Baltic Independence and Energy Politics

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BALTIC INDEPENDENCE

AND RUSSIAN FOREIGNENERGY POLICY

Dr Harold ElletsonSeries Editor: Dr Kevin Rosner


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Baltic Independence and Russia

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Publishers note

Every possible effort has been made to ensure that the information contained in this publication

is accurate at the time of going to press and neither the publishers nor any of the authors,editors, contributors or sponsors can accept responsibility for any errors or omissions, howevercaused. No responsibility for loss or damage occasioned to any person acting, or refrainingfrom action, as a result of the material in this publication can be accepted by the editors, authors,the publisher or any of the contributors or sponsors.

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GMB Publishing Ltd.120 Pentonville RoadLondon N1 9JNUnited Kingdomwww.globalmarketbriefings.com

This edition first published 2006 by GMB Publishing Ltd.

Harold Elletson

Hardcopy ISBN 1-905050-36-4 E-report ISBN 1-905050-89-5

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Contents

About the author

1. Introduction

2. An historical and political perspective

Separate nation states

Soviet rule Baltic independence BalticRussian relations

3. The economy

Impressive growth World Bank concerns EU integration and structural reforms

4. The Baltic energy system: structure and dynamics

Electricity

Natural gas Oil

5. Russias interest in Baltic energy

Thesiloviki and the key decision-makers Background to Putins energy and foreign policy Russias energy-security complex Energy as a foreign policy tool The Kremlins motives European energy security

6. The Baltics: options for the future

Russian dependency The energy security challenge Regional collaboration

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The nuclear option Renewable energy

Co-generation schemes

Energy efficiency and administrative improvements Encouraging EURussian cooperation

7. Conclusion

Notes and references

About the series

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About the author

Dr Harold Elletson leads The New Security Programme, which conducts researchinto the implications of the new security environment. He was previously Directorof the NATO Forum on Business and Security.

A former Member of the UK parliament, he served as Parliamentary Private Sec-retary to the Secretary of State for Northern Ireland and as a member of the SelectCommittee on Environment.

An international public affairs consultant and a fluent Russian speaker, he hasadvised many leading companies on aspects of their business in the former Soviet

Union, including BP in Azerbaijan and Alstom in Siberia.


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1.

Introductionn 27 February 2006, the headsof government of the threeBaltic States of Latvia, Lithua-

nia and Estonia, met in the Lithuaniantown of Trakai to discuss their posi-tion on energy issues, ahead of theforthcoming EU Summit. Energy se-curity and, particularly, the long-term

security of the Baltic States energy sup-plies were at the top of their agenda.

For several years, ever since Russiancompanies had begun to acquire sig-nificant stakes in companies operatingin key areas of Baltic energy infrastru-cture, politicians and the media in allthree Baltic countries had expressedconcern that an over-dependence onRussian sources of energy supply wasbound to compromise Baltic indepen-

dence. The Baltic Energy Ministershad recognized the importance of theissue in the context both of nationalsecurity and of future relations withthe European Union (EU) as long agoas 1999, when they agreed a joint en-ergy strategy.

Future growth in the Baltic coun-tries requires an affordable, reliableenergy supply in appropriate qualityand quantity, they had declared. Se-curity of supplies should be at the

level to ensure that present and futureenergy needs are met at financiallysustainable terms, which anticipatesutilization of diversified, stable and re-liable energy sources. Since energy isa vital factor of the countrys economy,the supply should be secured againstdisruption shortfalls and unexpectedprice rises.1

The issue was brought into muchsharper focus with the so-called Gas

War between Russia and Ukraine

Oearly in 2006 and the concerns ex-pressed by the Polish governmentover plans for a pipeline to exportRussian gas to Germany through theBaltic Sea, bypassing Poland and theBaltic States. The proposed pipeline isso controversial in Poland and theBaltic States that some political com-

mentators have even referred to it asthe energy version of the Nazi-SovietPact of 1939.2

The problem for the three BalticStates is that, although they are allcomparatively small consumers of en-ergy, neither one is a significant en-ergy producer. With the lowest percapita wages in the EU, which they joined in 2004, all three states arehighly dependent on cheap gas from

the Russian Federation, where themain supplier recently declared its in-tention to increase gas prices signifi-cantly. Furthermore, the situation islikely to get even worse as a result ofEU pressure to curb existing produc-tion, such as oil shale in Estonia andNuclear energy in Lithuania, on envi-ronmental grounds.

Against this background, some com-mentators fear that Russias new as-sertiveness under President Putin

presents a threat to Baltic indepen-dence. Russia is flexing her muscles,they say, because the Baltic States havefinally left the old Soviet sphere of in-fluence and joined NATO and the EU.They harbour the suspicion that en-ergy supplies to the Baltic States havea political significance for the Kremlinthat is beyond the normal parametersof mere commercial consideration.Energy, they suspect, is being used as

a tool of foreign policy in the region.


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An understanding of the regionshistory explains how explosive suchsuspicions are. The history of theBaltic States in the last century, in par-

ticular, is a story of three nations thatwon their independence against theodds, tenaciously clung to it and,when it was ultimately taken fromthem, never lost the hope that it wouldbe restored. Now that they have real-ized their ambition, as sovereignstates, to join the EU and NATO, anysuggestion that Moscow might be ableto use its control of vital energy sup-plies to re-establish its control is bound

to be greeted with alarm in Riga, Vil-nius and Tallinn.Yet, how realistic are these fears?

Is Russia using its control of energy

supplies as a means of advancing itsforeign policy objectives? If so, whatare those objectives in the Baltic Statesand how might they be realized? If se-

curity of energy supplies is essential tothe future sovereignty of the BalticStates, how can it be guaranteed?What are the Baltic States options?

These are important questions, notonly for the Baltic States but also forthe rest of the EU, as it seeks to estab-lish a stable partnership and a clearstrategic understanding with Russia.This report seeks to establish thecauses of Baltic concern, the nature of

Russian interests and the various op-tions for reducing the regions depen-dency on external sources of supply.


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2.

An historical and politicalperspective

t is difficult to escape history in theBaltic States. Its presence is every-where, a recurring leitmotif that

underscores the present and places itin the context of a turbulent past. The

three nations historical consciousness,in turn, is shaped by a collective senseof identity that comes from the factthat the Baltic peoples have a longerconnection with their homeland thanalmost any other nation in Europe.

This sense of belonging creates aspecial feeling of both attachment andlegitimacy. The kernel of the histori-cal awareness of the Baltic peoples isthe fact that they are directly de-scended from the original inhabitantsof their countries, one historian hasobserved.3 Indeed, the indigenousinhabitants of the three modern BalticStates of Estonia, Latvia and Lithuaniaare direct descendants of the originaltribes who settled on the shores ofthe eastern Baltic Sea four thousandyears ago. The Estonians are ofFinno-Ugric stock, like the Finns andHungarians, whereas the Lithuaniansand Latvians have Indo-European an-

cestry (Lithuanian, interestingly, be-ing the closest living language toSanskrit). Whatever their individualorigins, all three indigenous Balticpeoples have lived in their homelandfor far longer than any of the peopleswho have ruled over them since themiddle ages whether Scandinavians,Poles, Germans or Russians.

The last millennium of Baltic his-tory, culminating in the bloody up-heavals of the twentieth century, waspunctuated by regular periods of war

Iand conquest. The last peoples inEurope to be Christianized and withviable pagan tribal societies of theirown until the twelfth century, theBaltic nations nonetheless found that

their geographical location made theirhomeland a battleground for otherstates striving for political or economicmastery of the region.

Even in pagan times, the eastern sho-res of the Baltic were emerging as animportant staging post for trade bet-ween Russia and the Western world.Tallinn and Tartu, in particular, werecentres where furs, wax and slavescould be exchanged for salt, textilesand weapons. Foreign involvement inthe region, however, soon became for-eign domination at first Scandina-vian and later German. Mercantileinterests were combined with mission-ary zeal, as the Teutonic knightsforcibly converted the Baltic tribes toCatholicism. Whilst the Teutonic Or-der subdued the Old Prussians in thewest, in the north the Brotherhood ofthe Sword established a Christian, mil-itary state in Livonia with Riga, which

was founded in 1201, at the mouth ofthe river Daugava, as its capital.4

Despite the comparative brevity ofthe period of direct occupation by theTeutonic knights, the German pres-ence in the Baltic remained strong un-til the beginning of the twentiethcentury because of the rule of Germanlandowners over the Baltic peasantryand the dominance of German mer-chants in Hanseatic trading centres onthe Baltic, such as Riga and Tallinn.The German influence in the region


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persisted through the ensuing cen-turies, even as Swedish, Polish-Lithuanian and Russian interestscompeted for succession to the legacy

of the Teutonic knights.5Despite the eventual absorption of

the Baltic provinces into the Russianempire, they still enjoyed a compara-tively extensive degree of autonomyunder their local German aristocracy.Peter the Great confirmed the privi-leged position of the Baltic Germansand the Lutheran Church, and it wasthe middle of the nineteenth centurybefore any serious programme of Rus-

sification began.6

Separate nation states

It was not until the end of the FirstWorld War, however, that the powerof the German Baltic barons was fi-nally broken and, in an extraordinarycombination of circumstances whichcould hardly have been predicted atthe start of the conflict, the Baltic na-tions at last achieved their chance toestablish themselves as separate na-tion states. What created the opportu-nity for the establishment of Balticindependence was the defeat of theGerman army in the West and a rev-olution in the East, which led to thecollapse of the Imperial Russian Army. By signing a separate peacetreaty at Brest Litovsk in 1918,Russias new Bolshevik rulers not only

betrayed their allies but also freedthem from any obligation to defendthe territorial integrity of the Russianempire in a post-war settlement.

