House of Lords - European Union

Select Committee on European Union Written Evidence

Memorandum by Group Menatep Limited (GML)

INTRODUCTION

1. The House of Lords European Union Committee, Sub Committee C (foreign affairs, defence, and development policy) has requested evidence, in its inquiry into The European Union and Russia on, amongst other questions:

1. What is the nature of the Russia-EU dialogue with regards to energy questions? To what extent is Russia an indispensable partner, rival or obstacle for the EU in its efforts to attain the objectives of its recently adopted external energy policy?

2. What does the EU have to offer Russia in the context of a negotiation, and how can it best influence Russian thinking and policy? Is the current institutional framework for EU-Russia relations, based on the PCA, the four "common spaces" and the "Northern Dimension" working well?

3. What are the main characteristics of the Russian political, economic and social system, and how are these likely to evolve in the future?

2. GML Limited ("GML") (previously Group Menatep Limited), 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, Yukos has now been declared bankrupt and its assets sold, in the main below market value, at forced auctions the principal beneficiary of which has overwhelmingly been Russian state-owned oil monopoly: Rosneft. Tim Osborne is a director of GML. He does not represent Yukos or the individuals mentioned above.

3. We believe GML is in a unique position to comment on issues that crucially affect the European Union's relations with Russia. 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 domestic property rights and international energy security, not to mention the rule of law. GML currently has a claim under the Energy Charter Treaty ("ECT") against the Russian Federation for compensation for discriminatory treatment, If successful, the Russian Government will be required to pay compensation totalling not less than $33 billion to Yukos' former owners; this is the largest commercial arbitration claim ever filed.

4. We provide a background to GML and Yukos at Annex 1 (not printed here) and a briefing on the Energy Charter Treaty, and GML's claim, at Annex 2.

1. The Russian Federation—An Indispensable Partner?

5. The Russian Federation is the world's largest gas producer and exporter and is currently the second largest oil producer. Imports from the Russian Federation currently account for 45% of total gas imports (Pipeline and LNG) into the EU, equalling approximately 25% of total EU gas consumption. In October 2004 the New York Times reported that Gazprom was the sole supplier of gas to Estonia, Latvia, Lithuania and Slovakia and provides 89% of Hungary's gas, 86% of Poland's and nearly three quarters of the Czech Republic's. The article also added that, according to data available from the Energy Information Agency at the time, Gazprom supplies 36% of Germany's gas, 27% of Italy's, 25% of France's, 67% of Turkey's, 65% of Austria's and 100% of Finland's.[23] It is also thought that Gazprom supplies the majority of gas consumed by Moldavia, Macedonia and Bosnia Herzegovina. Official DTI estimates indicate that Britain will import 80% of its gas by 2020, with the majority of supplies originating in Russia. The Russian Federation currently supplies 27% of Europe's oil.[24]

6. The EU gas supply-side is highly concentrated, with the Russian Federation, Norway and Algeria accounting for over 85% of total gas imports into the EU yet the European energy market remains highly segmented and therefore uncompetttive 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. Despite increasing supply diversification towards LNG, it is likely that the Russian Federation will remain the single largest gas supplier to Europe. Russia is expected considerably to grow its share of gas supplies in the EU in the future. Some industry observers forecast that, by 2030, the EU may depend on Russian imports for up to 80% of its total gas consumption.[25]

7. The Russian Federation's dominance of European energy supplies gives rise to the prospect that this power can be leveraged for the political benefit of the Russian Government. This was recognised by Prime Minister Tony Blair MP in May 2007, who said, following the publication of the Government's 2007 Energy White Paper:

"Increasingly we will be required to look at importing energy from less stable parts of the world . . . As if that were not enough, we are now faced with countries such as Russia, who are prepared to use their energy resources as an instrument of policy".

8. Moreover, the Russian Federation has itself demonstrated its willingness to use its energy resources as a tool of its foreign policy. In January 2007, Russia dramatically raised the price at which it sells gas to Belarus from a subsidised $46 per 1,000 cubic metres to around $200 per 1,000 cubic metres. Whilst this increase to market prices for former Soviet states would normally have been welcomed, the suddenness of the move demonstrated the Kremlin's willingness to use energy as a political weapon.

