that tries to balance the United Sates/NATO allies and Russia, ensuring Azerbaijan’s independence in energy export decision-making, as well as the desire of the West to do everything possible to bypass Russia and to reduce Russia’s influence in the region, provides a strong support to the geopolitical hypothesis that stresses the role of geopolitical rivalries and geopolitical calculations (in this case, the calculations for the BTC pipeline route, when the parties chose the most expensive and technologically challenging route but made sure that the 159 route bypass Russia and Iran and went through friendly Georgia and Turkey). The geopolitical sub-hypothesis that implies that government control in the energy sector increases the probability that geopolitical calculations will prevail in energy decision- making is especially supported in the U.S.-Russia Azerbaijan case. As the evidence above shows, even the Western companies had to follow their governments’ guidance (e.g. meetings in the White House) in terms of which route to select, despite higher costs and expenses of the selected projects. 3.4. Domestic Interest Groups The domestic interest groups hypothesis predicts that if powerful domestic lobbies are in favor of energy cooperation, the chances of cooperation are higher. However, if powerful lobbies are divided on some issue or focused on other issues, they will not be able to interfere with energy deals even if they oppose them. Azerbaijan’s energy sector is tightly controlled by the state. As the power of the Aliyev family, who has ruled in Azerbaijan “for all but six years since 1969,” has grown, the country has not developed fully functioning democratic institutions, as resource curse literature (Karl, Ross) would predict. Petroleum wealth allowed the government to “stay in power simply by dolling out patronage – whether through subsidies, tax cuts, public sector employment, or lucrative contracts” and to “buy political support, pay off opposition, and depoliticize the population” (Overland et al. 2010). Azerbaijan, as well as Georgia, has 160 been successful in lobbying the U.S. government to help promote favorable policies toward the Caspian region (MacFarlane 2011:112). As a result, the opposition to energy projects comes from abroad, e.g. Armenian lobby in the United States. Armenia and Azerbaijan has been in a protracted conflict over the Nagorno- Karabakh region. This conflict originated from artificial state borders, established by the Soviet leader Joseph Stalin in the early 20 th century, so that he could “divide and rule” small nations in the Soviet Union. In 1924, the Soviet central government made Nagorno- Karabakh an autonomous entity within the Soviet Republic of Azerbaijan, although the majority of Nagorno-Karabakh’s population (94 percent) was ethnically Armenian. However, until the late 1980s, the Armenians and the Azerbaijani in Nagorno-Karabakh lived together peacefully. The ethnic conflict started in February 1988, when Nagorno-Karabakh’s legislative body (dominated by Armenian deputies) decided to unite the Nagorno-Karabakh region with Armenia, based on the fact that the region is dominated by the Armenian population. The Armenian population in Nagorno-Karabakh had felt discriminated against by the Heydar Aliyev government in the 1970s and 1980s, prior to this decision. This decision caused violence between the Armenians and the Azerbaijani and a massacre in the city of Sumgait. In 1989, the last president of the USSR, Mikhail Gorbachev, attempted to reconcile the two sides but did not succeed, and Azerbaijan officially announced that Nagorno-Karabakh was under the occupation by the Armenian army. As an attempt to return Nagorno-Karabakh to Azerbaijan, the Azerbaijani government established an economic blockade of the region that also failed to bring the desired outcome. When the 161 USSR ended in 1991, the conflict turned into a full-scale war, in which about one million Azerbaijani people became refugees or internally displaced (Nagorno-Karabakh 2005). The strategic Lachin corridor (the town and its surrounding area connecting the Nagorno- Karabakh Republic with Armenia) was the area of heavy fighting in 1990-1994. Since then, the restoration of Azerbaijan's territorial integrity became the main security priority for Azerbaijan, in its National Security Concept and all other official policies (Alieva 2011:198). The United States and Russia have tried to mediate the conflict by economic and diplomatic methods, although not coordinating their efforts enough. Historically, Armenia received more assistance from both states. Russia provided Armenia with arms from 1993 to 1995 and continuously supplied it with natural gas. In the United Sates, a numerous and powerful Armenian community has lobbied for support of Armenia. As a result of their lobbying activities, the United States cut off the U.S. economic assistance to Azerbaijan in the 1990s, under Section 907 or the Freedom Support Act, demanding that it lift the blockade against Armenia (Nagorno-Karabakh 2005). In addition to blocking the economic assistance to Azerbaijan, the Armenian lobby (the Armenian Cultural Association of America, 21 the Armenian National Committee of America, 22 the Armenian Assembly of America, 23 the Armenian General Benevolent Union, the Armenian Church, and others) in the United States has recently implemented other successful campaigns. 21 Led by Bedros Bandazian, Vasken Aivazian, Antranik Boudakian, Bedros Der-Bedrossian, and others. 22 Led by Kenneth V. Hachikian, Seto Boyadjian, Aida Dimejian, Ari Killian, and Stephen Mesrobian. 23 Led by Bryan Ardouny 162 In 2011, Armenian lobbyists influenced U.S. Congress members to withdraw U.S. Ambassador to Azerbaijan Matthew Bryza who had held a temporary ambassadorial position in Baku. Previously, Bryza had held positions in the U.S. government of Deputy Assistant Secretary of State for European and Eurasian Affairs and an adviser on Eurasian energy issues. He was one of the negotiators in the Nagorno-Karabakh mediation talks, one of the multiple pipelines policy architects who helped to shape the role of Azerbaijan in the Caspian energy security and energy supplies to the West (Lomsadze 2012). The Armenian community claimed that the Ambassador had a bias and excessively close ties to Azerbaijan and Turkey. 24 In the U.S. Senate, Barbara Boxer of California and Robert Menendez of New Jersey were the most vocal opponents of Amb. Bryza’s confirmation. Boxer and Menendez have well-known ties with the Armenian community in the United States. The Azerbaijani community’s reaction was vocal and blunt: On behalf of the Azerbaijani government, civil society leaders, 25 and the diaspora in the United States, Deputy Foreign Minister Araz Azimov said that this case “could become a bad precedent for American diplomats who would not know whose policy they should pursue – the president’s policy, the Senate’s or the interests of a handful of lobbyists” (Abbasov 2012). Earlier in 2009, Sen. Robert Menendez had received an award from the Armenian National Committee of America (ANCA) Eastern Region for his “commitment to the Armenian American community,” as ACAA Board Member George Aghjayan said at the award 24 Hi wife, Zeyno Baran, is a Turkish American and works as the Director of the Center for Eurasian Policy and a Senior Fellow at the Hudson Institute, a powerful think tank in Washington, D.C. 25 These society leaders included Eldar Namazov, chief of staff under the late President Heydar Aliyev; Leyla Aliyeva, Center for National and International Studies Director; Ilgar Mammadov, political analyst; Sabit Bagirov, economic analyst; and Mehman Aliyev, Turan News Agency Director; Elhan Shahinoglu, head of Baku’s Atlas research center. 163 ceremony, referring to the Senator’s support of Armenia in the issues of the Armenian Genocide and Nagorno-Karabakh ("Sen. Robert Menendez to Receive 2009 ANCA-ER Freedom Award at Third Annual Banquet" 2009). Another instance of the powerful lobbying action by the Armenian community is the failed Armenia-Turkey reconciliation protocol. The accord between the two countries was signed in 2009 for the re-opening of the countries' border, which was closed by Turkey in 1993 in solidarity with Azerbaijan after Armenian troops had occupied Nagorno-Karabakh. The accord had its critics, though, who argued that it did not recognize the Armenian Genocide ("Turkey, Armenia Agree to Forge Ties" 2009). The Armenia-Turkey rapprochement process of 2008–2009 that started on a high note have not gone far. In 2011, Armenian military and political analyst Richard Giragosian and other Armenian experts 26 expressed their disappointment with the development of the process, stressing that it was longer “a priority for Turkey,” and Turkey was trying to link the rapprochement to the issue of Nagorno-Karabakh, which was unacceptable by Armenia ("Armenia Delegation Disappointed with Istanbul Symposium to Revitalize Armenia-Turkey Rapprochement: Giragosian" 2011): Despite the fact that both the US and Russia, as well as the EU have made it clear there is no reference to Karabakh within the Protocols. And to attempt at this late stage to re-link the issues is unhelpful at best and insincere at worst. So what we see is Turkey seems rather insincere and in danger of being perceived as an unreliable and unready interlocutor for Armenia. Armenian analysts also emphasized close ties between Turkey and Azerbaijan that have intervened in the Turkey-Armenia reconciliation process. The same senator who 26 Caucasus Institute Director Alexander Iskandaryan, Human Rights and Conflicts Research Institute NGO President Armen Melkonyan, and Head of the Political Studies Department at the Caucasus Institute Sergey Minasyan. 164 played a key role in Ambassador Bryza’s story had gone even further in the Turkey- Armenia protocol: He called the protocol provisions, offered by Turkey, “frankly absurd,”and “an insult to the Armenian people. It is an insult to the memory of the victims. It is an insult to the top scholars who have clearly spoken on this issue and issued their unequivocal conclusions” ("Sen. Menendez Calls Protocols "Insult" to Armenian Nation" 2009). The powerful Armenian Diaspora even differed from the position by the President of Armenia Serzh Sarkisian. When Sarkisian arrived to California to discuss (“or force down our throats,” as a local Armenian commentator wrote in an Armenian American publication) the Turkey-Armenia protocols, he was harshly criticized by the Armenian Diaspora for supporting “the dangerous and defeatist documents that are sure to irreversibly change the course of Armenian history” (Khachatourian 2009). Moreover, about 10,000 Armenians protested Sarkisian’s agenda regarding the protocol in Glendale (Khachatourian 2009). Even though the results of Turkey-Armenia negotiations are not yet set in stone and are developing, it has been already obvious how powerful the Armenian Diaspora has been in holding the protocols back. These two examples – the U.S. Ambassador and the protocols – are very typical for how influential the Diaspora is. Nevertheless, they were not able to block the Baku-Tbilisi-Ceyhan pipeline or to divert it route via Armenia. The Diaspora tried to persuade the involved states that the route would be more economical and efficient via Armenia but it failed. In 2001, the Armenian lobby asked President George W. Bush to facilitate the route for the pipeline from Azerbaijan to Turkey via Armenia, instead 165 of the BTC route. They argued that it would make the pipeline $600 million cheaper than the BTC costs ("Armenian Lobby Applies Pressure to Get BTC Passing Through Armenia" 2001). Nevertheless, Armenia’s close ties with Russia and the U.S. plan to bypass Russia with the new pipeline resulted in the BTC pipeline selection. The Azerbaijani lobby was emphasizing these aspects to ensure that Armenia was not included in the route, for its own reasons – mainly Nagorno-Karabakh. Again, the extremely powerful lobby was not able to influence the U.S. government in this geo-strategic decision of avoiding the Russian territory for the BTC pipeline route, which is in line with the geopolitical hypotheses. It happened also because other, non- energy, issues has been more important for the Armenian Diaspora in the United States – Nagorno-Karabakh and the Armenian Genocide. The lobby has been much more united and influential in these aspects than in the oil and gas issues, in which historically Armenia has been outmaneuvered by Azerbaijan and Turkey. 3.5. Conclusion In this chapter, the U.S.-Azerbaijan energy cooperation case was explored using the integrated framework. The energy ties between these two countries and strong American support of Azerbaijan’s position in determining the BTC pipeline route and other multibillion projects are quite puzzling for several reasons: the geographic distance of Azerbaijan from the United States, varying estimations of Azerbaijan’s oil and gas reserves, human rights problems, lack of democratic institutions, and friendly relations with Iran. 166 Economic factors can only partially explain why the United States is so interested in Azerbaijan. Although the investment climate in Azerbaijan has been indeed improved over the last decade, and the government has been very friendly with Western investors, it does not explain some of the outcomes of energy deals, such as the route of the BTC pipeline. In the case of Baku-Tbilisi-Ceyhan pipeline, the geopolitical considerations of all the involved governments trumped the economic calculations of costs and benefits. Alternative routes – via Russia, Armenia, Iran – would have been much cheaper but would not ensure the main objective of the policy of multiple pipelines: to deliver Azerbaijani oil and gas to the NATO partners via friendly transit countries (in this case, Georgia and Turkey). Not only the cost of pipeline construction was the highest among the other options but also Turkey has been charging quite high fees for transit, aggravating Azerbaijan and pushing it to sign oil and gas import contracts with Russia as a way to balance the West. The state control of the Azerbaijani energy industry and a close guidance by the U.S. government of American energy companies also conforms to the geopolitical sub-hypothesis that predicts that an increased state control leads to the prevalence of geopolitical considerations. Finally, the domestic interest groups in this case provide mixed evidence for the domestic group hypothesis. On the one hand, the powerful Armenian lobby in the United States, which has been able to block such initiatives as the re-appointment of the U.S. Ambassador to Azerbaijan and the Turkey-Armenia rapprochement, was nevertheless unable to block BTC or divert its route through Armenia. On the other hand, the Azerbaijani government (and the Azerbaijani lobby) was skillful in maneuvering among 167 great powers and secured the BTC pipeline route and other projects. The explanation again shifts to the geopolitical interests of the U.S. government (i.e. the policy of multiple pipelines, the need to bypass Russia, etc.), and the Azerbaijani actions were fully in line with these geopolitical goals. 