Select Committee on Trade and Industry Written Evidence


APPENDIX 28

Memorandum by GML Limited

EXECUTIVE SUMMARY

  (a)  The YUKOS Affair was a turning point in terms of The Russian Federation's commitment to both domestic property rights and international energy security. Russia, once seen as a reliable supplier of natural resources to Europe, is now coming under heightened international scrutiny and is increasingly being criticised for its apparent control and manipulation of the energy sector for political reasons; its monopolisation of gas export routes; and its failure to ratify legally binding international treaties aimed at bolstering energy security. Whilst the Russian Government has attempted to convince onlookers that YUKOS was a one-off, it is becoming clearer that the YUKOS affair was only one strand in a broader strategy to bring Russia's natural resources under direct Kremlin control and to use those resources as a tool to reassert control over Russia's former sphere of influence and its western colleagues.

  (b)  Especially problematic is the fact that Europe's reliance on Russian natural gas is increasing at precisely the moment when Russia appears particularly disinclined to establish normalised energy relations with the West. Nor is the UK immune to the uncertainties posed by reliance on Russian energy imports. Because Britain's North Sea oil and gas reserves increasingly yield lower returns, Britain is expected to rely on imported gas supplies for 80% of total consumption by 2020.

  (c)  Britain, working in concert with its European colleagues, should press Russia to live up to its international obligations, under treaties aimed at developing energy cooperation between Eurasian states and ensuring security of supply to all those states. Further Britain should demand that Russia abide by international norms as an energy supplier and ensure that its energy sector is transparent and competitive before Russia is allowed membership of the WTO.

  (d)  Most prominent of these treaties is the Energy Charter Treaty which was designed to strengthen the rule of law on energy issues by creating a level playing field of rules to be observed by all signatories to the Treaty, thus minimising the risks associated with energy related investments and trade. Russia is legally bound by the Treaty but has yet to consolidate its commitment by ratifying it. Therefore, Britain must be robust in its insistence that Russia ratify the Treaty and live up to the obligations contained therein.

INTRODUCTION

  1.  The Trade and Industry Select Committee has requested evidence on the implications of increasing dependence on gas imports; as a director of GML Limited, formerly Group Menatep, I believe GML is in a unique position to comment on certain issues that crucially influence the UK's energy supply now and in the future.

  2.  GML is the successor to Group Menatep, a diversified financial holding company established in 1997 by Mikhail Khodorkovsky, the former CEO of YUKOS Oil Company, Platon Lebedev and others. GML remains the majority owner of YUKOS, holding approximately 51% of YUKOS equity capital through wholly owned subsidiaries. As a member of the GML Board of Directors, I am responsible for stewardship of the company. I do not represent YUKOS or the individuals mentioned above.

  3.  YUKOS was once the leader in the field of a new generation of companies emerging from post-Soviet Russia as a western-focused business with western standards of accounting and corporate governance. However, YUKOS' core asset, the oil production facility Yuganskneftegaz ("Yugansk"), which once produced in excess of one million barrels of oil per day, was seized by the Russian state in pursuit of its action against Mr Khodorkovsky. Even though YUKOS insisted Yugansk was worth at least US$30.4 billion based on a valuation from leading consulting firm DeGolyer and MacNaughton and had been valued between US$14.7-17.3 billion by, Russian Government-appointed auditors, Dresdner Kleinwort Wasserstein, on 19 December 2004, Yugansk was sold at auction for US$9 billion to an unknown company called BaikalFinansGroup ("Baikal") which was registered only a couple of days prior to the auction itself. The Russian tax authorities seized and sold Yugansk, a unit responsible for more than 60% of YUKOS' total oil production, despite Russian Federal law which states that core assets should not be sold to settle tax liabilities.

  4.  This, together with the prosecution and subsequent imprisonment of YUKOS' principals, is widely recognised as a politically motivated action by the Russian Government designed to punish Mr Khodorkovsky for his political ambitions.

  5.  Baikal was later purchased by state-owned Rosneft Oil Company, which thereby acquired Yugansk at a cost substantially below market value. President Putin himself has acknowledged that Baikal was used to ensure that future legal claims against this auction could not be levelled against Rosneft:

    "As regards Baikal everything is simple. The issue was resolved within the legal, and not the repressive, field. The future owners had to think about how they would work and face possible suits brought against them in court. When Baikal bought the relevant package, it became the owner. All that happened later occurred on the secondary market. So the claims of those who later bought property were practically reduced to zero."

  6.  This is a clear indication that the Russian state and Rosneft were determined to seize Yugansk in a manner designed to ensure that investors in YUKOS were prevented from bringing claims against the state or government-owned Rosneft in attempts to protect their investments.

