Baltic Independence and Russian Foreign Energy Policy

BALTIC INDEPENDENCE AND RUSSIAN FOREIGN ENERGY POLICY

Dr Harold Elletson Series Editor: Dr Kevin Rosner

Baltic Independence and Russia

Publisher’s note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. 120 Pentonville Road London N1 9JN United Kingdom www.globalmarketbriefings.com This edition first published 2006 by GMB Publishing Ltd. © Harold Elletson Hardcopy ISBN 1-905050-36-4

E-report ISBN 1-905050-89-5

British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library.

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Contents About the author

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1. Introduction

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2. An historical and political perspective

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„ „ „ „

Separate nation states Soviet rule Baltic independence Baltic–Russian relations

3. The economy

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„ Impressive growth „ World Bank concerns „ EU integration and structural reforms

4. The Baltic energy system: structure and dynamics

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„ Electricity „ Natural gas „ Oil

5. Russia’s interest in Baltic energy „ „ „ „ „ „

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The siloviki and the key decision-makers Background to Putin’s energy and foreign policy Russia’s energy-security complex Energy as a foreign policy tool The Kremlin’s motives European energy security

6. The Baltics: options for the future

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„ Russian dependency „ The energy security challenge „ Regional collaboration

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„ „ „ „ „

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The nuclear option Renewable energy Co-generation schemes Energy efficiency and administrative improvements Encouraging EU–Russian cooperation

7. Conclusion

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Notes and references

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About the series

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About the author Dr Harold Elletson leads The New Security Programme, which conducts research into the implications of the new security environment. He was previously Director of the NATO Forum on Business and Security. A former Member of the UK parliament, he served as Parliamentary Private Secretary to the Secretary of State for Northern Ireland and as a member of the Select Committee on Environment. An international public affairs consultant and a fluent Russian speaker, he has advised many leading companies on aspects of their business in the former Soviet Union, including BP in Azerbaijan and Alstom in Siberia.

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1. Introduction

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n 27 February 2006, the heads of government of the three Baltic States of Latvia, Lithuania and Estonia, met in the Lithuanian town of Trakai to discuss their position on energy issues, ahead of the forthcoming EU Summit. Energy security and, particularly, the long-term security of the Baltic States’ energy supplies were at the top of their agenda. For several years, ever since Russian companies had begun to acquire significant stakes in companies operating in key areas of Baltic energy infrastructure, politicians and the media in all three Baltic countries had expressed concern that an over-dependence on Russian sources of energy supply was bound to compromise Baltic independence. The Baltic Energy Ministers had recognized the importance of the issue in the context both of national security and of future relations with the European Union (EU) as long ago as 1999, when they agreed a joint energy strategy. ‘Future growth in the Baltic countries requires an affordable, reliable energy supply in appropriate quality and quantity’, they had declared. ‘Security of supplies should be at the level to ensure that present and future energy needs are met at financially sustainable terms, which anticipates utilization of diversified, stable and reliable energy sources. Since energy is a vital factor of the country’s economy, the supply should be secured against disruption shortfalls and unexpected price rises.’1 The issue was brought into much sharper focus with the so-called ‘Gas War’ between Russia and Ukraine

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early in 2006 and the concerns expressed by the Polish government over plans for a pipeline to export Russian gas to Germany through the Baltic Sea, bypassing Poland and the Baltic States. The proposed pipeline is so controversial in Poland and the Baltic States that some political commentators have even referred to it as the energy version of the Nazi-Soviet Pact of 1939.2 The problem for the three Baltic States is that, although they are all comparatively small consumers of energy, neither one is a significant energy producer. With the lowest per capita wages in the EU, which they joined in 2004, all three states are highly dependent on cheap gas from the Russian Federation, where the main supplier recently declared its intention to increase gas prices significantly. Furthermore, the situation is likely to get even worse as a result of EU pressure to curb existing production, such as oil shale in Estonia and Nuclear energy in Lithuania, on environmental grounds. Against this background, some commentators fear that Russia’s new assertiveness under President Putin presents a threat to Baltic independence. Russia is flexing her muscles, they say, because the Baltic States have finally left the old Soviet sphere of influence and joined NATO and the EU. They harbour the suspicion that energy supplies to the Baltic States have a political significance for the Kremlin that is beyond the normal parameters of mere commercial consideration. Energy, they suspect, is being used as a tool of foreign policy in the region.

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An understanding of the region’s history explains how explosive such suspicions are. The history of the Baltic States in the last century, in particular, is a story of three nations that won their independence against the odds, tenaciously clung to it and, when it was ultimately taken from them, never lost the hope that it would be restored. Now that they have realized their ambition, as sovereign states, to join the EU and NATO, any suggestion that Moscow might be able to use its control of vital energy supplies to re-establish its control is bound to be greeted with alarm in Riga, Vilnius and Tallinn. Yet, how realistic are these fears? Is Russia using its control of energy

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supplies as a means of advancing its foreign policy objectives? If so, what are those objectives in the Baltic States and how might they be realized? If security of energy supplies is essential to the future sovereignty of the Baltic States, how can it be guaranteed? What are the Baltic States’ options? These are important questions, not only for the Baltic States but also for the rest of the EU, as it seeks to establish a stable partnership and a clear strategic understanding with Russia. This report seeks to establish the causes of Baltic concern, the nature of Russian interests and the various options for reducing the region’s dependency on external sources of supply.

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2. An historical and political perspective

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t is difficult to escape history in the Baltic States. Its presence is everywhere, a recurring leitmotif that underscores the present and places it in the context of a turbulent past. The three nations’ historical consciousness, in turn, is shaped by a collective sense of identity that comes from the fact that the Baltic peoples have a longer connection with their homeland than almost any other nation in Europe. This sense of belonging creates a special feeling of both attachment and legitimacy. ‘The kernel of the historical awareness of the Baltic peoples is the fact that they are directly descended from the original inhabitants of their countries’, one historian has observed.3 Indeed, the indigenous inhabitants of the three modern Baltic States of Estonia, Latvia and Lithuania are direct descendants of the original tribes who settled on the shores of the eastern Baltic Sea four thousand years ago. The Estonians are of Finno-Ugric stock, like the Finns and Hungarians, whereas the Lithuanians and Latvians have Indo-European ancestry (Lithuanian, interestingly, being the closest living language to Sanskrit). Whatever their individual origins, all three indigenous Baltic peoples have lived in their homeland for far longer than any of the peoples who have ruled over them since the middle ages – whether Scandinavians, Poles, Germans or Russians. The last millennium of Baltic history, culminating in the bloody upheavals of the twentieth century, was punctuated by regular periods of war

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and conquest. The last peoples in Europe to be Christianized and with viable pagan tribal societies of their own until the twelfth century, the Baltic nations nonetheless found that their geographical location made their homeland a battleground for other states striving for political or economic mastery of the region. Even in pagan times, the eastern shores of the Baltic were emerging as an important staging post for trade between Russia and the Western world. Tallinn and Tartu, in particular, were centres where furs, wax and slaves could be exchanged for salt, textiles and weapons. Foreign involvement in the region, however, soon became foreign domination – at first Scandinavian and later German. Mercantile interests were combined with missionary zeal, as the Teutonic knights forcibly converted the Baltic tribes to Catholicism. Whilst the Teutonic Order subdued the ‘Old Prussians’ in the west, in the north the Brotherhood of the Sword established a Christian, military state in Livonia with Riga, which was founded in 1201, at the mouth of the river Daugava, as its capital.4 Despite the comparative brevity of the period of direct occupation by the Teutonic knights, the German presence in the Baltic remained strong until the beginning of the twentieth century because of the rule of German landowners over the Baltic peasantry and the dominance of German merchants in Hanseatic trading centres on the Baltic, such as Riga and Tallinn. The German influence in the region

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persisted through the ensuing centuries, even as Swedish, PolishLithuanian and Russian interests competed for succession to the legacy of the Teutonic knights.5 Despite the eventual absorption of the Baltic provinces into the Russian empire, they still enjoyed a comparatively extensive degree of autonomy under their local German aristocracy. Peter the Great confirmed the privileged position of the Baltic Germans and the Lutheran Church, and it was the middle of the nineteenth century before any serious programme of Russification began.6

Separate nation states It was not until the end of the First World War, however, that the power of the German ‘Baltic barons’ was finally broken and, in an extraordinary combination of circumstances which could hardly have been predicted at the start of the conflict, the Baltic nations at last achieved their chance to establish themselves as separate nation states. What created the opportunity for the establishment of Baltic independence was the defeat of the German army in the West and a revolution in the East, which led to the collapse of the Imperial Russian Army. By signing a separate peace treaty at Brest Litovsk in 1918, Russia’s new Bolshevik rulers not only betrayed their allies but also freed them from any obligation to defend the territorial integrity of the Russian empire in a post-war settlement. With the entry of the United States into the conflict, it at last became a ‘war for democracy’ and an opportunity for the Allies to use the issue of the rights of national minorities to create what Clemenceau called a ‘cordon sanitaire’ between Germany and Russia. Despite a sustained German attempt to maintain a presence in the region,

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even after the armistice in the West, and repeated incursions by both ‘White’ Russian and Bolshevik troops, the Baltic States at last won their independence, all three signing peace treaties with the Soviets during the course of 1920.7 The inter-war period of Baltic independence, which lasted from 1920– 1939, was characterized both by the desire to profit from a resurgence of trade with Russia by acting as the West’s commercial ‘springboard’ and by the attempt to maintain international support by acting as a barrier against Soviet interference or a new German–Russian combination. In the end, the various attempts to develop a more robust system of regional alliances, which might have guaranteed Baltic independence, failed – largely, perhaps, because they centred around Poland, whose relations with the Baltic States were poisoned by her capture of the ancient capital of Lithuania, the city of Vilnius, during the Polish-Soviet war in 1920. Ambitious Baltic diplomatic initiatives that might have led to the establishment of a large regional bloc in the ‘cordon sanitaire’ ‘were gradually whittled down. Ultimately, in 1934, only the so-called Baltic Entente between Latvia, Lithuania and Estonia came into being’.8 An entente between the three Baltic States, however, was not enough to save them. The three Baltic States were of such strategic significance to Germany, Poland and Soviet Russia that, without guarantees of military support from powers outside the region, their fate was dependent on the intentions of their various predatory neighbours within it.

Soviet rule The fate of the Baltic States was finally sealed in 1939. After Germany had

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reincorporated the Lithuanian port of Klaipeda into the Reich in March, secret protocols to the MolotovRibbentrop non-aggression pact divided the Baltic States into separate spheres of influence, giving Germany a free hand to attack Poland. It was initially agreed that Lithuania’s northern boundary would mark the division between the Soviet and German zones. After Germany had invaded Poland on 1 September and Ribbentrop had revisited Moscow, Lithuania, along with half of Poland, was consigned to the Soviet sphere. Estonia, Latvia and Lithuania were formally absorbed by the Soviet Union in 1940 but were under German military occupation from 1941 to 1944 when the Red Army re-imposed Soviet rule. At the end of the Second World War, the Baltic States were the only members of the League of Nations not to be restored to full sovereignty. They spent the next 50 years under the heel of the Soviet regime, which was determined that they should never regain their independence. In 1989, however, an extraordinary event, perhaps the most remarkable public demonstration in European history, marked the 50th anniversary of the signing of the Molotov-Ribbentrop Pact. Millions of people joined hands and formed a human chain stretching across the Baltic from Tallinn in the north, through Riga, to Vilnius. The demonstration was largely coordinated by the various popular fronts, which had sprung up in the Baltic States after Gorbachev’s introduction of ‘perestroika’ and ‘glasnost’ in the Soviet Union. At a meeting of all three Baltic popular fronts in Tallinn in May 1989, delegates agreed: ‘to coordinate joint policies of the biggest popular movements of the Soviet Baltic countries and to make the general public of

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the Soviet Union and the world at large aware of the democratic aspirations pursued by the Baltic popular movements.’9

One of the main issues chosen to highlight the Balts’ democratic aspirations was the Nazi-Soviet Pact and its secret protocols. When the peoples of the Baltic States linked hands, with Latvia’s Freedom Monument marking the country’s pre-war independence at the heart of the demonstration, the three popular fronts issued a statement emphasizing their peaceful, parliamentary path back to statehood, in contrast to the ‘criminal and unlawful agreement’ of 1939. Moscow gave a standard, formulaic response: the Baltic States had voluntarily chosen to join the Soviet Union in 1940. The sheer scale and organization of the human chain, however, provoked Gorbachev himself into declaring that ‘the state of the Baltic peoples is in serious danger’. Yet, it was too late to turn back the clock. Moscow’s efforts to contain and manage the drive to Baltic independence were doomed. Even the local communist parties in the three republics turned against the General Secretary and, despite a Soviet blockade of Lithuania, the despatch of OMON troops to the region and several bloody incidents, the momentum for independence became unstoppable.