168 Chapter 4. Russia-Germany Energy Cooperation Nord Stream is another step in solidifying the good Russian relationship with Germany and the EU. – President Dmitry Medvedev, November 2011 The Nord Stream pipeline is "a waste of European consumers' money" and “the Molotov-Ribbentrop pipeline.” - Polish Foreign Minister Radosław Sikorski, 2006 Russia and Germany has closely cooperated in oil and gas trade and investment for many decades. Even though Germany is the leading state in the European Union, the German government has not followed many other European members’ policy of reducing imports of oil and gas from Russia in favor of shale gas and Middle Eastern sources. Nor does Germany seem to be concerned with harsh criticism of key transit states for Russian energy resources – the Baltic States, Poland, and Ukraine. Instead, Germany and Russia has built a natural gas pipeline – 1,224-kilometre-long (761 miles), $10.2-billion Nord Stream -- that goes on the bottom of the Baltic Sea and directly connects Russia and Germany, bypassing Poland and traditional transit states. This pipeline stirred a heated debate both in the European Union and in Russia about whether it will increase Germany’s dependency on Russia and whether the pipeline is economically justifiable. The critics (mainly, the Baltic States that lost some of their influence and transit fees with the new pipeline’s implementation) assert that “the German government … has been the prime example of a European country actively seeing to foster dependencies with Russia” 169 (Perovic 2009:11). The proponents respond that the pipeline is the most economical way to deliver natural gas in Europe and will pay off very quickly, delivering the environmentally friendly fuel at a competitive price. Such close and growing energy ties between Russia and Germany are puzzling for several reasons. First, despite an obvious geographic closeness and Russia’s rich oil and gas resources, this economic explanation alone is not enough to account for ever increasing energy ties between the two states, especially that German businesses have to operate in Russia in the same increasingly difficult investment climate as do other foreign investors. For example, Poland and the Baltic States, while being in the same geographical proximity, are doing everything possible to reduce dependency on Russian oil and gas. Second, Russia and Germany had a long history of geopolitical rivalry and the legacy of the Second World War, even though Germany-USSR relations fluctuated during the Cold War, with occasional periods of warming in their ties. The fact that the two states could overcome this mostly negative past is quite puzzling, especially if one compares Russia-Germany relations to other cases in which the wounds and the legacy of WWII and the Cold War (e.g., the Baltic States or even U.S.-Russia relations) are still affecting contemporary economic ties. Third, as was mentioned before, Germany's decision to build this pipeline contradicts the main energy policy of the European Union that aims at diversifying energy supplies, especially away from imports of Russian oil and gas. While Germany is leading the European Union in many other issues (e.g. financial, fiscal, monetary, military), the 170 country has taken a clearly separate path in ensuring its own energy security, increasing imports of Russia’s oil and gas and investing billions in new pipelines. Finally, the Nord Stream pipeline project went through even despite a strong resistance and protests by Russian and European environmental NGOs that raised concerns about possible damage to the Baltic Sea flora and fauna, as well as a possible disturbance of chemical weapons that were left on the bottom of the Baltic Sea by fighting states. Even though it is hard to expect that such societal groups will have influence in Russia, they are normally very influential in Germany, shifting the German government’s stance on multiple issues (e.g. nuclear-free economy, solar energy, etc.) Nevertheless, in this case, the government’s decision to build the pipeline prevailed over multiple societal objections. An analysis of the Germany-Russia case shows that the two countries have put their differences aside for the sake of economic benefits (a stable supply of natural gas to Germany and a large export partner for Russia). The economic potential hypothesis is the most influential in this case. In addition to that, some geopolitical elements also convincingly add to the explanation here. The Nord Stream pipeline adds to Germany's importance as a major enery hub and the reseller of natural gas for Europe, which increases its geopolitical importance. Also, in line with the geopolitical sub-hypothesis, in this case the governments are major decision-makers in the Nord Stream pipeline projects, so the outcome is in line with the government energy policies. To overcome the legacy of historical enmity and to take advantage of the geographic proximity and opportunities, the two governments have had to apply substatial political will. It is a balanced combination of the economic and geopolitical evidence that provides an explanation of this puzzling case. 171 4.1. Economic Considerations This section applies the economic potential hypothesis that predicts that the chances of energy cooperation are higher when the exporter’s energy resources are plentiful and the investment climate is favorable. Russia’s investment climate was addressed in detail in Chapter 2. Despite Russia’s tightening of state control over energy resources and overall difficulties for foreign investors, German companies have been among those who have seemed to operate in Russia more seamlessly. The following pages till explore the availability and accessibility of natural gas supplies in Russia and the history of Russia-Germany and EU-Russia economic relations in the energy sector. 4.1.1. Russia’s Natural Gas Resources and Economic Ties with Germany Russia, sometimes called «the Saudi Arabia of natural gas» possesses the biggest natural gas reserves in the world. Energy expert Jonathan Stern, however, points to large discrepancies in various sources of data about Russian natural gas reserves. The Russian Energy Strategy stipulated in 2005 that Russia possessed 127 trillion cubic meters, which was half of the estimate provided by the Russian government in 2003 (Stern 2005:1). Just three giant fields - Bovanenkovskiy, Harasaveiskiy, and Novopostovskiy (Yamal) - have combined reserves of 5.9 trillion cubic meters. Some of the giant fields have been developed by government-controlled companies jointly with international ones. For example, the Shtokman field in the Barents Sea (3.7 trillion cubic meters of natural gas) is 172 being developed jointly with Total (France) and Statoil (Norway); the South Russian field (Yamal, 1 trillion cubic meters) - with Wintershall and Ruhrgas (Germany); and the Kovistinskiy field (East Siberia, 2 trillion cubic meters) - with TNK-BP (Yazev 2010:76). Figure 24. Russian Gas Export to Germany, 1973-2010 Year Amount, Bcm 1973 1.1 1975 6.4 1980 16.2 1985 18.7 1990 26.6 1995 32.1 2000 34.1 2003 34.9 2008 38.0* 2009 35.8** 2010 39.0** Source: (Stern 2011); * - (Gazprom 2011), ** - EnergyDelta.org In addition to gas exports, Russia’s Gazprom participates in Germany’s natural gas distribution system. In 1993, Gazprom and Germany’s Wintershall formed WINGAS – a joint venture that owns and operates 2,000 km of Germany’s gas pipelines, as well as the Rehden underground gas storage facility - the largest in Europe, with the capacity of 4 billion cubic meters. As of 2011, Gazprom’s share in WINGAS is 50% minus one share (Gazprom 2011). Germany produces only 20% of natural gas it consumes. The remaining 80 percent is imported from Russia (39% share of the overall gas imports), Norway (26%), the Netherlands (23%) and others (12%) (Eni 2011). Importing gas from Russia, Germany has 173 been heavily dependent on transit countries, such as Ukraine, Poland, and Belarus, via a complicated system of pipelines. Figure 25. Oil and Gas Pipelines from Russia to Europe (the Economist, 2012) The flow of natural gas has been interrupted several times because of trade disagreements between Russia and transit states, such as a dispute over transit fees and gas prices between Ukraine and Russia in January 2006. According to Gazprom, Ukraine had siphoned the European gas for internal consumption during the crisis; the Ukrainian government denied these accusations. 174 Since 2002, prices in the Former Soviet Union have gradually moved closer to the market level, but they are still a subject of intense negotiations between Russia and the post-Soviet regions. Gazprom announced in 2009 that the Russian state budget would be underpaid $ 2.5 billion because of the Belarus-Russia energy trade agreement that stipulated sub-market gas prices for Belarus (Mazneva 2009). However, in 2012 Gazprom already charged almost the same price for natural to Ukraine as to Europe ($416 and $416 dollars per cubic meter respectively)("Gazprom Opredelilsya s Tsenoi na Gas Dlya Evropy: Ona Budet Nizhe, Chem Dlya Urkainy" 2012). The dispute led Germany to question the reliability of transit routes. As a solution, Germany and Russia proposed a direct pipeline – Nord Stream. As a Wingas executive Gerhard König put it, “Europe needs ways of accessing supplies that are independent of transit countries, like the construction of the Baltic Sea pipeline” (2009c). As a result, Nord Stream, a 55-bcm per year natural gas pipeline was built on the bottom of the Baltic Sea in the exclusive economic zones of Denmark, Finland, and Sweden, with the onshore terminals in Germany and Russia ("Nord Stream AG: Project Information Document. Offshore pipeline through the Baltic Sea " 2006). Nord Stream is a multinational project that includes Gazprom (51%), Wintershall (a BASF subsidiary), E.On, and Gasunie (the Netherlands) (Topalov 2009). In November 2011, the inauguration ceremony for the Nord Stream pipeline was attended by state leaders Angela Merkel and Dmitry Medvedev, as well as the prime ministers of France and the Netherlands, Francois Fillon and Mark Rutte, and EU energy commissioner Günther Oettinger ("Germany, Russia to Launch Nord Stream" 2011). 175 Figure 26. Nord Stream Pipeline Route Source: Nord Stream AG, http://www.nord-stream.com/the-pipeline/pipeline- route.html Although Russia’s reserves are indisputably large, experts have voiced several concerns (and possible solutions) about whether Russia is producing enough natural gas, to be able to meet the country’s export commitments to Europe. First, Russia’s oil and gas production technology suffered from the lack of investments in the 1990s, which affected the current state of the industry’s technological development. Russia’s technology of oil and gas production is more energy intensive and less energy efficient than that of developed countries. The newest technology, such as liquefied natural gas production (LNG) was introduced in Russia only recently, as a part of the export diversification effort (Yazev 2010). Natural gas, compressed and cooled to the temperature of -260F may be delivered around the world in the liquid form by tankers, unlike the conventional natural gas that only can be delivered by pipelines in the gas form. Currently, only one LNG plant is operational in Russia – Sakhalin II. The Russian government plans to build three other LNG plants –Yamal, Shtokman, and Baltic. 176 Second, geographically, most new natural gas production sites in Russia are located in East Siberia, the Russian Far East (including Sakhalin), and the Arctic. The Arctic is the region of an increasing importance for all the Arctic states, and especially for Russia. The region contains huge oil and gas deposits. However, this is the most technologically challenging and costly region to produce oil and gas due to the harshest weather conditions, half-a-year night conditions, ice, and the lack of infrastructure. The environmental dangers of producing oil and gas here are the highest, as well, as any accident or spill would be fatal for the fragile environment in the Arctic. In addition to new oil and gas fields, another way to meet the export commitments to Europe is to continue delivering Central Asian gas through Russia from Turkmenistan and Kazakhstan. However, this solution has been complicated, as Central Asian states start to demand prices closer to the European ones and try to bypass Russia through pipelines in the Caucasus (e.g. the Trans Caspian pipeline). Third, another short-term solution for Gazprom is to buy natural gas from Russia’s smaller independent companies and resell it via Gazprom’s monopolistic system of pipelines (Hanson 2009:42). The largest shareholder of Gazprom is the state, which in 2005 reached a controlling stake (50.002%). As of 2008, Gazprom’s shareholders were the state of the Russian Federation (50.002%), ADR holders (20.150%), and other shareholders (27.848%). Foreign nationals are allowed to buy Gazprom’s shares (Gazprom 2011). Germany was one of the states that has taken full advantage of opporunities in the Russian economy. The German government has pursued a pragmatic approach to Russia, focused on trade and investements and less on democracy promotion, human rights, and 177 other sensitive issues. Among Russia's trade partners, Germany has long been in top five export-import countries. The relationship of a particular importance -- between Vladimir Putin and Gerhard Schröder – has been very productive and reached the level of personal friendship. During their terms, the two leaders participated in regular intergovernmental meetings between the two countries, and Schröder was even criticized for being very lenient about Putin's centralization of power and lack of democratic practices (e.g. on the Yukos case). Schröder's leniency to Putin even stirred domestic criticism in Germany. Nevertheless, their partnership remains stable -- Gerhard Schröder has been a board member of Nord Stream, helping to move the project to implementation. Angela Merkel has continued the pragramatic approach to Russia practiced by her predecessors. During Dmitry Medvedev's presidency, she repeatedly met with him and facilitated billion-dollar investment deals. Top-level politicians and executives from both countries regularly meet in forums, such as the 2010 Russian-German Commodities Forum in Freiberg, Germany. 27 The forum was established in 2006 by the major mining universities of Germany and Russia, under the aegis of both governments, in order to “bring together manufacturers, politicians, and academics” (Filatova 2010:11) and to ensure an uninterrupted supply of raw materials from Russia to Germany. The Nord Stream pipeline has been a regular topic discussed in such bilateral meetings. 27 The participants included Prime-Minister of Saxonia Stanislaw Tillich, Deputy Federal Minister of Economics and Technology Jochen Homann (Germany), Saxonia’s Minister of Finance Georg Unland, Minister of State of Foreign Ministry of Germany Cornelia Piper, and President of Russian Gas Society Valeriy Yazev (p. 10) (Bandlova 2010) 178 Critics of the pipeline have questioned its economic feasibility. Opponents of the pipeline, such as former Russian deputy energy minister Vladimir Milov, describes Nord Stream, as well as other pipelines bypassing Ukraine and Poland, as purely political projects, expensive and problematic. Milov argues that it is cheaper and more efficient to transport natural gas by land via Ukraine. He further insists that Russia should more actively participate in international energy institutions and charters rather than trying to find a “perfect” transit route. Milov, agreeing with environmental NGOs, also emphasizes possible environmental damage to the Baltic Sea. As a more economical option, he recommends that Russia should reach a more stable agreement with Ukraine and lay another gas pipeline via this country, parallel to the existing pipeline infrastructure (Grigoriev and Milov 2009). In defense of the pipeline, another prominent expert, Leonid Grigoriev, argues that international regimes are not effective enough to protect Russia’s interests and to ensure that transit countries comply with their contractual obligations. He refers to a serious of disputes between Russia and Ukraine over transit fees, gas prices, and Ukraine’s debt to Gazprom. Even though the disputes were simmering for several year, the crises happened “conveniently” in January 2006 and January 2009 in the midst of winter, when Russia cut off natural gas supplies to Ukraine. Since gas to Western Europe goes through Ukraine by the same pipelines, Ukraine used that gas for its own needs, leaving the Western consumers without the gas. These episodes sent chills across Western Europe and could not have happened in worse time than in the middle of winter. Both Russia and Ukraine blamed the other for the crises: the main result of which was the realization in Germany 179 that using transit countries is risky. Despite Russia’s disputes with Ukraine, Nord Stream, he continues, was started as a German initiative, rather than Russia’s attempt to bypass its transit countries. Grigoriev maintains that Nord Stream is a commercial project that will be very profitable in the future (Grigoriev and Milov 2009). This view has so far prevailed both in Russia and in Germany. Germany’s position is strengthened by its policy of diversification and establishing economic ties with as many exporters as possible and diversifying its energy imports. Nord Stream, which cost $12.5 billion to build, is important for Germany not only for its domestic gas supply but also for its role in European energy security. It will provide Germany with an exceptional access to Russian gas and will increase the importance of Germany in the European energy redistribution system (Szabo 2009:29). The capacity of the pipeline is 55 billion cubic meters of gas a year. Analysts debate about how cost- efficient the pipeline is but most common estimates predict that the pipeline will pay for itself in 10-16 years, depending on the price of natural gas. For the last two years, the price of Russian gas for Germany was about 450 dollars for 1,000 cubic meters, but it may change in the future, depending on market conditions and demand. Germany, of all European countries, has been especially concerned with creating an extended system of natural gas supplies. This system, which includes 46 natural gas storage facilities, was established in order to secure gas supplies in case of import shortages. Germany Energy and Water Association chief Martin Weyand estimated that the facilities would be able to store enough gas for 40 days consumption in case of interruptions in imports ("Europe Pushes for Russia to Resume Gas Deliveries" 2009). 