Dec 28 - International Herald Tribune

When President Vladimir Putin signed a major energy deal in the Kremlin last week with his counterparts from Kazakhstan and Turkmenistan, state television made a big deal of it. As if to show how relations between Russia and those Central Asian regimes had improved, it gave ample coverage to a smiling Putin, praising the merits of a contract that commits Turkmenistan to building a natural gas pipeline along the Caspian Sea to Russia.

And what a deal. Two years of intense negotiations between Gazprom, the state-owned Russian natural gas monopoly, and the leaders of Kazakhstan and Turkmenistan, helped by Putin's persistent intervention, showed just how much the Kremlin wanted this accord. "It is extremely important," Putin said at the signing ceremony. "It will become a new, important contribution of our nations into strengthening the European energy security."

For some energy industry analysts, that said it all. With Gazprom committed to fulfilling its contracts to Europe, this was probably the first time the Kremlin had admitted that Russia required gas from Central Asia because it did not have enough of its own to meet the increase in domestic and European demand.

"The reality is that Russia faces an energy deficit," said Andrew Monaghan, director of the Russian Research Network at the Defense Academy of the United Kingdom.

The Russian reliance on Central Asia for natural gas poses big questions for Europe, which imports nearly 50 percent of its gas from Russia, and particularly for Germany. The big German energy companies, Wintershall and E.ON Ruhrgas, continue to tighten their links with Gazprom in the expectation that Russia will start investing in its own gas sector so as to tap the huge reserves that lay deep in the inhospitable regions of western Siberia. But all this takes time, which is why Gazprom is prepared to pay heavily for the deal with Central Asia.

Indeed, the president of Turkmenistan, Gurbanguli Berdymukhamedov, struck a hard bargain. Gazprom agreed to pay $130 per 1,000 cubic meters of gas during the first half of 2008, compared with the $100 it now pays. It will increase to $150 during the second half of 2008.

In practical terms, these hefty prices could be catastrophic for neighbors to the west of Russia like Ukraine and Belarus, which are dependent on Russia for their energy. They can expect to be saddled with higher energy bills in order to carry some of the cost of this Central Asian deal. As for the average Russian consumer, long accustomed to subsidized heating, the Kremlin will be very wary about raising prices.

This is not the time for Putin or Dmitri Medvedev, Gazprom's chairman, to raise prices. It would prove too unpopular just before the presidential elections, scheduled for March, when Putin is poised to become prime minister. Medvedev has already been nominated by Putin to succeed him as president.

Regardless of the outcome of that election, neither Putin nor Medvedev, nor for that matter the Europeans, can continue to ignore Russia's inability to produce enough gas for its own needs and Europe. Viktor Khristenko, the Russian minister for industry and energy, has already predicted that Russia will face a gas shortage of about 4 billion cubic meters this year, rising to 27.7 billion cubic meters by 2010. By 2015, it could surge to 46.6 billion cubic meters, or about a quarter of what Europe buys annually from Gazprom.

So even if Gazprom embarked on a major investment program instead of investing in newspapers, ski resorts and unrelated expensive energy projects, there would still be a time lag before the natural gas reaches the transmission pipelines. That may explain why, in his quest for more energy resources, Putin is now seriously considering raising coal production. The plan, still under intense discussion, entails using coal increasingly for domestic consumption as well as exports so as to relieve the demand for natural gas both inside Russia and outside it.

It is a risky but fascinating option. At a time when Europe is beginning to take climate change seriously, several countries, including Britain, Germany and Russia, are relying ever more heavily on coal as an energy source. According to the International Energy Agency's World Energy Outlook, coal is the fastest-growing fossil fuel, with global consumption rising by 4.5 percent a year. It now accounts for more than 50 percent of the growth in global consumption.

If Putin is serious about diversifying into coal, this could provide the Kremlin with a unique opportunity to modernize the industrial sector.

Monaghan argues that Russian coal is particularly attractive to European consumers because of its low sulfur content. This means that it can be used in European plants that lack desulfurization units.

In Germany alone, nearly 50 percent of power production in 2005 was based on coal. Chancellor Angela Merkel's coalition government plans to build up to 30 new coal-fired power plants over the next decade, despite Merkel's commitment to reducing greenhouse gases. The decision by the government, however, to halt coal production by 2018, because of its costs, means that these power stations will have to be fed by imported coal, most likely Russian.

Here comes the bigger challenge for Russia. If its natural gas industry is seriously underfinanced, its long-neglected coal mines are even more so. Over half of the mines have been operating for more than 40 years.

The coal seams are thin and deep, making the mines prone to accidents. Production costs exceed revenues. Few new mines have been brought into production because of lack of investment. More important, Putin has to modernize Russia's railroad stock, crucial for transporting coal and for the development of the economy.

Above all, Putin has yet to unveil a long-term energy strategy that details the investments Russia will undertake over the next decades.

So far, the Kremlin has gone only for stopgap measures, paying dearly for gas from Central Asia. Unless Putin is prepared to match his speeches about modernizing the gas and coal sectors with serious money, Russia's long-term reliability as an energy partner is questionable. Europe, with its increasing dependency on its big neighbor to the east, may finally start asking some hard questions.

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E-mail: pagetwo@iht.com

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Tomorrow: Howard W. French on elections and unexpected consequences.

Originally published by The New York Times Media Group.

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