With the entry of the United Statesinto the conflict, it at last became a warfor democracy and an opportunityfor the Allies to use the issue of therights of national minorities to createwhat Clemenceau called a cordon san-

itaire between Germany and Russia.

Despite a sustained German attemptto maintain a presence in the region,

even after the armistice in the West,and repeated incursions by bothWhite Russian and Bolshevik troops,the Baltic States at last won their in-

dependence, all three signing peacetreaties with the Soviets during thecourse of 1920.7

The inter-war period of Baltic inde-pendence, which lasted from 19201939, was characterized both by thedesire to profit from a resurgence oftrade with Russia by acting as theWests commercial springboard and by the attempt to maintain interna-tional support by acting as a barrier

against Soviet interference or a newGermanRussian combination.In the end, the various attempts

to develop a more robust systemof regional alliances, which mighthave guaranteed Baltic indepen-dence, failed largely, perhaps, be-cause they centred around Poland,whose relations with the Baltic Stateswere poisoned by her capture of theancient capital of Lithuania, the city ofVilnius, during the Polish-Soviet warin 1920. Ambitious Baltic diplomaticinitiatives that might have led to theestablishment of a large regional blocin the cordon sanitaire were graduallywhittled down. Ultimately, in 1934,only the so-called Baltic Entente be-tween Latvia, Lithuania and Estoniacame into being.8

An entente between the three BalticStates, however, was not enough tosave them. The three Baltic States

were of such strategic significance toGermany, Poland and Soviet Russiathat, without guarantees of militarysupport from powers outside the re-gion, their fate was dependent on theintentions of their various predatoryneighbours within it.

Soviet rule

The fate of the Baltic States was finallysealed in 1939. After Germany had


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reincorporated the Lithuanian portof Klaipeda into the Reich in March,secret protocols to the Molotov-Ribbentrop non-aggression pact di-

vided the Baltic States into separatespheres of influence, giving Germanya free hand to attack Poland. It wasinitially agreed that Lithuanias north-ern boundary would mark the divi-sion between the Soviet and Germanzones. After Germany had invadedPoland on 1 September and Ribben-trop had revisited Moscow, Lithuania,along with half of Poland, was con-signed to the Soviet sphere.

Estonia, Latvia and Lithuania wereformally absorbed by the Soviet Unionin 1940 but were under German mili-tary occupation from 1941 to 1944when the Red Army re-imposed So-viet rule. At the end of the SecondWorld War, the Baltic States were theonly members of the League of Na-tions not to be restored to fullsovereignty. They spent the next 50years under the heel of the Sovietregime, which was determined thatthey should never regain theirindependence.

In 1989, however, an extraordinaryevent, perhaps the most remarkablepublic demonstration in European his-tory, marked the 50th anniversary ofthe signing of the Molotov-RibbentropPact. Millions of people joined handsand formed a human chain stretchingacross the Baltic from Tallinn in thenorth, through Riga, to Vilnius. The

demonstration was largely coordi-nated by the various popular fronts,which had sprung up in the BalticStates after Gorbachevs introductionof perestroika and glasnost in the So-viet Union. At a meeting of all threeBaltic popular fronts in Tallinn in May1989, delegates agreed:

to coordinate joint policies of the biggest

popular movements of the Soviet Baltic

countries and to make the general public of

the Soviet Union and the world at large

aware of the democratic aspirations pursued

by the Baltic popular movements.9

One of the main issues chosen tohighlight the Balts democratic aspira-tions was the Nazi-Soviet Pact and itssecret protocols. When the peoples ofthe Baltic States linked hands, withLatvias Freedom Monument markingthe countrys pre-war independenceat the heart of the demonstration, thethree popular fronts issued a state-ment emphasizing their peaceful, par-liamentary path back to statehood, in

contrast to the criminal and unlawfulagreement of 1939. Moscow gave astandard, formulaic response: theBaltic States had voluntarily chosen tojoin the Soviet Union in 1940.

The sheer scale and organization ofthe human chain, however, provokedGorbachev himself into declaring thatthe state of the Baltic peoples is in se-rious danger. Yet, it was too late toturn back the clock. Moscows efforts

to contain and manage the drive toBaltic independence were doomed.Even the local communist parties inthe three republics turned againstthe General Secretary and, despite aSoviet blockade of Lithuania, thedespatch of OMON troops to the re-gion and several bloody incidents, themomentum for independence becameunstoppable.

Baltic independenceThus, history played a prominent rolein fuelling the independence move-ment and it continues to play animportant role in the political psychol-ogy of the Baltic countries today. Justas in 1989 the truth about the Nazi-Soviet Pact was an important part ofthe case for independence, so today itcontinues to haunt relations between

the Baltic States and Russia, even


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stoking fears about the Kremlins trueintentions with its energy policies inthe region.

As independent states, the policy of

the Baltic States has been very similarto that of Poland and, as such, simi-larly offensive to the hard-liners in theKremlin, some of whom appear to be-lieve that an important measure ofRussias global status is the extent towhich it can continue to exert controlover its former East European vassals.

BalticRussian relations

Suspicions in the Baltic States havebeen stirred by the failure of succes-sive Russian leaders to take account ofthe national interests of their Balticneighbours. They have failed, too, todampen popular enthusiasm in Russiafor the notion that the indigenouspopulations of the Baltic countriesare, at best, Russo-phobic and, atworst, unrepentant about their sup-posed wartime collaboration. Suchpublic prejudices are the foundationson which the imperial ambitions ofthose who continue to believe that the

Baltic States still belong to Russia arebuilt.

In fact, the Baltic States all want nor-mal, friendly relations with the great

power on their doorstep. They seethemselves as a bridge between Eastand West, naturally linked to the Rus-sian market the Wests economicspringboard but also still Russiaswindow on Europe. The reason theywere so keen to join NATO was fear ofRussias intentions towards them.

If Russia had a thriving liberal democracy,

a vibrant civil society, an effective multi-

ethnic system, a productive capitalisteconomy, and a genuine peace policy in

Chechnya, one commentator on the region

has observed, then its influence may have

been welcomed in Eastern Europe,

regardless of historical experiences with

Russian imperialism.10

However, empirical observation hasconvinced many in the Baltic Statesthat little is fundamentally different inRussia and they continue to behaunted by the ghosts of history.


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3.

The economyhe three Baltic countries werequick not only to implementdemocratic political reforms

but also to adopt market economiesafter regaining their independence.They have thus largely managed toavoid the economic and political crisesthat have affected other regions in

transition from centrally plannedsystems.

Impressive growth

Despite the initial shock of the transi-tion from the Soviet system, the eco-nomic performance of all three BalticStates in the period since indepen-dence has been impressive by any

standards. Tough decisions have beentaken and privatization has been ex-tensive. The transformation has beenremarkable. In Latvia, for example,where the privatization of small andmedium-sized enterprises has beencompleted and many large publiccompanies, in sectors such as gas, ship-ping and banking, have also beentransferred from the public sector, thenational economy has achieved a re-markable turnaround from the posi-tion immediately after independencewhen real GDP fell by 50 per cent. In2004, Latvia saw real GDP growth of8.5 per cent and in the same year, de-spite sluggish growth in the globaleconomy, the Baltic States saw anaverage 6.6 per cent increase. Thefigures confirm the Baltic countriesposition as some of the fastest growingeconomies in Europe.