180 This system has been one of the major priorities in German energy policies over the last decade. Another area of cooperation with Russia is greenhouse gas emission reduction and renewable energy. Germany's RWE has partnered with Russia's Kurchatov Institute and the Skolkovo Foundation to explore «pro-climate» energy generation and utilization projects, such as biomass and energy efficiency ("RWE, Russians Explore Energy Efficiency" 2011). Research on energy efficiency and energy mix diversification has been especially important for Germany in the aftermath of the Fukushima nuclear disaster in Japan. In 2011, German Chancellor Angela Merkel announced that Germany would close all of its 18 nuclear power plants between 2015 and 2022, which currently produce about 28 percent of the country’s electricity (Daly 2011). In order to ensure its energy supplies, Germany uses several ways: first, diversification of exporters (Russia, the Middle East); second, diversification of transit routes (Ukraine, Poland, Belarus, the Baltic Sea route); third, diversification of energy generation (gas, oil, nuclear, alternative energy) ("Europe Pushes for Russia to Resume Gas Deliveries" 2009). However, in its efforts to diversify sources, Germany, unlike many other EU countries, has not reduced energy import from Russia. It is partly because Germany is not as much dependent on Russia as other countries (see the table below). 181 4.1.2. European Diversification Efforts Diversification of natural gas supplies has become a priority for the European Union over the last decade. The table below shows Europe’s dependency on Russia, which is even greater for some countries than what is presented here, because natural gas import from Turkmenistan (not shown in the table) goes to Europe through pipelines, also controlled by Russia (Gelb 2007). Figure 27. Share of Russian Natural Gas in Consumption in 2004 (Gelb, 2007) Country % Russian Gas in Domestic Consumption Austria 69 Belarus 99 Bulgaria 99 Czech Republic 77 Estonia 100 Finland 98 France 24 Georgia 100 Germany 39 Greece 82 Hungary 64 Italy 31 Latvia 100 Lithuania 100 Moldova 100 Netherlands 6 Poland 43 Poland 43 Romania 22 Slovakia 99 Slovenia 52 Turkey 65 Ukraine 35 Some of these states - e.g., Poland - have discovered shale gas reserves that will increase their energy security. The U.S. Energy Information Administration estimated in 2011 that Poland possesses 5.2 trillion cubic meters of shale gas, which is an equivalent of 182 300-year domestic supply. As said Marcin Zieba, the general manager of the Polish Exploration and Production Industry Organization, said in 2012, multiple companies (including Chevron, 3Legs Resources PLC, San Leon Energy PLC, and others) “are working in accordance with their plans, testing reserves and looking with optimism to the outlook of future shale gas production” (Kruk 2012). Some companies are skeptical, however: ExxonMobil conducted test drilling in central Poland and announced that gas wells “failed to yield commercial quantities, raising doubts about Poland’s hope to replicate the U.S. shale gas bonanza and free itself from dependence on Russian gas imports” (Kruk 2012). Shale reserves make East European nations revisit their energy ties with Russia. Also hoping to develop shale gas reserves, Bulgaria, for example, withdrew in 2011 from a large Russia-led pipeline project - the Burgas-Alexandroupolis oil pipeline. Simultaneously, the Bulgarian government has been reconsidering its participation the Russia-backed South Stream gas pipeline (Assenova 2011). This task of diversification has not been easy because of Russia’s geographic position and natural gas reserves. The graph below shows major exporters of natural gas in the world. Russia is still the biggest exporter and also a transit state for Kazakhstan, Uzbekistan, and Turkmenistan. The EU’s natural gas import currently comes from Russia (38%), Norway, Algeria, Nigeria, Libya, and Egypt. Considering the current situation in Libya and Egypt, these sources are unlikely to be more stable than those in Russia. In addition to that, future natural gas supplies from the Middle East and Africa will be 183 delivered mostly in the LNG form (Papava et al. 2009:26). This method of delivery will make natural gas more expensive than gas delivered by pipelines. Figure 28. Top 20 Natural Gas Exporters - Cubic Meters (IndexMundi, 2011) 1Russia 182,000,000,000 2Canada 101,900,000,000 3Norway 78,100,000,000 4Algeria 62,600,000,000 5Turkmenistan 58,000,000,000 6Netherlands 50,210,000,000 7Indonesia 29,600,000,000 8Malaysia 29,060,000,000 9Qatar 25,990,000,000 10Trinidad and Tob. 21,030,000,000 11United States 19,800,000,000 12Australia 12,900,000,000 13Uzbekistan 12,500,000,000 14Nigeria 11,550,000,000 15Bolivia 10,580,000,000 16Kazakhstan 10,200,000,000 17Oman 10,190,000,000 18Germany 9,420,000,000 19United Kingdom 8,843,000,000 20Brunei 8,776,000,000 Despite these obstacles, the twenty seven EU states has managed to substantially reduce the share of their combined gas imports from Russia from 66% in 1990 to 48% in 2007 (Papava et al. 2009). It was done by increasing natural gas supplies from other countries. For example, in 2009, the EU increased gas imports from Norway by 27% and from Qatar by 115% (Grib 2009). The following graph from the EnergyPolicyBlog shows how the share of the EU’s imports of Russian gas has fallen over the last two decades. 184 Figure 29. Russia's Share in the EU Gas Import and Consumption These discussions about diversification most often mean diversification from the Russian natural gas supplies. The European Union has tried to maneuver between the closer integration of Russia in the European economic space and attempts to reduce the EU’s energy dependency on Russia, as addressed by the European Commission in their Strategic Energy Reviews (Yazev 2010:81). Another example of the EU’s diversification effort is to build new pipelines in order to deliver natural gas from multiple producers (Russia, Central Asia, the Caspian). In addition to the implemented Nord Stream, the European Union is considering two other pipelines - South Stream (Russia-backed), and Nabucco (bypassing Russia). South Stream, a planned 26-billion-Euro pipeline with the maximum capacity of 63 billion cubic meters per year, would bring natural gas from Russia on the bottom of the Black Sea to Bulgaria, Greece, Italy and Austria. Its rival – Nabucco, a 15-billion-Euro natural gas pipeline with maximum capacity of 10 billion cubic meters per year would go from Turkey via Bulgaria, 185 Romania, and Hungary to Austria. In response to some critics who argue that Europe does not need that many pipelines, Germany stated that this rivalry among pipelines is inevitable and necessary, instead advocating its own “policy of multiple pipelines” that complement each other rather than compete ("Mi Izdadim Germano-Rossiiski Uchebnik Istorii: Interview with Walter Jürgen Schmidt" 2009). German officials and executives, such as Gerhard Schröder, a Nord Stream and TNK-BP board member, and Klaus Mangold, the chairman of the Committee on Eastern European Economic Relations of the Federation of German Industry, often emphasize that Europe needs to support more pipelines, to achieve better energy diversification (Europe Fails to Wean Itself Off Russian Gas 2009). Figure 30. Proposed Pipelines to the EU Source: The Wall Street Journal, November 27, 2009. 186 The discussions about alternative pipelines and import volume have happened in the overall context of the EU-Russia relations. Since the mid-1990s, Russia and the EU have worked (not always successfully) on several treaties and agreement to institutionalized their relations, alongside European internal agreements regarding Russia. The first legal framework of the EU-Russia cooperation was established in 1997 via the Partnership and Cooperation Agreement (PCA) that covered the energy sector, trade, capital movement, telecommunications, and transport (Johnson and Robinson 2005). Two years later, in 1999, the European Union adopted the Common Strategy on Russia that was created for the following goals: to ensure democracy promotion and rule of law in Russia; to support a political and economic transformation in Russia; and to share European experience in building modern political, economic, social and administrative structures. The Strategy was more a rhetorical instrument rather than a plan for specific actions. In 1998, the EU introduced the controversial Energy Charter Treaty (ECT), which provides regulations for the energy trade liberalization (Aalto 2008b). The Charter aims at the protection of investment, trade in energy materials and products, transit and dispute settlement. One of the key provisions is to make all parties combat market distortions and barriers to competition in economic activities in the energy sector. This provision would open individual energy markets to more foreign competition, and this is one of the reason Russia has not ratified the Energy Charter yet, even though the negotiations about it have been going on for more than a decade. Powerful energy market players (e.g., Gazprom) have opposed the treaty, so that they can keep their near-monopoly (Aalto 2008b). 187 Despite disagreements on ECT, in 2000 Russian Prime-Minister Victor Khristenko and European Commission Director-General Francois Lamoureux started another initiative, the EU–Russia Energy Dialogue, designed to create an improved diplomatic and institutional framework for European trade and investment in Russia (Aalto 2008b). The Dialogue’s goals are also to create market conditions and to facilitate as reforms: to reduce Russian natural resource monopolies, to improve Russia’s investment climate and the access by foreign companies to Russia’s resource extraction; to improve energy efficiency; and to develop a free market system, competitiveness and openness in the Russian energy sector. These goals were designed in order to ensure a stable energy supply to Europe and to reduce chances of Russia’s geopolitical manipulation (Morozov 2008). The end result of the Dialogue’s implementation would be a reduced dependency of Europe on Russia (Aalto 2008b). For over the decade since its start, the Dialogue served as a platform for several conferences and initiatives, as well as dispute resolution during such events as Russia- Ukrain gas dispute of 2009. On 24 February 2011, the Dialogue was expanded when EU Commissioner Günther Oettinger and Russian Energy Minister Sergey Shmatko signed three additional documents under the Dialogue framework: the EU-Russia Early Warning Mechanism in the field of energy, a Joint Statement to Create a Joint Gas Advisory Council and a Common Understanding on the Preparation of the Roadmap of the EU- Russia Energy Cooperation until 2050. The Energy Dialogue is accepted by Russia much more favorably than the Energy Charter because in the Dialogue Russia can see the value for its energy trade with Europe and protection of Russian interests during disputes. 188 Russian officials, on the contrary, point out that even in Europe itself, states protect their own national energy companies. As a result, in energy issues, the Russian government still prefers to deal with European countries on a bilateral basis (Klitsounova 2005). This can be partly explained by Russia’s deliberate policies and partly by internal divisions on energy security among EU members themselves. Another issue that has stirred fears in Western energy consumers has been Russia’s initiative to organize natural gas exporters in the Forum of Gas Exporting Countries, which is often compared to OPEC. Some Western analysts predict that the creation of the forum may lead to tightly controlled and manipulated natural gas markets. The forum, established in 2001 in Iran and officially registered in the United Nations, currently includes the following members: Russia, Qatar, Iran, Algeria, Bolivia, Venezuela, Egypt, Libya, Equatorial Guinea, Trinidad and Tobago, Norway (an observer) and the Netherlands (an observer). In 2009, the unanimous election of Russia’s Leonid Bokhanosky as the Secretary General was a sign of Russia’s leading position on the organization. Although Russian energy sector decision-makers have denied that the forum will be similar to OPEC, they expressed hope that the forum will become a working mechanism to protect its members’ interests. Russian Energy Minister Sergey Shmatko underscored that the forum will be especially important for future coordination in the world LNG market ("Rossiya Ne Dolzhna Upustit' Svoi Shans" 2009). In an attempt to further formalize Russia’s role as the leader in natural gas issues, President of the Russian Gas Society Yazev has proposed to create the world energy code, as a new legal basis for international energy cooperation (Starikov 2010:7). 189 Russia has seen itself as the “energy bridge” between the West and the East, not only as a producer and an exporter, but also as a logistics hub in the East-West transport corridor of global energy resources. This role is supposed to be achieved via pipelines and the development of LNG markets. However, Russia’s LNG production in the Arctic and in the Sakhalin Island has been developing rather slowly ("Gazprom Losing Battle for World LNG Market" 2010). In the meantime, major energy companies (ExxonMobil, Chevron, Royal Dutch Shell) keep signing long-term LNG supply contracts to China, India, Australia, and South-East Asia ("Gazprom Losing Battle for World LNG Market" 2010). 