9. This followed a similar episode in Ukraine in January 2006. In a move that was widely seen as a response to the victory of Western-leaning Victor Yuschenko in the Ukrainian Presidential elections over Kremlin-backed Victor Yanukovich, the Russian Federation restricted the supply of gas to its former ally by means of massively increasing the price from $50 to $230 per 1,000 cubic metres. This was threatened again in October 2007 following the anti Kremlin victory in the Ukrainian General Election.

10. In both examples, energy supplies were cut off, dramatically affecting end-customers in Europe; Germany, France, Poland and Hungary all experienced significant drops in supplies during the disputes. Cliff Kupchan, former US State Department official and director of the Eurasia Group was quoted in the Financial Times in 2006, 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".[27]

11. The Ukraine crisis was not the first time Russia has interrupted energy supplies as a way of exerting political pressure on a foreign government: Russia cut energy supplies to the Baltic States when they 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. The recent episode with Belarus is unlikely to be the last.

2. Negotiating With the Russian Federation—The Partnership & Co-operation Agreement

12. On 16 January 2007, the European Commission launched its long awaited European Union Common Energy Policy, the "Energy Package". Whilst the Energy Package set ambitious environmental goals it does not constitute a common external energy policy and in particular mentions nothing about Europe's relationship with the Russian Federation.

13. In its negotiations with the Russian Federation, the EU must acknowledge that the Kremlin, and state-owned gas monopoly Gazprom, is equally dependant on Europe as the main end-purchaser of oil and gas. This is a key negotiating tool that the EU must leverage when dealing with the Russian Federation on energy matters and was made in a French Parliamentary Report on Energy and Geopolitics in November 2006[28]:

"It is time to wring the neck of the notion that the European Union would be controlled by an ail-powerful energy supplier against whom it would have its hands and feet tied. Today indeed the relation between the European Union and Russia is too much regarded as a unilateral dependency of the former on the latter—but this analysis is not viable in the long term".

14. Marko Mihkelson MEP, Rapporteur on the Parliamentary Assembly of the Council of Europe's ("COE") December 2006 Report, "The Perils of Using Energy as an Instrument of Political Pressure", confirmed this by noting that energy resources are "at the heart of the Russian Federation's economy and its trade relationship with other European countries".[29]

15. However, foremost amongst Europe's failures to hold the Russian Federation to accepted standards and norms of behaviour is the EU's fundamentally weak position on the Russian Federation's observance of the Energy Charter Treaty. Eneko Landaburu, Director General of External Relations and Chief Negotiator of the new Partnership and Cooperation Agreement ("PCA") with Russia, said in February 2007: "its obvious we're not going to be able to convince the Russian authorities to agree with the ECT" suggesting instead that the "key principles" of the ECT should be incorporated into a new PCA.

16. This position is disturbing in that it might be interpreted as acceptance of the Russian Federation reneging on commitments it has made to the 50 other signatories to this international treaty. The European Union is not empowered to negotiate on behalf of all the other signatories to the ECT but importantly, if the Russian Federation will not abide by its obligations under this Treaty, it is logical to assume that the Russian Federation will only abide by new agreements that are weaker than those already in existence and only whilst it so chooses.

17. This position is also disturbing as it ignores the fundamental truth that the Russian Federation is legally bound by the ECT under Article 45(1) of the Treaty. No new PCA can change the Russian Federation's status as a legally bound signatory to the ECT irrespective of whether the PCA includes the "key principles" of the ECT or not. This point was made by Chair of the European Parliament's Foreign Affairs Committee, Jacek Saryusz-Wolski[30]:

"Emphasises that Russia is already bound by the ECT pursuant to Article 45 thereof

; . . . regards the mere transposition of the ECT principles into the Partnership and Cooperation Agreement as redundant, while acknowledging the added value of provisions clarifying or supplementing the obligations contained in the ECT, in particular those contained in the Transit Protocol".

18. The British Government has further acknowledged the Treaty's binding nature on all signatories[32]:

"The Energy Charter Treaty obliges Contracting Parties to endeavour to accord non-discriminatory treatment to Investors of other Contracting Parties as regards the Making of investments. This obligation is relevant for the 38 Contracting Parties who have ratified the Treaty and for the five Signatories applying the Treaty provisionally".

