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April 2011

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A leading American energy expert and retired U.S. diplomat holds little back in his commentary on European-Russian energy dealings. The dangers are evident and not easily solved. –The Editor

Corruption and Lack of Transparency in the Energy Sector

A major challenge to the new democracies of Central Europe is corruption and lack of transparency in the importing of oil and natural gas from Russia and other energy producing states once part of the Soviet Union. This situation has undermined good governance and ethical business practices in the “new democracies” and in the large and wealthier countries of Europe. EU membership has provided only limited energy security to the new democracies.

Wealth accumulation from the energy trade is often used by powerful groups in the East to buy support in Western countries for Russian economic and security policies. This situation is exacerbated by the lack of legal reporting requirements in the West concerning the outside funding of political and business groups.

The most serious threats result from the danger of intervention at any point in the commercial process on the part of elite cartels that dominate the energy trade, particularly in Russia, Ukraine, and Central Asia. These cartels are composed of governmental leaders, intelligence officials, and favored business oligarchs.

It will take greater coordination on the part of EU and Central European political leaders to bring about greater transparency and competition. Reformers are too often defeated at the next election. They need the full institutional and public support of the EU and other Central European governments.

Corruption and Non-transparency
Western energy firms too often confront demands from governmental officials and Eastern energy companies to engage in shady business practices when considering investment decisions, long-term sales contracts, and accounting procedures. Lack of a common EU energy policy and of strong antimonopoly enforcement regarding energy importers, have over the past 20 years increased opportunities for non-transparent state companies to increase their influence among Western governments and with political and economic elites in Europe.

Europe's Gaslines

Oil and Gas Pipelines in Europe

Dubious or outright corrupt business practices are distorting the energy decision making processes in both consumer and supplier countries. According to Transparency International, the business climate within the Russian energy sector has become less transparent and more corrupt in recent years. This corruption has sometimes affected decision making by leaders in Europe, particularly in countries heavily dependent on oil and gas imports from or through Russia. Recent experience has demonstrated that Western energy investors may lose their ownership rights or exploration permits whenever a powerful domestic group wants to take possession of an attractive asset.

Many businessmen in former Communist states engage in what people in the West refer to as corrupt practices as a result of having grown up in a culture that considers bribery and coercion to be normal methods of conducting business. There is a web of economic and personal ties that originated during the Soviet period. Newer and less experienced Western leaders are often at a disadvantage during energy negotiations with a highly trained former Soviet or Warsaw Pact intelligence officer.

Elite Beneficiaries
Corruption and tight Kremlin control of Russia’s energy companies have weakened the bargaining position of Western firms that normally use “best practices” when engaging in East-West energy trading. The domestic monopoly power and designated export privileges of Russia’s state-controlled energy companies have led to a marked reduction of alternative investment possibilities for Western companies. This further intensifies the pressure on Western companies to agree to corrupt or non-transparent demands of Eastern energy suppliers. This also raises the temptation for Western governments to ignore questionable business practices by their own domestic energy firms when engaged in trade with Russian suppliers.

Pipelines

Western firms are already at a disadvantage when making business decisions in the former Soviet area. The absence of a win-win business concept in the East, combined with the absence of impartial court systems to enforce internationally recognized contracts between business firms, gives nontransparent firms an advantage in negotiations. The most serious threats result from the danger of intervention at any point in the commercial process on the part of elite cartels that dominate the energy trade. These cartels are composed of governmental leaders, intelligence officials, and favored business oligarchs. Western businesses are usually compelled to work with non-transparent intermediaries benefiting elite cartels. It appears to some observers that the purpose of these elite cartels is to build national and transnational networks and alliances. By doing so, these elite members solidify their own power and wealth, while at the same time fending off challenges from more transparent and democratic business groups. The existing systems appear to be designed to enrich networks of higher-level elites and/or their political parties, making it even more difficult for reform elements to bring about political and economic change.