Baltic independence Thus, history played a prominent role in fuelling the independence movement and it continues to play an important role in the political psychology of the Baltic countries today. Just as in 1989 the truth about the NaziSoviet Pact was an important part of the case for independence, so today it continues to haunt relations between the Baltic States and Russia, even

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stoking fears about the Kremlin’s true intentions with its energy policies in the region. As independent states, the policy of the Baltic States has been very similar to that of Poland and, as such, similarly offensive to the hard-liners in the Kremlin, some of whom appear to believe that an important measure of Russia’s global status is the extent to which it can continue to exert control over its former East European vassals.

Baltic–Russian relations Suspicions in the Baltic States have been stirred by the failure of successive Russian leaders to take account of the national interests of their Baltic neighbours. They have failed, too, to dampen popular enthusiasm in Russia for the notion that the indigenous populations of the Baltic countries are, at best, ‘Russo-phobic’ and, at worst, unrepentant about their supposed wartime collaboration. Such public prejudices are the foundations on which the imperial ambitions of those who continue to believe that the

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Baltic States still belong to Russia are built. In fact, the Baltic States all want normal, friendly relations with the great power on their doorstep. They see themselves as a bridge between East and West, naturally linked to the Russian market – the West’s economic ‘springboard’ but also still Russia’s ‘window on Europe’. The reason they were so keen to join NATO was fear of Russia’s intentions towards them. ‘If Russia had a thriving liberal democracy, a vibrant civil society, an effective multiethnic system, a productive capitalist economy, and a genuine peace policy in Chechnya’, one commentator on the region has observed, ‘then its influence may have been welcomed in Eastern Europe, regardless of historical experiences with Russian imperialism.’10

However, empirical observation has convinced many in the Baltic States that little is fundamentally different in Russia and they continue to be haunted by the ghosts of history.

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3. The economy

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he three Baltic countries were quick not only to implement democratic political reforms but also to adopt market economies after regaining their independence. They have thus largely managed to avoid the economic and political crises that have affected other regions in transition from centrally planned systems.

Impressive growth Despite the initial shock of the transition from the Soviet system, the economic performance of all three Baltic States in the period since independence has been impressive by any standards. Tough decisions have been taken and privatization has been extensive. The transformation has been remarkable. In Latvia, for example, where the privatization of small and medium-sized enterprises has been completed and many large public companies, in sectors such as gas, shipping and banking, have also been transferred from the public sector, the national economy has achieved a remarkable turnaround from the position immediately after independence when real GDP fell by 50 per cent. In 2004, Latvia saw real GDP growth of 8.5 per cent and in the same year, despite sluggish growth in the global economy, the Baltic States saw an average 6.6 per cent increase. The figures confirm the Baltic countries’ position as some of the fastest growing economies in Europe.

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World Bank concerns The problem now facing the Baltic States is no longer economic stagnation but the very reverse. In its latest ‘EU-8 Quarterly Economic Report’, the World Bank warned that ‘overheating in the Baltic States is a key concern’.11 Although Lithuania has an impressive portfolio of exports, including refined oil products, machinery and textiles, and 70 per cent of its trade is now with the EU, the World Bank worries that, in general, growth has recently been ‘fuelled largely by domestic demand in the Baltic States’. The Bank has also expressed particular concern about exposure to external economic factors beyond their control, a state of affairs that has characterized much of the history of Baltic independence. In its review of the economic position in EU-8 countries, for example, it worried that: ‘Although the oil shock has not been fully passed on to domestic consumers, it complicated inflation control, not least in the Baltic countries.’ At the same time, it warned that ‘current account deficits remain very high in Estonia and Latvia’.

EU integration and structural reforms Such concerns have taken some of the gloss off what has otherwise been an impressive performance, slowing the Baltic States’ plans for full economic integration with the EU.

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‘Early Euro adoption plans in the Baltic countries have been postponed owing to problems in meeting the inflation criterion. This reflects a combination of higher energy prices, strong wage and credit growth, and inadequate support from fiscal policy. Meeting the very strict fiscal criterion is also complicated by the fixed exchange rate regimes and neutral convergence process.’12

In the long term, if they are to avoid slipping from rapid economic growth into a new period of stagnation, the Baltic States must deal with a range of fundamental structural problems.

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Sustaining their programme of structural reforms will be key to future economic development, job creation and poverty reduction. They need to develop and maintain an economy, which is competitive in European markets and does not simply rely on low wage rates. They need to improve public sector administration and performance and to promote regional development. Above all, perhaps, all three Baltic States need to pay particular attention to combating unemployment and reducing poverty, particularly in rural areas.13

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4. The Baltic energy system: structure and dynamics Electricity

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he electricity market differs in each of the Baltic States, although all three share the common characteristic that they are not linked to the European grid. Estonia and Lithuania are both net electricity exporters and their surplus supply is sold to Latvia, as well as to parts of the Russian Federation. The majority of Estonia’s electricity is generated by the Narva power plants, using oil shale as fuel. In 2004, Estonia produced 8.9 billion kilowatts (bkwh) of electricity. Its ability to continue to generate this amount of electricity over the longer term is questionable if it continues to rely on oil shale as fuel and, indeed, the EU has begun to exert pressure for oil shale-fired generation to be scaled back, on environmental grounds. The majority of Lithuania’s electricity has, until recently, been generated by the country’s Ignalina nuclear power plant, which contributed to the 19.8 bkwh of electricity that Lithuania produced in 2004. However, Ignalina operates an RBMK-type reactor and, under pressure from the EU, the Lithuanian government has agreed to shut down the plant by 2009. In return for its agreement to phase out Ignalina, Lithuania has received over $1.5 billion in foreign aid. The government has, however, indicated its interest in developing a new nuclear plant to replace Ignalina.

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Although Latvia has some hydroelectric facilities, in a dry year it is estimated to be only 60 per cent selfsufficient in meeting its energy needs and, as the Baltic States’ only net importer of electricity, it buys from its Baltic neighbours and from Russia. Currently, however, Latvia is working with Estonia and Finland to develop the ‘Estlink’ project, the Baltic States’ first connection to the European network, a 43-mile underwater cable linking them to the Scandinavian power grids. Estlink, which is scheduled to be completed late in 2006 is a highvoltage, direct current, undersea cable linking the Harku 330kV substation in Estonia with the Espoo 400kV substation in Finland. It has been designed, and will be laid, by ABB. Until Estlink is completed, however, the Baltic electricity network remains solely linked to the Russian and Belarusian systems. The Baltic Power System Control Centre in Latvia has operational control of the IPS 330kV transmission network in the Baltic States and is responsible for coordinating the link with the Russian system, which brings a 750kV line from Smolensk through Belarus to Ignalina in Lithuania. Lithuania then supplies the Russian oblast of Kaliningrad with electricity by means of this connection. The governments of the Baltic States see the electricity industry as vital to the future economic development of their countries. A report on energy policy, approved by the Latvian Cabinet in September 2001, identified energy policy in the electricity

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sector as ‘an integral part of (the) strategy of the national economy’. Its policy was aimed both at ‘the creation of preconditions for the establishment of a common Baltic electricity market…’ and at ‘ensuring the reliability and quality of electricity supply within the forthcoming 10 years, through both short-term immediate activities and regular annual measures that are vital for a stable development of the energy industry.’14 The Estonian government has been no less clear: ‘The fuel and energy sector is a strategic infrastructure of the state which must ensure that Estonia has an uninterrupted supply of high-quality fuel, electric energy and heat at optimal prices. At the same time the fuel and energy sector must be as efficient as possible and comply with the safety and environmental requirements.’15

The difficulty for the Baltic governments in assessing energy policy in the electricity sector has been the same as that facing them in other energy sectors: the lack of domestic supply and an addiction to subsidized fuel and energy from external sources. The Latvian Cabinet of ministers complained that past assumptions were based on ‘the import of inexpensive primary resources and electricity, satisfying the short-term demand of consumers’ and that the attainment of their goals in the energy sector was ‘hindered by circumstances related to the situation in the region where the stability of external suppliers can be planned only on a short-term basis’.16 Two major factors affect the future development of the Baltic electricity market. The first of these is the region’s reliance on unpredictable and potentially volatile external sources of supply.

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‘The supply of primary energy, including electricity (also import) in the Baltic region exceeds the demand, therefore today the electricity cross-border sales prices are low’, according to an assessment by the Latvian Cabinet. ‘However, these prices do not reflect the long-term marginal costs of electricity generation and it is hardly possible to forecast with certainty the price level for a period in excess of one year. The current situation does not provide for economic signals to be aimed at the introduction of new generating capacities, therefore undermining economically justified fulfilment of long-term supply objectives.’17

The other important factor affecting future development has been the need to ensure that Latvia meets its international environmental commitments and that industry makes the necessary improvements to meet EU standards. The Latvian government has emphasized that: ‘In the future development of the energy industry, utmost attention shall be paid to problems related to environmental protection, taking into consideration the increasing requirements with respect to environmental protection and security as dictated by the public wellbeing and international commitments of Latvia.’18

The Estonian government sees the country’s new international, environmental obligations as an opportunity. ‘The visions and needs relating to the future of power engineering have now changed to a significant extent – in connection with accession to the EU, a number of requirements and objectives have arisen, the energy technology has developed and implementation of the Kyoto Protocol provides new possibilities…’19 Both governments have identified the ‘promotion of renewable and domestic energy resources’ as critical to

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the attainment of their objectives, the main one of which, in the case of Latvia, is ‘to foster the development of the energy industry in line with balanced and sustainable growth of the national economy’.20 The Estonians have set environmental targets as formal, strategic objectives for the fuel and energy sector. They have specified that, by 2010, renewable energy should account for 5.1 per cent of gross consumption and that by 2020, electricity produced in combined heat and power production stations should form 20 per cent of gross consumption. The problem that all three Baltic countries now face is to ensure that the electricity sector can continue to service the requirements of rapid economic growth. The Latvian Cabinet has recognized that ‘there is a need to improve the reliability and quality of electricity supply with no delay, especially when connecting new users or changing existing loads. In the conditions of a swift economic development, the electricity supply companies have to guarantee stability and quality of electricity supply to the highest standards. Of late, the national economy of Latvia has been undergoing modernization and introduction of new advanced technologies and equipment, requiring extremely high quality of electricity and reliability of supply.’ However, the combination of new environmental commitments and reduced generating capacity in some areas is bound to create difficulties and increase reliance in the shortterm on imports. The Latvian government has admitted that: ‘It is anticipated that several electricity generation facilities in the Baltic Region (Ignalina NPP among them) will be closed down within the forthcoming 5–8 years, and the existing facilities will continue to

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depreciate. Simultaneously, compliance of the generating facilities with the environmental protection standards can be expected, which, in turn, will reduce the scope of generation. Hence, there is a risk of eventual inadequacy between the consumer demand and the ability to meet it.’

