Global Market Brief: Dec. 20, 2004

The strategic significance of Ukraine for Russia cannot be underestimated

From STRATFOR.COM

The strategic significance of Ukraine for Russia cannot be underestimated,

and yet the country will almost certainly be slipping through Moscow's

fingers on Dec. 26, when Ukrainians will likely elect opposition leader

Viktor Yushchenko to be their next president. Russia's siloviki, the leaders

of the country's security and military apparatus, who share power with the

more reform-minded St. Petersburg clan led by President Vladimir Putin, can

only be incensed by the outcome. Their push to purge Russia of Yukos CEO

Mikhail Khodorkovsky and the other oligarchs, however, will soon lead them

to the comeback trail. This effort often has appeared disorganized and

lacking direction, but important economic changes afoot in Russia already

seem to be giving the siloviki an organizing principle that they have been

lacking.

With the loss of Ukraine, Russia has reached an historical geopolitical low

from which it will be difficult to recover. Domestically, however, the

siloviki can take note of some significant successes with respect to the

destruction of Yukos, and with a string of acquisitions by natural gas giant

Gazprom that they have pushed for that are beginning to snowball. With the

world's largest reserves of natural gas, significant oil reserves and a

massive power sector under its control, Gazprom is set to become one of the

largest companies of any kind in the world -- thanks to the silovikis'

desire to reassert state control over strategic resources. With Gazprom now

Kremlin-owned, future acquisitions will likely see the oil pipelines of

state-owned Transneft, a billion-dollar state pipeline enterprise, merged

with Gazprom. This will give the company control of Russia's oil exports,

the second-largest in the world after Saudi Arabia. Along the way, Gazprom

will also likely swallow up more of Russia's private oil firms, adding to

the reserves of Rosneft and Yuganskneftegaz.

It is entirely possible that all of this will be completed in a matter of

months, and with the state firmly in control of Russia's oil and gas

revenues and the billions in hard currency that they bring in, the siloviki

will quickly realize that the gargantuan company that Russia has built would

be the perfect vehicle for projecting Russian influence abroad, and they

will push Putin to use it. Gazprom will come to represent economically

something that Russia now lacks militarily -- the capacity to project

influence beyond Russian borders.

Normally, the more reform-minded St. Petersburg clan led by Putin, with

which the siloviki coexist in the Kremlin -- or better put, against which

they compete -- would seek to block some of these more aggressive maneuvers,

particularly those that threaten the country's economic growth. Many St.

Petersburgers in the government, in fact, have been complaining about some

of the recent moves, especially those that are turning Gazprom into what

Economy Minister German Gref recently called a "hypermonopoly."

To find out why they are fighting a losing battle and will continue to do

so, however, one need only return to the fate of Ukraine. The haphazard

nature of the attack on Yukos illustrates that it was initially carried out

without a plan beyond the removal of Khodorkovsky and his executives from

the Russian political and economic stage. As the campaign wore on, the

gutting of the company through the removal of Yuganskneftegaz became the

center of the siloviki strategy, but once that decision was made a home had

to be found for the Yukos subsidiary.

After rumors abounded as to where Yugansk would go, the siloviki clearly

came to the realization that the breakup of Yukos was an opportunity to turn

Gazprom into a global oil and gas giant that will bolster the political

power of the state, and they have since started pushing for just that. With

the crisis in Ukraine occurring simultaneously and Russian national interest

coming out decisively on the losing end, the siloviki have all the

justification they need to demand concessions from Putin and the St.

Petersburg clan. Having consolidated political power by achieving total

control over the country's most powerful economic levers, they will next

realize that an enlarged Gazprom could be the perfect instrument for

reversing Russia's global loss of influence.

Russia no longer has the military might to sway governments, aside from its

deteriorating nuclear deterrent, which is unlikely to be put to (deliberate)

use any time soon. It does, however, have an enormous amount of

strategically vital energy resources upon which much of the world, Europe

and East Asia in particular, is dependent -- or lining up to become

dependent -- upon. As global energy demand continues its rapid growth, more

countries will come to depend on Russia for the energy supplies for economic

growth. This will be Russia's opportunity to wield renewed global influence,

and the siloviki will realize this if they have not already. The creation of

Gazprom Inc., begun as a siloviki-driven effort to create new foundations of

power for the Russian state at home, will likely become the principal tool

for the recalibration of their tactical approach to the world.