4.2. Geopolitical Rivalries In the geopolitical domain and its relations with Russia, Germany’s behavior in energy security seems to contradict the overall EU energy policy, i.e. the diversification of energy suppliers away from Russia, reducing Russia’s dominance of the European and global natural gas markets, and in general containing Russia’s influence in the Near Abroad and in the West. Germany’s divergence from the EU position is puzzling, considering that Germany is one of the founding states for the European Union and currently one of the pillars of the whole European economy. The geopolitical explanation in the integrated framework predicts that energy cooperation will increase when the geopolitical rivalry is not strong. This section shows that Germany and Russia have been in fact able to overcome historical enmities of WWII and the Cold War. Germany’s position 190 on Russia differs from many other EU members’ stance not only in energy security but also in such geopolitical aspects as NATO expansion, democracy promotion, the Iraq War of 2003, and others. The evidence suggests that Germany and Russia have been able to put their enmity aside thanks to the affinity and friendship between the countries’ leaders, a history of economic ties and import-export operations that took place even in the Cold War, and Germany’s divergence from other NATO members’ position on some key issues of the last two decades (the Iraq War, NATO expansion to Ukraine and Georgia, etc.) Some of these key geopolitical positions were closer to Russia’s point of view. Russia/USSR-Germany relations have experiences ups and downs over the course of post-WWII history. The Second World War itself left deep scars in relations between the two countries. However, in the Soviet culture West Germans were usually portrayed as successors to the Nazis, while East Germans were portrayed as "good" Germans who had had nothing to do with fascism (Stent 2000). Up until the last 1960s, USSR-Germany relations were mostly confrontational in the political realm, although since the late 1950s onwards, the Soviet government established economic ties with FRG. In 1969, the Soviet leader Leonid Brezhnev started a rapprochement with the West that continued during his rule in the 1970s, establishing contacts with Willy Brandt of Germany, simultaneously controlling the East German regime within the so-called Brezhnev Doctrine that stipulated that the East European counties had to do things the Soviet way, enforcing its ideological and economic model (Stent 2000). When Mikhail Gorbachev came to power in the 1980s, he relaxed the USSR’s grip to the East European block via the so-called Sinatra Doctrine that was jokingly used to 191 describe the policy of allowing East European states to decide for themselves. Gorbachev made relations with the European Union one of the biggest priorities in his foreign policy, especially after the collapse of the Soviet-controlled space in 1989 and Germany’s unification. Initially, however, many in the USSR were opposed the united Germany’s membership in NATO, and the conservative voices inside the USSR blamed Gorbachev for “giving away” the GDR (Miller 1992). The initial relations between Chancellor Helmut Kohl and President Gorbachev were also icy, and Kohl was even quoted as comparing Gorbachev to the Nazi Josef Goebbels, although later Kohl denied this quote. However, as Gorbachev opened the country to the values of the West, made substantially concessions for German reunification and NATO expansion, and initiated the country’s transformation, the rapprochement with the united Germany became very strong. The dissolution of the USSR in 1991 brought hopes of democratization and liberalization of the newly independent Russia (Buerrieri 2012). Since then, a number of leaders of both countries shared the bond and even personal friendship. Chancellor Helmut Kohl and President Mikhail Gorbachev, Helmut Kohl and President Boris Yeltsin, Vladimir Putin and Gerhard Schröder, and finally Angela Merkel and Dmitry Medvedev – enjoyed warm friendly relations which were far better than with many other world leaders. The current incumbent Angela Merkel, who came into politics in the East German government before the German unification and participated in political and social transformations in her country. Her relations with Vladimir Putin lack the warms and friendliness of the previous leaders and their friendship, instead being business-like and pragmatic. 192 Overall, although personal affinity between German and Russian leaders helped establish solid economic ties between the two countries, they still had to overcome serious geopolitical disagreements explored below: Russia's use of its energy resources as a foreign policy tool that critics refer to as an “energy weapon;” and NATO expansion followed by the disagrements among NATO members on such potential candidates as Georgia and Ukraine. Even though these two issues by no means represent the exhastive list of geopolitical challenges that Russia and German have faced in the course of their relationships; however, these have been the most salient issues that were the stumbling block in Russia's relations with the EU and other Western countries. These issues have affected the discussions of the Nord Stream pipeline, as well. 4.2.1. “Yesterday Tanks, Today Oil” Even though the European Commission officially approved Nord Stream’s plans in 2000, the pipeline’s critics have been very vocal. As the New York Times wrote at the beginning of the pipeline’s construction, Gazprom “is driving a political wedge between Eastern and Western Europe,” in order to “lead to a new era of gas-leveraged Russian domination of the former Soviet bloc.” The newspaper continues that “[w]ith its gas wealth and eyebrow-raising network of personal ties, Russia has divided members of the European Union that have vowed to act collectively to protect their security” (Kramer 2009a). The project was even compared to the 1939 Molotov-Ribbentrop Pact: “…the pipeline issue evokes deep memories of a darker era of occupation and collaboration, and 193 has become a proxy debate over Russia’s intentions toward the lands it ruled from the end of World War II to the fall of the Berlin Wall” (Kramer 2009a). Zbigniew Siemiatkowski of Poland has summarized Russia’s energy export to Europe as an energy weapon: “Yesterday tanks, today oil” (Kramer 2009a). Eastern European countries made multiple attempts to block the Nord Stream pipeline project, and the Baltic States have been especially vocal opponents. Latvia, for example, tried to lobby the Russian government against the construction of Nord Stream, using the LDPR party (Tolstikh 2006:85-6), as well as to secure American support of the Latvian position. Latvia and other Baltic States usually connect the discussions of the Nord Stream and other contemporary issues with the events of WWII. In 2009, Nils Muiznieks, Director of the Advanced Social and Political Research Institute at the University of Latvia, during his talk in the U.S. stated that the Baltic States and Poland have represented a unified front, the “anti-Russian axis,” which tries to reduce the dependency on Russia for energy resources and electricity (Muiznieks 2009). Referring to WWII, Muiznieks called for a new ruling by the European Court of Human Rights that would identify the Baltic States as victims and force Russia to pay compensation for the occupation. Muiznieks further stressed that only the integration with the EU and NATO would help them to avoid the Russian domination (Muiznieks 2009). Negotiations between the Baltic States and Russia are often stalled because of this historical enmity. However, the Baltic position has not gained enough momentum in the EU to deter Germany and other European states (France, Italy) from joining Russian energy projects, such as Nord Stream and South Stream. 194 Both proponents and opponents of the pipeline connect its construction to previous (and possible in the future) Russia-Ukraine gas crises. The critics describe the crises as Russia’s one-way manipulation in order to scare and punish Europe: “Russia shut down a pipeline that crossed Ukraine, ostensibly over a dispute with Ukraine on pricing and tariff fees. The shutoff left hundreds of thousands of homes in southeastern Europe without heat and shuttered hundreds of factories for three weeks” (Kramer 2009a). Pro-Russian voices, on the contrary, point to Ukraine’s multi-billion debt to Russia and claim that Ukraine had siphoned off of natural gas intended for Western Europe. The Russia-Ukraine natural gas trade has been one of the post-Soviet economic distortions described by Jeffrey Sachs (see Chapter 1). Even after several price increases, Ukraine still pays a relatively low price for Russian: in 2011, Ukraine paid $280 per 1,000 cubic meters of gas (Choursina 2011), compared to $330 Germany paid (see the graph below). After the Ukraine-Russia disputes, many experts agreed that even though it would be cheaper to upgrade the pipeline that goes through Ukraine, this option became unfeasible after the supply of gas to Europe had been interrupted in the middle of winter. Building another pipeline through the Baltic States and Poland would be equally problematic, because of hostile rhetoric between those states and Russia. As a result, Germany and Russia went through with Nord Stream, “bolstering ties between German and Russian energy companies” (Aalto 2009:170). In September 2005, Putin and Schroeder signed a $6 billion agreement to build Nord Stream (Stent 2007:426). 195 Figure 31. The Price of Russian Natural Gas for Germany at the Border (USD per 1,000 cubic meters) Source: IndexMundi, http://www.indexmundi.com/commodities/?commodity=russian-natural- gas&months=360 4.2.2. Geopolitical Complexities: Fluctuations in Russia-Germany Relations Since the Cold War Germany and Russia has had a long history of ups and downs in their relationships for the last 50 years: “German-Russian relations have often been extremely tense and militarized. Despite some periods of cooperation, the two states have rarely been formally allied and have more often been members of opposing blocs” (Newnham 2002). Shortly after WWII, for about a decade Germany and Russia barely had any relations. Resentment and distrust prevailed between Germany and Russia in the after-war period, especially during the Soviet-imposed blockade of Berlin in 1948-49. In 1953, the USSR suppressed an uprising in GDR, which further halted negotiations between West Germany and the 0 100 200 300 400 500 600 700 Jan-‐85 Sep-‐86 May-‐88 Jan-‐90 Sep-‐91 May-‐93 Jan-‐95 Sep-‐96 May-‐98 Jan-‐00 Sep-‐01 May-‐03 Jan-‐05 Sep-‐06 May-‐08 Jan-‐10 196 Soviet Union. The first trade agreement between the two countries was signed only in the late 1950s (Newnham 2002:110). 28 In 1955, Adenauer visited Moscow for the Adenauer-Khrushchev summit as a part of Ostpolitik, signifying the importance of Germany as an economic partner for the Soviet Union and for the countries under the Soviet influence. In the late 1950s, trade between the two countries increased substantially from DM 262.9 million in 1955 to DM 689.6 million in 1958. However, in 1962-1963, the German government used embargoes on grain and large-diameter pipes, trying to make the USSR dismantle the Berlin Wall. During the next decade, Germany turned to positive incentives toward the Soviet Union, “from travel rights for citizens of West Berlin to preserving German unification as a possible future legal option.” (Newnham 2002:40). This issue of the German unification was always at the center of German policy concerns and considerations in the country’s relations with the Soviets. In the 1960s, Germany started a policy of Ostpolitik toward the Soviet Union under the leadership of Willy Brandt, Chancellor of West Germany from 1969 to 1974 and previously the chairman of the Social Democratic Party. This policy was designed to improve relationships with the Eastern Block, and especially with the USSR. Like 28 “German-Soviet bilateral relations were destined to be influenced for decades to come by the events of the Second World War. Soviet perceptions of Germany were decisively shaped by the war. Hitler had unilaterally broken the Hitler-Stalin pact and its accompanying agreements by attacking Russia. The war on the Eastern front had begun with a German advance deep into the heart of the USSR, resulting in massive destruction and enormous casualties – both from the fighting itself and from the German atrocities that followed. The German occupation of large parts of the Soviet Union caused deep scars that have not fully healed to this day. Inevitably, then, the war would color Soviet political perceptions of Germany in succeeding years, greatly reducing the USSR’s trust in any political overtures from the German side” (p. 111) (Newnham 2002) 197 Gorbachev two decades later, Brandt promoted dialogue and open exchange of ideas, winning the 1971 Nobel Peace Prize for his policy (Wiegrefe 2010). Both the icy relations pre-1960s and the détente by Willy Brandt in 1970s, over several decades from 1945 to 1987, the USSR continuously imported German manufactured goods and exported raw materials: because of its technological backwardness in some consumer goods areas, the USSR was more dependent on Germany than Germany was on the USSR (Newnham 2002:109). After the end of the Soviet Union and the German reunification, the EU, and especially Germany, provided strong economic and political support to Russia (Stent 2007:417). East and West Germany were officially reunited in 1990, about a year after fall of the Berlin Wall on November 9, 1989. The key event that facilitated the reunification was Gorbachev and Kohl’s meeting in Russia on July 14, 1990. Germany’s membership in NATO was a precondition negotiated before the meeting. That meeting was when their personal relationship became warm and friendly, which was very important "in a period of rapid change like the end of the Cold War,” as experts, including Condoleezza Rice, emphasized after the events (Hellfeld and Chase 2010). Germany agreed to cover the cost of relocating the Soviet troops stationed in Germany back to the Soviet Union (about 40 billion euros). On October 3, 1990, Germany was officially reunited and December 25, 1991, the Soviet Union ended (Hellfeld and Chase 2010). Shortly after the end of the Cold War, Germany’s strength and position was not pre-determined. The in 1990s, the international relations literature debated about Germany’s future. John Duffield (1999), using the political cultural approach, explained 198 Germany’s rising participation in European collective security institutions and UN peacekeeping operations. Duffield responded to John Mearsheimer (1990) and other neorealists who argued that Germany had incentives to build up conventional forces and project unilateral power. In a way, Germany’s energy policy has offered the third way: building up Germany’s economic power, unilaterally dealing with Russia. Currently, Russia and Germany cooperate not only in the energy sector, but also in security issues, such as a joint diplomatic initiative in the territorial dispute of Transdniestria, in which Russia has maintained about 500 troops. In 2011, Angela Merkel and Prime Minister Vladimir Putin met to discuss a joint resolution, which analysts called the “first concrete instance of Russia and Germany working jointly to dictate the terms of key European security issues” (Stratfor 2011). Russia and Germany presented their initiative as a diplomatic move that is aimed at keeping peace and stability in Europe: The resolution would call for Transdniestria to receive representation in the Moldovan parliament. In exchange, Russia will consider allowing a peacekeeping or monitoring force from the European Union or the Organization for Security and Cooperation in Europe (OSCE) into Transdniestria to help the Russian military patrol the region (Stratfor 2011). Germany and Russia have worked together to clarify and discuss historical contentious issues, such as the Molotov-Ribbentrop Pact and the Katyn massacre. As the German Ambassador to Russia Walter Jürgen Schmidt put it, Germany’s approach is to admit the mistakes of the past and to find ways not to repeat them. The German government even suggested that a German-Russia history textbook should be written by historians from both countries, in order to reach a balanced interpretation of the historical 199 past and to alleviate fears of history falsification ("Mi Izdadim Germano-Rossiiski Uchebnik Istorii: Interview with Walter Jürgen Schmidt" 2009). The German public’s view has echoed the position of the German government. A substantial part of the German population is lenient about oil and gas import from Russia. Close ties between Russia and Germany has been further legitimized in the German population’s eyes by former Chancellor Schroder’s service on the board of Gazprom (Szabo 2009). 4.2.3. The Germany-U.S.-Russia Triangle and NATO Germany, as a major player in the European politics, has also been a mediator between Russia and the United States in debated issues, such as the Iranian nuclear program (Szabo 2009:23). This mediation has been considered very pro-Russian by many American commentators, such as the Heritage Foundation and similar organizations, who compared the closeness of contemporary Germany and Russia to the Molotov- Ribbentrop Pact of 1939 (The Hitler-Stalin Deal Dividing Europe 70 Years Later: How the 1939 Molotov-Ribbentrop Pact Impacts the World Today 2009). They also argued that Russia would be a “challenger in U.S.