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Exclusive: Putin's House Of Cards Coming Down

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  • Exclusive: Putin's House Of Cards Coming Down

    EXCLUSIVE: PUTIN'S HOUSE OF CARDS COMING DOWN
    Alex Alexiev

    FAMILY SECURITY MATTERS
    January 10, 2009

    To little notice in America, a drama is being played out in Eastern
    Europe that future historians may mark as the beginning of the end
    of Russia's neo-imperialist ambitions under Vladimir Putin, as the
    economic house of cards he built collapses and the tyrant himself
    heads for the dustbin of history. Turning off the natural gas spigot
    in the middle of a harsh winter to much of Eastern Europe that is
    completely dependent on it - and has few alternative sources to heat
    its schools and hospitals - is the kind of overreach that imperial
    hubris often drive dictators past the tipping point and ultimately
    to their downfall.

    Few believe that to be the case today and indeed most enlightened
    opinion in Europe seems to be playing to Putin's tune. Thus, the
    ever-eager-to-appease-Russian-misdeeds Western European elites
    have fallen in line behind the Kremlin mantra that the conflict
    with Ukraine is a purely commercial affair unworthy of European
    involvement. Meanwhile, Moscow's army of European lobbyists, led by
    paid Gazprom lapdog and former German chancellor Gerhard Schroeder,
    sing the praises of ever greater European dependence on Russian energy.

    Yet, Europe's cowardice notwithstanding, it is difficult for anybody
    with even a basic knowledge of the facts not to see that this time
    Putin has miscalculated badly and is playing a losing hand from an
    increasingly untenable position. None of this is to say that Ukraine
    is totally without fault in the conflict or that we should disregard
    some disturbing evidence of corruption in high places in Kiev with
    respect to the gas business.

    Still, Putin's gamble has little to do with business and everything to
    do with a desperate attempt to get some political mileage and perhaps
    temporarily arrest Russia's accelerating economic and political
    slide. But by doing that with his favorite strong-arms methods of
    economic and political blackmail, he has guaranteed that this time
    his policies will backfire dramatically.

    There are several facts seldom discussed in the Western media that
    need to be considered before one can truly understand the nature of
    the conflict.

    First, to dispense with the argument that this is a purely commercial
    dispute, it is worth pointing out that Russia has a sliding scale of
    prices it charges for its gas to ex-Soviet republics depending on
    the degree of their political sycophancy to the Kremlin. Obedient
    clients, like Armenia and Belarus, are charged $110-$120 per 1,000
    cubic meters, more independent countries like Georgia and Moldova pay
    $270-$280, while current bête noir Ukraine is asked to pay a punitive
    $500. This despite the fact that Russian natural gas - the price of
    which is pegged to oil with a six-month lag - will soon be worth less
    than half that even in the expensive Western European market. There
    is nothing commercial about these extortionate Russian demands that
    were first announced just two days before 2009 and a week before the
    gas was turned off.

    Secondly, Moscow's claims that the gas stoppage aims only to punish
    Kiev for its ostensible misdeeds are completely bogus. Ukraine has
    by far the largest gas storage facilities in Eastern Europe going
    back to Soviet times when it was the center of the gas industry
    and can easily survive the cutoff for the entire winter season by
    using its stored reserves. The real victims are the half a dozen
    Eastern European countries that have neither alternative supplies
    nor large storage facilities and are already in the midst of a dire
    socio-economic emergency. The Kremlin, of course, knew that very well
    and the fact that it consciously and callously caused such hardship
    will not soon be forgotten.

    Third, the conventional pundit wisdom that the Kremlin as the supplier
    is in the driving seat in the conflict looks less wise when the
    reality on the ground is considered. The fact is that Russia is almost
    certainly more vulnerable than Ukraine to any prolonged stoppage of the
    gas flows. Ukrainian pipelines carry 80% of Gazprom's exports to the
    West and the lion's share of its export earnings. Even a few months
    without these cash flows are likely to bring the already teetering
    Russian "national champion" to its knees. Therefore, the conflict will
    be settled quickly and it's not going to be exactly on Russia's terms.

    Given that Putin was certainly aware of these problems, it is
    interesting to speculate why he engaged in such a crass power play
    anyway. While it is difficult to put oneself in the mind of a bully,
    some have speculated that the Kremlin hoped that the artificial gas
    crisis and the accompanying market instability would cause a spike
    in oil prices and reverse the downtrend that's wreaking havoc with
    Russian revenues. Others have claimed - and indeed, both Putin and
    Schroeder have been beating the pavement on that in the past few days
    - that the crisis was engineered by the Kremlin to convince Western
    Europeans to line up behind two more Gazprom-planned gas pipelines
    (Nord Stream and South Stream) that bypass Ukraine, Poland and the
    Baltics. Whatever the motivation, there is little evidence that any
    of these purported outcomes are more likely now than before.

    Perhaps Putin's desperation could be better understood by sketching out
    to what extent Russia and its oil and gas industry are in the middle
    of the economic equivalent of a death spiral, with potentially dire
    political consequences for the Kremlin. It was only six months ago
    that Gazprom, at that time the third largest company in the world with
    $350 billion capitalization, confidently forecast that it will become
    the largest in the world with $1 trillion valuation by 2015. Many a
    Western banker also nodded in agreement to Gazprom's other prediction
    of $250/barrel price of oil in 2009.