  7.  It is GML's belief that the forced dismantling of YUKOS was a successful ploy to put key elements of the energy sector in the hands of the state and marked a turning point in terms of Russia's commitment to both domestic property rights and international energy security, not to mention the rule of law. GML currently has a claim under the Energy Charter Treaty (discussed below) against the Russian Federation for compensation for discriminatory treatment. If successful, the Russian Government will be required to pay compensation totalling not less than $28 billion to YUKOS' former owners.

  8.  Whilst the Russian Government has stated that the expropriation of YUKOS was a one-off, it is becoming clearer that this was only one strand in a broader strategy to bring Russia's natural resources under direct Kremlin control and to use those resources as a tool to reassert control over Russia's former sphere of influence and its western colleagues.

EUROPE AS A MARKET FOR RUSSIAN GAS SUPPLIES

  9.  The United Kingdom's consumer gas market is the largest in Europe, and total consumption for 2005 was around 100 Billion Cubic Metres (bcm). To put that figure in comparison, France uses 50 bcm, Italy 70 bcm, and Germany 90 bcm. The United Kingdom's domestic gas production, which is almost entirely derived from the North Sea, peaked in 2000 at 114 bcm. In 2005, domestic gas consumption outpaced production in the UK, and the economy is now in the process of becoming a net gas importer.

  10.  According to UK Energy Minister Malcolm Wicks MP, the United Kingdom currently generates 19% of its electricity from nuclear power, 33% from coal, and 40% from natural gas.  However, by the year 2020, the percentage of electricity generated from natural gas will increase substantially, in part due to Britain's commitment to meeting CO2 emissions standards outlined by the Kyoto Protocol, and in part due to the decommissioning of nuclear power plants and the uncertain future of coal power generation.

  11.  The combination of above outlined factors is forcing the UK to increasingly rely on imported natural gas. According to official DTI estimates, the UK is expected to depend on imported gas supplies for 50% of total consumption by 2010 and 80% by 2020. Although the UK only imports 2% of its current energy supplies from Russia, the situation in continental Europe suggests as the UK's reliance on imported gas inevitably increases, so will its dependence on Russia.

  12.  Natural gas is a key component of the EU's, and consequently Britain's, energy mix. Natural gas has significantly increased in importance to the EU over recent years and industry experts and scientists expect it to further grow in importance in future years. Natural gas had the highest growth rate of all energy sources both in absolute terms (an increase of 50% between 1990 and 2002) and in its relative share of the overall energy mix (from 17% to 23%). The EU relies on imported gas for approximately 50% of its current gas supply.

  13.  The supply side is highly concentrated. Russia (Gazprom), Norway (Statoil), and Algeria (Sonatrach) account for almost 95% of total imports into the EU, of which more than 85% come into the EU by pipeline. Approximately 53% of these imports by pipeline come from Russia. The remaining gas supplies to the EU (36 bcm, in 2004) consist of liquefied natural gas or "LNG", which is predominantly imported from Algeria. Russia currently accounts for more than 45% of total gas imports (pipeline plus LNG) into the EU, equalling approximately 25% of total EU gas consumption.

  14.  The European energy market remains highly segmented and therefore uncompetitive and vulnerable to monopolistic abuse. One of Russia's objectives has been to ensure that it remains so. It has used its oil and gas pipeline network to control energy distribution beyond its borders, acquire infrastructure in other countries and prevent new supply alternatives. For example, Russia has used its influence to block the construction of the Odessa-Brody pipeline that would supply Caspian oil to Europe without crossing Russian territory, while constructing a Baltic gas pipeline that would supply Western Europe, bypassing Eastern European countries such as Poland and Ukraine.

  15.  Despite increasing supply diversification towards LNG, Russia will remain the single largest gas supplier to Europe. Russia is even expected to considerably grow its share of gas supplies in the EU in the future. Some industry observers forecast that, by 2020, the EU may depend on Russian imports for up to 70% of its total gas consumption.

THE RISE OF GAZPROM AND THE IMPLICATIONS FOR EUROPE

  16.  Gazprom was created in 1992 from the former Soviet Ministry of Gas. Many observers note that the company has retained many features of its Soviet heritage. The Organisation for Economic Co-operation and development suggests: "it can be difficult, at times, to identify where the state budget ends and Gazprom's begins". The Institute for Energy Policy, a Moscow-based think-tank, notes that Putin effectively controls the company and makes all the key decisions about its strategy". Gazprom is ostensibly controlled by Dmitry Medvedev and Alexei Miller, who are both close confidants of President Putin and who have presided over an increase in the Kremlin's shareholding to a majority 51%.

  17.  Gazprom has managed to establish itself as the "single export channel". In this context, three categories of anti-competitive behaviour can be distinguished, namely:

    (i)  the prevention of exports by independent Russian gas producers and gas traders;

    (ii)  the decade-long blockage of gas suppliers from the three main Central Asian gas-producing countries, which depend on access to Gazprom's pipeline network for their exports, and the subsequent imposition of exclusive supply and transportation arrangements on these companies; and

    (iii)  the prevention or at least delay of gas supplies to the EU from Iran.