By locking in the physical dependence of European and East Asian economies

upon Russian energy supplies, Russia will find it much easier to pursue its

goals domestically and internationally. Once Gazprom's construction is

complete, a wave of business will follow that will see ground broken on oil

and/or gas pipelines radiating from Russia's continental shelf to China,

Japan and Europe, with major investments likely elsewhere, in South Asia and

South America, for example. As this occurs, Gazprom will use its newfound

cash flows and existing pipelines to fully consolidate its control over

Central Asian natural gas resources, which it will continue to import on the

cheap and re-export at global prices.

In order to garner foreign support for the existence of a monolithic Russian

energy giant and, ironically, to help fund its acquisitions, the Kremlin

will likely make a limited portion of Gazprom's shares available to foreign

investors who have been foaming at the mouth in recent years to get their

hands on the company's shares. The Kremlin will block any foreign

institution from collecting sufficient shares to able to influence company

(read "Kremlin") policy in any way. Instead, Gazprom shares will be

scattered in investment funds the world over, and everyone will gladly

support the monopoly because the name Gazprom will be synonymous with piles

of cash.

Once Gazprom is in control of both oil and gas supplies and the means to

deliver them and has stable revenue streams, Russian negotiation tactics

with many countries will begin to change. The next time there is a crisis in

the Caucasus and Europe begins to complain about Moscow's influence, Gazprom

will begin to wonder publicly whether or not it is time to raise gas prices.

After all, unlike oil, natural gas is not a fungible commodity. It

necessitates a multi-billion dollar in-place transport network -- like the

one linking Russian natural gas fields to European consumers -- to work.

Likewise, if Japan says that it intends to support U.N. resolutions put

forth by the United States that Russia opposes, Gazprom will begin to wonder

publicly whether or not China might be a more stable market for its

resources the next time long-term contracts are up for grabs. It might not

even wait that long.

Gazprom revenues will likely have a military component as well for Russia.

The other comparative advantage Russia has in the world aside is in military

technology. Research and development in new weapons systems collapsed after

1991, but that trend is likely to be reversed thanks to Gazprom. Some of the

money the company brings in will be channeled into new weapons systems, some

of which will go to the Russian military, but more importantly, to the

militaries of other countries. Russia has increasingly been peddling its

military wares in recent years, and has many eager buyers, just as it has

for its energy supplies.

Just as the direction in which Russia sends its energy supplies has

strategic implications that can compel potential customers to act, so does

its choice of buyers of its military hardware. Currently, Russia will sell a

great many things to anyone with the cash to pay for them, but this could

change once some of Gazprom's revenue streams are directed toward the

military establishment. Instead, countries could begin to compete to keep

Russian weapons out of each other's hands, thereby driving up the asking the

price in Russia's favor, which could very easily include some sort of

political concessions to the Kremlin. In this fashion, Gazprom could further

be used to reinvigorate the already highly advanced Russian arms industry

and put it on track for greater global influence than it already has. Russia

will not approach the United States in terms of defense spending in the

foreseeable future, but with the weapons it has and develops it will have

the opportunity to be a serious thorn in Washington's side -- essentially at

will.

>From this perspective, Gazprom is not an end in itself but a means to other

ends. The rest of the world has had Russia behind the eight-ball since the

fall of the Soviet Union because the country's global influence had been

linked entirely to its military, which collapsed like a house of cards.

Russia is now in the midst of a diversification in which it will seize the

opportunity to recast itself as a global player and get out from behind the

eight-ball. A new Gazprom will set multiple processes in motion for the

Russian government and make courses of action possible that have been out of

reach since 1991, which will result in a more muscular foreign policy.

Russia will not limit itself to the near-abroad forever -- it has always had

bigger aspirations. The siloviki are starting to think bigger now, and that

bigger thinking will be personified by a bigger Gazprom.