    As Putin managed to build monetary reserves of $600 billion -
    the third largest in the world - Russia did look invincible for a
    time. He also bribed the Russian people into political acquiescence
    by jacking up salaries and pensions 200% since 2000, even though GDP
    and productivity had gone up barely a third of that.

    Alas, it was but a house of cards. With no industrial production worth
    mentioning, its infrastructure badly dilapidated, virtually all of its
    food imported and mortality rates only found in sub-Saharan Africa,
    Russia under Putin had become a classic banana republic with oil and
    gas. It lived or died depending on the price of bananas over which
    it had no control.

    It had also instituted an economic model based on a complete
    symbiosis between personalized political power and corporate
    interests, which is the true mark of a fascist state, according
    to Mussolini. With Putin and his puppets directly controlling all
    key businesses and using mafia-like methods to eliminate potential
    opponents and foreign interests it seemed to work for a time. But
    it was rotten inside. Unable to build value with equity capital, the
    Kremlin's favorite state champions and corrupt tycoons depended not
    only on high commodity prices but also on ever larger injections of
    foreign loans even as the rights of foreign partners were brutally
    limited. It was an irrational economic model bound to fail and it
    did as oil prices collapsed.

    Today, Gazprom, run from top to bottom by Putin's cronies, with a
    market capitalization of $85 billion (or barely a quarter of what
    it was) and a debt burden of over $60 billion, is already in serious
    trouble. Putin and his coterie have made a significant contribution
    to its woes. According to a well-documented book by former Russian
    prime-minister Boris Nemtsov and top energy expert Vladimir Milov
    titled Putin and Gazprom, the Putin mafia pilfered assets worth $80
    billion from the company during the 2004-2008 period.

    It will get much worse. As gas prices and the company's revenues
    plummet in the next few months, it is quite conceivable that Putin's
    prize possession would shortly owe more than it's worth and become
    technically bankrupt. It is already begging the Kremlin for $5 billion
    in emergency handouts and paying 500 basis points over Libor for
    bridge loans to avoid default on loans coming due.

    Its longer term prospects look no brighter. With current production in
    decline and most of the new fields to be developed in the forbidding
    and extremely expensive Arctic region, Gazprom needs a minimum
    investment of $20 billion per year over the next 10 years to stave
    off production collapse. With its credit-worthiness in tatters and
    foreign capital now avoiding Russia like the plague, it is unlikely
    to have an easy time finding it.

    Nor is the oil sector in better shape. Over the past eight years,
    Russian state coffers were filled by exorbitant export and extraction
    taxes levied on oil producers that together amounted to more than $50
    per barrel. At current market prices below $50, the oil companies
    lose money on exports and are shutting down wells. With most major
    oil fields well past their peak and many nearly depleted, the oil
    industry needs new investment as badly as Gazprom, but is even less
    likely to get it. Western oil companies and banks that were once
    eager to pay any price to get into Russian oil are now wondering
    how to cut their losses. In just one example, Conoco/Phillips's 20%
    stake in oil major Lukoil worth $1.3 billion only four months ago is
    now worth less than half that and falling further.

    All of this is, of course, very bad news for the oil and gas sector
    but it is an unmitigated disaster for a government whose very economic
    model is doomed if that sector does not perform. According to finance
    minister Kudrin, Russia needs an oil price of $95 per barrel to avoid
    an economic downturn and is facing huge budget deficits if it falls
    below $70. We're now well past these points on the way down and the
    inevitable bursting of Putin's make-believe economics bubble is taking
    place in front of our eyes.

    Russia's monetary reserves are now nearly half gone as a result
    of Putin's wrong-headed policies of propping up with state funds
    dysfunctional Soviet-style enterprises and corrupt oligarchs, while
    bleeding billions on a weekly basis in a futile effort to avoid
    a massive ruble devaluation. Worse for the Kremlin, the inevitable
    political backlash to Russia's economic meltdown that can no longer be
    concealed will not be long in coming. With Russian savings currently
    being wiped out by creeping devaluation, unemployment spreading
    rapidly and food inflation approaching 30% outside of Moscow it is
    only a question of time before people take to the streets. And this
    time it would be difficult for Putin's media to convince people that
    it is all America's fault.

    Finally, to go back to Putin's arm-twisting in Ukraine, it is virtually
    certain that when all is said and done, Eastern Europe and, hopefully,
    parts of Western Europe as well, would decide that continued energy
    dependence on Russia is very bad for one's economic health and engage
    in a crash course of developing alternative sources. It is likely
    to involve a new emphasis on nuclear energy with several reactors
    already in the planning stages, clean coal power stations as well as
    coal gasification and liquefaction and liquid natural gas terminals
    among others.

    Hopefully, the new focus will involve renewed efforts to build the
    Nabucco gas pipeline that bypasses Russian territory, as well as
    stopping the construction of the new Gazprom pipelines.

    The United States should wholeheartedly support these policies and
    while at it think of dealing with its own energy dependence.

    FamilySecurityMatters.org Contributing Editor Alex Alexiev is a
    contributing editor to familysecuritymatters.org and vice-president
    for research at the Center for Security Policy in Wash. D.C. He is
    the author of a forthcoming book on shariah finance titled Jihad on
    Wall Street: Shariah Finance in the War Against America.

    --Boundary_(ID_NeGEQ6pMAAxRt0QUMYlR9A)--
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