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The Business Online: Putin’s assault on BP shows why the UK must embrace nuclear energy

PERHAPS the greatest paradox in political economy is how countries endowed with the most bountiful natural resources almost invariably end up with deeply unsavoury regimes and the worst economic policies.

In many cases, especially in Africa and the Middle East, this “resources curse” means that commodity-rich countries are also among the poorest, with many of their citizens living in unnecessary squalor; in other cases, they may appear to be doing relatively well but are, in fact, failing to fulfil their true potential, preferring instead to channel their new-found wealth into an aggressive foreign policy.

Russia under the increasingly authoritarian regime of President Vladimir Putin is a perfect case study of the latter. It has successfully ridden the oil and gas boom to enrich itself and improve the living standards of its citizens; but its windfall of billions has allowed it to neglect the tedious process of buttressing fragile capitalist institutions or keeping to the rule of law, while encouraging it to behave like a born-again Cold Warrior and bully abroad.

One former senior Russian official recently told this magazine it would have been far better for Russia had the price of oil and gas remained at rock bottom; this would have forced it to follow China and India, protect property rights and create an environment where business could thrive, creating jobs and prosperity for its people.

All of this is only too obvious with Moscow’s latest attempts this week to nationalise a $20bn gas field controlled by TNK-BP, the British energy company’s Russian joint venture. The field holds close to two trillion cubic metres of gas, vast amounts of gas condensate and could supply the world’s entire consumption for a year. Coming so soon after Royal Dutch Shell being forced to sell most of its shares in the $21.4bn Sakhalin-2 oil and gas project to Gazprom, the Kremlin-controlled energy giant, it will further harm Russia’s reputation.

But that matters not a jot to the apparatchiks in Moscow. After all, who cares what foreigners think when one is sitting on 12% of the world’s oil supplies (second only to Saudi Arabia) and 27% of the world’s proven gas reserves (more than any other country) as well as a huge pile of foreign exchange reserves? Like all countries in the grip of the resources curse, Russia doesn’t need to try too hard; that is its real problem.

Thanks to the surging price of energy, it is doing well enough to keep its coffers full and population content, despite failing to develop competitive services and manufacturing industries; and even though its performance is falling well short of Chinese or Indian levels of growth. The Russian economy powered ahead by 6.8% last year, while real incomes jumped around 12%, taking the average monthly wage to $450, which may not sound like much but is a rise of 300% under Mr Putin.

Inflation is now in single digits and foreign exchange reserves have surged, which means that there is no possibility of a run on the rouble or a default on foreign payments. According to the International Monetary Fund, every $1 per barrel increase in Urals blend oil prices for a year is estimated to raise federal budget revenues by 0.35% of GDP, or $3.4bn, a vast windfall. The value of Russia’s oil stabilisation fund, which is made up of proceeds from oil and gas exports, will hit $137bn by the end of the year; its futures generation fund holds $32bn.

This means it has plenty of money to squander on a new arms race. Sergei Ivanov, recently promoted from defence chief to deputy prime minister, says by the end of this year the Russian defence budget will stand at 832bn rubles ($31.6bn) after having quadrupled since oil prices took off in 2002. His projections are that, by 2017, this will reach five trillion rubles, with half the money devoted to intercontinental ballistic missiles and air defence systems. A complacent West may not want to accept it, but Russian spending on nuclear missiles is growing at the fastest level since the end of the Cold War.

For many non-energy Western companies, especially Wall Street and City banks, Russia’s move away from liberal democracy towards authoritarian corporatism doesn’t really matter; they see a fast-growing market to be exploited. Remarkably, despite the nationalisation of Yukos, Shell’s assets and soon BP’s gas field, foreign direct investment into Russia is rising, despite all the political risks. Western businesses are equally unworried by the fact that Mr Putin’s successor next year is likely to be Sergei Ivanov, who, if anything, is less liberal even than Mr Putin.

For years, such insouciance was also BP’s position: the company seemed to think that thanks to the diplomatic talents of its former chief executive John Browne, it would be able to protect its vast Russian interests. The country is BP’s single biggest source of oil; its share of TNK-BP’s output is 60% higher than its total US production; the bulk of its booked replacements for its oil and gas reserves came from Russia last year, as do a third of its unbooked reserves. Now all of this is under threat.

BP has been doing all it could to stay on side with the Kremlin, often even going too far for comfort. Especially seedy was the way in which TNK-BP lost out to Russia’s state-controlled Rosneft in the recent auction for what was left of Yukos’ assets. TNK-BP put in a below-market price bid and then withdrew after 10 minutes. TNK-BP’s participation undoubtedly helped legitimise what was in fact little more than expropriation of Yukos’s shareholders. It still was not enough for Mr Putin.