T World Bank concernsThe problem now facing the BalticStates is no longer economic stagna-tion but the very reverse. In its latestEU-8 Quarterly Economic Report,the World Bank warned that over-

heating in the Baltic States is a keyconcern.11

Although Lithuania has an impres-sive portfolio of exports, including re-fined oil products, machinery andtextiles, and 70 per cent of its trade isnow with the EU, the World Bankworries that, in general, growth hasrecently been fuelled largely by do-mestic demand in the Baltic States.

The Bank has also expressed partic-ular concern about exposure to exter-nal economic factors beyond theircontrol, a state of affairs that has char-acterized much of the history of Balticindependence. In its review of the eco-nomic position in EU-8 countries, forexample, it worried that: Althoughthe oil shock has not been fully passedon to domestic consumers, it compli-cated inflation control, not least in theBaltic countries. At the same time, itwarned that current account deficits

remain very high in Estonia andLatvia.

EU integration and structural

reforms

Such concerns have taken some of thegloss off what has otherwise been animpressive performance, slowing the

Baltic States plans for full economicintegration with the EU.


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Early Euro adoption plans in the Baltic

countries have been postponed owing to

problems in meeting the inflation criterion.

This reflects a combination of higher energyprices, strong wage and credit growth, and

inadequate support from fiscal policy.

Meeting the very strict fiscal criterion is also

complicated by the fixed exchange rate

regimes and neutral convergence process.12

In the long term, if they are to avoidslipping from rapid economic growthinto a new period of stagnation, theBaltic States must deal with a range

of fundamental structural problems.

Sustaining their programme of struc-tural reforms will be key to futureeconomic development, job creationand poverty reduction. They need to

develop and maintain an economy,which is competitive in Europeanmarkets and does not simply rely onlow wage rates. They need to improvepublic sector administration and per-formance and to promote regionaldevelopment. Above all, perhaps, allthree Baltic States need to pay partic-ular attention to combating unem-ployment and reducing poverty,particularly in rural areas.13


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4.

The Baltic energy system: structureand dynamics

Electricity

he electricity market differs ineach of the Baltic States, al-though all three share the com-

mon characteristic that they are notlinked to the European grid. Estoniaand Lithuania are both net electricityexporters and their surplus supply issold to Latvia, as well as to parts of theRussian Federation. The majority ofEstonias electricity is generated bythe Narva power plants, using oilshale as fuel. In 2004, Estonia pro-duced 8.9 billion kilowatts (bkwh) ofelectricity. Its ability to continue to

generate this amount of electricityover the longer term is questionable ifit continues to rely on oil shale as fueland, indeed, the EU has begun toexert pressure for oil shale-fired gen-eration to be scaled back, on environ-mental grounds.

The majority of Lithuanias electric-ity has, until recently, been generated by the countrys Ignalina nuclearpower plant, which contributed to the19.8 bkwh of electricity that Lithuaniaproduced in 2004. However, Ignalinaoperates an RBMK-type reactor and,under pressure from the EU, theLithuanian government has agreed toshut down the plant by 2009. In re-turn for its agreement to phase outIgnalina, Lithuania has received over$1.5 billion in foreign aid. The gov-ernment has, however, indicated itsinterest in developing a new nuclearplant to replace Ignalina.

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Although Latvia has some hydro-electric facilities, in a dry year it isestimated to be only 60 per cent self-sufficient in meeting its energy needsand, as the Baltic States only net im-

porter of electricity, it buys from itsBaltic neighbours and from Russia.Currently, however, Latvia is workingwith Estonia and Finland to developthe Estlink project, the Baltic Statesfirst connection to the European net-work, a 43-mile underwater cable link-ing them to the Scandinavian powergrids. Estlink, which is scheduled tobe completed late in 2006 is a high-voltage, direct current, undersea cablelinking the Harku 330kV substation inEstonia with the Espoo 400kV substa-tion in Finland. It has been designed,and will be laid, by ABB.

Until Estlink is completed, however,the Baltic electricity network remainssolely linked to the Russian and Be-larusian systems. The Baltic PowerSystem Control Centre in Latvia hasoperational control of the IPS 330kVtransmission network in the BalticStates and is responsible for coordi-

nating the link with the Russian sys-tem, which brings a 750kV line fromSmolensk through Belarus to Ignalinain Lithuania. Lithuania then suppliesthe Russian oblast of Kaliningrad withelectricity by means of this connection.

The governments of the BalticStates see the electricity industry asvital to the future economic develop-ment of their countries. A report onenergy policy, approved by the Lat-vian Cabinet in September 2001, iden-tified energy policy in the electricity


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sector as an integral part of (the)strategy of the national economy. Itspolicy was aimed both at the creationof preconditions for the establishment

of a common Baltic electricity mar-ket and at ensuring the reliabilityand quality of electricity supply withinthe forthcoming 10 years, through both short-term immediate activitiesand regular annual measures that arevital for a stable development of theenergy industry.14

The Estonian government has beenno less clear:

The fuel and energy sector is a strategicinfrastructure of the state which must ensure

that Estonia has an uninterrupted supply of

high-quality fuel, electric energy and heat at

optimal prices. At the same time the fuel and

energy sector must be as efficient as possible

and comply with the safety and

environmental requirements.15

The difficulty for the Baltic govern-ments in assessing energy policy in theelectricity sector has been the same asthat facing them in other energy sec-tors: the lack of domestic supply andan addiction to subsidized fuel and en-ergy from external sources. The Lat-vian Cabinet of ministers complainedthat past assumptions were based onthe import of inexpensive primary re-sources and electricity, satisfying theshort-term demand of consumersand that the attainment of their goals

in the energy sector was hindered bycircumstances related to the situationin the region where the stability of ex-ternal suppliers can be planned onlyon a short-term basis.16

Two major factors affect the futuredevelopment of the Baltic electricitymarket. The first of these is the re-gions reliance on unpredictable andpotentially volatile external sources ofsupply.

The supply of primary energy, including

electricity (also import) in the Baltic region

exceeds the demand, therefore today the

electricity cross-border sales prices are low,according to an assessment by the Latvian

Cabinet. However, these prices do not reflect

the long-term marginal costs of electricity

generation and it is hardly possible to

forecast with certainty the price level for a

period in excess of one year. The current

situation does not provide for economic

signals to be aimed at the introduction of

new generating capacities, therefore

undermining economically justified

fulfilment of long-term supply objectives.17

The other important factor affectingfuture development has been theneed to ensure that Latvia meets itsinternational environmental commit-ments and that industry makes thenecessary improvements to meet EUstandards. The Latvian governmenthas emphasized that:

In the future development of the energyindustry, utmost attention shall be paid to

problems related to environmental

protection, taking into consideration the

increasing requirements with respect to

environmental protection and security as

dictated by the public wellbeing and

international commitments of Latvia.18

The Estonian government sees thecountrys new international, environ-

mental obligations as an opportunity.The visions and needs relating tothe future of power engineering havenow changed to a significant extent in connection with accession to theEU, a number of requirements andobjectives have arisen, the energytechnology has developed and imple-mentation of the Kyoto Protocol pro-vides new possibilities19

Both governments have identifiedthe promotion of renewable and do-mestic energy resources as critical to


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the attainment of their objectives, themain one of which, in the case ofLatvia, is to foster the development ofthe energy industry in line with bal-

anced and sustainable growth of thenational economy.20

The Estonians have set environmen-tal targets as formal, strategic objec-tives for the fuel and energy sector.They have specified that, by 2010, re-newable energy should account for 5.1per cent of gross consumption andthat by 2020, electricity produced incombined heat and power productionstations should form 20 per cent of

gross consumption.The problem that all three Balticcountries now face is to ensure that theelectricity sector can continue to ser-vice the requirements of rapid eco-nomic growth. The Latvian Cabinethas recognized that there is a need toimprove the reliability and quality ofelectricity supply with no delay, espe-cially when connecting new users orchanging existing loads. In the condi-tions of a swift economic development,the electricity supply companies haveto guarantee stability and quality ofelectricity supply to the highest stan-dards. Of late, the national economyof Latvia has been undergoing mod-ernization and introduction of newadvanced technologies and equip-ment, requiring extremely high qual-ity of electricity and reliability ofsupply.

However, the combination of new

environmental commitments and re-duced generating capacity in someareas is bound to create difficultiesand increase reliance in the short-term on imports. The Latvian govern-ment has admitted that:

It is anticipated that several electricity

generation facilities in the Baltic Region

(Ignalina NPP among them) will be closed

down within the forthcoming 58 years, and

the existing facilities will continue to

depreciate. Simultaneously, compliance of

the generating facilities with the

environmental protection standards can be

expected, which, in turn, will reduce the

scope of generation. Hence, there is a risk of

eventual inadequacy between the consumer

demand and the ability to meet it.

Furthermore, the Latvians have iden-tified serious structural failings, whichwill increasingly affect the reliabilityand quality of supply.