Furthermore, the Latvians have identified serious structural failings, which will increasingly affect the reliability and quality of supply. ‘Along (with) changes in the energy consumption structure and load centres and the location of energy generating facilities, the technical condition of electricity transmission and distribution networks, as well as the pace of development of network systems, has resulted in the incompatibility of network capacities with the capacity transmission demand to meet the needs of energy users. Moreover, the development of electricity transmission and distribution systems is no longer sufficient and adequate.’21

The region faces a major infrastructure problem within the BRELL electrical ring, where not only is the transfer system inappropriate in the post-Soviet era but, according to one manager, ‘even at present some of the interconnections are operated close to the reliability limits’.22 The problem is compounded by the fact that ‘no transfer capacity allocation methods exist’ and ‘power exchanges are based on bilateral monthly contracts’. Power exchanges appear to be allocated on a ‘first come, first served’ basis and there is no clearly structured power reserve market. Instead, ‘mutually agreed power reserves’ are kept for the Baltic Interconnected Power Systems (IPS), the Belarus IPS and Russia’s UPS ‘with no clear principles of use’.23

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Nevertheless, despite these obstacles, the Baltic governments remain confident about the future. The Latvians even claim that ‘taking into account the technical condition and the market maturity level in the neighbouring states, as well as the related risk factors in the electricity trade, by (the) year 2008, the potential supplies of electricity from power plants under the Latvian jurisdiction shall reach 80–90 per cent of total consumption’. Such prognoses, however, have proved to be more than a little optimistic, in part because they anticipated extraordinary results from the development of new and environmentally sustainable sources of energy. The Latvians, for example, claimed that ‘such level of supply will be attained through preservation and modernization of the existing capacities, as well as by creating economically sound conditions for the development of facilities operating in a cogeneration cycle and using renewable energy resources’. In the long term, whether such optimism will be justified, given the scale of the restructuring involved, remains to be seen. What is clear, however, is that all three Baltic governments attach great significance to the development of renewable and environmentally-friendly sources of energy as part of their overall energy security planning. The Latvians, along with the other Baltic governments, are looking to the private sector to make the necessary improvements. ‘The international experience shows that the tendency of the energy users to improve the reliability and quality on their own, as well as the growing number of problems related to eligibility to build large energy facilities (power plants, transmission lines) promote the development of dispersed generation and combined energy generation

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technologies (micro turbines, fuel cells, small co-generation, etc) and concepts thereof.’

The government has even gone so far as to state publicly that: ‘No other restrictions than those relating to environmental protection and stability and public safety will be imposed with respect to the introduction of new electricity generating capacities in Latvia.’24 It may not be quite enough, however, given the scale of the restructuring involved, to justify the government’s optimistic prognoses about future domestic generating capacity. Equally, as the private sector responds to the challenge of modernizing and developing the electricity infrastructure of the Baltic States, as in other energy sectors, the same questions will confront political leaders about security of supply if, as is likely, much of the required investment comes from Russia.

Natural gas None of the Baltic countries is a producer of natural gas and all three depend on imports to meet demand from domestic consumers. In 2001, whilst producing no gas themselves, the Baltic countries consumed a total of 202 billion cubic feet. Most of the Baltic States’ imported gas comes from Russia and is provided by the quasi-state monopoly company Gazprom and its subsidiaries at rates which, until recently, have been favourable. The Baltic States have long-term supply agreements with Gazprom, which has traditionally maintained a good relationship with them, in part because of their importance hitherto as transit states. However, with the development of other strategic routes for supplying gas to Western Europe, such as the North European Gas Pipeline, the Baltics are

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losing their importance as transit states and political concerns seem increasingly to motivate Gazprom’s activity in the region. When Aleksandr Ryazanov, Gazprom’s deputy CEO, announced that he was planning to raise the price of gas supplied to the Baltic States, he specifically linked his decision to a political development. ‘Following the accession of the Baltic States to the EU, we will be raising prices to the corresponding level,’ he announced. As an example of what the Baltic countries might expect, Ryazanov cited the current Polish price of $120 per 1,000 cubic metres.25 Gas prices in all three countries have, to date, been held artificially low, at around $80–85 per 1,000 cubic metres. In a region with the lowest per capita wages in the EU, Gazprom’s decision to raise prices has, understandably, caused widespread concern. Suspicion persists that the decision is politically motivated, an act of vengeance because the Baltic nations joined the EU and NATO or part of a plan to choke Baltic independence.26 However, Gazprom does have a point. It insists that the plan is simply to increase prices in the Baltic States to the level of the rest of the EU, in line with growth. As growth rates have been more impressive in the Baltic States recently than virtually anywhere else in the EU though, the price rises could soon be very steep. The Russian gas giant does appear to be concerned about protecting its Baltic market, however, and seems wary of the effect that punitive price rises could have on its position. ‘ We must not increase prices too much because then Lithuania, Latvia and Estonia could switch to alternative fuel, such as fuel oil,’ Ryazanov said.27 He also confirmed Gazprom’s long-term interest in the Baltic market, telling a press conference that

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‘The Baltic States’ market is stable and Gazprom is interested in it.’28 President Putin himself has painted a similarly rosy picture, telling European leaders at a recent summit meeting on Russia’s Black Sea coast: ‘The launch of construction of the North European Gas Pipeline, measures to strengthen the energy security of the continent – all this is moving towards progress, towards global and regional development and towards our main aim of improving the quality of life of Europeans.’29

As Gazprom expects continued economic growth and a corresponding increase in demand for gas, Ryazanov has also stressed that the company would be foolish to encourage the development of other sources of fuel supply by increasing prices to unsustainable levels. ‘There are estimates that by 2010 the consumption of gas in the country will reach 5–5.5 billion cubic metres and we are ready to satisfy the demand in full.’30 More worrying perhaps than the planned price increases, however, has been Gazprom’s corporate acquisition activity in the region. The company has recently set about making a series of strategic acquisitions of natural gas utilities. It now holds a 34 per cent stake in the Latvian gas company Latvijas Gaze and 37 per cent of Estonia’s Eesti Gaas. With Lithuania’s partial privatization and price deregulation in January 2004, Gazprom acquired 40 per cent of the state-owned natural gas company. Whilst it has joined other foreign companies, such as Germany’s EON-Ruhrgas and Finland’s Fortum, in investing in the Baltic gas sector, the concern is that Gazprom is not a ‘normal’ investor, whose actions are determined primarily by market considerations. In some Baltic countries, concern about Gazprom’s intentions has led to

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second thoughts about privatization. In Latvia, where Gazprom supplies more than 80 per cent of the country’s gas, it has a long-term supply deal with its local partner, Latvijas Gaze. Even before the planned liberalization of the Latvian market in 2007, Gazprom already has a powerful hold on the economy, with a virtual monopoly on the import, transmission and distribution of gas. Some commentators fear that further liberalization may simply help Gazprom to tighten its grip. Ultimately, however, many in the Baltic States feel that, without European support, their room for manoeuvre is limited. As so often in history, the fate of the Baltic countries may depend on guarantees of support from outside the region. If Germany pushes ahead with the North European Gas Pipeline and the rest of Europe continues to increase its dependence on Russian gas, there will be very little that the Baltic countries can do, on their own, to slip from Gazprom’s grip. The three Baltic governments appear to have recognized the limits to their capacity to deal with the issue of energy dependency. In a declaration following their meeting on 27 February 2006, Prime Ministers Ansip of Estonia, Kalvitis of Latvia and Brazauskas of Lithuania said: ‘Taking into account the sensitive issue of the security of energy supply in the Baltic States and the fact that the Baltic States do not have any gas and electricity interconnections with other EU Member States, and therefore do not have possibilities to participate in the internal energy market; considering the necessity to reduce the dependency of the Baltic States on the dominant supplier of the energy resources; bearing in mind that the closure of the Ignalina Nuclear Power Plant will have serious effects on the energy security of

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the Baltic States; the Prime Ministers of the Baltic States: 1) express their support to the development of a common European energy policy as a guarantee to the security of supply at the Community level; 2) state that the energy security problem of the Baltic States should be addressed at the EU level and therefore request that the European Commission by the end of 2006 assesses energy vulnerability of individual Member States and EU regions in order to propose specific actions at the EU level for the reduction of such vulnerability… 3) consider that there is a need to integrate the EU energy and foreign and security policies. A harmonized EU external energy policy should be established towards third countries and organizations, notably with Russia and OPEC… 4) call for the development of an EU mechanism that prepares for and ensures solidarity and assistance to a country facing difficulties following damage to its essential infrastructure or disruptions in energy supply…’31

Oil Russia currently supplies approximately 90 per cent of the Baltic States’ oil. There is a small amount of domestic production, with Lithuania producing roughly 14,000 barrels per day (bbl/d) and Estonia around 6,000 bbl/d, most of which comes from oil shale. Latvia is entirely dependent on imports. The main significance of the Baltic States in the oil sector has been their role as an export terminal for Russian crude transported to ports on the Baltic via Transneft’s pipeline system. The amount of oil traded through the Baltic region has increased significantly in recent years, with export capacity nearly doubling since 1999. However, as nearly all the exported oil

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arrives at the Baltic via the Russian pipeline system, competition has been fierce and there have been dramatic changes in the distribution of market share. Until recently, Ventspils in Latvia was the largest port in the region and the second largest terminal for the export of Russian crude oil after Novorossisk. In 2002, however, Transneft completed work on its port at Primorsk near St Petersburg and immediately stopped deliveries of crude oil to Ventspils. Faced with the overnight eradication of its main source of business, Ventspils tried to increase deliveries of crude oil and petroleum products by rail, simply in order to be able to maintain its position as an oil-exporting port. Although far from ideal and very much a short-term solution, this policy had some success in plugging the gap created by the absence of piped Russian crude. By 2004, with the construction of a new rail terminal, Ventspils was able to export 215,000 bbl/d of oil. This was, however, only one third of the average amount exported before Transneft’s completion of Primorsk and the beginning of what is, effectively, an embargo. Moreover, transporting petroleum products and crude oil by rail rather than via the pipeline system has brought significant extra costs for Ventspils, increasing exposure to risk, as profit margins are much slimmer.32 The primary competitive threat to Ventspils is now Primorsk. Russia’s Baltic Pipeline System now brings oil from western Siberia and the TimanPechora oil fields to the new Russian port. By the end of 2003, Primorsk had already become the Baltic region’s busiest port, handling 600,000 bbl/d. In 2004, crude oil flows reached an average of 880,000 bbl/d. Further expansion, currently being planned by Transneft, would dwarf the

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capacity of Ventspils, giving Primorsk a crude oil export capacity of 1.2 million bbl/d. In addition, Transneft plans to develop a petroleum product export terminal, which would be capable of handling up to 120,000 bbl/d. The future of Ventspils thus remains uncertain. The problem is that, as Primorsk is wholly owned and operated by Transneft, priority will automatically be given to it. This is not a question of normal commercial considerations or even anxiety about the presumed patriotic prejudices of Russian companies. Transneft is a stateowned monopoly and the Russian authorities have stated explicitly that, when allocating resources for export, seaports in which Russia has a stake will be given precedence over foreignowned ones.33 The Baltic States’ other main oilexporting ports are less exposed than Ventspils but for different reasons. Tallinn in Estonia, which comprises a complex of four large ports (Muuga, Old City Harbour, Palyasaare and Paldiski) has recently undergone a period of some expansion. Despite the fact that it depends on the railways for its crude oil and petroleum products, it has seen the largest annual increases in fuel oil export levels of all the Baltic Sea ports, with exports rising to 16.338 million tonnes in 2004. As a consequence, new rail links and jetties have been added at the main export terminals, Estonian Oil Services, Pakterminal and Eurodek. The new facilities have also allowed Tallinn to increase its exports of other Russian products, most notably coal, exports of which rose to 2.276 million tonnes in 2004 from 1.825 million tonnes in 2003. In Lithuania, the port of Butinge, which is located between the Latvian border and the Russian enclave of Kaliningrad Oblast (the former German province of East Prussia), has apparently been more fortunate than

