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Global Market Brief: Russia's Tattered Ties to the EU

12 MINS READNov 15, 2007 | 18:34 GMT
It has been one year since Poland's veto stalled partnership agreement negotiations between Russia and the European Union, and overall relations between Europe and Moscow seem to be deteriorating. There was much talk of a breakthrough at the Russia-EU summit held in Mafra, Portugal, at the end of October; Poland had just elected a more moderate government that claimed to be open to negotiating with Russia over its veto, which was said to be a response to Moscow's refusal to import Polish meat. But regardless of who is in charge in Warsaw, Poland's interests are locked against Russia's. Furthermore, Poland's veto is now supported by quite a few other EU members that have sizeable disputes with Russia. Russia is the EU's third-largest trading partner, after the United States and China. Trade between the EU and Russia has doubled in the past four years, reaching $230 billion annually. Of that, around $125 billion comes from energy, since Russia supplies almost a quarter of the EU's energy. The EU also makes up about 75 percent of foreign direct investment into Russia's economy. In short, the EU-Russian relationship is essential to both sides. But using trade and economic relations as political levers or as a means of reasserting power is all the rage for Moscow, and it has alienated more than one EU member. This has created complications for the EU, because officially all member states must act together to make EU foreign policy. The single-member veto policy is what allowed Poland to create the current EU-Russian stalemate. Previous European foreign policy disputes like this were over either future concerns such as military policy, or minor matters like Balkan-related issues. But Russia's reassertion of its strength and some EU members' knee-jerk reactions to it are now playing out economically, with the union's trade relationship with Russia at stake.

The Polish Meat Dispute

Russia began implementing trade barriers against Polish agricultural products in 2005 under the guise of product safety. The embargo has cost Poland dearly; approximately 8 percent of all Poland's agricultural exports — about $506 million a year — were products going to Russia. Poland threatened to push the issue into the EU arena, a threat Russia dismissed until November 2006, when Warsaw made good on its promise. But the Warsaw-Moscow dispute isn't just about meat. The dispute is part of Poland's struggle to assert itself as a full member of the West against an increasingly aggressive and assertive Russia. Warsaw has now placed itself as the roadblock between Europe and Russia, showing that it does have its own voice and ability to push back.

The Lithuanian Oil Dispute

Another country ready to block the EU's relationship with Russia is Lithuania. A major trunk of the Druzhba oil pipeline running from Russia to Lithuania ruptured in July 2006, cutting off 324,000 barrels per day. Lithuania receives 90 percent of its oil from the Druzhba, which also supplied the Baltic state's Mazeikiu Nafta refinery. The line and refinery also supplied oil to Lithuania's neighbors Poland, Latvia and Estonia. The rupture should have taken no longer than a few days to fix, but Russian pipeline company Transneft has said the repairs have been put off "indefinitely." The Druzhba's "accidental rupture" came most conveniently during Russia's attempt to take over the Mazeikiu Nafta refinery, which Lithuania was looking to sell to anyone but Russia. Vilnius is still feeling the ramifications of the economic dispute that turned political and has been paying to have its oil expensively shipped from Russia.

Disputes With Finland, Sweden and Germany

Russia's economic disputes are not just with EU members that used to be behind the Iron Curtain. Russia is also economically bullying Finland, Sweden and Germany — a move that could lead the EU to a more unified stance on Russia. Russia sees Finnish and Swedish paper and pulp processing industries as the largest rivals to its own aspirations to expand its timber industry domestically. Russia is the world's largest exporter of cut logs and supplies 80 percent of Finland's timber imports, chiefly for the Finnish-Swedish timber behemoth Stora Enso. But in July, Russia announced it was raising the tariff on timber exports from $7 to $15 per cubic meter, followed by a jump to $75 planned to take effect before 2009. The extra costs have already caused a 20 percent drop in timber exports from Russia to Finland in 2007. Members of the Finnish government have said Russia's move will force Finnish paper companies to either fall to ruin or move to Russia to avoid the tariff. The large Finnish timber industry is already seeing the tariff's effects, as Stora Enso is talking about closing many of its plants in Finland and Sweden. Meanwhile, Germany's Lufthansa — the second-largest airline in Europe — is deadlocked with the Kremlin over Russia's demands to move Lufthansa's air-freight hub en route to Southeast Asia from Kazakhstan to Russia. After Lufthansa declined, Moscow banned the airline's cargo flights from Russian airspace Oct. 28, forcing Lufthansa's planes to make costly detours on their way to Asia. It seemed the dispute would escalate quickly when Germany briefly banned Russian airline Aeroflot's cargo flights from the Frankfurt airport — a move the Kremlin called "blackmail." But the German Transport Ministry made the surprise decision to agree to Russia's proposal for Lufthansa. Russia has given Lufthansa until February 2008 to agree to the German and Russian governments' decision. Lufthansa, which had planned to take the issue to the EU, was bewildered by the German government's last-minute deal, but this is one dispute that German Chancellor Angela Merkel does not want to see escalate outside her control. When the EU's heavyweight, Germany, gets into a row with Russia, relations between Russia and the whole EU — not to mention the whole West — can deteriorate very quickly and nastily. Merkel is not looking for another large dispute between Europe and Russia, especially not over a small issue like airspace.