Along (with) changes in the energy

consumption structure and load centres andthe location of energy generating facilities,

the technical condition of electricity

transmission and distribution networks, as

well as the pace of development of network

systems, has resulted in the incompatibility

of network capacities with the capacity

transmission demand to meet the needs of

energy users. Moreover, the development of

electricity transmission and distribution

systems is no longer sufficient and

adequate.21

The region faces a major infrastruc-ture problem within the BRELL elec-trical ring, where not only is thetransfer system inappropriate in thepost-Soviet era but, according toone manager, even at present some ofthe interconnections are operatedclose to the reliability limits.22 Theproblem is compounded by the fact

that no transfer capacity allocationmethods exist and power exchangesare based on bilateral monthly con-tracts. Power exchanges appear to beallocated on a first come, first servedbasis and there is no clearly structuredpower reserve market. Instead, mu-tually agreed power reserves are keptfor the Baltic Interconnected PowerSystems (IPS), the Belarus IPS andRussias UPS with no clear principles

of use.23


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Nevertheless, despite these obsta-cles, the Baltic governments remainconfident about the future. The Lat-vians even claim that taking into ac-

count the technical condition and themarket maturity level in the neigh-bouring states, as well as the relatedrisk factors in the electricity trade, by(the) year 2008, the potential suppliesof electricity from power plants underthe Latvian jurisdiction shall reach8090 per cent of total consumption.

Such prognoses, however, haveproved to be more than a little opti-mistic, in part because they antici-

pated extraordinary results from thedevelopment of new and environmen-tally sustainable sources of energy.The Latvians, for example, claimedthat such level of supply will be at-tained through preservation andmodernization of the existing capaci-ties, as well as by creating economicallysound conditions for the develop-ment of facilities operating in a co-generation cycle and using renewableenergy resources.

In the long term, whether such op-timism will be justified, given the scaleof the restructuring involved, remainsto be seen. What is clear, however, isthat all three Baltic governmentsattach great significance to the devel-opment of renewable and environ-mentally-friendly sources of energy aspart of their overall energy securityplanning.

The Latvians, along with the other

Baltic governments, are looking to theprivate sector to make the necessaryimprovements.

The international experience shows that the

tendency of the energy users to improve the

reliability and quality on their own, as well

as the growing number of problems related

to eligibility to build large energy facilities

(power plants, transmission lines) promote

the development of dispersed generation

and combined energy generation

technologies (micro turbines, fuel cells, small

co-generation, etc) and concepts thereof.

The government has even gone sofar as to state publicly that: No otherrestrictions than those relating to en-vironmental protection and stabilityand public safety will be imposed withrespect to the introduction of newelectricity generating capacities inLatvia.24 It may not be quite enough,however, given the scale of the re-structuring involved, to justify thegovernments optimistic prognosesabout future domestic generating ca-

pacity. Equally, as the private sectorresponds to the challenge of modern-izing and developing the electricity in-frastructure of the Baltic States, as inother energy sectors, the same ques-tions will confront political leadersabout security of supply if, as is likely,much of the required investmentcomes from Russia.

Natural gasNone of the Baltic countries is a pro-ducer of natural gas and all three de-pend on imports to meet demandfrom domestic consumers. In 2001,whilst producing no gas themselves,the Baltic countries consumed a totalof 202 billion cubic feet.

Most of the Baltic States importedgas comes from Russia and is providedby the quasi-state monopoly companyGazprom and its subsidiaries at rateswhich, until recently, have beenfavourable. The Baltic States havelong-term supply agreements withGazprom, which has traditionallymaintained a good relationship withthem, in part because of their impor-tance hitherto as transit states. How-ever, with the development of otherstrategic routes for supplying gas toWestern Europe, such as the North

European Gas Pipeline, the Baltics are


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losing their importance as transitstates and political concerns seem in-creasingly to motivate Gazproms ac-tivity in the region.

When Aleksandr Ryazanov, Gazpromsdeputy CEO, announced that he wasplanning to raise the price of gas sup-plied to the Baltic States, he specifi-cally linked his decision to a politicaldevelopment.

Following the accession of the BalticStates to the EU, we will be raisingprices to the corresponding level, heannounced. As an example of whatthe Baltic countries might expect,

Ryazanov cited the current Polishprice of $120 per 1,000 cubic metres.25

Gas prices in all three countrieshave, to date, been held artificiallylow, at around $8085 per 1,000 cubicmetres.

In a region with the lowest percapita wages in the EU, Gazproms de-cision to raise prices has, understand-ably, caused widespread concern.Suspicion persists that the decision ispolitically motivated, an act of ven-geance because the Baltic nationsjoined the EU and NATO or part of aplan to choke Baltic independence.26

However, Gazprom does have apoint. It insists that the plan is simplyto increase prices in the Baltic Statesto the level of the rest of the EU, in linewith growth. As growth rates have been more impressive in the BalticStates recently than virtually any-where else in the EU though, the price

rises could soon be very steep. TheRussian gas giant does appear to beconcerned about protecting its Balticmarket, however, and seems wary ofthe effect that punitive price risescould have on its position.

We must not increase prices toomuch because then Lithuania, Latviaand Estonia could switch to alter-native fuel, such as fuel oil, Ryazanovsaid.27 He also confirmed Gazpromslong-term interest in the Baltic mar-ket, telling a press conference that

The Baltic States market is stable andGazprom is interested in it.28

President Putin himself has painteda similarly rosy picture, telling Euro-

pean leaders at a recent summit meet-ing on Russias Black Sea coast:

The launch of construction of the North

European Gas Pipeline, measures to

strengthen the energy security of the

continent all this is moving towards

progress, towards global and regional

development and towards our main aim of

improving the quality of life of Europeans.29

As Gazprom expects continued eco-nomic growth and a correspondingincrease in demand for gas, Ryazanovhas also stressed that the companywould be foolish to encourage the de-velopment of other sources of fuelsupply by increasing prices to unsus-tainable levels. There are estimatesthat by 2010 the consumption of gasin the country will reach 55.5 billioncubic metres and we are ready to sat-

isfy the demand in full.30More worrying perhaps than the

planned price increases, however, hasbeen Gazproms corporate acquisitionactivity in the region. The companyhas recently set about making a seriesof strategic acquisitions of natural gasutilities. It now holds a 34 per centstake in the Latvian gas companyLatvijas Gaze and 37 per cent of Esto-nias Eesti Gaas. With Lithuanias

partial privatization and price dereg-ulation in January 2004, Gazprom ac-quired 40 per cent of the state-ownednatural gas company. Whilst it hasjoined other foreign companies, suchas Germanys EON-Ruhrgas andFinlands Fortum, in investing in theBaltic gas sector, the concern is thatGazprom is not a normal investor,whose actions are determined primar-ily by market considerations.

In some Baltic countries, concernabout Gazproms intentions has led to


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second thoughts about privatization.In Latvia, where Gazprom suppliesmore than 80 per cent of the countrysgas, it has a long-term supply deal with

its local partner, Latvijas Gaze. Even before the planned liberalization ofthe Latvian market in 2007, Gazpromalready has a powerful hold on theeconomy, with a virtual monopoly onthe import, transmission and distribu-tion of gas. Some commentators fearthat further liberalization may simplyhelp Gazprom to tighten its grip.

Ultimately, however, many in theBaltic States feel that, without Euro-

pean support, their room for manoeu-vre is limited. As so often in history,the fate of the Baltic countries may de-pend on guarantees of support fromoutside the region. If Germany pushesahead with the North European GasPipeline and the rest of Europe con-tinues to increase its dependence onRussian gas, there will be very littlethat the Baltic countries can do, ontheir own, to slip from Gazpromsgrip.

The three Baltic governments ap-pear to have recognized the limits totheir capacity to deal with the issue ofenergy dependency. In a declarationfollowing their meeting on 27 Feb-ruary 2006, Prime Ministers Ansipof Estonia, Kalvitis of Latvia andBrazauskas of Lithuania said:

Taking into account the sensitive issue of the

security of energy supply in the Baltic States

and the fact that the Baltic States do nothave any gas and electricity

interconnections with other EU Member

States, and therefore do not have

possibilities to participate in the internal

energy market; considering the necessity to

reduce the dependency of the Baltic States

on the dominant supplier of the energy

resources; bearing in mind that the closure

of the Ignalina Nuclear Power Plant will

have serious effects on the energy security of

the Baltic States; the Prime Ministers of the

Baltic States:

1) express their support to the development

of a common European energy policy as a

guarantee to the security of supply at the

Community level; 2) state that the energy

security problem of the Baltic States should

be addressed at the EU level and therefore

request that the European Commission by

the end of 2006 assesses energy vulnerability

of individual Member States and EU regions

in order to propose specific actions at the EU

level for the reduction of such vulnerability

3) consider that there is a need to integrate

the EU energy and foreign and securitypolicies. A harmonized EU external energy

policy should be established towards third

countries and organizations, notably with

Russia and OPEC 4) call for the

development of an EU mechanism that

prepares for and ensures solidarity and

assistance to a country facing difficulties

following damage to its essential

infrastructure or disruptions in energy

supply31

Oil

Russia currently supplies approxi-mately 90 per cent of the Baltic Statesoil. There is a small amount of domes-tic production, with Lithuania pro-ducing roughly 14,000 barrels perday (bbl/d) and Estonia around 6,000 bbl/d, most of which comes from oil

shale. Latvia is entirely dependent onimports.