Weak Western Reaction

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A passive reaction by Western governments and the European Union to non-transparent business practices by Moscow only encourages the Kremlin to believe in the effectiveness of its aggressive energy policies. The West’s lack of effective action until recently also extends to the apparent acceptance of monopoly and antitrust practices on the part of Russian companies. These antitrust and anti-competition practices are a clear violation of the EC Treaty, the Energy Charter Treaty and now of the Lisbon Treaty.

Western governments continue to be reluctant to investigate and enforce the anti-bribery laws and regulations of the European Union and the Organization for Economic Co-operation and Development (OECD). The lack of a common EU approach to Russian and Central European energy policies allows Moscow to carry out a “divide-and-conquer” strategy that plays to the particular vulnerabilities of each European state.

Most EU member states do not require that their national firms accepting payments from foreign governments or companies report this information to official government agencies. Nor is this material made available to the public. This makes it virtually impossible to know who is behind foreign-directed public relations campaigns or political influence peddling.

The problem is particularly pronounced in countries where the media is either not able or is unwilling to engage in aggressive investigative reporting. Many newspapers and television stations in the new democracies are in precarious financial positions and are vulnerable to offers of help from well-financed foreign companies or their intelligence services.

The EU organizations in Brussels are particular targets of Eastern intelligence services that in many cases are promoting the interests of their country’s energy companies. Also, lobbying and public relations firms in Brussels are frequently hired directly and indirectly to further the interests of Gazprom and other Russian companies. Russian nationals are often employed by the European Union but few, if any, EU nationals occupy important posts in Russia.

Competition and Transparency
The new democratic states of Central and Southeastern Europe have too often been relatively passive in dealing with transparency and anticorruption issues. One reason for this could be that there are large numbers of political and economic leaders in the region who are holdovers from the Communist period. In the chaos resulting from the collapse of the Soviet Union and the Warsaw Pact, many former officials were able to gain control of the Communist Parties’ assets and/or purchase large industries cheaply. The business ethics of most former Communist officials did not significantly change with the fall of the old system.

Murky Alliances
The weak state of transparency in Central Europe aids the formation of new alliances between East European elites and the former Communist/intelligence class in Russia who dominate the major energy companies. This again puts Western firms at a clear disadvantage when negotiating for facilities acquisition or pipeline construction. With the renationalization of Russian energy assets, top Kremlin officials often carry out negotiations with the West. Fewer bilateral agreements are negotiated at the company level. Few Western political leaders are able to negotiate effectively with the seasoned intelligence officers in the Kremlin who determine Russia’s energy relationships.

Western leaders rarely have the skills or the ability to fully mobilize the state’s resources to negotiate on an equal basis, and they often lack good intelligence regarding the tactics of the other side. Russia’s top leadership is directly involved in energy sector deals with other countries. Prime Minister Putin devotes more time and attention to promoting his country’s energy interests than does any leader from a Western country. Putin knows how to effectively use the Russian intelligence services to promote pipeline projects and downstream acquisitions. This does not necessarily indicate that the agreements are the result of corruption, but present or former intelligence officers involved in cross-border deals are not constrained by OECD anticorruption treaties or by anti-bribery laws.

The views expressed above are solely those of the author and do not necessarily represent those of the Center for Strategic and International Studies.


imageAmbassador (ret.) Keith Smith is currently a Senior Associate at the Center for Strategic and International Studies (CSIS). He has been a consultant to several European and American energy companies and lectures on Russian-European energy issues in the U.S. and Europe. From 1997-2000, he was U.S. Ambassador to Lithuania. During his 38 years in the Foreign Service, he served in several Latin American posts, Hungary (twice), Norway and Estonia. His Washington assignments included EUR Director of Policy, and Senior Advisor to the Deputy Secretary of State for Support of East European Democracies (SEED Program). His articles have appeared in the International Herald Tribune, The Economist, the Georgetown Journal of International Affairs, the Center for European Policy Studies and a report of the Norwegian Atlantic Committee. He has appeared on BBC World, CNN and CNBC. His most recent CSIS publications include "Bringing Energy Security to East Central Europe" and "Lack of Transparency in Russian Energy Trade."

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