19. Russia is one of the countries that apply the Treaty provisionally and is thus legally bound. The Energy Charter Treaty is fully binding on and enforceable against the Russian Federation. The EU should encourage the Russian Federation, to acknowledge and abide by its obligations under the ECT.

20. The Financial Times[33] reported, on 29 August 2007, that it had seen draft Commission proposals to reform the European energy sector further by unbundling ownership of production, distribution and supply assets. The FT also reported on a separate Commission document about the implications of unbundling which said the "EU could be vulnerable to a strategy of third countries to dominate the EU markets not only in terms of supply but also by acquiring the networks . . . where investment is driven by other motives than economic ones". The Commission, according to the Financial Times, proposed several measures to prevent uncontrolled access and ensure reciprocity of investment; the most notable was a proposal to declare Europe's energy sector a "Strategic Asset" thus restricting access for non-EU states. The FT commented:

"The requirement for reciprocity would be a particular blow to Gazprom . . . which has intense ambitions to expand in Europe and already owns a range of assets and equity stakes in the EU".

21. The Commission published its draft legislation on 19 September 2007 which included the legal basis for a reciprocity of investment rule. The Draft Directive on Common Rules for the Internal Market for Natural Gas Article 7(a) provides:

1. Without prejudice to the international obligations of the Community transmission systems or transmission system operators shall not be controlled by a person or person from third countries.

2. An agreement concluded with one or several third countries to which the Community is a party may allow for derogation from paragraph 1.

This would appear at first sight to give the Community the power to block acquisition or control of energy transmission assets and a further power to negotiate access to energy markets in third states thus providing the basis for reciprocity rule in the energy sector. However, it is limited to the transmission network.

22. This is a positive step forward but the EU should not limit its rules on reciprocity of investment to the transmission network rather, seek a broader prohibition against ownership by third country companies and individuals of all energy assets, with the prospect of a negotiated exemption for states who provide reciprocal market access in the energy sector to European firms and individuals. The standard for judging such reciprocal access should be full compliance with the Energy Charter Treaty which is binding and enforceable on all signatories irrespective of whether the Treaty has been ratified or not (excluding those signatories which opted out of provisional application under Article 45 (1), which Russia did not).

23. Any new PCA with the Russian Federation must have as its foundation the fact that the ECT is binding on the Russian Federation and build an agreement from there. Any other agreement will inherently be weaker and will allow the Russian Federation to continue its aggressive dominance of Europe's energy supply market. The ECT is the strongest legal protection available and any replacement is likely to be weaker, given the now much stronger negotiating position of Russia.

4. Russia's Political, Economic and Social System

24. The politically motivated destruction of Yukos, and the imprisonment of its executives and ultimate beneficial owners, was a turning point in terms of the Russian Federation's commitment to both international energy security and domestic legal, human, and property rights. It has also become clear, since the beginning of the Yukos affair that the Russian Federation has allowed its criminal justice system to become infected with corruption and political influence. Its courts have become susceptible to outside pressure and inducements to the extent that persecution of political enemies of the state has been facilitated by judges. In October 2004, Chairman of the Russian Constitutional Court, Valerii Zorkin, marked the 13th anniversary of Russia's judicial reform by saying that the country's judicial system is in many aspects worse now than it was in the Soviet era.[34] In July 2006 the state controlled oil company Rosneft accepted "the possibility that certain judges may be susceptible to economic, political or nationalistic influences".[35]

25. Since the December 2004 auction of Yukos' key production unit, Yuganskneftegaz, the number of people targeted by the Russian authorities in connection with Yukos has risen from 18 to 45 and now includes senior western managers of Yukos and its remaining assets, and Tim Osborne, a director of GML. This is the first time the Russian Prosecutors have targeted western businessmen personally in the Yukos affair and is an alarming escalation in the Russian Federation's vendetta against Yukos and its shareholders.

26. As reported in The Times[36], Mr Osborne and the Yukos officers (US citizens) have received no official communication of the accusations against them. The accusations are groundless and were posted on the Russian Federal Prosecutor's website straight after GML had won a Netherlands court ruling whereby the proceeds from any future sale of Yukos' international assets would be handled by the Dutch Courts rather than the Russian liquidator. This would ensure that legitimate Yukos creditors would be recognised. The accusations limit Mr Osborne's ability to travel and discharge his fiduciary duty to manage GML's claim under the ECT. They further damage his personal and professional reputation and ability to carry on his legal practice. Mr Osborne has offered to be interviewed, in London, by the Federal Prosecutor in connection with this investigation but he has received no reply to his offer. The Foreign and Commonwealth Office have sent an official Demarche to their Russian equivalent on Mr Osborne's behalf.