-Germany relations” (Szabo 2009:37). Germany and the United States also differ in their interpretation of how the Cold War ended and of the energy dependency on Russia. Germany’s view is closer to Russia’s: that the end of the Cold War was a peaceful outcome of negotiations that led to the unification of Germany. The prevailing view in the United States is that the Cold War 200 ended by an overwhelming U.S. victory over the Soviet “evil empire” (Szabo 2009). Karsten Voigt, a Germany-U.S. coordinator at the German Foreign Ministry, compared the debate around the Nord Stream project to Germany’s oil pipeline from the Soviet Union via Poland, built in the 1980s, despite objections by the United States after the Soviet invasion in Afghanistan ("Noviy Evropeisky Miroporyadok: Initsiativi i Strategii Ikh Realizatsii. Sokraschennaya Stenogramma." 2009). Voigt emphasized that Germany views the relations with Russia as a mutual dependency (including Russia’s dependency on German technology and trade). Voigt compared Russia’s reaction to the expansion of NATO to Germany’s reaction to the European neighbors’ policies after WWI, intended to weaken Germany ("Noviy Evropeisky Miroporyadok: Initsiativi i Strategii Ikh Realizatsii. Sokraschennaya Stenogramma." 2009). Energy security has become a theme in discussions about the role of NATO, which is now more than a military security alliance. Some experts have suggested that energy security should also be included in NATO's priorities. Andrew Monaghan of the NATO Defense College proposed that NATO should protect energy businesses and pipelines from military and political threats in situations such as the dispute between Ukraine and Gazprom in January of 2006. After this dispute, energy security appeared for the first time on the agenda of a NATO summit that took place in Latvia in November of 2006 (Monaghan 2009:64-5). Monaghan admits, however, that energy security is a challenging issue to put on NATO’s agenda because NATO members themselves differ in their opinion on energy: some of them consider energy security as an economic matter, while others give it a strong geopolitical meaning (Monaghan 2009:71). 201 Russia has long been extremely dissatisfied with NATO's expansion to the East but has tried to become a part of the EU security framework. Visiting Germany in 2009, President Medvedev suggested a new architecture of the European security that would take into account Russia's role as a major power in Eurasia, pointing to the diminishing power of the United States as a global hegemon and the low functionality of the existing European security system (Kortunov 2009:36). However, new NATO members have openly expressed fear of Russia (which made them join NATO in the first place), especially after the Georgia-Russia military conflict in August of 2008. One of the salient aspects of that conflict was a possibility of Georgia and Ukraine becoming NATO members. Angela Merkel was the strongest opponent in the EU of NATO membership for Ukraine and Georgia. Pointing to the ongoing territorial dispute with South Ossetia and Abkhazia, she said that "countries that are themselves entangled in regional conflicts, can in my opinion not become members" ("Merkel Against NATO Membership for Georgia, Ukraine" 2008). Energy security has been a divisive issue in tri-lateral Germany-Russia-U.S. relations. At a conference in 2009, Germany stressed that energy supply was the main area in which Russia and the West needed to achieve common understanding. As a solution, German Foreign Minister Steinmeier suggested to create a common security system from Vancouver to Vladivostok, coordinating among OSCE, the UN, NATO, and the EU. At the same conference, Anatoly Korobeinikov of the Russian delegation accused the European Union as being too dependent on the United States, arguing that the expansion of the American influence in Europe prevented the EU from achieving a fuller integration of 202 interests with Russia ("Noviy Evropeisky Miroporyadok: Initsiativi i Strategii Ikh Realizatsii. Sokraschennaya Stenogramma." 2009). Russia has presented its energy ties with Europe as a “soft” economic leverage. In the United States, however, Russia’s tri- lateral initiatives with France and Germany have been perceived as an attempt to play the “European” card against the United States, especially during disagreements between the United States and Europe (Stent 2007:420). This disagreement between the United States and Western Europe on the issue of oil and gas pipelines from Russia is similar to the situation in the 1970s, when the Reagan Administration objected the pipelines from the Russian Urengoy gas field to Europe and even banned American companies from selling equipment for these pipelines. Back then, the U.S. insisted that the pipelines were a security threat and increased the over- dependence on Russian energy resources. The Western European states did not have the same concerns and considered the issue to be economic rather than political (Orban 2008:1). To sum up, despite all the potential geopolitical difficulties between Germany and Russia, the two countries still have partnered in energy ties, increasing import-export operations and building the Nord Stream pipeline. The main reasons for such close economic relations are personal friendships and affinity between the countries’ leaders, a long history of keeping economic partnership even in the Cold War period, separating political and ideological disagreements from economic benefits of import-export, in which Germany provided advanced machinery to the USSR, and the Soviet Union could export raw materials to Germany; a shared history of the USSR and East Germany that after the 203 end of the Soviet Union went through similar transformations; and German’s position divergent from other NATO members on Georgia and Ukraine membership, as well as seeing Russia as a partner in the European security framework rather than a threat. The history is still relevant because of the path dependence and reverberations that some states experience for several decades in their relations. The geopolitical hypothesis has provided a partial explanation for this case, even though it is balanced with the economic explanation. The geopolitical component in this case is determined by the governments’ preferences and strong promotion of their interests via business deals. The level of geopolitical rivalry between Russia and Germany is low, underlined by substantial initial concessions that Mikhail Gorbachev made during Germany’s reunification and Russia’s further acceptance of NATO expansion to the East, except for Ukraine and Georgia. As a result of these geopolitical factors, the level of cooperation between Russia and Germany is extremely high, especially in the energy sector, but also in other sectors. However, in addition to geopolitical challenges that were solved between Russia and Germany, some domestic interest groups (e.g. environmental NGOs and others) were strongly opposed to Nord Stream pipeline. The next section will explore the domestic interest group aspect in more detail. 204 4.3. Domestic Groups Domestic interest groups hypothesis predicts that powerful domestic groups, such as political and business lobbies, will influence energy cooperation or lack of thereof. The probability of energy projects being implemented if powerful societal groups are in favor of them. The sub-hypothesis predicts that if domestic interest groups are fragmented and not united on the issues, they will have less chance to prevent energy trade and investments. In the case of Russia-Germany, similar to the previously discussed cases of U.S.-Russia and U.S.-Azerbaijan energy ties, governments control or seriously influence the energy sector. As a result, the domestic groups that align their goals with the government policies are often more successful in achieving their goals. The controversial Nord Stream pipeline, as well as other aspects of Russia-Germany oil and gas cooperation, have been affected by three major societal groups: German political parties and the media aligned with them; the business lobbies; and environmental and ethnic NGOs. 4.3.1. German Political Factions One first needs to examine if there is a substantial debate on Russia inside of the German political establishment. Even though views on Russia differ among Germany’s parties, they have reached what they call a pragmatic decision of securing as many energy supplies as possible, including Nord Stream ("Mi Izdadim Germano-Rossiiski Uchebnik 205 Istorii: Interview with Walter Jürgen Schmidt" 2009). This consensus resulted in a unified view on Nord Stream. Germany’s political scene is comprised of conservative parties (Christian Democrats-CDU and Free Democrats), left-leaning parties (Social Democrats), and environmentalists (Green Party) ("Europe Pushes for Russia to Resume Gas Deliveries" 2009). Among them, Schroder’s Social Democratic Party (SDP), currently led by Foreign Minister Steinmeier and Kurt Schumacher, not surprisingly, is very pro-Russian and pushes for stronger cooperation (Szabo 2009). However, former German Foreign Minister Joschka Fischer said in 2011 that “it is very unfortunate that we receive a large portion of our energy supply from countries with questionable human rights records” (Steininger 2011). Among German parties, the Christian Democratic Union has been very powerful over the last several decades, currently having a CDU incumbent in power and shaping relations with Russia. The CDU generally believes that there are strong economic reasons to cooperate with Russia. The most influential voice in this party – the incumbent Angela Merkel - takes a cautiously optimistic view, emphasizing the need for multi-dimensional cooperation not only in the energy sector but also in car manufacturing, trade, and human rights promotion (Szabo 2009:32-3). The views on the USSR and then Russia by this powerful political party have been consistent over several decades, even when they diverged from the United States and other NATO partners. In the 1970s, Germany increased economic ties with the USSR despite American opposition. For instance, the 2,000-km Mannesmann natural pipeline with 206 maximum capacity of 52 billion cubic meters was built from the USSR to West Germany in the 1970s. Another example is the 2,000-km Yamal pipeline in the 1980s, strongly opposed by the American President Ronald Reagan: nevertheless, Chancellor Helmut Kohl proceeded to cooperate with the Soviet Union and made a decision to build the pipeline. The German government put energy security priorities higher than the commitments to contain the Soviet Block. Recently, even the CDU has started to change its stance on Russia. In the second half of the 2000s, even though there was some divergence between a cautious and increasingly skeptical incumbent Angela Merkel and the Minister of Foreign Affairs Frank-Walter Steinmeier: “Steinmeier was the driving force behind Gerhard Schröder’s integrative Russia policy” (Meister 2012). Steinmeier and his ministry has promoted the policies of “rapprochement through interweavement” and “partnership for modernization” toward Russia, with a great emphasis on energy security and climate change (Meister 2012). The Christian Democratic-Liberal government coalition (CDU/CSU and FDP) of 2009 brought “sobriety” into Russia-Germany relations, as opposed to personal friendship that had existed between Boris Yeltsin and Helmut Kohl, and between Gerhard Schröder and Vladimir Putin. In 2008-2011, Angela Merkel preferred to deal with President Medvedev rather than with Prime Minister Vladimir Putin. New Liberal Foreign Minister Guido Westerwelle also had other priorities in Eastern Europe, distancing himself from Russia. Russia has lost its importance for German foreign policy (Meister 2012). Analysts distinguish two different dimensions of the German rhetoric on Russia. The first one is dissatisfied with Russia’s lack of democratic institutions and its human 207 rights violations. Angela Merkel has intensified this school of thought recently. The second school of thought is more traditional for CDU, and now for the Green Party, and focuses on purely economic interests for German businesses and German energy security (Meister 2012). Political parties’ views are best reflected in newspapers that align themselves with these parties and thus shape German public opinion, including views on cooperation with Russia. Major newspapers in Germany are traditionally categorized as center-left, right, and center-right media. The center-left Süddeutsche Zeitung takes a pragmatic approach and urges to focus on the economic rationale in energy contracts with Russia and transit countries. The newspaper argues that the “prudent thing to do is to not allow ourselves to be drawn into taking sides [Russia or transit countries] and thereby further the political goals of either of them” ("The Pipeline Power Play" 2009). Therefore, this view emphasizes the need to negotiate and follow the business model of cooperation, rather than participate in political debates between Russia and transit states. The right-leaning Die Welt takes the almost opposite view and discusses relations with Russia and Russia’s energy policies in terms of a geopolitical war. In particular, the newspaper describes Russia’s natural gas trades as “a weapon to collect debts but also to sour the West on making Ukraine a member of NATO” ("The Pipeline Power Play" 2009). Referring to Russia’s share of natural gas supplies to Germany, the newspaper calls Russia’s gas trade “a monopoly.” As a result, the newspaper insists on Germany’s reducing 208 imports of Russian gas and increasing the domestic production of nuclear energy 29 ("The Pipeline Power Play" 2009). The center-right Frankfurter Allgemeine Zeitung acknowledges the importance of the energy market fundamentals, such as the need to pay for oil and gas imports on time and in full and Russia’s right to demand a market price from its consumers, including Ukraine. However, the newspaper also argues that price disputes with transit countries also have a political meaning, especially in light of a possible NATO membership for Ukraine ("The Pipeline Power Play" 2009). As a result, the newspaper asserts that “alternatives must be found” to the Ukrainian pipeline that “evidently doesn’t work” some of the time. Still, according to this view, Nord Stream will increase the EU’s dependence on Russian gas. The newspaper brings up the question of whether Iranian gas imports through Nabucco would be more secure than Russian gas supplies ("German Mideast Proposal Doesn't Go Far Enough" 2009). German political parties and their media outlets have a divergence of view on Russia: some are cautious; others are optimistic that a mutual dependency will guaranty the stability of oil and gas supplies. The divergence has not resulted in a wide dissent, and the incumbent CDU party has proceeded with the line that Germany has been pursuing since the 1969 rapprochement – to engage Russia in economic ties, despite disagreements on political and ideological issues. In this case, German domestic groups that dissent with the government line have not been able to block the Nord Stream pipeline. Unlike Germany, 29 The parties in Germany are divided over the issue of nuclear energy, as well. The Christian Democrats (conservative), represented by Minister of Economics Michael Glos, suggest increasing the share of nuclear energy in the German economy. Social Democrats, such as Minister of Environment Sigmar Gabriel, object to this plan, instead suggesting that Germany should develop solar and wind energy (2009b). 209 Russia’s political elite is much more united around the government line, in a “small elite circle controls the distribution of the oil rents” (Orttung 2009:51). 4.3.2. Energy Business Lobbies Germany and Russia are among most important trade partners in each other’s ranking of trade members. Just in one year, in 2011, they increased overall trade volume by 30-per cent, and the annual trade volume has reached 75 billion euros (Meister 2012). Germany has various business associations that promote German businesses abroad, including in Russia, and German government is aware of their activities and helps them to operate. For example, during her trips to Russia, Angela Merkel helps German business representatives to receive access to the Russian government during intergovernmental meetings (Meister 2012). Vast oil and gas revenues have been conducive to Russia’s turn to authoritarianism, merging the Russian political elite with the country’s energy sector (including such powerful actors as Vladislav Surkov, Igor Sechin, Sergei Naryshkin, Aleksey Kudrin, Viktor Khristenko, Yevgeniy Shkolov, Sergei Sobianin, German Gref, and even Dmitry Medvedev himself). Orttung calls it a “rent-distribution mechanism benefiting numerous inside players” (Orttung 2009:64). 