Why EU-Russia frictions look set to an end

Russia’s dwindling oil and gas earnings won’t greatly change Europe’s often fractious relationship with its great neighbour, says Christopher Weafer. But Russia is changing for a number of other reasons, making this a good time for the EU to improve its relations with the Kremlin
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When oil peaked on $147 a barrel in July 2008 Russia earned about $1.3bn a day from its energy exports. Now that has dropped to around $500m a day and Russia is in shock because its easy source of wealth seems in jeopardy. Could this be a catalyst for change, leading in particular to a review of its often difficult relationship with the European Union? The EU-Russia relationship has over the past decade alternated between periods of cooperation and episodes of confrontation. It would be fair to say that both sides have felt justified in their frustration. The EU had hoped for better access to Russia’s natural resources and its financial services markets, and had also wanted to see the development of a more open political system in which opposition parties played a significant role. Europe looked, too, for a greater alignment between Moscow and itself on many issues of international politics, and at the same time it voiced complaints about the inadequacy of the rule of law in Russia, its obstructive bureaucracies, corruption and too much state control.
MATTERS OF OPINION
Russians want foreign investment, but not ownershipMany Russians think inward foreign investment is helping rather than harming their country's economy, but there is widespread opposition to allowing foreign ownership of Russian companies: over twothirds – 68% – believed the government should prohibit this, supporting a law enacted by Vladimir Putin in 2008 that restricts foreign investment in 42 sectors, e.g. oil and gas, fishing and publishing. This view was held even among those who would like Russia to become a Western-style democracy: Of these, fewer than a quarter thought the Russian government should allow foreign firms to purchase Russian ones. http://www.gallupworldpoll.com/
Russians, including former president and now Prime Minister Vladimir Putin, pointed out for their part that EU investment in Russia is significantly greater than that which Russia has been allowed to make in the other direction. Moscow sees the investment issue from a diametrically opposite viewpoint to that of Brussels, pointing to EU entry barriers as an important reason for the current strains in the relationship. One way of smoothing this persistently tense relationship might be to accept that it should be limited to being no more than a commercial arrangement between Russia as a major commodity producer and the EU as a consumer. Such an arrangement works well, for example, in the otherwise fractious relationship between Venezuela and the United States. The security of energy supplies from Russia to the EU from the Soviet era to the present day has never been an issue other than as a consequence of Russia’s transit route rows with Ukraine. To accept that on the EU’s part would certainly reduce the level of frustration. But such a relationship would not be in either side’s best long-term interests. It would clearly be much better to forge a closer economic, cultural and political relationship than to base it on a somewhat frosty commercial one. Many commentators hope that the current economic recession and Russia’s much lower hydrocarbon revenues may force Moscow to adopt a more accommodating stance with the EU, and to lose some of the almost arrogant swagger that its critics observed when the oil price was rising to last year’s record peak. Some on the Russian side hope that the EU’s steadily growing need for imported energy will break down the trade and investment barriers that they in part blame for holding back the development of some of Russia’s strategic industries. The political row that ensued in 2007 after a Russian bank bought a 5% stake in EADS, the Airbus parent company, is cited regularly as an example. Russia is broadly following a long-term development plan, despite being frequently side-tracked by issues such as the dispute with Shell over its Sakhalin-2 project, and the slow progress that Russians themselves acknowledge in advancing reforms. Episodes such as Sakhalin are not the result of random management decisions; when Vladimir Putin was president he set out goals for the country that can only realistically be achieved over a period of at least 20 years. They include creating a more diversified economy with less dependence on commodities, greater wealth distribution, improved social infrastructure and greater political debate. But Putin also said that before making progress on reforms, and before spending money to create new industries, there were legacy issues from the Soviet period and the 1990s that needed to be fixed. He believed that the state was the best institution to control the evolution, because private enterprise had failed to do so in the 1990s. On a more pragmatic level, he has also regularly acknowledged that it is not possible to move too fast with reforms and other changes because Russia does not yet have the required management skills, either in the civil service or in the country’s big corporations. It is a problem that will require a generation change rather than just money. So for the eight years of Putin’s presidency, the Kremlin’s priorities included restoring the power of government, rebuilding the country’s international standing and restructuring Russia’s so-called strategic industries. During this time the government was not too interested in pushing ahead with new energy deals or major reforms. In any case, the Kremlin had not decided on, or published, the “rules for investing” in strategic sectors such as energy. As to reforms, they were seen as liable to absorb a lot of senior government time that was simply unavailable. The end of the Putin presidency brought an end to what can be described as the “preparation” phase of the long-term plan. The start of Dmitry Medvedev’s presidency marks the start of a secondary phase of targeting reforms, of investment spending and of brokering energy deals with neighboring countries. Putin chose Medvedev as his successor, and on important issues they share a common view. But Medvedev’s first year in office has been less than auspicious, and little progress has been made with his programme. Instead, we have had corporate problems with steel producer Mechel and fertilizer producer Uralkali both coming under attack. Then there was the conflict with Georgia and another dispute with Ukraine over gas. Now the main priority for the Russian government is to preserve domestic economic and social stability while riding out the global storm. To that extent, the 20-year plan has been extended by a year or two. But it remains in place and the crisis should provide a spur. Previous periods of oil weakness and economic decline have produced significant directional changes in Russia. Decline in the late 1980s was a major contributory factor to the demise of the Soviet Union, while the crisis of the late 1990s ended the transition phase between the Soviet era and modern Russia. The silver lining in this particular cloud may well be that it gets the Medvedev programme moving; it will be nothing dramatic, but for all that a positive driver. The energy frustrations that have sometimes bedeviled Russia’s relationship with the EU should now be coming to an end. In signing into law the strategic industries legislation in May last year, Russia finally established its new investment rules. Realistically, the Kremlin was never likely to allow any major new projects involving strategic industries to be created until these rules were in place. Now, Russia will be in a hurry to move ahead with such major projects as developing the Yamal gas province; a project that will eventually produce up to 250bn cubic metres (bcm) of gas annually. That is equal to almost half of the country’s present output. Russia needs that project to replace the expected decline from maturing fields, and the EU needs it to provide a significant amount of the expected 200 bcm increase in its gas imports over the coming 20 years. But with an estimated cost of $200bn to develop the project over the coming 20 years, it is clear that Russia cannot do this alone. Russia’s problems and priorities are very deeply rooted, so real progress will take time. But any assumptions that having less daily cash flow as a result of the oil price plunge will change Russia into a more compliant and accommodating neighbour are simply unrealistic. For all that, now is the time for the EU to widen its interaction with Russia because for both sides patience will pay off in the end.