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Ventspils. Despite being smaller than the Latvian port, Butinge exported more oil in 2003 than Ventspils and, as a consequence, undertook a limited expansion of its facilities.34 On the face of it, the reason for Butinge’s comparative success has been the fact that it has enjoyed better relations with its Russian suppliers than Ventspils. This has, however, been something of a double-edged sword, to say the least. Butinge is part of the Mazeikiu Nafta complex, the largest energy enterprise in Lithuania, which also includes the oil refinery at Mazeikiai and a pipeline at Birzai. In 1999, Lukoil, one of Russia’s leading oil companies, with close connections to the Kremlin, tried to gain control of the complex but was firmly snubbed by the Conservative/Christian Democrat coalition government, which instead sold a controlling share to Williams International, a US company. The government apparently feared that a takeover by Lukoil would represent a serious threat to Lithuania’s strategic interests, allowing Moscow not only to gain a stranglehold on the country’s energy infrastructure but also to influence its foreign and security policies. Some reports suggest that Moscow was so unhappy about the sale of Mazeikiu Nafta to Williams, that it launched a determined campaign to undermine the deal.35 In 2002, Mazeikiu was sold to a Russian company, although not to the proKremlin Lukoil but to Yukos, an oil and gas giant, headed by a so-called ‘oligarch’, Mikhail Khodorkovsky, who was openly critical of President Putin. In October 2003, however, Khodorkovsky, perhaps the most progressive

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of Russia’s leading oligarchs, was arrested on charges of tax evasion and other ‘economic crimes’. Dragged from his seat on an aeroplane at a Siberian airport by special forces, Khodorkovsky’s arrest was soon frontpage news and a powerful warning to Russia’s emerging business class. After a lengthy trial, the Yukos boss, who was once Russia’s richest man and, reputedly, worth £8 billion, was sentenced to eight years in a Siberian prison camp, where he continues to languish to this day.36 It is fair to speculate that the reason for the harsh treatment meted out to Khodorkovsky was not simply his political opposition to Putin but also the fact that his activities were increasingly running counter to the Kremlin’s foreign and security policies. One commentator recently specifically identified Khodorkovsky’s purchase of Mazeikiu Nafta as a reason for the oligarch’s downfall: ‘As the head of Yukos and bent upon operating the company in a manner in keeping with Western and not Russian enterprises, Khodorkovsky had refused to abide by the Kremlin’s direction that Russian energy entrepreneurs advance the government’s security priorities first and only later think about profit margins. He not only purchased the largest oil refinery in the Baltics, Lithuania’s Mazeikiu Nafta – thereby denying that prize to Lukoil, a Kremlin favourite, he also contemplated a partnership with China in the construction of an oil pipeline, and indicated that he sought a close commercial relationship with one of the major American oil companies. If successful, Khodorkovsky would have compromised Putin’s drive to play the energy card on the global chessboard.’37

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5. Russia’s interest in Baltic energy The key question in any assessment of Russia’s objectives and interests in the Baltic States’ energy systems is: does the Russian state want to encourage Russian companies to secure a predominant position for legitimate commercial reasons or are their actions a symptom of a wider attempt to promote Russian foreign and security policies? Any attempt to answer this question must, first of all, pay attention to the composition and antecedents of the key decision-makers in Moscow. It must also appreciate the extent to which energy and security concerns inform their common Weltanschauung.

The siloviki and the key decision-makers President Putin and his advisers are very different to the men who ran Russia in the 1990s under Boris Yeltsin. Whereas, at least in the early part of his rule, Yeltsin tended to surround himself with liberal reformers, buccaneering businessmen and even former anti-Soviet dissidents, Putin’s advisers and intimates come almost exclusively from the same security service milieu as the president himself. Today’s governing elite in Russia is substantially composed of the socalled ‘men of power’, the siloviki, an epithet that only hints at what often tends to be their collective view that they represent the ‘eternal state’, the postoyannoye gosudarstvo. In its most basic form, it is a view that, whilst political systems come and go, the interests

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of the state remain the same. The mission of the siloviki, therefore, is to reestablish, preserve and extend the authority and influence of the state. Whilst it is certainly possible to overestimate their importance, some reports suggest that as many as one quarter of Russian government officials could be classed as siloviki.38 Of these, Putin himself is, clearly, the best known. However, his close friend, the Defence Minister, Sergei Ivanov, is also a former KGB officer, as is Rashid Nurgaliyev, the Minister of the Interior. It was Sergei Ivanov, in the wake of 9/11, who said that Russia would in no way assist the United States in its military action against the Taliban and al-Qaeda in Afghanistan. Although the more diplomatically adept President Putin quickly slapped down his defence minister, Ivanov’s comments were indicative of a typical silovik attitude to foreign policy, seeing the United States as head of a Western alliance determined to humiliate Russia and prevent its re-emergence as a world power. Two of the President’s closest advisers, Viktor Ivanov and Igor Sechin, deputy chiefs of staff in the Kremlin, worked for the KGB in Putin’s home town of St Petersburg. Ivanov, a graduate of the Leningrad BonchBruyevich Electrical-Technical University, who worked as an engineer before joining the KGB in 1977 and fighting in Afghanistan, is now a deputy head of the president’s administration. In addition, five of the seven people selected to serve as regional ‘super-governors’ were siloviki. They included Viktor Cherkessov, who was

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responsible for the KGB’s campaigns against anti-Soviet dissidents until the dissolution of the USSR in 1991. Putin considered him a suitable choice for ‘super-governor’ of north-west Russia. What is more interesting, however, is the involvement of the siloviki and the security establishment in Russia’s energy complex. Equally significant is the geo-strategic, political importance that the president himself has long attached to issues concerning the development of Russia’s energy resources. An example of a prominent silovik with an important position in Russia’s energy structure is the deputy Chairman of Gazprom, Aleksandr Ryazanov. He became Chief Executive of the Siberian oil company, Sibneft, in 2005, after it was bought by Gazprom. He was also recently appointed to head UkrGazEnergo, a Russian–Ukrainian joint venture company, which was created to act as a bridge between Ukraine’s state-run Naftohaz Ukrainy and the Swissregistered RosUkrEnergo.

Background to Putin’s energy and foreign policy In order fully to understand the importance of Russia’s energy resources in Vladimir Putin’s world view, however, it is necessary to return to the period in the 1990s when the future president spent most of his time in St Petersburg. He had already served 15 years there as an officer in the KGB and its successor organization, the Federal Security Service (FSB), when he joined the St Petersburg Mayor’s office. He also enrolled as a ‘mature student’ in the St Petersburg Mining Institute. Both the Mayor’s office and the Mining Institute were to play an important role in the development of

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Putin’s approach to energy and foreign policy. In 1994, the Mining Institute appointed a new rector, Vladimir Litvinenko, who is believed to have exerted a significant influence on the development of Putin’s thinking. Litvinenko believed in the importance of energy as a tool of state policy, and Putin followed his lead when he came to defend his doctoral thesis in 1997 with an examination of the contribution of natural resources to regional economies and strategic planning. Two years later, as director of the FSB, he wrote an article for the Mining Institute’s in-house journal entitled ‘Mineral Natural Resources in the Development Strategy for the Russian Economy’. Putin argued that hydrocarbons were crucial both to Russia’s future development and the restoration of its former power. His central thesis was that the most effective way to harness Russia’s natural wealth was by state regulation of the fuel sector and the parallel creation of large, vertically integrated companies, which would work in close partnership with the state. During his time at the St Petersburg Mayor’s office, Putin met several key figures, who would go on to occupy important positions in Russia’s energy-security complex. They included Alexey Miller, who is now the Chief Executive of Gazprom; Dmitri Medvedev, who became the head of the Presidential administration, deputy Prime Minister and chairman of the board of Gazprom; and Igor Sechin, who is now the chairman of the board of Rosneft, a position he has managed to combine with the office of deputy head of Putin’s administration. The influence of Litvinenko and his Mining Institute has endured too. The Institute, according to one report, is now a compulsory stop for Russian and German energy leaders

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visiting St Petersburg. The Institute’s website, for example, recently noted that it had received a delegation from Gazprom’s close ally, the German gas giant, Wintershall.39

Russia’s energy-security complex The energy-security complex is now at the centre of power and policymaking in Russia. Trusted figures from the security apparatus have managed to occupy key positions in both the government and the energy sector.40 The president and his closest advisers believe that the use of Russia’s energy resources is an essential element in their plan to re-establish Russia’s power and influence, particularly in the ‘near abroad.’ ‘…Kremlin planners realized at some point in the 1990s that they possessed an economic weapon of significant potential, one capable of promoting Russia’s foreign policy objectives in the space of the former Soviet Union’, according to one commentator. ‘The weapon was a massive supply of natural gas and petroleum along with strategic pipelines from East to West, refineries, pumping stations and other installations associated with Russia’s energy wealth.’41

By the middle of the 1980s, the Soviet Union had become the largest oil producer in the world and, although fluctuating prices masked the true extent of its wealth, by 1998, it was sending more than 4.09 million barrels per day for export. A decade later, as Putin and his team prepared to take over the reins of power from President Boris Yeltsin, they realized the significance of Russia’s energy resources, particularly at a time when oil prices

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were rising and there was growing unease about the West’s ability to continue to rely on the Middle East.

Energy as a foreign policy tool In the Baltic States and Poland, there is little doubt that energy has acquired a new geo-political significance for the Kremlin and that Putin is determined to use Russia’s energy resources to secure his foreign policy objectives. At the same time, the West so covets Russia’s vast pool of oil and gas that it is, seemingly, prepared to ignore Putin’s willingness to use energy to secure deeper foreign policy goals with the new NATO and EU Member States in the ‘near abroad’. The Baltic specialist, Richard Krickus, has emphasized the geo-political potential of Russia’s energy asset. He believes that, particularly in the Eastern Baltic Sea Region (ESBR), the importance of energy as a tool of foreign and security policy now overrides the usual economic considerations. ‘Through its energy industry, Russia has vast resources that enable it to play the energy card on a global basis… Moscow has used the pipeline system as a foreign policy weapon. Indeed, the Kremlin is prepared to make economic sacrifices to promote its foreign policy agenda. Russia, for example, is building its Baltic Pipeline System to carry oil to the Russian port of Primorsk; it could find cheaper outlets were it to use the underutilized oil transit routes through the three Baltic countries. At the same time, sceptical about Warsaw’s good will or merely wishing to punish Poland, Russia is building an undersea gas pipeline at a cost three to four times as much as running a parallel pipe along the Yamal route through Poland.’42

The former US Ambassador to Latvia, Keith Smith, has identified the

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extent to which Putin has been prepared to interfere in the energy sector in order to establish control as a real cause of concern. ‘Putin appears to share the widespread view in Russia that energy is too important a national asset to allow the market or any private individual free rein in deciding on issues such as links to foreign partners, pipeline construction or competition for the right to explore new oil and gas fields.’43

The Kremlin’s motives If energy is, indeed, being used as a tool of foreign policy in the Eastern Baltic Sea, what exactly is the Kremlin’s objective? The row over Russia’s decision temporarily to curtail gas supplies to Ukraine and concern in Poland and the Baltic countries over the North European Gas Pipeline have drawn the attention of some of the world’s richest energy consumers in Western Europe to the question of the reliability of Russia as a long-term energy supplier. In purely commercial terms, the Kremlin does not appear to have played its hand very cleverly. It has encouraged the European nation states to re-examine the need for a common energy policy and it has helped to fuel demand for alternative technologies and sources of supply. However, as an instrument of foreign policy, it has achieved several important objectives. First, and perhaps most worryingly, it has sent a clear signal about what it continues to regard as its legitimate sphere of interest. This is, perhaps, a measure of the frustration of the siloviki at NATO expansion in the region but also a warning that Russia is determined to maintain its interest there. In part, the Kremlin’s motive may have been its unease about what it per-

