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Disaggregation and Asymmetry

Today the Wall Street Journal issued another report on the developing fiasco of the Sakhalin Energy consortium. The Russian authorities appear to be using the Ministry of Environment to threaten a total shutdown of production to pressure Royal Dutch Shell on a dodgy asset swap with Gazprom.

But do we really honestly believe that Shell will speak out against this crass hustling that has become modus operandi of Russian state corporatism? Likely not, as Shell seems to have abandoned any hope of fair treatment in Russia, and, like ABN AMRO, has turned into an apologist to its new master. The truth is that wherever the Russian state has less than 50% control of an energy resource, the majority owner can expect to pressured, intimidated, and, in extreme cases, jailed or worse.

At the same time this is going on, Western leverage in Russian energy is getting weaker by a process I have come to call disaggregation and asymmetry.

Consider the situation in the following framework: A global economic challenge has been presented by Russia, driven by energy markets and threatening to distort the foundations of international trade. This challenge to the world follows grand-scale state theft and the subjugation of the rule of law in Russia.

It is based on the theory that from politicians to the comprador class of Western intermediaries, massive and distorting economic incentives can be used to disaggregate the economic and political system in Europe and beyond. Russia’s attack is based on a fundamental meta-narrative, that of Russia as victim.

The West victimized Russia in the 1990s through shock therapy and Market Bolshevism, resulting in domination by oligarchs and enfeeblement on the geopolitical stage. Therefore, whatever path Russia takes today it is somehow acceptable as an antidote or corrective to the penuries of the 1990s. The pervasive ideological cloud created by this narrative obscures the judgment of Gerhard Schroeder and other Kremlin apologists.

Beyond this ideological screen the Kremlin campaign represents the most brazen attack on the free market in a generation. It includes the development of state enterprises in the energy sphere which are acting as Trojan horses to freeze out Western players in Russia while at the same time distorting foreign energy markets by demanding access on the basis of free market principles.

The Kremlin has stolen one of the key oil producers in the world and then resold it to Western investors who have now bought the same assets twice, with the complicity of Western banks who have accepted an entirely new and corrupt Kremlin-imposed concept of risk and reward.

It has steered its foreign relations so as to divide the West by breaking off Germany from the rest of Europe while teaching Norway that it values access to energy over human rights. No sooner does the Kremlin have Romano Prodi accept market access for Gazprom than it seals a deal with Algeria to tie up over two thirds of Italy’s energy supply, leaving Italy to seek assistance from Brussels and forsake any go-it-alone energy strategy.

In addition to disaggregation there is asymmetry.

Yet unequal deals that favor Russia make sense as reparations for the 1990s. The failure to soften the Gazprom monopoly, which grossly violates fundamental norms of competition in the EU, WTO and Energy Charter Treaty, is somehow acceptable because Western financiers and investors can participate in the resulting windfalls.

The true adaptive brilliance of the Kremlin’s strategy is the concept of cooptation. Whether turning Germany against Poland or political leaders against their own people or ABN AMRO against a proud Dutch history of sensitivity to human rights, not only does everyone have a price, but everyone avoids shame while being loud and remonstrative declaring the beauty of the emperor’s clothes.

In the case of the Western banks and the Rosneft oil company, the moral repugnancy of Russia’s state-sanctioned theft is only matched by that of the banks scurrying to profit from a level of illegality unique in the annals of underwriting. This summer’s Rosneft floatation was a testament to the willingness of Western banks to accept Kremlin rules of the game which are both market distorting and corrupt.

The risk calculus for Rosneft’s bookrunners – ABN AMRO, Dresdner Kleinwort, Morgan Stanley and JPMorgan, is driven by political factors above capital markets logic – just witness their willingness to exercise their greenshoe option to buy 31 million shares in Rosneft at the original offer price, above current market values.

Another feature of the Russian offensive is speed. Not since the negotiations over the Helsinki Accords have so many Russians been negotiating with so many countries over sensitive issues.

From Algeria to Iran to Venezuela, a new gas cartel is being formed. From Norway to Canada to Brazil, new opportunistic energy market players are being co-opted. From Slovakia to Lithuania to Poland and Ukraine, old-style energy hardball is being played involving everything from phony pipeline repairs to outright blockade.

Indeed, political realists should applaud the Kremlin: behind the smokescreen of relations with Brussels, the Russians are preparing to dominate the EU’s energy markets and are already driving wedges into the European economic space.

Meanwhile, the Kremlin meets with Hamas, sells rockets to Syria and negotiates a major gas deal with Israel. Russia is in a frantic competition with both China and the EU to pre-empt alternative supply sources, and yet on the surface relations with both appear strong. Russia’s fuel diplomacy, and the abuses of state authority that have engendered it, present a challenge of historic proportions for Western leaders, since in many ways the new instruments of Russian power are far more potent than the weapons that could not be used during the Cold War. Western leaders must challenge their own assumptions about the real nature of the current Russian regime.

A parallel may be drawn to 1946, when George Kennan dispatched his “long telegram” from the United States Embassy in Moscow. The 8,000-word telegram, perhaps the most famous diplomatic dispatch of history, provided an elaborate explanation of the undercurrents of the emerging post-war Soviet foreign policy.

For over a generation thereafter, Washington’s Cold War strategy of containment was grounded in the analysis and recommendations found in the telegram. Today the world stands at a similar geopolitical turning point.

Russia is mutating rapidly, and the post-Cold War window of opportunity to engage Russia, as an ally and partner with shared values, is closing. It is time that someone writes the “long telegram” of 2006 – not to reignite a Cold War, but rather to avert one by awakening to the realities and implications of an insidious kleptocracy that steamrolls over human rights and poses real threats to global economic and political security.