  18.  In addition Gazprom has exploited its negotiation clout vis-a"-vis its downstream customers, especially those in Central and Eastern European countries, by imposing itself in a way that renders market entry by other gas producers virtually impossible. This includes:

    (i)  the conclusion of long-term agreements with take-or-pay provisions covering all or at least the vast majority of the wholesalers' gas requirements, which have a significant foreclosure effect for potential competitors; and

    (ii)  vertical integration at the downstream level, mainly through the acquisition of minority shareholdings in national gas wholesalers and pipelines operators.

  19.  With a view to maintaining the status quo within its "sphere of influence," Gazprom has taken active measures to counteract the EU's liberalisation efforts in the gas sector. In particular, Gazprom's supply contracts in most, if not all new EU-accession countries contain so-called destination clauses, which prevent the resale of delivered gas outside the buyers' assigned territory (usually the country where the wholesaler is located).

  20.  Gazprom's strategy runs counter to the recommendations of the European Commission's Green Paper on energy security, issued in March 2006. The Green Paper advocates "the development of a common external energy policy" towards Russia, with a view towards increasing Europe's collective bargaining effectiveness in oil and gas negotiations with its Eastern neighbour. However, as EU Commissioner for Trade Peter Mandelson noted in the Financial Times on 9 March, Gazprom still prefers to pick off EU countries one by one and negotiate bilateral energy pacts.

  21.  Gazprom publicly declared its interest in extending its influence into British households this year when the company indicated it may bid for the owner of British Gas, Centrica. Whilst Gazprom currently supplies only 2% of British gas supplies, decreasing yields from North Sea fields, Britain's position of becoming a net importer of gas by 2010, and the fact that Gazprom controls most of the pipelines emerging from Russia means that Britain's dependence on Gazprom for gas supplies will become increasingly important.

  22.  These factors suggest that Gazprom is determined to dominate the European gas market. This behaviour is actively encouraged by the Russian Government through its control of Gazprom. The Russian state effectively has direct influence over European gas supplies.

ENERGY AND RUSSIA'S FOREIGN POLICY AMBITIONS

  23.  Russia's current and future dominance of European energy supplies gives rise to the potential that this power could be leveraged for the political benefit of the Russian Government.

  24.  It has become clear recently that Russia is intent on using its natural resources, notably oil and gas, as a tool of its foreign policy. Underlying this is the declared ambition of Russia's governing elite to re-establish its position as a regional hegemony and world power. One only needs to look to the beginning of 2006 to see a cogent example of this phenomenon: the restriction of gas supply to Ukraine and Georgia by means of massively increasing the price (up from $50 to $230 per 1,000 Cubic Metres) whilst delivering gas to Belarus at $47 per 1,000 Cubic Metres illustrates how countries that are out of favour with the Kremlin are treated compared to those whose relationships are closer.

  25.  The Ukraine crisis isn't the first time Russia has interrupted energy supplies as a way of exerting political pressure on a foreign government, and it is unlikely to be the last. Russia cut energy supplies to the Baltic States when it insisted on the withdrawal of Russian forces in the early 1990s, to Ukraine during a dispute about the future of the Black Sea Fleet in 1993-94 and to Belarus, Poland and Lithuania in 2004. Georgia and Moldova have also experienced price rises after signalling their political independence from Moscow.

  26.  Cliff Kupchan, former US State Department official and director of the Eurasia Group was quoted in the Financial Times on 14 March, as saying: "there is a correlation between the price at which Russia sells gas to its former satellites and their political loyalty to the Kremlin."[90] Britain must ensure that it is either, always on friendly terms with Moscow or that there exist sufficient alternatives and safeguards to ensure that supplies from Russia cannot be disrupted in the same way as in Ukraine.

SECURING BRITAIN'S SUPPLY—RUSSIA MUST LIVE UP TO ITS INTERNATIONAL OBLIGATIONS

  27.  The gas dispute with Ukraine was a poignant reminder of the fact that Russia is increasingly unwilling to adhere to international norms as an energy supplier. Whilst diversification of Britain's gas supplies is clearly crucial to reducing its dependence on Russian supplies, Britain should also press Russia to live up to its international obligations regarding energy co-operation and put in place protections against the kind of action that prompted the Ukrainian dispute.

  28.  Of particular value in this context is the Transit Protocol to the Energy Charter Treaty and the Treaty's dispute settlement regime as a means of dealing with conflict, ending monopoly control over supply, and improving energy security.