The main significance of the BalticStates in the oil sector has been theirrole as an export terminal for Russiancrude transported to ports on theBaltic via Transnefts pipeline system.The amount of oil traded through theBaltic region has increased signifi-cantly in recent years, with export ca-pacity nearly doubling since 1999.

However, as nearly all the exported oil


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arrives at the Baltic via the Russianpipeline system, competition has beenfierce and there have been dramaticchanges in the distribution of market

share.Until recently, Ventspils in Latvia

was the largest port in the regionand the second largest terminal forthe export of Russian crude oilafter Novorossisk. In 2002, however,Transneft completed work on its portat Primorsk near St Petersburg andimmediately stopped deliveries ofcrude oil to Ventspils. Faced with theovernight eradication of its main

source of business, Ventspils tried toincrease deliveries of crude oil andpetroleum products by rail, simply inorder to be able to maintain its posi-tion as an oil-exporting port. Al-though far from ideal and very mucha short-term solution, this policy hadsome success in plugging the gap cre-ated by the absence of piped Russiancrude.

By 2004, with the construction of anew rail terminal, Ventspils was ableto export 215,000 bbl/d of oil. Thiswas, however, only one third of theaverage amount exported beforeTransnefts completion of Primorskand the beginning of what is, effec-tively, an embargo. Moreover, trans-porting petroleum products andcrude oil by rail rather than via thepipeline system has brought signifi-cant extra costs for Ventspils, increas-ing exposure to risk, as profit margins

are much slimmer.32

The primary competitive threat toVentspils is now Primorsk. RussiasBaltic Pipeline System now brings oilfrom western Siberia and the Timan-Pechora oil fields to the new Russianport. By the end of 2003, Primorskhad already become the Baltic re-gions busiest port, handling 600,000bbl/d. In 2004, crude oil flows reachedan average of 880,000 bbl/d. Furtherexpansion, currently being planned by Transneft, would dwarf the

capacity of Ventspils, giving Primorska crude oil export capacity of 1.2 mil-lion bbl/d. In addition, Transneftplans to develop a petroleum product

export terminal, which would be ca-pable of handling up to 120,000 bbl/d.

The future of Ventspils thus re-mains uncertain. The problem is that,as Primorsk is wholly owned and op-erated by Transneft, priority will au-tomatically be given to it. This is not aquestion of normal commercial con-siderations or even anxiety about thepresumed patriotic prejudices of Rus-sian companies. Transneft is a state-

owned monopoly and the Russianauthorities have stated explicitly that,when allocating resources for export,seaports in which Russia has a stakewill be given precedence over foreign-owned ones.33

The Baltic States other main oil-exporting ports are less exposed thanVentspils but for different reasons.Tallinn in Estonia, which comprises acomplex of four large ports (Muuga,Old City Harbour, Palyasaare andPaldiski) has recently undergone a pe-riod of some expansion. Despite thefact that it depends on the railways forits crude oil and petroleum products,it has seen the largest annual increasesin fuel oil export levels of all the BalticSea ports, with exports rising to16.338 million tonnes in 2004. As aconsequence, new rail links and jettieshave been added at the main exportterminals, Estonian Oil Services, Pak-

terminal and Eurodek. The new facil-ities have also allowed Tallinn toincrease its exports of other Russianproducts, most notably coal, exportsof which rose to 2.276 million tonnesin 2004 from 1.825 million tonnes in2003.

In Lithuania, the port of Butinge,which is located between the Latvian border and the Russian enclaveof Kaliningrad Oblast (the formerGerman province of East Prussia), hasapparently been more fortunate than


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Ventspils. Despite being smaller thanthe Latvian port, Butinge exportedmore oil in 2003 than Ventspils and,as a consequence, undertook a limited

expansion of its facilities.34On the face of it, the reason for

Butinges comparative success hasbeen the fact that it has enjoyed betterrelations with its Russian suppliersthan Ventspils. This has, however, been something of a double-edgedsword, to say the least.

Butinge is part of the MazeikiuNafta complex, the largest energy en-terprise in Lithuania, which also in-

cludes the oil refinery at Mazeikiai anda pipeline at Birzai. In 1999, Lukoil,one of Russias leading oil companies,with close connections to the Kremlin,tried to gain control of the complex but was firmly snubbed by theConservative/Christian Democrat coa-lition government, which instead solda controlling share to Williams Inter-national, a US company. The gov-ernment apparently feared that atakeover by Lukoil would represent aserious threat to Lithuanias strategicinterests, allowing Moscow not only togain a stranglehold on the countrysenergy infrastructure but also to in-fluence its foreign and securitypolicies.

Some reports suggest that Moscowwas so unhappy about the sale ofMazeikiu Nafta to Williams, that itlaunched a determined campaign toundermine the deal.35 In 2002,

Mazeikiu was sold to a Russian com-pany, although not to the pro-Kremlin Lukoil but to Yukos, an oiland gas giant, headed by a so-called

who was openly critical of PresidentPutin.

In October 2003, however, Khodor-kovsky, perhaps the most progressive

of Russias leading oligarchs, was ar-rested on charges of tax evasion andother economic crimes. Draggedfrom his seat on an aeroplane at a

Siberian airport by special forces,Khodorkovskys arrest was soon front-page news and a powerful warning toRussias emerging business class. Aftera lengthy trial, the Yukos boss, whowas once Russias richest man and, re-putedly, worth 8 billion, was sen-tenced to eight years in a Siberianprison camp, where he continues tolanguish to this day.36

It is fair to speculate that the reason

for the harsh treatment meted out toKhodorkovsky was not simply his po-litical opposition to Putin but also thefact that his activities were increasing-ly running counter to the Kremlinsforeign and security policies. Onecommentator recently specificallyidentified Khodorkovskys purchaseof Mazeikiu Nafta as a reason for theoligarchs downfall:

As the head of Yukos and bent upon

operating the company in a manner in

keeping with Western and not Russian

enterprises, Khodorkovsky had refused to

abide by the Kremlins direction that Russian

energy entrepreneurs advance the

governments security priorities first and

only later think about profit margins. He not

only purchased the largest oil refinery in the

Baltics, Lithuanias Mazeikiu Nafta

thereby denying that prize to Lukoil, a

Kremlin favourite, he also contemplated apartnership with China in the construction

of an oil pipeline, and indicated that he

sought a close commercial relationship with

one of the major American oil companies. If

successful, Khodorkovsky would have

compromised Putins drive to play the

energy card on the global chessboard.37


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oligarch, Mikhail Khodorkovsky,


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5.

Russias interest in Baltic energyThe key question in any assessment ofRussias objectives and interests in theBaltic States energy systems is: doesthe Russian state want to encourageRussian companies to secure a pre-dominant position for legitimate com-mercial reasons or are their actions asymptom of a wider attempt to pro-

mote Russian foreign and securitypolicies?

Any attempt to answer this questionmust, first of all, pay attention to thecomposition and antecedents of thekey decision-makers in Moscow. Itmust also appreciate the extent towhich energy and security concerns in-form their common Weltanschauung.

The siloviki and the keydecision-makers

President Putin and his advisers arevery different to the men who ranRussia in the 1990s under BorisYeltsin. Whereas, at least in the earlypart of his rule, Yeltsin tended to sur-round himself with liberal reformers, buccaneering businessmen and evenformer anti-Soviet dissidents, Putinsadvisers and intimates come almostexclusively from the same security ser-vice milieu as the president himself.Todays governing elite in Russia issubstantially composed of the so-called men of power, the siloviki, anepithet that only hints at what oftentends to be their collective view thatthey represent the eternal state, the

postoyannoye gosudarstvo. In its most ba-sic form, it is a view that, whilst politi-

cal systems come and go, the interests

of the state remain the same. The mis-sion of thesiloviki, therefore, is to re-establish, preserve and extend theauthority and influence of the state.

