Russian oil motives in Ukraine By STEVE AUSTIN for OIL-PRICE.NET, 2014/04/07

The recent Russian takeover of Crimea has grabbed the world's attention. The Russian government has long held a secret desire to recover the peripheral territories that were split away from the Soviet Union at the collapse of Communism. After decades of independence, Ukraine, Belorussia, Lithuania, Latvia and Estonia still rely on fuel supplies from Russia. There has been little attempt to realign infrastructure to source supplies from other countries. Russia regards these countries as its own, and it wants them back. Does the seizure of Crimea represent a single step in the road to Russia's territorial re-assembly? Do oil and gas play a part in Putin's strategy?

Putin's Strategy

Prevented by international agreements and a weak economy from simply invading Russia's former territories, Putin began a long-term strategy of using oil and gas to create a dependence among the former republics of the Soviet Union and beyond to the USSR's previous fiefdom in Eastern Europe. The main routes of Russia's gas pipelines, which now also supply Western Europe, all cross the territory of Ukraine. Putin needs to control that country as tightly as though it were part of Russia. He needed an ally in charge of Ukraine, and he got that in 2010 when Victor Yanukovych won free and fair presidential elections.

The friendly Yanukovych quickly gave Russia the extension it needed on its lease of the Black Sea naval base at Sevastopol. All pro-Western moves of the previous administration were quickly reversed. Yanukovych's final gift to Putin was the rejection of an EU trade deal in favour of taking Ukraine into the Russian-led Commonwealth of Independent States. It was that act of subjugation to a former Imperial master that set the mob in Kiev ablaze with fury and Yanukovych was ousted.

Timing

Kremlin insiders relate that the Russian government had an invasion plan for Crimea since 2008. At that point, Ukraine's leader, Yulia Tymoshenko was busily unravelling Putin's stranglehold on gas supplies to her county. The Ukrainian Prime Minister was a former gas industry impresario and busied herself finding alternative suppliers for her country. Her failure to win the 2010 presidential election put those invasion plans on hold. So why did everything suddenly go wrong for Yanukovych to the point where his Russian allies felt they had no choice but to rescue Crimea from Ukrainian Nazi revolutionaries?

The Russians knew very well that the EU trade deal had the support of the majority of the Ukranian public and the Ukranian parliament. Fortunately, the President of Ukraine has sweeping powers that enable him to overrule the parliament. Putin used his newly restored Ace card of gas supply prices to force Yanukovych to switch from the EU deal to the CIS's offer. When the inevitable riots occurred, the only support the Russians gave to the legally elected, but deeply despised President was to offer him a refuge from his own people. Putin had one last requirement from his captive counterpart. As head of state, Yanukovych was empowered to appeal to Russia for military support. That assistance came, although the tanks rolled into Crimea instead of Kiev.

Motive

The Russian government seems to have forced the President of Ukraine, their strongest ally, into an unsustainable policy. They then abandoned him and lured him into captivity disguised as asylum. But why? Yanukovych had bent over backward to do the Kremlin's bidding at the risk of his own personal safety. How could Putin have expected more?

Yanukovych failed in one important task and undermined Putin's strategy. The Russian president expects to control Europe through energy dependence and that stranglehold was in peril. In September 2013 an international consortium lead by ExxonMobil and Shell won the right to explore for offshore oil in the Black Sea. The oil and gas that lies beneath the sea 100 miles off the southern coast of Ukraine would be a welcome lifeline to the economically embattled Ukraine. Russia's Lukoil lost the bid and that was a grave failure on the part of Yanukovych.

Yanukovych played for time. He delayed ratifying the contract for as long as possible, soon an angry violent protest began on the square in front of his palace. He ran out of time and was airlifted away.

End Game

If Russia intended to intervene in Ukraine politics it should have struck at the capitol, Kiev. However, Russia already had its Western and Southern military divisions amassed at its border with Crimea, which lies at the southern tip of the country and far from the government's seat. Crimea has a majority Russian speaking population, representing 58% of the population and it is also home to Russia Black Sea naval port. The rebel pro-Western government rescinded Russia's lease on the port of Sevastopol as one of its first acts.

