Russia Is Dabbling in Risky Pipe Dream

On this Fourth of July, its 230th birthday, the United States bestrides the world like a colossus. No other nation can match its military or economic power. But such power can prove evanescent if it is not accompanied by humility, hard work, sacrifice and, above all, a policy aiming at cooperation rather than dominance.

Consider America's great postwar superpower rival—the USSR. Only yesterday the USSR had a large empire in Eastern Europe, client states in Asia, the Middle East, Africa and Latin America, conventional armies and navies considerably larger than those of the West, and a nuclear arsenal roughly equivalent (and by some measurements larger) than America's deterrent.

Today the USSR's "successor state," Russia, has two main strategic assets: nuclear missiles and energy reserves. Without these the country would be a large Holland—and a declining Holland at that, since the Russian population is shrinking even more rapidly than the populations of Western Europe.

Russia's nuclear missiles are a psychological and political asset rather than a military one. No one supposes that the Russian government intends to fire off its missiles in a crisis. They are maintained both to deter any nuclear attack—which, given Iran's steady progress toward nuclear weapons, is no longer a purely theoretical risk—and to ensure that the Kremlin has to be consulted on any matter of vital interest in world politics. It is highly doubtful, for instance, that Russia would be invited to any G-8 meetings if it did not possess the means of world destruction.

But Russia's energy reserves—the second largest oil reserves after Saudi Arabia and the world's largest reserves of gas—are an asset economically, politically and strategically. Russia benefits massively from the high price of oil as money pours into the country and revenue pours into President Putin's treasury. Foreign investment in Russian energy is likely to bring the most advanced technology and management methods into Russia's infant capitalism. And as a main supplier of energy (both oil and natural gas) to energy-scarce Western Europe, Russia is sitting pretty strategically: Its concerns have to be seriously considered by Germany, France, Italy, etc.

But these advantages depend on Russia—and for the moment that means Putin—acting prudently and like a good neighbor. As Kipling warned the British 109 years ago, arrogance and the ruthless exploitation of short-term advantages are self-defeating. They recruit enemies against you. And, unfortunately, Putin is acting with a kind of reckless arrogance in his exploitation of Russia's energy reserves.

This arrogance is most flagrant in the Yukos affair, where it threatens to undermine the appeal of Russian capitalism to foreign investors. When the owner of Yukos and one of the most prominent Russian "oligarchs," Mikhail Khodorkovsky, talked of using his vast wealth to enter politics as a rival to the president, Putin promptly hit the company with a series of charges including fraud and tax evasion. After the judicial smoke had cleared, Khodorkovsky was in a Siberian cell and Yukos had gone into bankruptcy. Its assets were snapped up by an obscure small company with no known assets and then resold at a massive profit to the Russian oil company, Rosneft. Partly state-owned, Rosneft is seeking new investors on the London and New York exchanges.

Rosneft is in many respects an excellent company: it has low costs, Western directors on its board, modern accounting methods, large energy reserves, and above all friends in high places. As Time magazine points out, however, it also has $47 billion in outstanding legal claims that stem from the expropriation, sale and resale of Yukos' assets.

Unless these previous investors—they include Richard V. Allen, once Reagan's National Security Adviser and so presumably a bad man to cross—are treated fairly, future investors in Rosneft and other Russian companies are likely either to disappear or to demand higher returns to compensate for the higher legal risks.

The rule of law is itself an economic asset. And if it looks unreliable, the economic cost of Putin's aim of "world leadership" in energy for Russia will rise accordingly and perhaps prohibitively.

That will certainly be the result if Putin makes the even more serious mistake of treating energy as a means of politically pressuring his neighbors and customers. Herewith a cautionary tale:

One asset of Yukos outside Russian control is an oil refinery in Lithuania. After much international legal haggling, this was recently sold to the Polish energy company Orlen by the international directors of Yukos with the permission of the U.S. courts. This sale was resisted by Russia (which wanted the refinery for Rosneft), endorsed enthusiastically by Lithuania (which did not want a Russian company to enjoy more or less total control of its energy supplies) and supported by the Polish government with misgivings (the sale was a coup for an enterprising Polish company but the price was high).

Nor is cost the only consideration. As the Eurasia Daily Monitor points out, Russia had earlier blocked the transfer of Kazakh oil to Lithuania and last year cut off gas supplies to Ukraine, both apparently for political reasons. Are countries that rely on Russian energy supplies buying into political vulnerability?

Fear of precisely that is persuading policymakers in the former Eastern Europe to hedge their energy bets. They would like to see cooperation between countries such as Kazakhstan, Turkey, Romania, Hungary, Austria, Poland and Ukraine to bring central Asian oil by pipeline to the Black Sea and from there into the heart of Europe by pipeline again. Bypassing Russia, these new oil routes would render energy pressure by the Kremlin much more difficult—and ultimately more costly. Various such schemes are, ahem, in the pipeline.

If Russia is to make a success of its capitalism, Putin must learn that investors cannot be cheated and customers cannot be bullied. Under capitalism there is always somewhere else to go.

This article appeared in the Chicago Sun-Times on July 4, 2006.