Whilst it is certainly possible to over-estimate their importance, some re-ports suggest that as many as onequarter of Russian government offi-

cials could be classed as siloviki.38 Ofthese, Putin himself is, clearly, the bestknown. However, his close friend, theDefence Minister, Sergei Ivanov, isalso a former KGB officer, as is RashidNurgaliyev, the Minister of the Inte-rior. It was Sergei Ivanov, in the wakeof 9/11, who said that Russia would inno way assist the United States in itsmilitary action against the Taliban andal-Qaeda in Afghanistan. Although

the more diplomatically adept Presi-dent Putin quickly slapped down hisdefence minister, Ivanovs commentswere indicative of a typicalsilovik atti-tude to foreign policy, seeing theUnited States as head of a Western al-liance determined to humiliate Russiaand prevent its re-emergence as aworld power.

Two of the Presidents closest advis-ers, Viktor Ivanov and Igor Sechin,deputy chiefs of staff in the Kremlin,worked for the KGB in Putins hometown of St Petersburg. Ivanov, agraduate of the Leningrad Bonch-Bruyevich Electrical-Technical Uni-versity, who worked as an engineerbefore joining the KGB in 1977 andfighting in Afghanistan, is now adeputy head of the presidents admin-istration. In addition, five of the sevenpeople selected to serve as regionalsuper-governors were siloviki. They

included Viktor Cherkessov, who was


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responsible for the KGBs campaignsagainst anti-Soviet dissidents until thedissolution of the USSR in 1991. Putinconsidered him a suitable choice

for super-governor of north-westRussia.

What is more interesting, however,is the involvement of the siloviki andthe security establishment in Russiasenergy complex. Equally significant isthe geo-strategic, political importancethat the president himself has longattached to issues concerning thedevelopment of Russias energyresources.

An example of a prominentsilovikwith an important position inRussias energy structure is the deputyChairman of Gazprom, AleksandrRyazanov. He became Chief Executiveof the Siberian oil company, Sibneft,in 2005, after it was bought byGazprom. He was also recently ap-pointed to head UkrGazEnergo, aRussianUkrainian joint venture com-pany, which was created to act as a bridge between Ukraines state-runNaftohaz Ukrainy and the Swiss-registered RosUkrEnergo.

Background to Putins energy

and foreign policy

In order fully to understand the im-portance of Russias energy resourcesin Vladimir Putins world view, how-

ever, it is necessary to return to theperiod in the 1990s when the futurepresident spent most of his time in StPetersburg. He had already served 15years there as an officer in the KGBand its successor organization, theFederal Security Service (FSB), whenhe joined the St Petersburg Mayorsoffice. He also enrolled as a maturestudent in the St Petersburg MiningInstitute. Both the Mayors office and

the Mining Institute were to play animportant role in the development of

Putins approach to energy and for-eign policy.

In 1994, the Mining Instituteappointed a new rector, Vladimir

Litvinenko, who is believed to haveexerted a significant influence on thedevelopment of Putins thinking.Litvinenko believed in the importanceof energy as a tool of state policy, andPutin followed his lead when he cameto defend his doctoral thesis in 1997with an examination of the contribu-tion of natural resources to regionaleconomies and strategic planning.

Two years later, as director of the

FSB, he wrote an article for the Min-ing Institutes in-house journal enti-tled Mineral Natural Resources in theDevelopment Strategy for the RussianEconomy. Putin argued that hydro-carbons were crucial both to Russiasfuture development and the restora-tion of its former power. His centralthesis was that the most effective wayto harness Russias natural wealth wasby state regulation of the fuel sectorand the parallel creation of large, ver-tically integrated companies, whichwould work in close partnership withthe state.

During his time at the St PetersburgMayors office, Putin met several keyfigures, who would go on to occu-py important positions in Russiasenergy-security complex. They in-cluded Alexey Miller, who is now the

Medvedev, who became the head of

the Presidential administration, dep-uty Prime Minister and chairman ofthe board of Gazprom; and IgorSechin, who is now the chairman ofthe board of Rosneft, a positionhe has managed to combine with theoffice of deputy head of Putinsadministration.

The influence of Litvinenko and hisMining Institute has endured too.The Institute, according to one re-port, is now a compulsory stop forRussian and German energy leaders


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Chief Executive of Gazprom; Dmitri


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visiting St Petersburg. The Instituteswebsite, for example, recently notedthat it had received a delegation fromGazproms close ally, the German gas

giant, Wintershall.39

Russias energy-security

complex

The energy-security complex is now atthe centre of power and policy-making in Russia. Trusted figuresfrom the security apparatus have

managed to occupy key positions inboth the government and the energysector.40 The president and his closestadvisers believe that the use of Russiasenergy resources is an essential ele-ment in their plan to re-establishRussias power and influence, partic-ularly in the near abroad.

Kremlin planners realized at some point

in the 1990s that they possessed an

economic weapon of significant potential,one capable of promoting Russias foreign

policy objectives in the space of the former

Soviet Union, according to one

commentator. The weapon was a massive

supply of natural gas and petroleum along

with strategic pipelines from East to West,

refineries, pumping stations and other

installations associated with Russias energy

wealth.41

By the middle of the 1980s, the So-viet Union had become the largest oilproducer in the world and, althoughfluctuating prices masked the true ex-tent of its wealth, by 1998, it was send-ing more than 4.09 million barrels perday for export. A decade later, asPutin and his team prepared to takeover the reins of power from PresidentBoris Yeltsin, they realized the signif-icance of Russias energy resources,

particularly at a time when oil prices

were rising and there was growing un-ease about the Wests ability to con-tinue to rely on the Middle East.

Energy as a foreign policy tool

In the Baltic States and Poland, thereis little doubt that energy has acquireda new geo-political significance for theKremlin and that Putin is determinedto use Russias energy resources to se-cure his foreign policy objectives. Atthe same time, the West so covets Rus-sias vast pool of oil and gas that it is,

seemingly, prepared to ignore Putinswillingness to use energy to securedeeper foreign policy goals with thenew NATO and EU Member States inthe near abroad. The Baltic special-ist, Richard Krickus, has emphasizedthe geo-political potential of Russiasenergy asset. He believes that, partic-ularly in the Eastern Baltic Sea Region(ESBR), the importance of energy as atool of foreign and security policynow overrides the usual economicconsiderations.

Through its energy industry, Russia has vast

resources that enable it to play the energy

card on a global basis Moscow has used

the pipeline system as a foreign policy

weapon. Indeed, the Kremlin is prepared to

make economic sacrifices to promote its

foreign policy agenda. Russia, for example,

is building its Baltic Pipeline System to carry

oil to the Russian port of Primorsk; it couldfind cheaper outlets were it to use the under-

utilized oil transit routes through the three

Baltic countries. At the same time, sceptical

about Warsaws good will or merely wishing

to punish Poland, Russia is building an

undersea gas pipeline at a cost three to four

times as much as running a parallel pipe

along the Yamal route through Poland.42

The former US Ambassador to

Latvia, Keith Smith, has identified the


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extent to which Putin has been pre-pared to interfere in the energy sectorin order to establish control as a realcause of concern.

Putin appears to share the widespread view

in Russia that energy is too important a

national asset to allow the market or any

private individual free rein in deciding on

issues such as links to foreign partners,

pipeline construction or competition for the

right to explore new oil and gas fields.43

The Kremlins motivesIf energy is, indeed, being used as atool of foreign policy in the East-ern Baltic Sea, what exactly is theKremlins objective? The row overRussias decision temporarily to cur-tail gas supplies to Ukraine andconcern in Poland and the Balticcountries over the North EuropeanGas Pipeline have drawn the attentionof some of the worlds richest energy

consumers in Western Europe to thequestion of the reliability of Russia asa long-term energy supplier.

In purely commercial terms, theKremlin does not appear to haveplayed its hand very cleverly. It hasencouraged the European nationstates to re-examine the need for acommon energy policy and it hashelped to fuel demand for alternativetechnologies and sources of supply.

However, as an instrument of foreignpolicy, it has achieved several impor-tant objectives. First, and perhapsmost worryingly, it has sent a clear sig-nal about what it continues to regardas its legitimate sphere of interest.This is, perhaps, a measure of the frus-tration of thesiloviki at NATO expan-sion in the region but also a warningthat Russia is determined to maintainits interest there.

In part, the Kremlins motive mayhave been its unease about what it per-

ceives as Polands increasing attemptsto influence events in the region andto return to the pre-war idea of a cor-

don sanitaire around Russia. Moscow

may also have been influenced by adesire to slap down the Balts, whohave continued to enrage the silovikiever since they achieved indepen-dence with a series of irritating politi-cal challenges, such as encouragingthe EU to deny Russian citizens visa-free access through Lithuania toKaliningrad and providing a platformfor Chechen exiles to criticise Russianpolicy in the Caucasus.