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ceives as Poland’s increasing attempts to influence events in the region and to return to the pre-war idea of a cordon sanitaire around Russia. Moscow may also have been influenced by a desire to slap down the Balts, who have continued to enrage the siloviki ever since they achieved independence with a series of irritating political challenges, such as encouraging the EU to deny Russian citizens visafree access through Lithuania to Kaliningrad and providing a platform for Chechen exiles to criticise Russian policy in the Caucasus. More significant, however, is the role Moscow believes them to have played in frustrating the Kremlin’s attempts to establish a relationship with major EU countries in a bid to counterbalance US power. Baltic support for the American-led coalition in Iraq was crucial in undermining European opposition to US policy and caused irritation not only in Moscow – when the Balts signed a letter supporting the US invasion, they were told to ‘shut up’ by the French President Jacques Chirac. Worse still, in Moscow’s eyes, was Baltic support for Polish initiatives to resolve the political crisis in Ukraine, paving the way for the ‘orange revolution’ and the loss of political control. The fact that President Bush visited Latvia on his way to Moscow for the celebrations commemorating the 60th anniversary of the end of the Second World War, which were boycotted by two out the three Baltic leaders, was an indication to Moscow of Washington’s desire to use the Balts to counterbalance Russian pressure on the EU. NATO’s recent decision to host its next summit for heads of government in Riga in November 2006 was, perhaps, the final humiliation for the siloviki, an indication that Russia’s former Baltic provinces were now not only members of a different military bloc but also capable of exerting

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influence within it against Moscow’s interests. In such circumstances, it would hardly be surprising if the Kremlin decided that Russia’s state monopoly energy companies were an appropriate instrument with which to issue an admonitory slap to the Baltic States. Secondly, Putin’s sabre-rattling was, perhaps, designed to impress his colleagues in the G8. It was, effectively, an announcement that Russia could no longer be ignored or taken for granted. ‘…Just as Russia focuses the G8 on energy security, Putin has illustrated why its position is at least as powerful as any other around the table’, one investment analyst has observed. ‘The argument has been made that there is a symbiotic relationship between energy producer and energy supplier – Russia needs the consumer just as much as Europe needs the producer. But this seems to be somewhat unimaginative rhetoric. It is difficult to imagine a scenario when Europe will unilaterally stop buying gas from Russia. Russia, on the other hand, has shown it can turn off gas supplies simply because of an unpaid gas bill. As the G8 focus on energy security, Russia has shown where the balance of power lies.’44

Thirdly, Russia has shown that it is willing to use energy to advance its foreign policy agenda and not simply as a means of securing increased revenue. ‘By throwing the switch for a couple of days when most of the world was focused elsewhere, Russia has shown that its threat to energy supplies is not empty. The Kremlin’s determination to gain control over Russia’s hydrocarbons has not simply been about access to revenue flows but also to gain power that they are not afraid to use.’45

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The Kremlin’s use of energy as a tool of foreign policy is about buying influence, rather than winning friends. Russia’s economic performance during the past decade has meant that it is now able to make its presence felt once again on the world stage. Equally, it is now the only European country with both the resource base and the political will to pursue a genuinely independent foreign policy. What the precise implications of this fact are is still unclear. However, it is clear that, although Putin has tried to appear closely aligned with Europe, the Kremlin will not hesitate to pursue a policy that it considers to be in Russia’s best interest, despite the reservations of its partners in the West. It is important to remember, too, another fact that increasingly links energy to Russia’s security interests. The growth in Russia’s energy sector and the steady rise in prices underpinning it have also fuelled the reconstruction of Russia’s defence industry and allowed President Putin to begin to rebuild the Russian armed forces. In his seventh state of the nation address recently, President Putin said that ‘…we must make our own house strong and firm. Because we can see what is happening in the world’. He added that Russia needed to rebuild its military not just to deal with new and unpredictable threats, such as terrorism, but to ‘preserve the strategic balance of forces’. ‘We should be able to respond to attempts to put foreign pressure on Russia… and it should be said frankly: the stronger our armed forces are, the less temptation there will be to put pressure on us.’46

A reinvigorated Russian military, financed by the silovik-led energy sector and controlled by a Kremlin leadership determined to maintain Russia’s strategic interest in the Baltics, is

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unlikely to be a prospect greeted with universal enthusiasm in Riga, Tallinn or Vilnius. Finally, one major factor, which must be taken into account in any consideration of the Kremlin’s motive for using energy as a tool of its policy in the Baltics, is its anxiety over the future viability of Kaliningrad. As Moscow’s Baltic outpost is linked to the Russian grid through the Lithuanian network, it is only fair to acknowledge that Russia is bound to continue to have an interest in the region’s energy system. However, whether it has so far employed legitimate, or even sensible, means to advance that interest is another question. All this means first, that the Baltic States are likely to continue to be confronted with the Kremlin’s conviction that it has a legitimate strategic interest in the Eastern Baltic Sea Region and, secondly, that Europe needs to develop a clear Eastern policy (see below), which takes full account of the importance of energy security.

European energy security In any assessment of Russia’s interests in supplying energy to European markets, however, it must be emphasized that it is hardly possible now to exclude Moscow from the discussion about Europe’s security of supply. Poland, however, supported by the Baltic States, has been seeking recently to do just that. In March 2006, the Polish President, Lech Kaczynski, presented a draft energy security pact for EU and NATO Member States. The plan, which was drawn up by the office of Kazimierz Marcinkiewicz, Poland’s conservative Prime Minster, had four main elements: „ a mutual energy-security guarantee clause, modelled on NATO’s

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article 5, under which signatories would agree to support each other ‘in the event of a threat to their energy security from natural or political causes’; „ the development of new technical infrastructure for the transport, transmission and storage of energy, to allow cooperation if supplies to Member States were restricted; „ a greater focus at European level on the diversification of energy sources and the imposition of a ‘ceiling’ to limit dependency on particular sources of energy; „ the proposed energy security alliance would be ‘open to all Member States of the European Union or NATO’ and would thus automatically exclude Russia, although it might be possible for countries, such as Ukraine, to join at a later stage. Poland has recently been lobbying extensively for Ukraine to be granted an ‘action plan’ for future membership of NATO, which would make it eligible to join an energy security alliance.47 It is difficult to avoid the conclusion that, whilst it is easy to understand the legitimate concerns of Poland and the Baltic States, the proposed energy security alliance could end up being highly damaging to Europe’s wider security interests. The President of the European Commission, Jose Manuel Barroso, was surely right to emphasize that Europe should refuse ‘any kind of nationalism’ in the energy sector.48 Furthermore, energy specialists in both Russia and Western Europe have pointed out the impracticability of excluding Russia from any dialogue about European energy security. ‘All you have to look at is how much energy Russia supplies to Europe’, said Katinka Barysch, an energy

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expert at the Centre for European Reform. ‘This shows you cannot exclude Russia… The Polish view seems to be a contingency view. If the EU cannot reach a deal with Russia, then the Poles seem to be saying Europe needs alternative plans. But it is clear several Member States will not want to exclude Russia. Germany has already made that clear to Poland.’ Indeed, German officials have made clear their view that Russia should not be marginalized over an issue as crucial as energy security.49 Russian energy specialists have also been quick to emphasize Russia’s credentials as a reliable, long-term energy partner. The Director of the Russian Institute of Energy and Geopolitics, Ms E A Telegina, a board director of the Union of Russian Oil Exporters, said recently: ‘Russia has been a traditional, reliable and important exporter of energy… to the European Union. The EU has a serious interest in preserving and increasing the role of Russia as an oil and gas supplier. An important trend in world development and, in particular, in the development of advanced countries (North America, Europe, Japan) is an increase in natural gas consumption, which requires material investments in world energy…

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‘An important factor of world energy development is the gas and electric power sectors’ liberalization process, which is going on today, especially in the European Union (EU). The basic consequences would be the development of competition among producers, a possibility to choose a supplier and reduction of prices for end users. One of the key strategic tasks of the Russian Fuel and Energy Complex is to preserve and to maintain the competitiveness of Russian fuel and energy resources in world energy markets.’50

Ms Telegina argues that Moscow’s interest in securing European inward investment in infrastructure projects, combined with the strategic objective of maintaining competitiveness in increasingly liberalized European energy markets, means that the EU and Russia have a strong mutual interest. She insists that there is now an opportunity for ‘enlargement of the largescale cooperation, which can be characterized as a mutually beneficial strategic partnership built upon the principles of equality and parity of interests’.51 She may be right but the problem is that, so far, Moscow has done little to reassure consumers in Poland, the Baltic States and the rest of Europe about its intentions.

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6. The Baltics: options for the future The Baltic States’ concern about energy security is not unique. It is shared by several European countries, which are anxious about many different features of the current world energy market, including: „ the continuing rapid growth of demand; „ a reliance on hydrocarbons from areas of political instability; „ environmental issues, such as harmful emissions and nuclear risk; „ a failure so far to develop significant renewable energy solutions; and „ volatility in the market system and prices.

Russian dependency In many ways, in the past, the Baltic States have been fortunate in being able to draw on the vast energy resources of the Russian hinterland. Although antiquated, the system that links them into the Russian grid and pipeline system is an enormous advantage that could help to drive future economic development in both the Baltic States and Russia. The problem the Baltic States face is not the fact that Russia supplies them with energy, at hitherto heavily discounted prices, but that energy from Russian sources accounts for such an overwhelming, and increasing, proportion of the Baltic market. This situation is aggravated by the nature of Russian corporate activity in the Baltic for two main reasons.

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First, key Russian companies, such as Gazprom or Transneft, are either wholly or partly owned by the Russian state and, therefore, their activities in the recent past have seemed to reflect the Kremlin’s broader foreign and security policy agenda. Given the region’s painful history in the last century, it is hardly surprising that there should be anxiety about allowing Russian companies to enjoy a virtual monopoly of the supply and distribution of energy in various sectors. Secondly, and perhaps more significantly, the lack of transparency and the business practices of some Russian companies operating in the region have contributed to the suspicion that they are not normal private sector entities seeking to operate in a free market. The dilemma for Baltic governments, as they look to entice the private sector into investing in the region’s energy infrastructure, is that Russian companies are only too willing to invest but are often either secretive or state-owned, which makes them difficult to accept as partners in the liberalized, competitive environment that the Baltic States want to create in the energy sector. In considering their options, as they seek to reduce their dependency on Russian sources of energy, therefore, the Baltic States need to bear in mind that it is not Russian energy per se that is the problem but the fact that an over-dependence on it has potentially uncomfortable political implications. In this respect, the Baltic States are no different from those countries in Europe, North America or parts of Asia, which fear the consequences of

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their continuing dependence on energy from the Middle East. Equally, it is not the fact that Russian companies are keen to invest in the energy infrastructure of the Baltic States that is a problem but rather that they often seem to do so without operating to the same standards as Western European companies.

The energy security challenge So, the fundamental energy security challenge for the Baltic countries, as for many modern industrialized societies, is to diversify supply and, at the same time, control demand more effectively. Janis Folkmanis, economic adviser to the President of Latvia and a former European Commission energy policy specialist, has identified four key measures that the Baltic States must adopt quickly to ensure security of supply: „ diversify import supplies; „ strengthen indigenous sources; „ increase renewable energy components; „ curb demand.52 In analysing what needs to be done, however, the Baltic States also have to consider carefully what exactly is meant by energy security or security of supply. In a world of increasingly complex and interlinked energy markets, it is not, perhaps, as easy as might be expected to define these terms. One senior energy executive in the region, Arnis Staltmanis of the Baltic Power System Control Centre, has suggested that security of power supply means: „ a secure fuel supply for power plants; „ a balance between generation and demand;

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„ the ability of power systems to withstand normal and abnormal circumstances.53 In terms purely of security of power supply, that may be an adequate definition. In broader political or economic terms, however, it is not enough to define what sovereign nation states, such as the Baltic countries, might mean by ‘security of supply’ or ‘energy security’. However, whatever else it is, energy security is an international issue, a fact that means that the Baltic States can draw on international experience and support in developing policy, particularly at the European level, where the energy portfolio at the European Commission is now held by a Latvian, Andrijs Piebalgs. Concerns about energy security are no more unique to the Baltic States than the various other pressures and constraints affecting energy policy, which are shared by many European countries. The energy policies of all European countries have to be set within the context of developments in the global energy market, but there is a general consensus that overdependence on any single source of energy supply is very unwise. It is, perhaps, particularly unwise when the source of supply is liable to disruption, whether through technical difficulty, terrorist activity or political sabre-rattling. However, this is a major concern for many countries, with much greater economic and even political exposure than the Baltic States, the United States being the most obvious example. Many countries, therefore, share the dilemma of the Baltic States. They all recognize that the best guarantee of security is diversity of supply. Internationally, diversity of supply is best achieved by a package of measures, including:

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„ different means of energy generation (hydrocarbons, nuclear, renewables); „ a flexible energy transmission infrastructure; „ alternative sources of fuel supply; „ a thorough energy conservation programme; „ regional collaboration – for example, on storage capacity, reserves and sharing of facilities. The latter point is of particular importance to the Baltic States, which will find that the key to diversifying their supply lies partly in working closely with their regional and international partners. All three Baltic countries, working together, will find it much easier to develop appropriate solutions to reduce their dependency on particular external sources, than individual countries trying to ‘go it alone’.

