Russian economic expansion in the Caucasus: a challenge for Georgia

Mamuka Tsereteli
Central Asia Caucasus Analyst

Most of the states of the Black and Caspian Sea region are facing a very serious dilemma: the effective governance of the economy requires the privatization of the state-owned enterprises. At the same time, no Western companies seem immediately interested in investing in those enterprises. But Russian state-owned companies and oligarchic groups associated with the government are capitalizing on high prices of energy and other resources, and using available cash to purchase important assets. Georgia is currently facing high controversy regarding increasing Russian investment.

Background: The first major entry by Russian companies into the Georgian economy took place under the earlier Shevardnadze regime. In the summer of 2003, United Energy Systems (UES), a power company majority-owned by the Russian government, purchased Tbilisi electricity distribution company Telasi and the 9th (the only one in working condition) block of the Gardabani Power station from the American AES Corporation. RAO UES also received the right to manage hydroelectric power stations Khrami-1 and Khrami-2, and through its 50 percent of the shares in the Sakrusenergo joint venture, acquired ownership of 50% of all the 500 kw power lines in Georgia. In early March 2005, the Georgian government and UES started negotiations on a new five-year cooperation plan. The details are still unknown, but it is expected that UES may acquire ownership of other distribution and generation facilities in Georgia.

Developments have accelerated in early 2005. In mid-January, Russia’s Vneshtorgbank purchased 51% of the shares of the United Georgian Bank. The major shareholder in Vneshtorgbank is the Government of the Russian Federation. In the end of January 2005, the Georgian government signed a memorandum with Russia’s YevrAzHolding, the winner of a tender to buy the Chiaturmarganets (one of the largest manganese concentrate producers in the former Soviet Union and one of western Georgia’s biggest enterprises) and the Vartsikhe hydro cascade for $132 million. Manganese is one of the most important export commodities for Georgia.

The Russian State natural gas monopoly Gazprom made its first big move into Georgia in 2003, taking over the gas transportation business from Russian-American gas trader Itera, itself affiliated with former Gazprom officials. On July 1, 2003 the Georgian government and Gazprom signed a memorandum on strategic cooperation for 25 years. The agreement envisaged the supply of natural gas to Georgian customers and the rehabilitation of gas pipelines, a task that Gazprom never performed. In January 2005, Gazprom announced its interest in privatizing Georgia’s gas pipeline system. The Georgian gas pipeline system include pipes which distribute gas in Georgia’s regions and pipelines which are used for transporting gas from Russia to Georgia and Armenia.

Implications: With Russian state-owned companies expanding into Georgia, the Russian Federation is acquiring greater leverage over sensitive political issues. This is not only a perceived, but a real threat. The Russian government has a recorded history of using energy dependence as a tool for the political pressure. That was the case in the Baltics, when Estonia, Latvia and Lithuania demanded the withdrawal of Russian troops in 1992. That was the case in Ukraine, where pressure was used for economic reasons. That was the case in Georgia in 2000-2001, when Moscow demanded support for the war in Chechnya and adjustments in Georgia’s western-oriented foreign policy.

With Russian state-owned companies in charge of most of the natural gas market, both commercial (power plants, chemical factories) and residential, it is hard to believe that Georgia will have a chance to diversify its natural gas supplies, despite the construction of the U.S. government-backed Baku-Tbilisi-Erzerum pipeline, which is planned to ship gas from the Shah-Deniz Field in Azerbaijan to Turkey via Georgia.

In addition, the sale of the gas pipelines is not really a matter of privatization, since Gazprom is a government-owned, poorly managed, and financially not very sound company. Gazprom cannot bring effective management or modern technology. Quote to the contrary, Gazprom, as well as other Russian state-owned companies, bring an old Soviet-style authoritarian management culture. In addition, Gazprom’s future is itself not clear. The company does not have money to invest in exploration, and the company is heavily dependent on gas from Turkmenistan and other Central Asian countries in its future strategies. Gazprom capitalizes on these countries’ lack of access to markets and uses its monopoly on gas pipelines to set a minimal purchase price. But Turkmenistan is giving Gazprom hard times, not fulfilling some of its earlier contractual obligations and demanding higher prices, thus casting doubts on the success of Gazprom’s announced strategy.

This uncertainty surrounding Gazprom is a challenge to Europe as well. Europe is heavily dependent on Russian gas. The dependence varies from twenty-two percent of consumption in France, to almost forty percent in Germany, sixty in Turkey, sixty-five in Austria, seventy-nine in the Czech Republic, ninety-seven in Bulgaria, and a hundred percent in Slovakia, to name a few. The European market is growing rapidly and Russia may lose its share unless it increases its reserves and potential. Europe is already beginning to wake up and look for all possible directions, including the Caspian.

In this context, Gazprom sees the potential for competition and tries to attract all the regional gas in its system. Gazprom is not only after Turkmenistan and Kazakhstan, but after Azerbaijan as well. The purchase of the existing Georgian pipeline system is a step in that direction. It gives Russia the opportunity to consider different scenarios of shipping Azerbaijani and Iranian gas from the South Caucasus through its own system to markets in Europe. If successful, Gazprom could make all those producing countries depend on its transportation system and would dictate commercial considerations. It could also maintain greater leverage on European consumer countries.

Conclusions: It is in Georgia’s interest to avoid a transfer of all of its energy assets to government-owned monopolies of the Russian Federation, in contrast to private Russian investments that should be welcomed in various industries, particularly in tourism, real estate, hospitality business, wine industry etc. On the other hand, the government of Georgia needs to find a way to attract investments from different parts of the world. That will require a clear long-term economic strategy, simplification of regulations, transparency in the privatization process, and respect and enforcement of property rights by an independent judiciary. It will also require the support of friendly governments. Georgia still cannot afford large-scale investments in infrastructure, and will require assistance in that direction. The energy sector remains the priority, although road infrastructure has an important role as well.

Author’s bio: Mamuka Tsereteli is the Executive Director of the America-Georgia Business Council and an Adjunct Professor at the School of International Service at American University in Washington, D.C.