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Wednesday, 11 September 2002

RUSSIA CLOSE TO REGAINING CONTROL OVER STRATEGIC GEORGIAN ASSETS

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By Mamuka Tsereteli (9/11/2002 issue of the CACI Analyst)

BACKGROUND: In late August the Georgian Government had a series of negotiations with Itera International Energy LLC on privatization of the Tbilisi natural gas distribution company Tbilgazi. Those negotiations were conducted on the backdrop of the fact that Georgian state owned entities owe to Itera $90 million for the natural gas delivered to Tbilisi and the Chemical plant in Rustavi in recent years (the official Georgian number mentioned in relation to this deal is $32 million). As a result of negotiations, the Georgian government signed a memorandum of understanding, which envisages creation of a joint venture between the Georgian government and Itera, with the latter having 51 percent and control over the management of the company.

BACKGROUND: In late August the Georgian Government had a series of negotiations with Itera International Energy LLC on privatization of the Tbilisi natural gas distribution company Tbilgazi. Those negotiations were conducted on the backdrop of the fact that Georgian state owned entities owe to Itera $90 million for the natural gas delivered to Tbilisi and the Chemical plant in Rustavi in recent years (the official Georgian number mentioned in relation to this deal is $32 million). As a result of negotiations, the Georgian government signed a memorandum of understanding, which envisages creation of a joint venture between the Georgian government and Itera, with the latter having 51 percent and control over the management of the company. Under the MOU, Tbilgazi and twelve other municipal natural gas distribution companies are going to be transferred into the ownership of the newly created joint venture. This is in fact another equity for debt swap operation, aggressively pursued by Russia elsewhere in the former Soviet Union and Eastern European states. Georgia meets most of its gas needs by buying natural gas for approximately $60/thousand cubic meters at the Russian border from Florida-registered trading company Itera, which has ties to Russian gas giant Gazprom. Itera had occasionally cut supplies of gas to Georgia stating non-payment of debts by Tbilisi, usually doing it during the politically sensitive times, during the winter, or when Georgians and Russians are negotiating status of Russian military bases in Georgia. This development reflects very serious trend of Russian attempts to acquire strategic energy assets of former Soviet Union and Eastern Europe. Just recently Gazprom and Itera received ownership rights on the Armenian distribution network and pipeline system in exchange for cancellation of debts. A preliminary agreement has been signed with the Ukrainian government to create an international consortium, dominated by Gazprom, which will control the natural gas pipelines in Ukraine.   Russia has always been the dominant supplier of oil and natural gas to Eastern Europe, and refineries in Eastern Europe have traditionally depended on Soviet crude as the primary source of supply. In the late 1980s, the degree of this dependence varied from 55 percent in the case of Yugoslavia to 90 percent in the case of Hungary. Dependence was even higher on Russian natural gas. The fundamental shift in the policy of state-owned and private Russian energy companies occurred in the late 1990s, when they started acquiring downstream assets, mainly refineries, as well as pipelines and marketing assets. Lukoil is ahead of others in that process. It already owns refineries in Burgas, Bulgaria, Odessa in Ukraine, and Ploiesti in Romania. In addition, Lukoil owns several petrochemical plants in Ukraine, Bulgaria, and Hungary. Its particular focus is the Balkans. As company's vice-president Leonid Fedun stated in an interview last April, "Lukoil's strategy is to 'dominate the Balkans'". It is clear that the best acquisition targets for Russian companies are in southeastern Europe. There is no significant competition, and assets are substantially undervalued, since the risks are still high. The fact that no Western companies have participated in the bid for Tbilgazi determined the choice of Georgian government as well. The lack of interest from Western corporations is understandable. Russia has monopolistic control over the gas supplies to Georgia, and will maintain this position until 2006, when natural gas from the Shah-Deniz field will start flowing through Georgian territory to Turkey.

IMPLICATIONS: The risks for Georgia associated to the deal with Itera are multiple.  As previous experience shows, Russia will use control over the strategic energy assets of Georgia for political purposes. Another major risk factor is that Georgia, under the Host Government Agreement on the Shah-Deniz-Tbilisi-Erzerum gas pipeline project, has the obligation to buy so called supplemental gas from BP, starting from the amount of 200,000 million cubic meters in the first years of the operation, rising to 500,000 million cubic meters in year 6-20, with the fixed price of $55/thousand cubic meters, and with an annual escalation rate of 1,5 percent. It is very unlikely that Itera will buy that gas, since they have access to cheaper gas from Russia, or even Turkmenistan (Russia pays $42 for thousand cubic meter of Turkmen gas). It means that Georgia may need to pay for gas that it is unable to market. The amount to pay eventually will exceed $20 million, a burden the Georgian budget cannot afford.     The negotiations on distribution of shares in the newly created joint venture between the Georgian government and Itera are not finished yet, and the Georgian side tries to put additional conditions in the contract, including investment plan for the upgrade of the network. The government also tries to keep at least 50 percent of the shares in order to maintain some control, although it is unlikely that Itera will agree on any major changes. In last several years Tbilgazi, with its poor management and continued problems, became a huge liability for the government. And in the absence of a competitive bid, the government feels that a deal with Itera is a better solution for the problem than letting the existing situation of uncertainty continue.  In addition, Georgian officials hope that the country will get secure gas supplies next winter, which is critically important for the internal stability of Georgia. It remains to be seen whether the 51% stake in Tbilgazi and other distribution companies is big enough an incentive for Russia to support internal stability of Georgia.  

CONCLUSIONS: The West, and particularly Europeans are calmly observing how Russia continues its successful process of establishing control over the strategic assets of former Soviet Union and Eastern Europe. Control over those assets brings critical political influence to Russia in this strategically important region. In the last two years Russia managed to have the near-entirety of Kazakh oil flowing through Russia, and with the Blue stream project close to its end, additional leverage over the Turkish natural gas market is becoming a reality. By regaining control over the Georgian gas distribution market, Russia puts additional pressure on the Shah-Deniz project, and the prospects are less promising for the development of an alternative corridor of supply of natural gas from Caspian to the Europe. The proactive policy, including tax and other incentives for European and American companies investing in strategic assets of Eastern Europe, Caucasus and Central Asia should be in the long-term economic security interests of Europe, as well as United States. Meanwhile, diversified sources of the investments and partnerships would help strengthen independence and economic security of Eastern European and Former Soviet States. 

AUTHOR BIO: Mamuka Tsereteli is the executive director of the America-Georgia Business Council and adjunct professor of international relations at American University in Washington, D.C. His areas of interests include economic security, business environment and development strategies.

Copyright 2001 The Central Asia-Caucasus Analyst. All rights reserved.

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