Regional collaboration Inevitably, in the near future, the Baltic States will have to make major investments in infrastructure in order to improve their energy security. The old Soviet infrastructure was deliberately designed without a national basis and has left most of the former ‘captive nations’ with unbalanced national energy infrastructures. If the Baltic countries are to make the investments necessary in infrastructure, it would clearly be most cost-effective if it were done on a collaborative, regional basis. One obvious case in point is Latvia’s massive geological gas storage capacity, which could be made available to the other Baltic States, thus providing an important buffer against disruption of supply. The relatively small investment needed to extend the existing storage facilities would mean

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that all three Baltic States’ gas needs could be supplied for the duration of a whole winter. Equally, other large-scale energy generation projects could be both economically viable and reduce dependency on external sources of supply if they were applied on a regional, rather than a purely national, basis. A new nuclear plant of 750–1000MW at Ignalina, for example, would make economic sense as part of a regional energy strategy. Similarly, a 275– 400MW coal-fired plant in Latvia could compete with gas as an element in a regional policy.54 The importance of regional collaboration to achieve energy security was emphasized at a recent Policy Development Exercise in Lithuania. The exercise, which was held jointly by the Lithuanian Academy of Sciences and the Defence Academy of the United Kingdom, considered various options for Lithuania to improve its energy security and concluded that any attempt to reach a purely national solution to the problem was doomed to fail. ‘If Lithuania continues to pursue its energy policy on a purely national basis, it will be impossible to achieve energy security at an affordable cost, and any energy policy will be expensive. Energy security and lower supply costs can be achieved through regional collaboration. If that collaboration is developed proactively, however, Lithuania can become a regional energy hub, linking firstly to Sweden and Poland (by 2012), and linking Russia with Western Europe. This offers a tremendous opportunity for the future and would be the ultimate guarantee of energy security for a very model investment over the next decade. Many European companies should have a strong interest in seeing this develop. ‘However, this can only happen if Lithuania first develops a regional solution to energy problems, and pursues solutions

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proactively, tackling the issues by the necessary deadlines, and not waiting until a crisis occurs.’55

The nuclear option The question of the future of nuclear power in the Baltic States, whether ultimately for or against, is clearly one area where a regional, rather than a purely national, solution would be most appropriate. Some form of new nuclear plant to replace the existing RBMK reactor at Ignalina now looks increasingly likely and would enjoy a much higher level of public support in the Baltic States than might have been the case a decade ago. Whilst there is no fundamental contradiction between environmental concern and energy security, the international trend of the last decade away from nuclear power, largely influenced by concerns over environmental issues and financial costs, now seems to be reversing, in part because of a widespread recognition of its importance in achieving a mixed energy portfolio and thus contributing to security of supply. The nuclear option is being increasingly canvassed inside the Baltic States as a partial answer to the region’s problems over security of supply. In assessing whether to proceed with a new nuclear plant at Ignalina, political leaders in the region will be aware of the increasingly widespread view that nuclear power generation is less damaging to the environment than burning hydrocarbons. Improvements in the security of power stations, especially in construction and design, making them less vulnerable to terrorist attacks and accidents; a reassessment of the likely reduced impact of a major incident; and the security of fuel supplies, coming mostly from stable democracies, all increase the

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attractiveness of the nuclear option. In the context of the global energy market, in which oil and gas prices are rising steadily and Russia’s inability to ‘surge’ effectively to meet demand means that it will inevitably be forced to increase gas prices to the Baltics – whether it wants to or not – nuclear power begins to look a particularly attractive option. EU policy has been to press for the closure of all the RBMK reactors in central Europe. Lithuania has agreed to phase out nuclear power generation at Ignalina’s RBMK reactor by 2009 and, as a consequence, will receive European compensation funds. In such circumstances, the EU would be unlikely to react kindly to proposals to replace the existing reactor with one of a similar size and capacity. Equally, the cost of such a large-scale project would be prohibitive for Lithuania alone, which would, in any case, be left with a significant overcapacity. Patching up Ignalina and struggling on with it in its present form is not, therefore, a viable option. However, as participants at the recent policy development exercise in Riga recognized, ‘the nuclear option becomes more viable if (a) Lithuania can develop an energy policy based on regional agreements and shared supply, and (b) a smaller capacity nuclear reactor is built, instead of the current large options on offer’.56 In the Baltic context, the clear advantage of retaining some form of nuclear capacity is that it would maintain diversity of supply and thus improve regional energy security. In time, it might also contribute to a better energy relationship with Russia. Nuclear power is not the solution to the Baltic States’ problems with energy supply but, if European public confidence in nuclear safety continues to grow, it may be part of one.

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Renewable energy All three Baltic States clearly believe that renewable sources of supply can play a major part in helping to improve their overall energy security. However, the Latvian cabinet, for example, has made clear its view that significant investment in renewable technologies will have to be made in order to secure future benefits. ‘Taking into account the prevailing share of hydro resources, as well as the imported electricity in the energy balance of Latvia, the need for radical and expensive activities in support of (the) use of renewable resources in energy generation cannot be substantiated only from the perspective of (a) reduction of gas emissions having hothouse effect and elimination of global climatic changes.’57

However, in their enthusiasm for an environmentally-friendly, independent future, the Latvians and their fellow Balts may have overestimated the short-term potential of the ‘renewables’ sector as an answer to their prayers. A report to the Latvian cabinet in 2001 claimed that: ‘In the recent decade, technologies for the use of renewable energy resources have been developing particularly swiftly, which encourages to expect that the efficiency of some types and equipment of energy generation will improve and reach the level attained by conventional types; it will also promote wider consumption of renewable energy resources to improve the foreign payment balance of the country, minimize dependence of the country on energy import and promote creation of new jobs.’58

Despite the lack of significant, immediate gains in the ‘renewables’ sector, the longer term looks much more

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promising. The Baltic governments are determined to pursue development of ‘renewables’ for both environmental and security reasons. They have been actively reviewing the public sector framework within which the ‘renewables’ sector might be encouraged and promoted. ‘Taking into consideration the prospects for renewable energy sources and technologies of their consumption, as well as the fact that they in their development are in the transition to operation in a competitive conventional or traditional energy market, the total energy resources balance of all Latvian electricity consumers will include a renewable (‘green’) energy component, which would be aimed at social, economic and technical balancing and promotion of consumption of renewable resources and minimization of energy import in the country… ‘Purchase of energy from generators using renewable resources (water, wind, biomass – wood waste, peat) will be ensured by imposing the public service obligation on the system operators. As a result, the generation of electricity and heat and energy at power plants operating on renewable energy resources would be promoted in a predictable and planned manner and, upon reaching a certain level of development, will enable Latvia to join the ‘green certificate’ market supported by the European Union.’59

Co-generation schemes Co-generation schemes also offer significant potential energy savings and the Baltic governments have made clear their intention to support them. The Latvians, for example, noted in 2001 that ‘Co-generation plants will obtain support on the competitive market, if the annual average

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efficiency of primary energy utilization reaches 80 per cent and heat energy is supplied mainly to the district’s heat supply system of the respective licence validity area… With due consideration given to the development of the electricity market in Latvia and the common Baltic commercial territory, the electricity prices will be deregulated, should the market signals be favourable for the promotion of co-generation projects.’60

Energy efficiency and administrative improvements Outside advisers, such as the participants in the Riga policy development exercise, have pointed out the enormous potential for energy efficiency savings and administrative improvements. They suggested, for example, that ‘Lithuania can improve its energy security by: „ ensuring that there is a clear, comprehensible and enforceable legal framework; „ improving the administrative competence of civil servants and limiting the political lobbying of policy-makers and decisionmakers; „ improving the culture of risk management in the public and private sector; „ developing the role of NGOs to cope with the social impact of energy-related problems and to help improve mechanisms and education to counter corruption; „ setting up a sound energy taxation system with reasonable price regulation, making a much greater effort to introduce energy saving measures to reduce waste and to increase the

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efficiency of consumption (currently these are far below European norms).’61

Encouraging EU–Russian cooperation Finally and perhaps most importantly, whilst the Baltic States can do much in cooperation with one another to reduce their collective dependency on external sources of supply, it is clear that Baltic energy security can only ultimately be guaranteed within the context of future European energy strategy and a long-term agreement between Russia and the EU. The European Commission has recognized both the importance of a proper assessment of the EU’s energy security interests and the central role of Russia as a source of supply to meet Europe’s long-term energy needs. As Andre Merlin, President of the European Energy and Transport Forum and Chairman of the Executive Board of RTE has observed: ‘The European Union’s energy dependence is a strategic issue, which encourages us to seek a balanced partnership, notably with Russia. It is from this standpoint that the Energy Council of June 8th 2006 approved the proposal set out in the paper prepared with a view to the next June European summit on energy security and external policy of the Union, a proposal which considers making the Energy Charter operational… ‘…That’s why I’m convinced, in the light of these great challenges that this is no longer a time when each nation drew up its own energy guidelines without taking into account its neighbouring countries. That era is behind us! The latest energy crises remind us that energy must be resolutely placed within a European perspective for the sake of

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our security of supply. We must set up a genuine European energy policy… This European energy policy only has meaning if there is true commitment in favour of a European energy market. The integration of the electricity and gas markets, of their operation and regulation is, in my opinion, the cornerstone of European energy policy.’62

That is why, perhaps, the most important contribution that Baltic leaders can make towards ensuring their countries’ future energy security is to internationalize the issue, wherever possible, and to press the EU to ensure that Russian companies, operating in the region, do so in accordance with internationally recognized standards of good governance and transparency. In this way, it should be possible for the Baltic States both to reassure themselves about the longterm security of their energy supplies and to develop an improved energy relationship with Russia, which would, in any case, be in the overall strategic interest of the EU. Participants at the Policy Development Exercise in Vilnius in 2005 came to just such a conclusion and advised the Lithuanian government that:

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‘Lithuania can improve her energy relationship with Russia by: ensuring that her energy security considerations are raised effectively in appropriate EU fora and bilaterally with large European countries undertaking energy deals with Russia; by encouraging other countries to help Russia realize that it is in her own long-term interests to improve transparency and governance of Russian energy companies and by ensuring complete transparency and adherence to international norms for any naturally important energy agreements and deals.’63

In concentrating on such an approach, the Baltic countries may find that they are pushing at an open door. One leading Russian energy specialist commented recently that ‘…the objective analysis indicates that for the creation of an effective market, Russia will gradually have to harmonize national regulation of energy in accordance with the global practice. Thus, it will need certain time and comprehensive preparation performed by means of in-depth analysis, including assistance of the EU countries’.64

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7. Conclusion There is substantial evidence that Russia has, indeed, sought to use its control of energy resources as a means to further certain of its foreign policy objectives in the Eastern Baltic Sea region. In countries, such as Poland and the Baltic States, with long memories and a painful experience of recent history, this has, understandably, been a cause of real concern, particularly since the row over supplies with Ukraine and the announcement by the German and Russian governments of a North European Gas Pipeline. However, the issue of Baltic energy security should be seen within a broader European context and form part of the agenda for a wider discussion between the EU and Russia about a long-term energy partnership. It is certainly true that both the EU and Russia have a significant interest in the development of a stable and reliable partnership in the energy sector. In the meantime, however, as they continue to press for a broader European agreement with Russia on energy security, there are a number of measures, including possibly the development of a new regional nuclear capacity at Ignalina, which could help

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to reduce the Baltic countries’ dependence on external sources of supply. These should be pursued actively with the full support of the EU, as part of a plan to integrate the Baltic States fully into the European energy system and reduce the risk that the Baltic countries might be seen as somehow divorced from the rest of Europe. Finally, in a region haunted by the ghosts of history, outsiders should tread with particular care and seek to reassure their partners about their intentions. Equally, perhaps, whilst understandably remaining wary of the intentions of their neighbours, the Balts themselves would be well advised to avoid seeing every commercial development in the energy sector in their region as part of an apocalyptic political conspiracy against them. With the support of the EU and a new understanding of the importance to the whole of Europe of securing sources of energy supply and reducing dependency, the Baltic peoples are in a better position than at any time in their history both to entrench their independence and to secure their position as a bridge between Western Europe and Russia.