Once the legally elected president was ousted, Putin assumed the duty to protect the Russian majority in Crimea. Following a rushed referendum, which the Russian military conveniently prevented international observers from attending, Crimean parliament quickly appropriated all the offshore oil and gas rights off its Black Sea coast. ExxonMobil's contract with the Ukrainian government was null and void. Vladimir Konstantinov, the speaker of Crimea's parliament, instantly came up with a solution to the need to develop the Black Sea oil and gas resources: "Russia, and Gazprom, should take care of the oil and gas production. It's not our issue," he reasoned.

This lucky turn of events must have delighted Vladimir Putin. Russia doesn't need Crimea's oil and gas reserves; it just needs Ukraine not to have it. It needs to keep Ukraine under the thumb and beholden to Russia for its fuel supplies. Keeping Ukraine on Russian life support will ensure the safety of Russia's gas pipelines that cross the country way to the north of Crimea.

The invasion of Crimea didn't give Putin control of his pipelines. It didn't give him any valuable resources -- the offshore oil and gas fields have not even yet been explored and may never be drilled. However, Putin gained free access to his port at Sevastopol on the southern tip of Crimea and it slapped Ukraine down and kept that country subjugated while still nominally independent. Vladimir Konstantinov's snap decision has another happy consequence for Vladimir Putin: he is said to have a considerable slice of his personal fortune invested in Gazprom.

Oil Prices

Putin's policy of championing his country's energy sector has left the country with few other productive industries. The Russian government relies on oil and gas revenue to fill its treasury. Analysts including ourselves believe that the Russian government will have to make cuts either to its military budget or to its social services if the Brent crude index falls below $110 per barrel. The lower the fall in oil prices, the deeper the cuts will need to be in the Russian government's budget.

This year does not portent well for the price of Brent crude. Iran and Iraq are already bringing their production back online and Libya will be back in the market in full force later this year. OPEC predicted rising demand to justify its failure to cut its output. However, with the BRICs in or on the threshold of recession that forecast seems to be flawed. Brent crude could possibly fall this year and Putin would be in trouble. His encouragement of a crisis in Ukraine could have been an attempt to bring panic to oil speculators and support the price of oil, thus saving his budget. However, that gambit seems to have failed. The Brent crude oil price fell throughout the crisis and remains below the vital $110 mark.

Possible Developments

Ukraine's neighbor to the south is Moldova. This also used to be part of the Soviet Union and contains a region with a Russian majority. In the same week that Crimea declared independence from Ukraine, the troublesome region of Transdniestria also requested to become part of Russia. Putin was never interested in helping the Russian citizens in this enclave in Moldova before, but now it seems he may make a grab for it.

Interestingly, the transfer of Crimea enabled Russia to acquire 41 of Ukraine's 51 naval vessels -- including their only submarine. This seizure leaves Ukraine's remaining coastline, and the great port of Odessa, vulnerable to attack. In the week following the vote in Crimea to join Russia, Putin moved most of his 250,000 troops in the peninsula over to its Western coast. NATO's Supreme Commander in Europe, General Breedlove theorizes that this indicates a new willingness to integrate Transdniestria.

The benefits of Crimea's untapped mineral reserves to Russia are slight. However, there is a vast methane bed beneath the North West corner of the Black Sea in what remains Ukrainian territorial waters. The three remaining coastal province of Ukraine, which include the important port of Odessa, also have large Russian populations and they lie between Crimea and Transdniestria. Integration of these territories would further deny Ukraine the opportunity of energy independence. It would make a vast gas reserve available to Russia and cut Ukraine off from the sea completely.

Russia currently plans to build a southern gas pipeline underwater across the Black Sea from the Caucasus to Bulgaria. Grabbing the remaining Ukrainian coastline would enable the pipeline to be rerouted overland, which would be cheaper both to build and to maintain.

Russia's acquisition of Crimea does not seem worth the money. It gains them resources they don't need and brings them no closer to borders with gas buying EU nations. However, the naval hardware they acquired from Ukraine will bolster the dwindling Russia fleet at Sevastopol. Although Russia has humiliated Ukraine by this action, it has not crippled that country. If the invasion of Crimea is just phase one, with an undefended Odessa and a compliant Transdniestra to follow, the strategy makes financial and political sense.

The sting in the tail for Russia, however, is that the acquisition of Crimea was a wakeup call throughout the governments of Europe. Reservations over tapping Europe's vast shale oil and gas reserves crumbled in the face of the urgency of energy independence. Europe which depends on Russia for one third of its energy needs, has gone into fracking overdrive. A surplus of oil and gas on the continent will not bode well with Putin who relies on high Brent prices to fund his military.