27. Further, the diplomatic exchange with Moscow over the murder of Alexander Litvinenko highlighted a fundamental inequality inherent in UK extradition law: Russian citizens in Russia cannot be extradited due to provisions in the Russian Constitution; Russian citizens with asylum in the UK cannot be extradited to Russia due to the Government's view that they would not receive a fair trial; yet British citizens In the UK could be extradited to Russia due to provisions in the 2003 Extradition Act under which the Russian Federation is designated a Category 2 Territory (which permits Russia, on seeking extradition from the UK, to simply provide "particulars of information" rather than a prima facie case). Thus British citizens living in the UK are not protected politically and must rely on the UK courts for protection.

28. The Russian authorities' prosecution of the Yukos case demonstrates a worrying trend towards Russia's abuse of its privileges, under international extradition treaties, and the deterioration of the rule of law in the Russian Federation. In two rulings in Bow Street Magistrates Court on extradition requests for individuals connected to Yukos, Judge Timothy Workman refused to allow extradition on the basis that the requests were politically motivated and the defendants would not receive a fair trial in Russia. The Supreme Court in Lithuania made a similar ruling in a separate case and government authorities in the Netherlands and Luxembourg have refused to hand over Yukos-related documents to the Russian Prosecutor. Most recently, the Swiss Federal Tribunal ruled the Russian Government's prosecution of Messrs Khodorkovsky and Lebedev was politically motivated and refused to cooperate with Russian requests for mutual legal assistance.

29. The Swiss Tribunal's judgment was delivered on 23 August; the following day Mr Yuri Chaika, Russian Prosecutor General, held an impromptu press conference to denounce the Tribunal's decision and describe it as politically motivated and an attack on Russia's sovereignty.

30. As mentioned in 27 above, the Russian Federation is designated by the UK as having Category 2 status under the Extradition Act 2003. The political justification for according Russia this status was that Russia respects fundamental and due process rights in its criminal law. However, in its pursuit of individuals connected to Yukos, the Russian Federation has breached several international treaties relating to extradition and mutual assistance, including the European Convention on Extradition 1957[37], the European Convention on Mutual Assistance in Criminal Matters 1959[38], is in breach of Article 3 of the Council of Europe's Statute[39] and also undermines the Council's raison d'étre: respect by member states for the rule of law and human rights. Values about which the Council has rejected all compromise.

31. The Russian Federation has systematically breached these treaties in its prosecution of the Yukos case. Therefore no request for extradition to the Russian Federation of an individual connected to the Yukos case can be seen as free from political motivations.

32. This evidence is submitted by Tim Osborne, director, by and on behalf of GML Limited.

16 October 2007

23 "Europe worried over Russia Gas Giant's Influence", 3 October, Julie Dempsey, retrieved from www.energybulletin,net/2389.html Back

24 "Peril of using energy as an instrument of political pressure, Report, Political Affairs Committee, Marko Mihkelson, 20 December 2006. Back

25 "Peril of using energy as an instrument of political pressure, Report, Political Affairs Committee, Marko Mihkelson, 20 December 2006. Back

26 The Times, 23 May 2007: "How to stop the lights going out in a dangerous world: The right energy policies will secure our future", by Tony Blair. Back

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

28 Paul Quille"s and Jean-Jacques Guillet, Report of the French Parliamentary Mission on Energy and Geopolitics, 29 November 2006, p 290. Back

29 "Peril of using energy as an instrument of political pressure, Report, Political Affairs Committee, Marko Mihkelson, 20 December 2006. Back

30 "Towards a Common European Foreign Policy on Energy", European Parliament Foreign Affairs Committee Report, 11 September 2007. Back

31 "Article 45(1) of the ECT provides for states that have signed but not ratified the ECT to be provisionally bound thereby from signature to ratification, unless they have opted out pursuant to Article 45". Back

32 Department of Trade & Industry website, 9 May 2007, http://www.dti.gov.uk/europeandtrade/key-trade-issues/investment/paqe22718.html Back