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Notes and references 1. 2.

3.

4. 5.

6.

Baltic Energy Strategy of Baltic Council of Ministers’ Energy Committee, Vilnius, Riga, Tallinn, April 1999. An article on Baltic Energy in The Economist of 5 January 2006 even quotes one Polish official describing the planned pipeline as ‘a pact between the KGB and the Stasi’, possibly a reference to the curriculum vitae of the German boss of the pipeline, Matthias Warnig, a former East German intelligence officer, who worked with President Putin in St Petersburg in the 1990s. G von Pistohlkors, Die historischen Voraussetzungen fuer die Enstehung der drei baltischen Staaten. In B Meissner (ed), Die baltischen Nationen: Estland, Lettland, Litauen, Cologne 1990, p. 11. Quoted in The Baltic Nations and Europe: Estonia, Latvia and Lithuania in the Twentieth Century, by John Hiden and Patrick Salmon, Longman, 1991. J Hiden and P Salmon, op.cit. German influence has always been much less strong in Lithuania, which reflects that country’s separate historical development, as much as its geographical location. The Lithuanians were the last pagans in Europe. Although Grand Duke Mindaugas converted to Christianity in the thirteenth century, his people did not. It was not until 1386 that Lithuania’s ruler Jogaila (Jagiello) ordered the mass baptism of his subjects when he married a Polish queen. Thereafter, Lithuania’s fate was closely linked to that of Poland, the two nations together defeating the Teutonic knights at Tannenberg in 1410 and formally uniting in 1569. Ultimately, when Poland was partitioned for the third time by her neighbours in 1795, Lithuania was absorbed into the Russian empire. Most of the rest of the eastern Baltic had been formally annexed by Russia almost three quarters of a century earlier, under the terms of the Treaty of Nystad of 1721. Again, Lithuania’s history is different, a feature both of her close connection to Poland and her Catholic faith. Russification was much more extreme in Lithuania than in the other Baltic provinces, perhaps because the local aristocracy tended to be more ‘polonized’ than elsewhere in the Baltic. After the abortive Polish uprisings against Tsarism in 1830 and 1863, the government began confiscating estates from the suspect Lithuanian nobility and encouraging the Orthodox Church to convert the Catholic peasantry. The Russian educational system was imposed on schools, the study of the Lithuanian language was

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7.

8. 9. 10. 11. 12. 13.

14. 15.

16. 17. 18. 19. 20. 21.

repressed and the use of the Roman alphabet was outlawed in favour of Cyrillic. The story of German involvement in the region, after the fall of the Kaiser and the signing of the armistice, is a fascinating but little known chapter in the history of the period. Confusion about allied policy towards Russia gave the Germans an opportunity to re-establish control of the region. After landing his ‘Iron Division’ at Liepaja in February 1919, General Count Ruediger von der Goltz launched a putsch against the new Latvian nationalist government of Karlis Ulmanis, attempting to install the more malleable Andrievs Niedra as a German puppet. The German military leadership hoped that, by appearing to act as a bulwark against Bolshevism in the region, they could not only gain better peace terms but also create a German outpost in the Baltic, effectively turning the region into another East Prussia and establishing a new ‘land bridge’ to a restored and realigned ‘White’ Russia. J Hiden and P Salmon, op. cit. J-T Dahlburg, ‘Baltic Nationalists Press Demands for Freedom’, Independent, 15 May 1989. Janusz Bugajski, ‘Cold Peace’, CSIS, Washington, 2004. World Bank, EU-8 Quarterly Economic Report, May 2006. Ibid. Unemployment is a serious problem in all three Baltic countries. In Latvia, it is 10% and in Estonia 9.6%. Poverty, particularly in rural areas, is also a major threat to social cohesion. In Latvia, for example, national statistics estimate that 16% of the population live in poverty. Report on ‘Energy Policy in the Electricity Sector’, approved by the Latvian Cabinet of Ministers on 11 November, 2001. ‘Long-term Public Fuel and Energy Sector Development Plan until 2015’, English translation by Estonian Legal Language Centre 2005. ‘Energy Policy in the Electricity Sector’, op. cit. Ibid. Ibid. ‘Long-term Fuel and Energy Sector Development Plan’, op. cit. ‘Energy Policy in the Electricity Sector’, op. cit. Ibid.

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22. Arnis Staltmanis, Manager of the Power System Reliability Department of the Baltic Power System Control Centre, ‘Security and Independence of the Baltic Interconnected Power Systems’. Paper presented at the Latvian Government Conference on Future Energy Options, Riga, April 2005. 23. Ibid. 24. Ibid. 25. Aleksandr Ryazanov, quoted by RIAN News Agency, 15 June 2004. 26. Kevin Kerr, an American commodities trader and market analyst with strong local connections, admitted that, whilst the planned price increases made some strict commercial sense for Gazprom, they were likely to cause real hardship. ‘The average worker in the region earns between $400 and $600 a month. (My own mother-in-law is a doctor in Estonia and earns around $700 a month.) With such low wages and the region’s notoriously cold winters, the next several months are going to be tough for the people. The Baltic States may truly discover the price of independence’. Kevin Kerr, ‘Red Storm Rising’, The Daily Reckoning, 30 July 2005. 27. ITAR-TASS, 15 June 2004. 28. RIAN News Agency, 15 June 2004. 29. ‘Russia pledges energy security for Europe,’ AFP, 25 May 2006. 30. ITAR-TASS, 15 June 2004. 31. Declaration of the three Baltic Prime Ministers, text issued by the government of Lithuania, 27 February 2007. 32. Energy Information Administration, US Department of Energy, Report on Baltic Sea Region, March 2005. 33. Export Information Administration, op cit. 34. In 2003, Butinge exported some 230,000 bbl/d of crude oil and counted on adding a further 30,000 bbl/d to export figures the following year. In addition, Butinge planned a major increase in storage capacity, thus ensuring a stable supply of crude oil during bad weather. However, the hurricanes that hit the Baltic coast early in 2005 meant that Butinge was unable to handle any oil shipments in January that year. Energy Information Administration, op. cit. 35. In an article in Vilnius Monthly, Issue No. 8, 2005, pp. 10–13, ‘Mazeikiu Nafta: Controversy and Corruption’, Keith Smith, who was US Ambassador to Lithuania at the time, reported that, after the appointment of the former KGB officer Yuri Zubakov as Russian Ambassador in Vilnius, unfavourable reports about Williams began to appear in the Lithuanian media, suggesting that it was unwise to snub Russia and that the Williams deal compromised Lithuania’s sovereignty. The article is quoted in Iron Troikas: The New Threat From The East, by Richard Krickus, who also alleges that ‘Lukoil persuaded Transneft and the Russian Ministry of Fuel and Energy on

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36.

37.

38. 39.

40.

41. 42. 43. 44.

45. 46.

47. 48. 49.

several occasions to halt the flow of oil to Lithuania’. December 2005. Khodorkovsky’s treatment has caused widespread concern outside Russia, where several human rights groups have complained about his treatment, which is certainly harsh, even by Russian standards. He reportedly sleeps in a single dormitory with 100 other prisoners in the penal camp at Krasnokamensk in Siberia and has been the subject of punishments for minor infringements (said to include drinking tea in the wrong part of the prison) to ensure that he does not receive parole. Krasnokamensk is heavily contaminated with radioactive waste and in winter the temperatures drop to –40C. Recently, Khodorkovsky was attacked, as he slept, by a fellow prisoner who slashed his face repeatedly with a razor. Sunday Times, 16 April 2006. Krickus, Iron Troikas, op.cit. The author again also cites the former US Ambassador to Lithuania, Keith Smith, in support of this opinion. A study by the Russian Academy of Sciences, quoted by Richard Krickus in Iron Troikas, op.cit. ‘ Energy Key to Russian Foreign Policy,’ a Radio Free Europe/Radio Liberty story, published in Czech Business Weekly, 20–26 February 2006. In fairness, it should be noted that the West has been happy to do business with many countries that have a similar ‘overlap’ between government and key ‘strategic’ parts of the private sector. Krickus, Iron Troikas, op.cit. Krickus, op. cit. Keith Smith, quoted in Krickus, op. cit. Prime-Tass, Article by Roland Nash, Head of Research, Renaissance Capital, quoted in Alexander’s Gas and Oil Connections, News and Trends: CIS/Russia. Ibid. ‘Putin stresses need to ‘make our own house strong’, Financial Times, 11 May 2006. Putin did, however, emphasize that Russia would not repeat the mistakes of the Cold War when the Soviet Union spent so much on weapons that it undermined its economy. He also made some reassuring noises on energy security, saying that Russia could play a positive role in forming a ‘uniform energy strategy’ for Europe. He celebrated Gazprom’s position as the world’s third largest company by market value and said that it would ‘fully meet the demand’ of traditional partners, as well as developing new markets. ‘EU Urges An Energy Pact With Russia,’ article by Judy Dempsey, Alexander’s Oil and Gas Connections, 9 March 2006. Ibid. Ibid.

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50. ‘International Gas Investment: New Dimensions of European Energy Security’, speech by E A Telegina at Second International Conference on Energy Security: Role of Russian Gas Companies. 51. Ibid. 52. Janis Folkmanis, BASREC (Baltic Sea Region Energy Cooperation), Energy in Europe and in the Baltic Sea Region, 21 April 2005, Latvian Government Conference on Energy Options, Riga. 53. Arnis Staltmanis, ‘Security and Independence of Baltic Interconnected Power Systems’, a paper presented to the Latvian Government Conference on Energy Options, Riga, April 2005. 54. These were two of the conclusions of an interesting Policy Development Exercise (PDx) and workshop on the security of Lithuanian energy supplies, organized jointly by the Lithuanian Academy of Sciences, the Lithuanian Institute of Energy, Kaunas Business College and the Defence Academy of the United Kingdom’s Advanced Research and Assessment Group in July 2005. The exercise emphasized the importance of regional collaboration and even suggested that, if Lithuania pursued active cooperation with its

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55. 56. 57. 58. 59. 60. 61. 62.

63. 64.

neighbours, it could become a ‘European energy hub’. It was keen to stress the dangers of a purely national approach, however. ‘If Lithuania continues to pursue its energy policy on a purely national basis, it will be impossible to achieve energy security at an affordable cost, and any energy policy will be expensive. Energy security and lower supply costs can be achieved through regional cooperation’. ARAG, UK Defence Academy, PDx, 22 July 2005. Ibid. Ibid. Energy Policy in the Electricity Sector, op.cit. Ibid. Ibid. Ibid. ARAG, UK Defence Academy, PDX, 2005, Op.cit. ‘Energy Cooperation Around The Baltic Sea’, speech by Andre Merlin, president of the European Energy and Transport Forum at the European Energy Forum, June 2006. ARAG, UK Defence Academy, PDX, Vilnius, 2005, op.cit. Telegina, op.cit.