  29.  The Transit Protocol is a key tool for ensuring open access to pipeline networks crossing Russia and which allow transfer of oil and gas from alternative suppliers, such as Novatek or Lukoil, into Europe. The Russian Federation is demanding concessions in negotiations on the Transit Protocol that would allow Gazprom to maintain its monopoly over export pipelines out of Russia. Without such concessions, as Energy Minister Viktor Krishtenko commented recently, the Treaty will not be ratified.

  30.  The Treaty was developed as a legally binding, multilateral treaty dealing with inter-governmental cooperation in the energy sector. The fundamental aim of the Treaty is to strengthen the rule of law on energy issues by creating a level playing field of rules to be observed by all governments who are signatories to the Treaty, thus minimising the risks associated with energy related investments and trade.

  31.  The Russian Federation signed the Treaty on 17 December 1994. Article 45(1) of the Treaty states that:

    "Each signatory agrees to apply this Treaty provisionally pending its entry into force for such signatory in accordance with Article 44 to the extent that such provisional application is not inconsistent with its constitution, laws or regulations."

  32.  Therefore, the Russian Federation has agreed to apply the Treaty provisionally[91] and is thus legally bound by the Treaty's provisions. The Russian Federation has stated on several occasions that it attaches great importance to the Treaty as part of its energy policy.

  33.  On 28 November 2003, Viktor Khristenko, then Deputy Prime Minister of the Russian Federation, met the head of the Energy Charter Conference and the General Secretary of the Energy Charter Secretariat. At this meeting it was confirmed that Russia would participate in accordance with the Treaty to ensure the stability of world and regional energy markets. However, in spite of these assurances, the Russian Federation has never ratified the Treaty. The Treaty was last debated in the Duma in 2001, when ratification efforts failed after Gazprom fiercely lobbied against it. Gazprom argued that the Treaty should not be ratified due to perceived threats to its domestic and export revenues and the fear that it would be forced to open up its pipeline network to lower cost gas from Kazakhstan and Turkmenistan.

  34.  On 9 February 2006, Russian Finance Minister Alexei Kudrin stated prior to the G8 finance minister's meeting that:

    "Russia must develop its gas network in order to provide access to everyone, including private companies, and we are working on it. In that context we are going to ratify the charter [the Treaty]... but we cannot set a date for the moment"

  35.  Following the meeting, Mr Kudrin refused to further clarify plans for ratification and Energy Minister Viktor Krishtenko has subsequently said that the Treaty will not be ratified unless concessions are granted in the negotiations over the Transit Protocol.

  36.  At 16 March meeting of G8 energy ministers, Russian authorities displayed their intransigence and apparent unwillingness to remove Gazprom's monopoly over gas export channels. Energy Minister Viktor Khristenko denied Russia was ready to open its gas pipelines to third parties, claiming: "When something already belongs to somebody there can't be any free access to it." Meanwhile, Alexander Medvedev, the deputy chairman of Gazprom's management committee, defended Gazprom's export pipeline monopoly by stating: "The single export channel is the basis of security of supply today."

  37.  The Russian Federation's refusal to consolidate the protection of industry by ratifying the Treaty, despite pressure from Secretary of State for Trade & Industry Alan Johnson MP, French Finance Minister Thierry Breton, and the European Commission (in its Green Paper on Energy Security), is a clear indication of how Russia views its wealth of energy resources. Russia wants to protect its influence over its energy resources to use them as leverage as part of its foreign policy with its neighbours and the West.

CONCLUSIONS

  38.  As the politically motivated attacks on YUKOS and the subsequent dismantling of the company demonstrates, Russia cannot be relied upon to respect the rule of law and property rights, and as the most recent dispute with Ukraine illustrates, it cannot be trusted to provide a reliable source of gas, without regard to the prevailing political conditions.

  39.  GML considers it of utmost importance to reduce Britain's current and future dependence on the Russian Federation for gas supply. Alternatives should not only be considered but should be actively pursued.

  40.  The expropriation and sale of Yuganskneftegaz is the exact type of conduct the Energy Charter Treaty protects against. The Russian Federation has repeatedly stated the importance it attaches to the Treaty in the conduct of its energy policy. The Treaty provides clear obligations for the protection of energy investments. These obligations include prohibitions against discrimination, unfair and inequitable treatment, and State interference in private property, all of which have been breached in the case of the YUKOS affair.

  41.  The Russian Federation must be pressed to consolidate the protections provided by the Energy Charter Treaty by ratifying it and abide by international norms as an energy supplier before it is allowed to join the WTO. Its energy sector should become more transparent and competitive and it should stop using energy supplies as a political lever. The Russian Federation's access to European and world markets should be made dependent on its willingness to end market abuse and respect proper commercial standards.

22 March 2006







90   Financial Times, 14 March 2006, Arkady Ostrovsky: "Energy of the state: how Gazprom acts as a lever in Putin's power play". Back

91   If a country chooses not to apply the Treaty provisionally (such as Australia, Iceland and Norway) they must state their decision when signing the Treaty. Back


 
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