210 The Russian government has also influenced organizations, formed to represent the interests of foreign investors. One of them, the Foreign Investment Advisory Council 30 – FIAC - was established in 1994 “to assist Russia in forging and promoting a favorable investment climate based on global expertise and the experience of international companies operating in Russia” (FIAC 2010). Council members are CEOs of foreign companies in Russia, such as ENI s.p.a., Ernst & Young, ExxonMobil, Shell, and Total. Membership is rotated in compliance with the Regulations on the Rotation of Members of the Foreign Investment Advisory Council (FIAC 2010). This organization is under the Russian government’s control, and the Prime Minister of Russia is the chair of the council. FIAC members - forty-two foreign companies - have to comply with the organization’s rules and procedures, such as doing charity work in Russia and refraining from decreasing their investments in the country. Membership in this organization is important for companies, as they establish solid connections with the Russian government in order to “solve problems that foreign investors might have during their investment project implementation via the executive branch and federal government” (Shapovalov et al. 2010). The number of German businesses on the Russian market steadily grows, and they unite in business associations, focused on European and German representation in Russia ("Rossiisko-Germaniskaya Torgovaya Palata - Predstavitelstvo Nemetskikh Firm v Moskve" 2010). Among them, the most prominent ones are the German-Russian Forum (Deutsch-Russisches Forum), the European-Russian Business Association (Европейско- Российская бизнес ассоциация - ERBA), and the Association of European Businesses in Russia (AEB). The organization that specifically focuses on Germany is the Russian- 30 Konsultativniy Sovet po Inostrannim Investitsiyam – KSII. 211 German Trade Chamber (Deutsch-Russische Auslandshandelskammer - AHK), formed in 2007 on the basis of the German Economic Union in Russia. The Chamber facilitates business contacts between Germany and Russia, and provides business services to German companies in Russia. Russian energy companies unite in their own organizations, such as the Russian Union of Industrialists and Entrepreneurs (Российский союз промышленников и предпринимателей), the National Energy Security Fund (Фонд национальной энергетической безопасности), and the Center of Political Technologies (Центр политических технологий). The organization most relevant to the natural gas industry, the National Association “Russian Gas Society” (Российское газовое обществo), established in 2001, includes 147 natural gas companies and serves as a liaison for the industry, promoting interests of participating businesses on the domestic market and globally. The Society represents Russia at major oil and gas forums and conferences around the world, such the Russia- Europe energy dialogue (Starikov 2010:4). According to their mission statement, the Society communicates with international organizations (e.g. the International Gas Union and the European Gas Industry Union) on behalf of Russian gas producers in legislative and economic issues, defending their interests on international markets (especially during trade disputes) and conducting public relations on behalf of the industry. Traditionally, their position has been strongly aligned and intertwined with the Russian government’s energy policy. 212 Kremlin appointees dominate the Russian gas industry. During Putin’s presidency, Gazprom’s more independent managers were replaced by those close to the Kremlin. One example of such a resignation was Alexander Ryazanov, deputy CEO of Gazprom and President of Gazprom Neft, who was considered excessively “independent” in his actions. He insisted that Gazprom Neft remain a separate company rather than being integrated with Gazprom. He also disagreed with Gazprom’s CEO Alexey Miller about the TNK-BP deal and oil export volume ("Gazprom Uvolil Alexandra Ryazanova za Samostoyatelnost" 2006). As a result, Ryazanov was replaced with Valery Golubev, who had worked in KGB for more than a decade and later at St. Petersburg Mayor’s office with Vladimir Putin ("Gazprom Uvolil Alexandra Ryazanova za Samostoyatelnost" 2006). As of 2006, nine out of fifteen members on Gazprom’s Board of Directors were from St. Petersburg: CEO Alexey Miller, Chief Accountant Elena Vasilyeva, Chief of Finance Andrei Kruglov, Chief of Security Sergey Ushakov, Chief of Construction and Investments Valery Golubev, Chief of Asset Management and Corporate Relations Elena Pavlova, Chief of Marketing and Refining Kirill Seleznev, Chief of Law Department Konstantin Chuichenko, and Deputy CEO Alexander Kozlov ("Alexander Ryazanov ne Vkhodil v "Piterskoe" Bolshinstvo Pravleniya "Gazproma"" 2006). Another close friend of Vladimir Putin since the 1980s - Nord Stream AG Managing Director Matias Varnig - was lobbying for Nord Stream in Europe (Ispolnova 2009). In Russia, business lobbies in the energy sector are very tightly intertwined with the government. They may be considered more as an extension of the government’s foreign policy rather than a separate force on the international arena. Domestically, they are 213 extremely powerful for obtaining the biggest government contracts and oil and gas fields. In the case of Nord Stream, as in cases of other pipelines (e.g. BTC), the decisive voice belonged to the participating governments at the level of the heads of states. Private and state controlled energy businesses had to follow the government lead. This dynamics is explained more persuasively by the geopolitical hypothesis than by the influence of domestic interest groups. 4.3.3. Think Tanks and Environmental NGOs Think tanks and environmental NGOs are social entities less intertwined with the government than the political parties and energy business lobbies explored above. These organizations were the most vocal critics of the Nord Stream pipeline, mobilizing and åchanneling the grassroots public voice. While think tanks and NGOs in Russia did not ultimately have a substantial influence on the Nord Stream pipeline planning and implementation, the European think tanks and NGOs were active players in debates about the pipeline. Independent analysts in multiple German think tanks have raised concerns against the German government’s decision to build the Nord Stream pipeline. Unlike American think tanks, however, the German ones focus less on the geopolitical dangers of Russia’s domination and more on the need for Germany to diversify sources of energy as much as possible. 214 Oliver Geden of the German Institute for International and Security Affairs (a policy-oriented think tank established in 1962) warns that excessive dependency on energy producing countries subjects Germany to the risk of being blackmailed by the producers. As a solution, Geden suggests that Europe should create an internal energy gas market that would include natural gas and other sources of energy: “The EU can achieve more for its gas supply security by expanding its internal energy market than it could by building any new import pipeline” (Geden 2012). He further predicts that Germany’s climate change policy (which includes renewable energy sources) may even make natural gas itself a “thing of the past” in the coming decades. In the meantime, he argues that competition between the Nabucco and South Stream pipelines has mainly been geopolitical, in which each side (Turkey for Nabucco and Russia for South Stream) try to minimize the economic justification for the rival pipeline. Geden concludes that the key to the European energy security is maximum diversification of energy suppliers and energy sources, as well as the creation of the unified European internal energy market. In a way, his recommendation is the opposite of the German government’s line, in which Germany has worked to secure projects with Russia that give Germany a unique access to Russian resources and increase German leverage in the EU. Another think tank, Germany's DIW economic institute holds a similar view about the need to diversify energy sources as broadly as possible ("Germany, Russia to Launch Nord Stream" 2011). Claudia Kemfert of this institute emphasized the role of new technology and the upcoming global market of LNG, in which suppliers will be competing 215 with one another: "There is a gas surplus in the world – why fixate on Russia?" ("Germany, Russia to Launch Nord Stream" 2011). Not unlike the previous two think tanks, Euro Institute for Information and Technology Transfer in Environmental Protection admits that multiple pipelines, including Nord Stream, South Stream, Nabucco, and others are “urgently needed” ("Pipeline Technology Conference 2010 - Final Report" 2010). The Institute also welcomes the increasing LNG supplies to Europe. Similarly, the Institute of Transportation System focuses of a technical side of safe transportation of resources around Germany, including railway systems. The German Institute for Economic Research concludes that Nord Stream is an important step for Europe in diversifying energy routes. The analysts of this institute examine costs and predicted profits of the pipeline and argue that Nord Stream is actually the most expensive way to deliver natural gas to Germany. They continue that the decision to build the pipeline was made based on strategic grounds, mainly to avoid the transit states - Ukraine, Poland, and Belarus (Hubert and Suleymanova 2009). Overall, the institute comes to the conclusion that Nord Stream pipeline will have positive implications for European energy security, despite concerns about overdependence on Russia, if Europe continues to diversify its energy mix. Some think tanks, more focused on political analysis, traditionally point to possible resource wars as oil and gas becomes depleted. Alexander Rahr of the German Council on Foreign Relations predicts that “the 21st century will be the century of fights over natural 216 resources,… and we will see new alliances struck all over the globe attempting to create energy security“ (Steininger 2011). Stefan Meister of the Center for Central and Eastern Europe of the Robert Bosch Stiftung at the German Council on Foreign Relations (DGAP) (Meister 2012) provides an insightful geopolitical analysis of Russia-Germany relations and predictions for the future course after Vladimir Putin came back to presidency for the third term in 2012. Meister argues that the goals of Russia and Germany in the course of this cooperation are quite different: “While the German side wants to develop common projects of good practice which will modernize the Russian economy and politics, the Russian side is interested in technology transfer” (Meister 2012). However, his contrasting these goals does not seem convincing enough – they seem to be in line with what President Medvedev in 2008 defined as “modernization” – a technological breakthrough similar to the Silicon Valley in the United States. Meister is right, however, by saying that even this variant of modernization is not feasible after the new authoritarian leadership by Vladimir Putin. Meister very convincingly shows that Russia-Germany relations are changing, and not in favor of Russia, as the anti-democratic turn of the Russian political development in 2012 is not going to find support in Germany at all levels. Hubertus Bardt of the Cologne Institute for Economic Research gives an example of one such conflict – the gas disputes between Russia and Ukraine: “There was no bad guy and good guy in the gas conflict between Russia and Ukraine… They both played a high-risk game. But it showed Europe how vulnerable it is” (Steininger 2011) He takes a cautiously optimistic view about Russia, though, saying that Russia has “proven to be a 217 very reliable supplier, even in Cold War times. Without selling gas Russia’s whole economy and its social security would collapse” (Steininger 2011). This view is in line with the interdependence school of thought (addressed in Chapter 1) that argues that mutual trade dependency leads to a higher chance of peace between the two states. Nord Stream has attracted the attention of multiple environmental NGOs that were concerned about the impact of the pipeline on the marine environment of the Baltic Sea (damaging marine wildlife and disturbing toxic wastes and chemical munitions, remaining on the sea bottom since WWII). NGOs investigated issues and problems that needed to be solved during pipeline construction and maintenance: corrosion, leaks, accident prevention, and protection from terrorism. Most importantly, chemical weapons on the bottom of the Baltic Sear, dumped after the end of the WWII, may endanger the pipeline and damage the surrounding natural habitat (Hubert, 2009). No consensus has been reached in the scientific community about what needs to be done about those chemical weapons on the bottom of the sea. Leaks from chemical munitions in the Baltic Sea may affect the population of fish and fisheries that are a vital component of the surrounding countries’ economies. Fishermen get injured by chemical substances spelled from munitions in the sea or by old weapons caught in fishnets. A closed nature and the level of pollution of the Baltic Sea make pipeline construction and maintenance very challenging, forcing us to find a balanced solution between the need for energy sources and the preservation of environment (Hubert, 2009). The final group of social actors, extremely vocal about the Nord Stream pipeline, has been environmental NGOs, both in Europe and Russia. Greenpeace, Green Cross, 218 WWF, the Baltic Fund for Nature, and others – all of them raised concerns about possible negative effects that pipeline can cause in the Baltic Sea, including damage to fisheries, disturbances of WWII-chemical munitions, possible leaks and accidents, and the compensation to those people whose lifestyle will be destroyed by the industrial infrastructure that goes along with the pipeline. Russia environmental NGOs blossomed in the early 1990s, as a result of democratic reforms and international NGOs’ coming to open branches in Russia (Perovic, 2009). They have been active in their commentary and activism in the 2000s, as well, although the strengthening of the state power in Russia and the setback in democratic reforms reduced their influence to an advisory and consultant role, lacking a decision-making voice in multi-billion-dollar projects, such as Nord Stream. Alexey Yablokov -- Boris Yeltsin’s Counselor for Ecology and the chair of the Russian National Security Council’s Interagency Commission for Ecological Security in the early 1990s, Minister of Environment and then Minister of Economy in 1992-1993, and later the president of the Centre for Russian Environmental Policy, correspondent-member of the Russian academy of sciences – has been one of the experts who raised strong concerns about Nord Stream’s environmental consequences, especially related to oil chemical munitions. He pointed to the lack of transparency on Nord Stream’s behalf in addressing these concerns (Yablokov 2008). Despite the fact that NGOs were not able to block the decision to build the pipeline, they have achieve quite a remarkable goal nevertheless – to hold large energy companies more accountable on the environmental front. In 2008, the Nord Stream managing company conducted a comprehensive environmental assessment of the pipeline and 219 regularly held meetings with NGOs before the construction was started, documenting all meetings on the company’s web-site. When Nord Stream decided to modify the route of the pipeline on the Gogland Island, the Forum of Baltic NGOs, the international coalition “Clean Baltics,” the Russian Regional Environmental Centre (RREC), the Baltic Environmental Forum Group (Riga), Project “Ecocentrum” (Saint-Petersburg), and other organizations were given explanations concerning the threats to the Ingermanlandsky nature reserve located in that area. This has led to a tendency in Russia that large companies are more accountable to the NGOs than small companies that have become the biggest polluters, according to leading NGOs (Bellona, Greenpeace). Nevertheless, NGOs are not able to block projects implemented by the Russian government, due to the lack of democratic institutions and social accountability in Russia. In developed democracies, such NGOs may have an influential voice, as it was with the XL Keystone pipeline – in this case, they represent grassroots movements and votes for politicians. In the case of Russia, civil society does not have such leverage on the government, especially after 2012. 