BP has been doing all it could to stay on side with the Kremlin, often even going too far for comfort. Especially seedy was the way in which TNK-BP lost out to Russia’s state-controlled Rosneft in the recent auction for what was left of Yukos’ assets. TNK-BP put in a below-market price bid and then withdrew after 10 minutes. TNK-BP’s participation undoubtedly helped legitimise what was in fact little more than expropriation of Yukos’s shareholders. It still was not enough for Mr Putin.

Earlier this week, TNK-BP, a 50:50 joint venture with a Russian consortium, Alfa Group, lost its appeal to prevent the Russian authorities seizing its operating licence at the giant Kovykta gas field in eastern Siberia. While it will now appeal to a different court, the writing is clearly on the wall for BP. Gazprom, a state-controlled energy giant, wants to grab close to 75% in Rusia Petroleum, which operates the licence for the Kovytka field; given that TNK-BP currently has a 62.7% stake in Rusia, there was always clearly going to be a problem.

Officially, the reason why the authorities want to withdraw the Kovykta licence from TNK-BP is that the production volumes have failed to meet their target of 9bn cubic metres a year; but, as ever in Mr Putin’s increasingly Kafkaesque Russia, there is more to this than meets the eye. For TNK-BP to be able to meet these targets, it was always planned that it would use Kovykta for gas exports to China. The trouble is that Gazprom is also the country’s gas export monopoly and it is refusing to co-operate; the result is that the authorities can now crack down on TNK-BP and hand the gas fields to Gazprom, the very people responsible for its failure in the first place.

So when the Irkutsk arbitration court this week ruled that RosPrirodNadzor and Rosnedr, the two Russian environmental agencies, can continue the process of stripping TNK-BP’s licence, nobody should have been surprised, certainly not Tony Hayward, BP’s new boss. Gazprom always gets what it wants; it is now just a question of time before BP will sell most of its shares in the project and the “environmental” problems will suddenly go away. Already, TNK-BP has announced that it is willing to let Gazprom control Kovytka if the field becomes part of a bigger development in East Siberia; it is unlikely to have any real choice in the matter.

Mr Putin’s goal is straightforward: he wants the state to gain direct control of the commanding heights of the Russian economy, which primarily means its energy industries; and he wants to use the rest of the world’s growing dependence on Russian energy exports as a tool to exercise influence. It is not only BP and any other Western company trying to operate in areas deemed to be of strategic significance that should watch their backs: Britain and the rest of Europe must urgently review their foreign and energy policies in the light of Russia’s increased belligerence.

Time is running out. Russia already supplies around a quarter of European gas imports, including 39% of Germany’s imports, numbers that are set to grow further in coming years; and it is extending its reach in other ways. Gazprom has drawn up ambitious plans to grab up to 10% of the British gas market by 2010, focusing on business and industrial users. It claims to have decided to stay clear of the consumer market but already supplies more than 2,000 businesses. The company’s British-based subsidiary, Gazprom Marketing and Trading, which trades oil, gas and carbon emissions throughout Europe, had revenues of £1.5bn last year, up from £594m the previous year and £324m three years ago.

If the Russians can threaten to switch off energy supplies to countries such as Ukraine and Georgia, as they have, they would have no qualms about putting pressure on Western European countries, too. Ultimately, Gazprom’s real purpose is not to make money and compete in the free market; it is to boost the power of the Russian state. It should not therefore be treated like any other capitalist business.

So it makes sense for Britain to move wholeheartedly into nuclear power and to pursue a vigorous policy of energy independence. There are many disadvantages in doing so, not least that nuclear is unlikely ever to make commercial sense once clean-up costs and insurance are taken into account, which means that the state will be given an uncomfortably large role in the provision of energy for years to come. But because countries such as Russia have decided to use energy as a branch of foreign policy, Britain must follow.

The Blair-Brown government’s energy White Paper, while deeply flawed in other respects, was right to push for nuclear. It is imperative for Britain, whose North Sea oil and gas reserves are dwindling fast, to make sure that it doesn’t have to depend on an erratic, expansionist and deeply troublesome Russia for its energy supplies; the only realistic alternative is a wholesale embrace of nuclear generation. If Gordon Brown is looking for a realpolitik, pro-business policy to kick off his premiership in four weeks’ time, that should be it.

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