More significant, however, is therole Moscow believes them to haveplayed in frustrating the Kremlins at-tempts to establish a relationship withmajor EU countries in a bid to coun-terbalance US power. Baltic supportfor the American-led coalition in Iraqwas crucial in undermining Europeanopposition to US policy and caused ir-ritation not only in Moscow when theBalts signed a letter supporting theUS invasion, they were told to shutup by the French President JacquesChirac. Worse still, in Moscows eyes,was Baltic support for Polish initiativesto resolve the political crisis inUkraine, paving the way for the or-ange revolution and the loss of polit-ical control. The fact that PresidentBush visited Latvia on his way toMoscow for the celebrations com-memorating the 60th anniversary ofthe end of the Second World War,

which were boycotted by two out thethree Baltic leaders, was an indicationto Moscow of Washingtons desire touse the Balts to counterbalance Rus-sian pressure on the EU.

NATOs recent decision to host itsnext summit for heads of governmentin Riga in November 2006 was, per-haps, the final humiliation for the

siloviki, an indication that Russias for-mer Baltic provinces were now notonly members of a different military bloc but also capable of exerting


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influence within it against Moscowsinterests. In such circumstances, itwould hardly be surprising if theKremlin decided that Russias state

monopoly energy companies were anappropriate instrument with which toissue an admonitory slap to the BalticStates.

Secondly, Putins sabre-rattling was,perhaps, designed to impress his col-leagues in the G8. It was, effectively,an announcement that Russia couldno longer be ignored or taken forgranted.

Just as Russia focuses the G8 on energysecurity, Putin has illustrated why its

position is at least as powerful as any other

around the table, one investment analyst

has observed. The argument has been made

that there is a symbiotic relationship

between energy producer and energy

supplier Russia needs the consumer just as

much as Europe needs the producer. But this

seems to be somewhat unimaginative

rhetoric. It is difficult to imagine a scenario

when Europe will unilaterally stop buying

gas from Russia. Russia, on the other hand,

has shown it can turn off gas supplies simply

because of an unpaid gas bill. As the G8

focus on energy security, Russia has shown

where the balance of power lies.44

Thirdly, Russia has shown that it iswilling to use energy to advance itsforeign policy agenda and not simply

as a means of securing increasedrevenue.

By throwing the switch for a couple of days

when most of the world was focused

elsewhere, Russia has shown that its threat

to energy supplies is not empty. The

Kremlins determination to gain control over

Russias hydrocarbons has not simply been

about access to revenue flows but also to

gain power that they are not afraid to

use.45

The Kremlins use of energy as a toolof foreign policy is about buying influ-ence, rather than winning friends.Russias economic performance dur-

ing the past decade has meant that itis now able to make its presence feltonce again on the world stage.Equally, it is now the only Europeancountry with both the resource baseand the political will to pursue a gen-uinely independent foreign policy.What the precise implications of thisfact are is still unclear. However, it isclear that, although Putin has tried toappear closely aligned with Europe,

the Kremlin will not hesitate to pursuea policy that it considers to be inRussias best interest, despite the res-ervations of its partners in the West.

It is important to remember, too,another fact that increasingly links en-ergy to Russias security interests. Thegrowth in Russias energy sector andthe steady rise in prices underpinningit have also fuelled the reconstructionof Russias defence industry and al-lowed President Putin to begin to re-build the Russian armed forces.

In his seventh state of the nation ad-dress recently, President Putin saidthat we must make our own housestrong and firm. Because we can seewhat is happening in the world. Headded that Russia needed to rebuildits military not just to deal with newand unpredictable threats, such as ter-rorism, but to preserve the strategicbalance of forces.

We should be able to respond to attempts

to put foreign pressure on Russia and it

should be said frankly: the stronger our

armed forces are, the less temptation there

will be to put pressure on us.46

A reinvigorated Russian military, fi-nanced by thesilovik-led energy sectorand controlled by a Kremlin leader-ship determined to maintain Russias

strategic interest in the Baltics, is


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unlikely to be a prospect greeted withuniversal enthusiasm in Riga, Tallinnor Vilnius.

Finally, one major factor, which

must be taken into account in any con-sideration of the Kremlins motive forusing energy as a tool of its policy inthe Baltics, is its anxiety over the fu-ture viability of Kaliningrad. AsMoscows Baltic outpost is linked tothe Russian grid through the Lithua-nian network, it is only fair to acknowl-edge that Russia is bound to continueto have an interest in the regions en-ergy system. However, whether it has

so far employed legitimate, or evensensible, means to advance that inter-est is another question.

All this means first, that the BalticStates are likely to continue to be con-fronted with the Kremlins convictionthat it has a legitimate strategic inter-est in the Eastern Baltic Sea Regionand, secondly, that Europe needs todevelop a clear Eastern policy (see be-low), which takes full account of theimportance of energy security.

European energy security

In any assessment of Russias interestsin supplying energy to European mar-kets, however, it must be emphasizedthat it is hardly possible now to ex-clude Moscow from the discussionabout Europes security of supply.Poland, however, supported by the

Baltic States, has been seeking re-cently to do just that. In March 2006,the Polish President, Lech Kaczynski,presented a draft energy security pactfor EU and NATO Member States.The plan, which was drawn up by theoffice of Kazimierz Marcinkiewicz,Polands conservative Prime Minster,had four main elements:

a mutual energy-security guaran-

tee clause, modelled on NATOs

article 5, under which signato-ries would agree to support eachother in the event of a threat totheir energy security from natu-

ral or political causes; the development of new techni-

cal infrastructure for the trans-port, transmission and storageof energy, to allow cooperationif supplies to Member Stateswere restricted;

a greater focus at European levelon the diversification of energysources and the imposition of aceiling to limit dependency on

particular sources of energy; the proposed energy security

alliance would be open to allMember States of the Euro-pean Union or NATO andwould thus automatically ex-clude Russia, although it might be possible for countries, suchas Ukraine, to join at a laterstage. Poland has recently been lobbying extensively forUkraine to be granted an actionplan for future membership ofNATO, which would make it el-igible to join an energy securityalliance.47

It is difficult to avoid the conclusionthat, whilst it is easy to understand thelegitimate concerns of Poland and theBaltic States, the proposed energy se-curity alliance could end up beinghighly damaging to Europes wider se-

curity interests. The President of theEuropean Commission, Jose ManuelBarroso, was surely right to emphasizethat Europe should refuse any kind ofnationalism in the energy sector.48

Furthermore, energy specialists inboth Russia and Western Europe havepointed out the impracticability of ex-cluding Russia from any dialogueabout European energy security.

All you have to look at is how muchenergy Russia supplies to Europe,said Katinka Barysch, an energy


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expert at the Centre for European Re-form. This shows you cannot excludeRussia The Polish view seems to bea contingency view. If the EU cannot

reach a deal with Russia, then thePoles seem to be saying Europe needsalternative plans. But it is clear severalMember States will not want to ex-clude Russia. Germany has alreadymade that clear to Poland. Indeed,German officials have made clear theirview that Russia should not bemarginalized over an issue as crucialas energy security.49

Russian energy specialists have also

been quick to emphasize Russias cre-dentials as a reliable, long-term en-ergy partner. The Director of theRussian Institute of Energy andGeopolitics, Ms E A Telegina, a boarddirector of the Union of Russian OilExporters, said recently:

Russia has been a traditional, reliable and

important exporter of energy to the

European Union. The EU has a serious

interest in preserving and increasing the roleof Russia as an oil and gas supplier. An

important trend in world development and,

in particular, in the development of

advanced countries (North America, Europe,

Japan) is an increase in natural gas

consumption, which requires material

investments in world energy

An important factor of world energy

development is the gas and electric power

sectors liberalization process, which is

going on today, especially in the European

Union (EU). The basic consequences would

be the development of competition among

producers, a possibility to choose a supplier

and reduction of prices for end users. One of

the key strategic tasks of the Russian Fuel

and Energy Complex is to preserve and to

maintain the competitiveness of Russian fuel

and energy resources in world energy

markets.50

Ms Telegina argues that Moscowsinterest in securing European inwardinvestment in infrastructure projects,combined with the strategic objectiveof maintaining competitiveness in in-creasingly liberalized European en-ergy markets, means that the EU andRussia have a strong mutual interest.She insists that there is now an oppor-tunity for enlargement of the large-scale cooperation, which can be

characterized as a mutually beneficialstrategic partnership built upon theprinciples of equality and parity of in-terests.51 She may be right but theproblem is that, so far, Moscow hasdone little to reassure consumers inPoland, the Baltic States and the restof Europe about its intentions.