4.4. Conclusion Despite Germany’s leading position in the European Union, Germany has not followed the European policy of maximum diversification of energy supply sources away from Russia. On the contrary, Germany and Russia recently implemented a multi-billion- 220 dollar natural gas pipeline on the bottom of the Baltic Sea – Nord Stream – that directly connects Russia and Germany, bypassing traditional transit states (Poland, the Baltic States, Belarus, Ukraine). This pipeline project is puzzling because it presumably increases Germany’s and Europe’s dependency on Russia natural gas, already extremely high. The pipeline has been criticized by many European governments who lose leverage and transit fees, by environmental NGOs, by Germany think tanks, and even NATO allies, such as the United States. Nevertheless, Germany proceeded with the project that received the highest approval on the government level. The geographic advantage has been vital in this case – Russia is the biggest producer of natural gas in the world, and Russian gas is still cheaper for Germany than LNG from the Middle East. Germany has been aware of this fact throughout the decades and has practiced a pragmatic approach to the USSR and then Russia even in the period of the Cold War, and especially after the end of the Soviet Union. The economic potential sub-hypothesis receives very strong evidence here – if economic potential is very high, the governments put aside geopolitical and ideological disagreements for the sake of trade benefits. Although the economic element is the strongest in this case study, the relations between the two countries are complicated and the explanation is multi-faceted, as well. Both the Russian and German governments fully controlled the planning and implementation of the Nord Stream project, which is in line with the geopolitical sub- hypothesis about the connection between the prevalence of government control in the energy sector and the priority of geopolitical calculations. In this case of Russia-Germany, 221 geopolitical considerations were also extremely influential, as Germany has achieved an unprecedented access to Russia’s energy resources and increased its influence on the EU energy redistribution and storage market. Russia, in its turn, received another long-term loyal customer for its natural gas, which may prove crucial if oil prices happen to drop and the state income will rely on natural gas revenues. As for domestic groups, such as NGOs, think tanks, business associations, and political parties, they had less impact, similar to the cases of U.S.-Russia and U.S.- Azerbaijan energy ties. Despite extremely vocal opposition by some of these groups, the pipeline project was not blocked or even modified. Nevertheless, the positive impact of such opposition has been in a higher accountability and transparency by large energy companies in Russia that work with foreign investors and care about their image. 222 Chapter 5. Conclusions and Policy Recommendations: Away from Resource Dependency toward a Sustainable Energy Mix 5.1. Overview Why are some international energy projects, such as pipelines or joint productions of oil and natural gas, actively implemented while others, seemingly equally feasible and possibly even more profitable, fail to materialize? Why are some states willing to promote bilateral energy trade and investment while others seem unable to take advantage of mutually beneficial energy projects? To answer these questions, this study has scrutinized three important post-Cold War interstate energy relationships to evaluate the relative importance of power, profits, and politics. More specifically, relevant theories of international relations – realism, liberalism, and domestic interest-groups – have been applied here to explain interactions in the energy security area. Realism (Krasner, Gilpin, Socor, et al.) stresses the prevalence of states’ considerations of geopolitical survival, power, relative gains and zero-sum thinking. Examples include the legacy of the Cold War, military alliances, and security dilemmas. According to realism, a government will trade in energy resources only if such trade and investment are in its national interest, in which security concerns prevail over profit maximization. Liberalism (Keohane, Nye, Copeland, Sachs, Banks, Stiglitz, et al.), on the contrary, stresses the importance of absolute gains and argues that energy interdependence is a 223 peace-inducing factor: states are able to trade and cooperate even when there are political and ideological disagreements. Liberalism in energy cooperation focuses on the economic fundamentals of projects -- the availability of oil and gas resources, the demand for them, and the investment climate for joint oil and gas production, as well as geographical opportunities for export and import. Finally, the literature on domestic interest groups, from the classic works of the 1960s to contemporary studies (from Baumgartner, Leech, Foyle, Belle to Franklyn Griffiths, Pavel Tolstykh, et al.) provides an insight on lobbying and other activities of influential business, ethnic, and other societal groups. Such interest groups promote their political and economic goals and may advance or oppose specific policies in the energy sector. Each of these theoretical approaches provides valuable knowledge that sheds light on various aspects of energy cooperation, but alone each is narrow and one-sided, unable to embrace the broad complexity of real-world energy relations. This study offers a unified framework that allows simultaneous testing of their theories and a deeper understanding of important on-going cases in energy relations. This framework, based on the three theoretical approaches, includes three independent variables and attendant hypotheses that predict the relationship between the dependent variable – energy cooperation (i.e. the volume of trade and investment) -- and the independent variables (namely, geopolitical rivalries, economic potential, and domestic interest groups, which refer to power, profits, and politics. 224 The unified framework differs from existing energy security explanations in that they typically “test” only a single theory or simply employ a descriptive historical approach. While historical work (such as that of Marshall Goldman and Daniel Yergin) gives us extremely useful knowledge of how events have unfolded in the energy domain, the framework developed in this dissertation will help offer a more generalizable explanation of energy trade and investment outcomes. Focusing on oil and natural gas, as well as future renewable energy development, this dissertation explores three important and sometimes puzzling bilateral cases of energy cooperation: U.S.-Russia, U.S.-Azerbaijan, and Russia-Germany. These cases vary in their geographic proximity, in the country size and power status, and in their regime type - from democracy to defacto autocracy. These bilateral relations have been analyzed in four contexts: international, state, industry, and project dimensions. The major conclusion is that geopolitical rivalries are the most influential explanatory factor in energy relations between states. Geopolitical calculations often trump economic efficiency and profitability considerations. This geopolitical hypothesis is also supported by governmental domination of energy security decisions, even in developed democracies with free market systems. However, in some cases, despite obvious geopolitical or ideological enmity, governments choose to use their political wills to overcome these differences for the sake of mutually profitable energy projects. Such cases as the Russia-Germany Nord Stream pipeline provide strong evidence for the economic potential hypothesis. Finally, domestic interest groups may be influential in promoting their common interests, if they are united and organized around an energy issue. However, 225 oftentimes, powerful lobbies divide their attention and prioritize other, non-energy issues, which again allow the government line to dominate in decision-making. The cases explored and tested here provide empirical support for these developments. 5.2. The U.S.-Russia Case After the investment frenzy of the 1990s, American energy companies working in Russia experienced difficulties and setbacks in the 2000s. The frenzy began when Russia opened its economy and its energy sector to foreign investors shortly after the end of the Soviet Union. American businesses were encouraged by the Clinton administration to take advantage of opportunities in Russia, despite the economic turmoil, inflation, and overall instability ("Doing Business in the New Independent States -- A Resource Guide" 1994). Relations between Boris Yeltsin and Bill Clinton were amicable, and American advisers were invited to help with economic and political reforms (Lieven 1998). In that period, Western energy companies -- Chevron, ConocoPhillips, ExxonMobil, and others – started to work in Russia, signing PSAs with the Russian government for such multibillion-dollar projects as Sakhalin-1 (ExxonMobil 2010). In the 2000s, driven by oil and gas revenues and soaring oil prices, the incoming Putin administration was able to strengthen its domestic and international position. As a result, Russia became more assertive on such issues as NATO’s expansion, U.S. missile defense in Europe, and the Iranian nuclear program (Goldman 2008). Simultaneously, the 226 share of American investments in Russia drastically dropped, while other countries maintained their investment levels. Russia tightened government controls over domestic oil and natural gas resources that received the status of the highest strategic importance for the country’s economic security. As a result, major Western energy companies did not sign new large contracts in Russia for most of the decade, and the Russian government renegotiated the existing PSAs on environmental and tax grounds (Donohue and Shokhin 2008). In 2008, during the Obama-Medvedev “reset,” opportunities for major energy companies started to reappear, mostly in the Arctic and the remote East Siberian oil and natural gas fields (Cohen 2011). In addition to political obstacles and geographic challenges, another reason why American companies seem no longer interested in importing Russian LNG is the soaring domestic production of shale gas in the United States that has changed the global supply- demand balance for natural gas. Since 2011, the United States has been self-sufficient in production of natural gas and does not need expensive imports. This change occurred extremely quickly and unexpectedly: as recently as in 2009, North America was Gazprom's primary destination for liquified natural gas ("Gazprom to Sell as Much as 90% of Shtokman LNG in North America" 2009). However, by 2011, the U.S. had drastically increased shale gas production, which drove domestic prices down, making Russian LNG imports to the United States unfeasible. As a result, Russia diverted its LNG exports to Asia. Even though LNG trade between Russia and the United States is no longer feasible, oil exports from Russia, however, still have a strong economic potential. Based on factors 227 such as the availability of oil reserves, their accessibility via the new ESPO pipeline, and the distance to the U.S. ports, American imports of Russian oil could be substantially increased. In addition to this, Russian companies still need Western technology. However, despite these potential benefits of oil trade, U.S.-Russia energy ties still experience difficulties because of strong intergovernmental disagreements. In this case, the geopolitical explanation prevails, especially after Vladimir Putin’s return to the presidency in 2012, when U.S.-Russia relations deteriorated again, and the future of new energy deals is in doubt. During Putin's third term, Russian energy lobbies have been even more intertwined with the government, as energy executives simultaneously hold government positions and promote government agendas. 5.3. The U.S.-Azerbaijan Case U.S.-Azerbaijan is a puzzling case of growing energy cooperation despite such seemingly unfavorable conditions as Azerbaijan’s landlocked position with no ocean access; problems with human rights and democratic institutions; and a strong Armenian lobby in the U.S., which has attempted to block energy projects with Azerbaijan. Additionally, estimates of Azerbaijan’s oil reserves differ widely in different sources -- from 7 to 233 billion barrels (Blanchard 2005) – but nevertheless the country is one of the key energy partners for the United States. The United States strongly supported the Baku- Tbilisi-Ceyhan pipeline that now delivers oil from Azerbaijan to Turkey via Georgia. 228 The BTC pipeline was successfully built by a consortium of Western companies, despite strong opposition by domestic interest groups (the Armenian lobby in the United States). The Armenian lobby in the United States is considered very powerful. It was successful in blocking other intergovernmental decisions, such as the recall of U.S. Ambassador to Azerbaijan Matthew Bryza (who was accused of pursuing Azerbaijan’s interests) and the lobby’s interference in the Turkey-Armenia rapprochement (Abbasov 2012). Based on these previous successful instances, we might expect that the Armenian lobby would be able to block the BTC pipeline or to divert its route to Armenia instead of Georgia. However, this pipeline was of the highest importance for the U.S. multiple pipeline policy for reducing Russia’s influence in the region (Alieva 2011). As a result, the U.S. government backed the pipeline route and ensured that it was successfully built. In addition to that, Azerbaijan’s close relations with Israel and the Israeli lobby in the United States help promote Azerbaijan’s position in the West. The BTC route was selected from several other alternatives: via Russia, via Iran, and via Armenia ("Armenian Lobby Applies Pressure to Get BTC Passing Through Armenia" 2001). Among these options, the BTC route was considered by experts as the most expensive and technologically challenging one (Shaffer 2009b), complicated by Georgia’s secessionist conflict in South Ossetia and Abkhazia, which could endanger the pipeline. Despite improvements in Azerbaijan’s economic climate that created favorable conditions for foreign investors for the last two decades, the economic evidence alone is not sufficient to explain why the United States opted for the BTC route, because of the route’s costs and technological challenges. 229 The BTC route was clearly selected on the geopolitical grounds. Since the early 1990s, the government of Azerbaijan has maintained close relations with the United States and its allies. The government has also managed to maneuver successfully among several competing powers in the Caspian region – Russia, the United States, Turkey, and Iran. Similar to the case of U.S.-Russia, this case supports the geopolitical hypothesis, which stresses the role of governments and geopolitical calculations. 5.4. The Russia-Germany Case Russia-Germany energy cooperation is a puzzling case in which the two countries have been able to overcome their past Cold War enmity and to pursue joint projects despite opposition from the EU and the United States. The $10.2-billion Nord Stream natural gas pipeline, which was built on the bottom of the Baltic Sea and bypassed European transit states, was surprising to many, taking into account that the European Union had been working on energy source diversification in order to reduce its dependency on Russia (Steininger 2011). The pipeline boosted Germany’s position as the European energy hub and reduced transit states’ (Poland and the Balkans) revenues and influence in the European Union. As a result, Nord Stream caused an outcry in multiple circles – new EU member-states, environmental NGOs, and Western think tanks (Kramer 2009a). The explanation for this case is less straightforward than the previous two cases, in which geopolitical evidence clearly dominated. Unlike U.S.