Consequences

Merkel knows that Europe and Russia are tied together by energy and trade and that regardless of what she and most Europeans think about the Russians, threatening Moscow rarely produces favorable results. Merkel cannot force the other EU members to share her hesitation to counter Moscow — and it only takes one EU member to break economic relations with Russia. Yet Moscow's continued use of trade and economic relations as political levers is only entrenching many EU members against the bloc's giant neighbor. The EU has already said that the Polish and Finnish crises with Russia violate Moscow's 2004 deal with the EU in which Russia agreed, in exchange for the EU's support for Russia's bid for World Trade Organization (WTO) membership, not to change trade prices or place embargoes on trade. Moscow's WTO membership bid has long been in jeopardy, and while WTO membership would benefit its economy, Russia will not budge on anything that infringes upon its politics. The Kremlin's continued use of politics in choosing its economic relations will come back to bite it. Politically motivated trade, energy projects or embargos tend to not be economically competitive. For example, the politically motivated Nord Stream pipeline project to connect Russia to Germany without passing through "problematic" states like Poland or the Baltics is an excessively expensive project that realistically does not have the financial or political support it needs. Russia's economic blackmail has left many EU states turning to alternatives in energy and trade to avoid the messy ties to Moscow. IRAN: A National Iranian Oil Company official said Nov. 14 that the firm cut its official prices for selling crude oil to Asia for December. It set the December official selling price (OSP) for Iranian heavy crude at a discount of $1.49 a barrel below the average of Oman-Dubai quotes. The December OSP for Iranian light was cut by $1 to a premium of $1.70 a barrel to Oman-Dubai, while Forozan blend was discounted $1.40 a barrel. The company raised all prices for Europe, a move related to the tensions over the nuclear issue. The price decrease for the Asian states comes a day after the Chinese foreign minister held talks with Iranian officials in Tehran. FRANCE: France's national rail system shut down Nov. 13 as workers launched an indefinite strike to combat French President Nicolas Sarkozy's labor reform measures. Specifically, Sarkozy is targeting the union members' right to retire with full benefits after only 37.5 years of work, versus the standard 40 years for other workers. Later, several other state unions — including electricity workers — joined the strike. France's transport and electricity unions are among the country's most powerful, as they can not only shut down their respective industries, but also remove France from the world's economic map altogether. Future strikes are planned in the aforementioned sectors as well as among police officers, judicial system employees, civil servants and fishermen. The most severe French strikes in more than a decade are now under way. When they end, either the unions or the president will be broken. ECUADOR: Ecuadorian President Rafael Correa said Nov. 10 that he will consider revoking concessions on mining properties not currently being exploited. Though Ecuador is in a mineral-rich zone, its mining industry fails to produce significant output, partly because mining firms buy concessions and hold them in order to sell them at a profit in the future. Correa said that five or six firms are producing, and his government will negotiate current terms with them but will revoke the concessions of non-producing firms. He did not name the companies. Currently, mining firms do not have contracts with the government and do not pay royalties. Earlier in November, Ecuador announced that mining firms may need to enter contracts similar to those of oil firms operating in the South American country. The contracts would establish royalties at a referential price for each type of mineral mined, but if market prices exceed the established price, mining firms would have to pay a large portion of their windfall revenues back to the government. For oil firms, Ecuadorian President Rafael Correa recently raised the windfall tax from 50 percent to 99 percent. Officials said, in the case of mining, royalties would be determined on a "case-by-case" basis. CHINA/RUSSIA: Interfax reported Nov. 7 that Gazprom wants to be listed on the Shanghai stock exchange. The Kremlin is using Gazprom as a propaganda machine in this case, as Gazprom's Shanghai ambitions are more for political than economic reasons. Any such listing in the foreseeable future is nearly impossible. Other non-Russian companies have voiced a desire to list in Shanghai before but have been rejected, as China's stock market reforms are not yet complete. Reforms will continue for at least another year and will not be considered complete until smaller mid-sized Chinese firms that still lack the political connections needed to list are able to raise capital on Chinese stock exchanges. The report of Gazprom's desire to list in China coincides with a Kremlin drive to ramp up Russian business activities inside China; at a Nov. 7 Russo-Chinese economic forum, Russian Deputy Prime Minister Alexander Zhukov called for Russian businesses to step up their presence inside China. NIGERIA: A pipeline leading to the Royal Dutch/Shell-operated Forcados terminal in Nigeria's Delta state was blown up Nov. 15, causing production to decrease by at least 20,000 barrels per day. No one has claimed responsibility for the explosion, but it took place within the territory of Government Tompolo, a militant leader of the Delta state faction of the Movement for the Emancipation of the Niger Delta (MEND) militant group. The blast occurred three days after gunmen on eight boats attacked the ExxonMobil-operated Qua Iboe Terminal in the Niger Delta state of Akwa Ibom. The gunmen, believed to have been led by Niger Delta Strike Force militant group head Prince Farah Ipalibo, retreated without impacting production or oil personnel when reinforcements from Nigeria's Joint Task Force arrived. The Nigerian government continues to call for peace talks with Niger Delta activists and politicians. Abuja has relied on one MEND leader in particular, Mujahid Asari-Dokubo, to rein in militant groups in the Niger Delta. Asari, however, has had a public falling out with another MEND leader and spokesman, Henry Okah (aka Jomo Gbomo), who was arrested Sept. 22 in Angola. Militants seeking prominence and control over local fiefdoms are believed to be motivating the ongoing attacks. BANGLADESH: Cyclone Sidr, a Category 4 storm with winds of 155 miles per hour, hit Bangladesh. Though Bangladesh is accustomed to extensive flooding, this storm is expected to result in large-scale devastation. The country's main port, Chittagong, which handles more than 80 percent of import-export cargo, lies east of the storm's path and should be able to avoid the brunt of the storm. Textiles are Bangladesh's economic lifeline, making up three quarters of the country's more than $12 billion in annual export earnings. The destruction caused by this storm is bound to result in major disruptions to the country's supply chain operations.

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