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6.

The Baltics: options for the futureThe Baltic States concern about en-ergy security is not unique. It is sharedby several European countries, whichare anxious about many different fea-tures of the current world energy mar-ket, including:

the continuing rapid growth of

demand; a reliance on hydrocarbons from

areas of political instability; environmental issues, such as

harmful emissions and nuclearrisk;

a failure so far to develop signif-icant renewable energy solu-tions; and

volatility in the market systemand prices.

Russian dependency

In many ways, in the past, the BalticStates have been fortunate in beingable to draw on the vast energy re-sources of the Russian hinterland. Al-though antiquated, the system thatlinks them into the Russian grid andpipeline system is an enormous ad-vantage that could help to drive futureeconomic development in both theBaltic States and Russia.

The problem the Baltic States face isnot the fact that Russia supplies themwith energy, at hitherto heavily dis-counted prices, but that energy fromRussian sources accounts for such anoverwhelming, and increasing, pro-portion of the Baltic market. This sit-uation is aggravated by the nature ofRussian corporate activity in the Baltic

for two main reasons.

First, key Russian companies, suchas Gazprom or Transneft, are eitherwholly or partly owned by the Russianstate and, therefore, their activities inthe recent past have seemed to reflectthe Kremlins broader foreign andsecurity policy agenda. Given the re-gions painful history in the last cen-

tury, it is hardly surprising that thereshould be anxiety about allowing Rus-sian companies to enjoy a virtualmonopoly of the supply and distribu-tion of energy in various sectors.

Secondly, and perhaps more signif-icantly, the lack of transparency andthe business practices of some Russiancompanies operating in the regionhave contributed to the suspicion thatthey are not normal private sector

entities seeking to operate in a freemarket. The dilemma for Baltic gov-ernments, as they look to entice theprivate sector into investing in the re-gions energy infrastructure, is thatRussian companies are only too will-ing to invest but are often either se-cretive or state-owned, which makesthem difficult to accept as partners inthe liberalized, competitive environ-ment that the Baltic States want tocreate in the energy sector.

In considering their options, as theyseek to reduce their dependency onRussian sources of energy, therefore,the Baltic States need to bear in mindthat it is not Russian energyper se thatis the problem but the fact that anover-dependence on it has potentiallyuncomfortable political implications.In this respect, the Baltic States are nodifferent from those countries inEurope, North America or parts of

Asia, which fear the consequences of


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their continuing dependence on en-ergy from the Middle East.

Equally, it is not the fact that Russiancompanies are keen to invest in the

energy infrastructure of the BalticStates that is a problem but rather thatthey often seem to do so without op-erating to the same standards as West-ern European companies.

The energy security challenge

So, the fundamental energy securitychallenge for the Baltic countries, as

for many modern industrialized soci-eties, is to diversify supply and, at thesame time, control demand more ef-fectively. Janis Folkmanis, economicadviser to the President of Latvia anda former European Commission en-ergy policy specialist, has identifiedfour key measures that the BalticStates must adopt quickly to ensuresecurity of supply:

diversify import supplies; strengthen indigenous sources; increase renewable energy com-

ponents; curb demand.52

In analysing what needs to be done,however, the Baltic States also have toconsider carefully what exactly ismeant by energy security or securityof supply. In a world of increasinglycomplex and interlinked energy mar-kets, it is not, perhaps, as easy as mightbe expected to define these terms.

One senior energy executive in theregion, Arnis Staltmanis of the BalticPower System Control Centre, hassuggested that security of power sup-ply means:

a secure fuel supply for powerplants;

a balance between generation

and demand;

the ability of power systems towithstand normal and abnormalcircumstances.53

In terms purely of security of powersupply, that may be an adequatedefinition. In broader political oreconomic terms, however, it is notenough to define what sovereignnation states, such as the Baltic coun-tries, might mean by security of sup-ply or energy security.

However, whatever else it is, energysecurity is an international issue, a factthat means that the Baltic States can

draw on international experience andsupport in developing policy, particu-larly at the European level, where theenergy portfolio at the EuropeanCommission is now held by a Latvian,Andrijs Piebalgs.

Concerns about energy security areno more unique to the Baltic Statesthan the various other pressures andconstraints affecting energy policy,which are shared by many Europeancountries. The energy policies of all

European countries have to be setwithin the context of developments inthe global energy market, but thereis a general consensus that over-dependence on any single source ofenergy supply is very unwise. It is,perhaps, particularly unwise whenthe source of supply is liable to dis-ruption, whether through technicaldifficulty, terrorist activity or politicalsabre-rattling. However, this is a ma-

jor concern for many countries, withmuch greater economic and evenpolitical exposure than the BalticStates, the United States being themost obvious example.

Many countries, therefore, share thedilemma of the Baltic States. They allrecognize that the best guarantee ofsecurity is diversity of supply. Inter-nationally, diversity of supply is bestachieved by a package of measures,including:


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different means of energy gen-eration (hydrocarbons, nuclear,renewables);

a flexible energy transmission

infrastructure; alternative sources of fuel

supply; a thorough energy conservation

programme; regional collaboration for ex-

ample, on storage capacity, re-serves and sharing of facilities.

The latter point is of particular im-portance to the Baltic States, which

will find that the key to diversifyingtheir supply lies partly in workingclosely with their regional and inter-national partners. All three Balticcountries, working together, will findit much easier to develop appropriatesolutions to reduce their dependencyon particular external sources, thanindividual countries trying to go italone.

Regional collaborationInevitably, in the near future, theBaltic States will have to make majorinvestments in infrastructure in orderto improve their energy security. Theold Soviet infrastructure was deliber-ately designed without a national basisand has left most of the former cap-tive nations with unbalanced nationalenergy infrastructures. If the Baltic

countries are to make the investmentsnecessary in infrastructure, it wouldclearly be most cost-effective if it weredone on a collaborative, regionalbasis.

One obvious case in point is Latviasmassive geological gas storage capac-ity, which could be made available tothe other Baltic States, thus providingan important buffer against disrup-tion of supply. The relatively smallinvestment needed to extend the ex-isting storage facilities would mean

that all three Baltic States gas needscould be supplied for the duration ofa whole winter.

Equally, other large-scale energy

generation projects could be both eco-nomically viable and reduce depen-dency on external sources of supply ifthey were applied on a regional,rather than a purely national, basis. Anew nuclear plant of 7501000MW atIgnalina, for example, would makeeconomic sense as part of a regionalenergy strategy. Similarly, a 275400MW coal-fired plant in Latviacould compete with gas as an element

in a regional policy.54

The importance of regional collabo-ration to achieve energy security wasemphasized at a recent Policy Devel-opment Exercise in Lithuania. Theexercise, which was held jointly by theLithuanian Academy of Sciences andthe Defence Academy of the UnitedKingdom, considered various optionsfor Lithuania to improve its energy se-curity and concluded that any attemptto reach a purely national solution tothe problem was doomed to fail.

If Lithuania continues to pursue its

energy policy on a purely national basis, it

will be impossible to achieve energy security

at an affordable cost, and any energy policy

will be expensive. Energy security and lower

supply costs can be achieved through

regional collaboration. If that collaboration

is developed proactively, however, Lithuania

can become a regional energy hub, linkingfirstly to Sweden and Poland (by 2012), and

linking Russia with Western Europe. This

offers a tremendous opportunity for the

future and would be the ultimate guarantee

of energy security for a very model invest-

ment over the next decade. Many European

companies should have a strong interest in

seeing this develop.

However, this can only happen if Lithuania

first develops a regional solution to

energy problems, and pursues solutions


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proactively, tackling the issues by the

necessary deadlines, and not waiting until a

crisis occurs.55

The nuclear option

The question of the future of nuclearpower in the Baltic States, whether ul-timately for or against, is clearly onearea where a regional, rather than apurely national, solution would bemost appropriate. Some form of newnuclear plant to replace the existingRBMK reactor at Ignalina now looks

increasingly likely and would enjoy amuch higher level of public support inthe Baltic States than might have beenthe case a decade ago.

Whilst there is no fundamentalcontradiction between environmentalconcern and energy security, the in-ternational trend of the last decadeaway from nuclear power, largely in-fluenced by concerns over environ-mental issues and financial costs, now

seems to be reversing, in part becauseof a widespread recognition of its im-portance in achieving a mixed energyportfolio and thus contributing tosecurity of supply.

The nuclear option is being increas-ingly canvassed inside the Baltic Statesas a partial answer to the regionsproblems over security of supply. Inassessing

Documents

Baltic Independence and Energy Politics