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About the series: Russian foreign energy policy reports

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his series of reports establishes for the first time the confluence of Russian foreign policy with the acquisition of foreign energy assets by Russian entities. Ten specific country profiles focus on the oil, gas, electricity and nuclear power industries. Each report, written by an author of international standing, explains how Russian foreign energy downstream mergers and acquisitions are transpiring to consolidate the new Russian empire. These unique studies address many questions of substance for energy industry professionals, investors, policy experts, and decision makers who seek to make sense of the dynamic changes that have overcome the Russian energy complex and altered the balance of global energy geopolitics. Series Editor Kevin Rosner Ph.D., is a specialist in Russian oil and gas, security of critical energy infrastructure, and international energy-security policy. He served as the 2006 CoDirector of the NATO Forum on Energy Security. He is a Senior Fellow both at the UK Defence Academy and at the Institute for the Analysis of Global Security (IAGS) in Washington, DC. Posts held include Senior Security Advisor to the Baku-TbilisiCeyhan pipeline company, Project Director with the Program on Cooperation with the Russian Federation at the OECD, and Project Manager with the UNESCO Science Division in Paris. Dr. Rosner is the founder of The Rosner Group serving leading members of the global oil and gas community with energy and security analytical products.

‘Russian Involvement in Eastern Europe’s oil, Petroleum Industry: The Case of Bulgaria’

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Adnan Vatansever

his report answers questions such as: as one of the largest foreign acquisitions by a Russian company occurred in Bulgaria, what lessons are applicable to charting future Russian downstream takeovers? Why have Eastern Europe and Western FSU countries been the primary focus of Russian acquisitions? What drives LUKoil (and other Russian oil companies) to pursue acquisition of assets in these regions? Finally, what is the stance of the Russian government in terms of promoting such acquisitions abroad? Adnan Vatansever is a freelance energy consultant and the author of a number of reports for Cambridge Energy Research Associates. He is currently in the process of completing his Ph.D. dissertation on Russia’s energy sector at the Paul Nitze School of Advanced International Studies, Johns Hopkins University. He holds a B.A. in International Relations from the Middle East Technical University in

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Ankara, M.A. in Russian and East European Studies from Georgetown University’s School of Foreign Service. Hardcopy ISBN 1-905050-40-2 E-report ISBN 1-90505080-1

‘Kazakhstan: Energy Cooperation with Russia – Oil, Gas and Beyond’ Dr Ariel Cohen

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his important study explains how Russia, with its private sector and policy makers working in tandem, has exerted a significant amount of control over Kazakhstan’s vast natural resources and its economic freedom. It looks at the way Russia and Kazakhstan agreed to divide the Caspian Sea shelf and how Kazakhstan has managed to maintain good relations with Moscow overall, despite its insistence on exporting energy resources to China and Europe directly and its hopes to export through Iran. Ariel Cohen, L.L.B., Ph.D., is an international expert in international security/ terrorism; Russian, Eurasian, European and Middle Eastern foreign, security, economic and business policy. He is Senior Research Fellow in Russian and Eurasian Studies and International Energy Security at the Davis International Studies Institute at the Heritage Foundation. Dr. Cohen has conducted conferences and briefings for the US Government departments and agencies. He appears on major US and foreign TV networks. Dr. Cohen also has extensive experience consulting for the private sector, international organizations, and technical assistance projects in the Central and Eastern Europe and CIS regions. Hardcopy ISBN 1-905050-41-0 E-report ISBN 1-905050-81-X

‘Georgia: Russian Foreign Energy Policy and Implications for Georgia’s Energy Security’ Liana Jervalidze

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his report shows that as Georgia has restructured its energy sector, the new Russian and Georgian political elites exerted their influence, particularly through the participation of Russian gas company Itera in privatizations of Georgian gas enterprises. And how, over the past few years, Russian-Georgian business groups with their offshore capital have been working to monopolise the Georgian economy and Russia’s gas industry has been consolidating its hold over the CIS pipeline infrastructure, particularly through the expansion of Gazprom. However, Gazprom failed to take control of Georgia’s pipeline infrastructure and Georgia is insistent on developing its pipeline potential in order to boost its role as a transit route to Europe, Turkey and Iran. Liana Jervalidze has worked with several government and research institutions working on Caspian region energy policy and development. She has advised private

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sector companies in on the development of east-west energy corridor and Georgia’s potential role in regional integration. Since 2003, Ms.Jervalidze has been working on the development of Georgia’s gas market. She has spoken on regional energy policy at international conferences in the CIS, Europe and the US. Her analyses have been published in both Georgian and English. Hardcopy ISBN 1-905050-35-6 E-report ISBN 1-905050-84-4

‘Russia’s Energy Interests in Azerbaijan’

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Fariz Ismailzade

n 2003-2004, an increased number of senior Russian officials and major energy companies, such as Itera, Gazprom and RAO UES visited Baku in the hopes of participating in energy projects in Azerbaijan. While maintaining diplomatic relations with Moscow, Azerbaijan is more hesitant when it comes to close cooperation with Russian energy companies. Baku fears that if Russia gains more assets in Azerbaijan, control of these assets will be used for political purposes. This unique study looks at the confluence of Russian private and public sector interest Azerbaijan’s energy sector. Fariz Ismailzade works with the International Republican Institute in Baku and is a part-time lecturer at the department of political science at the Western University in Baku. He holds an MA in Social and Economic Development from Washington University, St. Louis, and a BA in Political Science from Western University, Baku. Hardcopy ISBN 1-905050-42-9 E-report ISBN 1-905050-87-9

‘Ukraine: Post-revolution Energy Policy and Relations with Russia’

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Olena Viter

his report looks at how the new Ukrainian government plans to decrease Russian influence over Ukraine’s energy sector. President Viktor Yushchenko has declared goals which include the diversification of oil and gas supply sources, the reform of the domestic market, and the creation of a strategic oil stock. Ukraine’s search for more partners in the energy sphere has affected the relationship between Ukraine and Russia; from a “brotherly” relationship to one of pragmatic interest. Olena Viter is a Senior Adviser to the Operational Department of the Secretariat of the President of Ukraine. She is Coordinator of Energy Programs at the School of Policy Analysis, National University of Kyiv-Mohyla Academy, and a member of the non-governmental Expert Council on Energy Security. In 2002, she was an

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intern at the Hudson Institute, and in 2003 she participated in drafting Ukraine’s Energy Strategy. Hardcopy ISBN 1-905050-31-3 E-report ISBN 1-90505077-1

‘Turkmenistan-Russian Energy Relations’ Gregory Gleason

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urkmenistan has large gas reserves, but as its immediate neighbours have little import demand, Russia holds the key to its gas transport. In April 2003 Turkmenistan and Russia concluded a 25 year transport and marketing agreement for Turkmen natural gas. The new arrangements permit Turkmenistan’s gas production to reach 100,000 million cm per year in 2007. This unique study details the background and looks at the prospects for Turkmenistan’s gas production and export in the context of Russian strategy, and at Turkmenistan’s role in the new energy strategies throughout Eurasia and the Middle East. Gregory Gleason, Ph.D., is an internationally recognized expert in energy policy and international relations. A professor of political science and public administration at the University of New Mexico, Dr. Gleason has extensive field experience in Turkmenistan and the other countries of Eurasia and Central Asia. He has served as a consultant to Lawrence Livermore National Laboratory, Sandia National Laboratories, the Asian Development Bank, and the US Agency for International Development. His research has been sponsored by the National Science Foundation and the National Academy of Sciences as well as other public and private foundations. Hardcopy ISBN 1-905050-33-X E-report ISBN 1-905050-82-8

‘Belarus: Oil, Gas, Transit Pipelines and Russian Foreign Energy Policy’ Dr Margarita M Balmaceda

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elarus relies on Russia for about 85% of its total energy needs, while Russia needs Belarus’ oil and gas pipelines to export its supplies to Western Europe. How will energy exports from Russia and Belarus’ transit capabilities impact Western Europe if this interdependent relationship ends, either through political changes in Belarus or if Russia ends its energy subsidies to Belarus? This report looks at transit, infrastructure and investment issues and analyzes both the state of the current infrastructure, as well as the possibilities this transit opens to Western investors, particularly as the Yamal Pipeline nears completion. In addition, it looks at the current conflict between Belarus and Russian investors for control of the country’s gas transit system and oil refineries. Margarita M. Balmaceda is Associate Professor at the John C. Whitehead School of Diplomacy and International Relations, Seton Hall University, New Jersey, and an Associate of Harvard University’s Davis Center for Russian and Eurasian Studies

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and the Harvard Ukrainian Research Institute. She received a Ph.D. in Politics from Princeton University (1996), and Post-Doctoral training at Harvard University. She has published widely on Russian, post-Soviet and East European energy and foreign policies. Hardcopy ISBN 1-905050-34-8 E-report ISBN 1-905050-83-6

‘Gazprom and the Russian State’

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Dr Kevin Rosner

azprom is the world’s single largest producer of natural gas, long acknowledged as a state-within-a-state. In 2005 it reached a turning point in its history when the Russian government reasserted its majority stakeholder position, whilst also continuing its own push to gain control over an increasing share of Russia’s energy complex overall. This timely report provides answers to questions such as: what do these movements mean for the future of the Russian energy sector? What will be the impact of state control over Gazprom on domestic and foreign shareholders? And what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? And what will these changes mean to world? Hardcopy ISBN 1-905050-30-5 E-report ISBN 1-905050-85-2

‘Baltic Independence and Russian Foreign Energy Policy’

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Dr Harold Elletson

stonia, Lithuania and Latvia are uniquely dependent on the Russian Federation for energy supplies. The security of energy supplies are national security issues in the three ex-Soviet republics, which are now part of the EU. Increasingly dependent on Russian gas imports and with negligible sources of domestic energy supply, the Baltic countries have been the target of aggressive Russian commercial activity and a sustained attempt to lock them into a long-term reliance on Russia. Now, as Baltic political leaders, energy specialists and intelligence analysts consider their options, the implications for the security and independence of the three Baltic States are a matter of concern well beyond the Baltic. This important report will be essential reading for anyone with an interest in the future energy supplies of both the Baltic States and eastern Europe. Dr Harold Elletson leads The New Security Programme, which conducts research into the implications of the new security environment. He was previously Director of the NATO Forum on Business and Security. A former Member of the UK Parliament, he served as Parliamentary Private Secretary to the Secretary of State for Northern Ireland and as a member of the Select Committee on Environment. An international public affairs consultant and a fluent Russian

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speaker, he has advised many leading companies on aspects of their business in the former Soviet Union, including BP in Azerbaijan and Alstom in Siberia. Hardcopy ISBN 1-905050-36-4 E-report ISBN 1-905050-89-5

Russo-Chinese Energy Relations: Politics in Command Dr. Stephen Blank

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his report makes the point that in both Russia and China it is politics – and not market or commercial considerations – that largely drive energy relationships with each other and the outside world. For both countries, energy and energy security are regarded as strategic assets and/or objectives that are at risk from outside forces. Moreover, both countries are taking a statist approach to energy issues. Therefore cooperation between Russia and China will be difficult even though Russia wants to sell and China wants to buy. Russia has blocked Chinese efforts to realize its version of energy security, yet it has not been able to come up either with the resources or means for a coherent policy of supplying China with reliable quantities of energy that would lead China away from Middle Eastern and other producers. Given the political dimension in both countries, the under-fulfilment of the potential for Russia to supply energy to China will continue and remain a source of strain in their relationship. Stephen Blank is Professor of Russian National Security Studies at the Strategic Studies Institute of the U.S. Army War College. Dr. Blank has been an Associate Professor of National Security Affairs at the Strategic Studies Institute since 1989. In 1998-2001 he was Douglas MacArthur Professor of Research at the War College. Prior to this appointment Dr. Blank was Associate Professor for Soviet Studies at the Center for Aerospace Doctrine, Research, and Education of Air University at Maxwell AFB. Dr. Blank’s M.A. and Ph.D. are in Russian History from the University of Chicago.

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