-Russia and U.S.-Azerbaijan 230 energy ties, the Russia-Germany case has been explained by both economic and geopolitical hypotheses. The proximity between the two countries and Russia’s vast energy resources ensure a powerful economic rationale and make oil and gas trade between Russia and Germany economically justifiable. As a result, both governments have actively promoted their cooperation in the energy sector. Since the Cold War era, Russia has admitted that it needs German technologies in exchange for Russia’s raw material, oil and gas. Germany’s rising power in Europe has been debated in the literature and the policy world, and energy deals in Russia contribute to strengthening Germany’s position. However, in addition to the powerful economic reasons, the geopolitical explanation is very important in this case, too, but it is seen in a more regional, European, context, rather than on the global scale. Multibillion-dollar projects (such as the Nord Stream) have materialized only as the result of governments’ decisions, rather than “pure” market mechanisms. This pipeline strengthened Germany’s position as the EU’s energy hub and redistributor. Germany has benefited from its exclusive access to Russia’s oil and gas. Simultaneously, Russia has kept its near-monopolistic role in European energy supplies. Finally, as in the previous two cases, domestic business lobbies (e.g., associations of energy businesses and European business associations) were closely aligned with their governments and intensively advocated for the pipeline. Other societal groups, such as environmental NGOs, were opposed to the pipeline but did not have enough influence to block the Nord Stream project. 231 5.5. Long-Term Lessons from the Cases Studies such as this dissertation provide valuable empirical insight in the energy security literature and lessons for policy-making. They help determine the selection of pipeline routes and production sharing agreements. The three cases -- U.S.-Russia, U.S.- Azerbaijan, and Russia-Germany – have provided several lessons that can be applied to other cases, such as the planned Nabucco pipeline (that bypasses Russia) and its contender, the South Stream pipeline (backed by Russia). The first lesson is that geopolitical rivalries, even in non-energy spheres, are the main obstacle to mutually lucrative energy deals. Therefore, it is important to take into account the issue-linkage between energy negotiations and non-related security concerns, such as nuclear weapons, war, human rights, and imperial aspirations. For example, Russia’s concerns about NATO’s expansion 31 and other military issues affect Russia’s decisions about oil and gas production deals, awarding these contracts to “friendly” countries. Since energy projects are very closely guided by the state, any political disagreements between governments can negatively affect the outcome of energy negotiations, such as those between the United States and Russia. The West’s position in negotiations with Russia has been somewhat helped by the recent global economic recession, which reduced the world demand for Russian energy resources. The reduced demand has weakened Russia’s bargaining position on European energy markets. 31 Russian Ambassador to NATO Dmitry Rogozin complained in 2010 about “a unilateral world, NATO- centrism, the alliance's spontaneous expansion eastwards and refusal to recognize the principle of integrity and security” (Moran 2010). 232 Recent renegotiations of long-term gas price contracts with the Russian monopolist by major European utilities (including Germany’s E.On AG, Austria's OMV, and Italy's Edison and Eni, France’s GDF Suez (GSZ) SA) [have] showed Gazprom’s willingness to give concessions. Such leverage on Moscow may weaken in a few years, as gas demand picks up [the] pace… in Europe (Berdikeeva 2012). The second lesson is that countries should treat competing projects not as a zero- sum game but as an opportunity favorable for all the involved parties. Following the liberal agenda of pursuing absolute gains and creating projects of mutual advantage, may help overcome the “us versus them” mentality, which has deadlocked negotiations with Vladimir Putin. This might be very difficult, especially because of the U.S. recent presidential election rhetoric and Russia’s anti-democratic turn (Landsberg and Abcarian 2012). At this point, since governments seem to be unable to reach a compromise, energy companies step in and offer solutions. For example, in 2010, to overcome the stalemate in the Nabucco and South Stream pipeline discussions, the Italian energy company ENI offered a compromise, suggesting an alternative means of natural gas transportation in the Caspian region. ENI suggested shipping natural gas by sea in compressed form from Turkmenistan to Azerbaijan, eliminating the need for a pipeline (Socor 2012). This solution would bring natural gas to consumers without constructing either pipeline. Similarly, joint pipelines, built by energy businesses (such as ENI or Total), could be another solution, which would result in the most economical route and the mode of investment. Companies are better suited to find an economical solution that would benefit their investors, rather than to participate in geopolitical games. 233 The third lesson is a possibility to delegate decision-making to international organizations, such as the International Energy Agency and the World Bank’s energy division, which might provide impartial insight and profitable solutions. In the last two decades, most energy deals have been decided by governments dominated by geopolitical concerns. If decision-making could be at least partially delegated to other levels -- international, industry, and project – it would be possible to achieve more gains for all involved countries (Razavi 2007). Independent experts in international institutions could evaluate various options and offer policy recommendations. Thus, decision-making would be less politicized, allowing the selection of the most economically, technologically, and financially efficient projects. However, such a scenario might not be very realistic in the near term, since governments are unlikely to cede their power over energy resources and energy deals. 5.6. Short-Term Policy Recommendations The above lessons obviously contain implicit policy recommendations, although they are too idealistic because of strong government control in the energy sector. However, there is another realm of energy cooperation where tensions are lower, projects are more modest, and political statements are less complicated. So, starting at this level, small-scale projects could eventually lead to greater cooperation in projects of high strategic 234 importance. The sum-total of these small projects could establish greater trust, which could help to overcome impasse in larger investment projects. Collaboration could start in areas less sensitive geopolitically such as renewable energy, environmental protection, energy conservation, refining, and oil-drilling safety. These are the areas in which the United States and Germany have vast knowledge, which the former Soviet states lack. More cooperation in these aspects would create a better business environment for future joint projects in the strategically important sector of oil and gas production. Promoting these less sensitive projects would help improve the economic climate for subsequent large-scale oil and gas deals. IR literature has long addressed analogous cases of this type of trust-building cooperation, in which the reduction of tensions was very gradual and thus less inflammatory. Cooperation starts small and gradually leads to larger agreements. One example is nuclear negotiations and disarmament between the USSR and the United States (explored by Rublee; Sagan; Donaldson and Donaldson), which started with modest reductions and led to major agreements such as START-1 and START-II, among others. This is a good example of the gradual reduction in tension (GRIT), theorized by Charles Osgood as “de-escalation by making a small, unilateral (one-sided) concession to the other side, and at the same time, communicating a desire or even an expectation that this gesture will be matched with an equal response from the opponent” (Osgood, 1962). Similarly, in the area of political economy, such scholars as Peter Evans in his “Is an Alternative Globalization Possible?” (2008) and Peter Hall in The Political Power of Economic Ideas 235 (1989) explore how gradual concessions and small steps in economic liberalization lead to a larger-scale economic cooperation and trade agreements among states. Another instance of incremental policies becoming bigger milestones was the abolition of South African apartheid via informal activist networks (Keck and Sikkink, 1998). The anti-apartheid movement was formed at smaller conferences and included incremental legal actions, leading to United Nations laws that became legally binding and imposed harsh, punitive sanctions. These gradually increasing actions put a stop to this abhorrent human practice and culminated in an international regime backed by the United Nations. In the energy domain, less contentious, non-military projects (e.g., climate change research, carbon emission reduction, energy efficiency, and renewable energy) can be implemented with government backing and federal support. These projects might be especially beneficial for oil-dependent countries (Russia, Azerbaijan) to break out of their resource-income dependency and to become competitive on the world market (Desai and Goldberg 2008). Investing some current oil revenues in “green” technologies would help oil-dependent states diversify their economies. An example of such programs is the “Smart Energy” initiative by Green Cross Russia. This program unites scientists, environmental activists, and politicians in shaping a strategy of alternative energy development. The program covers all kinds of alternative energy – wind, geothermal, solar, and biomass (Chumakov 2008). Alternative energy could be an area in which scientists, NGOs, and governments productively collaborate. In the area of green energy, Russian scientists already do 236 advanced research on wind turbines, photoelectric systems, lumber production waste, solar water heating systems, bio energy from manure and harvest waste, anaerobic fermentation of agricultural and forestry, solar energy, and municipal waste burning. NGOs, which are the main agenda-setters for alternative energy development, could bring such scientists together, with continued government support to diversify the energy mix (English 2000). Government support of green energy started in Russia in the 2000s, when the Russian government funded research and development in renewable energy. It also implemented “green certificates” - a program similar to the Western cap and trade system. Via tax incentives and special prices for renewable energy, the government designed policies for encouraging “green” development (Zerchaninova 2006:455). In 2012, the Russian government again attempted to reform the energy sector and to improve energy efficiency, using modern technology. According to the director of the Center for Efficient Energy Use, Igor Bashmakov, the government's goal has been to reduce energy use by 40% by 2020, cooperating with scientists and independent energy experts. However, these goals have been slowed down by bureaucratic red tape and corruption, including an ineffective system of energy audits and energy passports (Davydova 2012). Cooperation with Western NGOs and governments could help Russia reduce its bureaucracy and paperwork, bringing Western business practices and cutting-edge research to outdated Russian enterprises. Major energy companies, such as those that invest in Russia, have also joined the renewable energy race. Oil companies, previously sceptical, have launched multiple alternative energy projects. For example, in 2009, ExxonMobil announced that it would 237 invest heavily in algae and other biofuels (up to $600 mln per year). Biofuel production has also enjoyed support and incentives by the U.S. government, which has set the target of 36 billion gallons of biofuels produced in the United States per year. Currently, biofuels (mostly corn) already provide 9 percent of the U.S. fuel consumption ("ExxonMobil Will Invest in Algae to Fuel Development" 2009). ExxonMobil, BP, and other energy companies are interested in investing in alternative energy projects abroad, including post-Soviet states. Such joint ventures could bring American advanced technology and capital to Russia, Azerbaijan, Kazakhstan, while utilizing scientific talent in chemistry and biology. In addition to biofuels, such projects could be started in battery production, as well as oil shale, ethanol, and liquid coal production (Blanchard 2005). These joint projects in “green” energy could be a potentially lucrative area with little geopolitical contention, providing high-paying jobs for local scientists. Another area of cooperation, in which major American and German energy companies want to participate in Russia and Azerbaijan, is energy efficiency. Russia is currently the third largest emitter of greenhouse gases in the world, and the country’s energy consumption could be reduced by half via more efficient technology. Greater energy efficiency and renewable energy sources (e.g., wind) would also help Russia solve the problem of electricity blackouts in the Russian Far East (Newell 2004). One more “renewable” resource, plentiful in Russia, is wind. In the area of wind energy, the U.S. National Renewable Energy Laboratory (NREL) have already installed wind-diesel hybrid systems in Northern Russia (Wind Energy Applications Guide 2001). 238 Examples of wind turbine suppliers in Russia include the Global Wind Energy Council and Bergey Windpower (USA) (Global Wind Energy Market Report: Wind Energy Expands Steadily in 2004 2005). With the Russian government’s encouragement, more such American companies could invest in Russia’s wind energy, diversifying Russia’s energy mix. Unless Russia, Azerbaijan, and other post-Soviet oil-dependent states modernize and diversify their economies and reduce their dependence on petroleum revenues, the governments have little choice but to pump out more oil and gas. Any reduction in global petroleum demand or a drop in oil prices would be catastrophic for oil-dependent economies. Cooperating with foreign companies and governments in “green” technologies would help Russia and Azerbaijan break out of the “resource curse” (Ross, 2012). At the same time, joint “green” projects would increase the population’s exposure to Western values and practices in high-tech industries, potentially facilitating societal change in Russia. Cooperation in projects of low contention would also help alleviate Cold War fears and mentality. As a result, one would likely see a creation of a possibly more democratic and economically sound Russia, which would be a better partner for the West, both in energy projects and beyond. 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Creator Svyatets, Ekaterina (author)

Core Title Power, profits, and politics: energy security and cooperation in Eurasia

School College of Letters, Arts and Sciences

Degree Doctor of Philosophy

Degree Program Politics and International Relations

Publication Date 07/25/2013

Defense Date 08/13/2013

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Azerbaijan,domestic interest groups,energy economics,energy security,geopolitics,Germany,natural gas,North America,OAI-PMH Harvest,oil,Russia

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Advisor English, Robert D. (committee chair), James, Patrick (committee member), Katada, Saori N. (committee member), Meshkati, Najmedin (committee member)

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