IN THIS ISSUE:

* Russia postpones military restructuring due to deepening financial crisis
* Organized crime involved in the Russia-Ukraine gas war
* Russia-Ukraine gas crisis creates major opportunity for Nabucco on eve of summit
* Erdogan government tries to ease strains in Turkey- Israel relations

Russian Military Reform Delayed by Financial Crisis

Roger N McDermott

Russia’s agenda for military reform, announced by Defense Minister Anatoliy Serdyukov in October 2008, is facing revisions and delays due to the global financial crisis. This has also affected the arms industry, as there are fewer customers for the purchase of military hardware, and has consequently damaged Russia’s defense industry, which relies heavily on the international export market. Boris Obnosov, the general manager of the Tactical Missile Arms Corporation, for example, recently expressed his confidence that the defense industry would pull through the crisis but admitted that this would depend on state assistance in the form of inexpensive loans, tax breaks, and additional state orders. Without this, many Russian defense companies would go under.

Prime Minister Vladimir Putin is already actively deflecting blame away from the government by attacking the inefficiencies of the defense industry. He underscored the vital nature of Russia’s defense industry, which he linked to maintaining Russia’s security at a time when the country’s own military was in desperate need of modern equipment. Despite the declining demand abroad, Putin is confident that increased state spending will preserve the volume of production. He said that fiscal planning envisaged spending 1 trillion rubles ($30 billion) in 2009, rising to 4 trillion rubles ($121 billion) by 2011, for the purchase of military equipment for the Russian armed forces. “The majority of defense enterprises are companies [with local employees]; the well-being of millions of citizens depends on them. A fitting response from the state is therefore required,” Putin explained. The trouble for the Russian state, however, is that the number of defense industry companies on the list for state assistance during the crisis is continuing to escalate (Komsomolskaya Pravda, Moscow, January 16).

Putin attributes these problems, in the mainly state-owned enterprises, to mismanagement and the “inefficiency” of executives. Alluding to the longer term implications of the crisis, Putin acknowledged that the state could not bail out such companies indefinitely and called for checks to be made about whether banks were lending to the defense industry and were not artificially inflating interest rates on those loans. He said that the state would not cover these losses endlessly.

The sense of crisis within Russia’s defense industry is noticeably deepening, even over a short period of time, as reports increase about the number of companies struggling to cope with the current economic climate. In Bolshoy Kamen in Russia’s Far East, the Dalenergosbyt Far East energy company cut power to the Vostok plant, a subsidiary of the Amur shipyard, which repairs submarines for the Ministry of Defense (MoD). The radical action was taken as a result of the plant’s failure to pay its electricity bills since October 2008. A concession has now been agreed, allowing the debt to be repaid in installments, but the debt itself is continuing to mount. Dalenergosbyt has been imposing tougher measures on such companies since the start of 2009. “The money from these enterprises is needed for the stable and uninterrupted operation of [electricity] generation companies and power grid organizations supplying electricity to end consumers, especially in times of peak demand,” the company said (ITAR-TASS, Moscow, January 20).

Meanwhile, Putin has sought to shore up the defense industries, following a government meeting on January 15. He declared afterward:

We have agreed to provide subsidies from the federal budget to enterprises in the defense industry complex to compensate partly for interest paid on loans provided by Russian credit organizations. We have agreed to provide subsidies to compensate for some of the losses as a result of basic industrial operations, that is, subsidies preventing an unfavorable development of the economic situation and bankruptcies of enterprises (Interfax, January 15).

For the time being, this entails using the banking sector in support of the defense industries, but Putin has made it clear that the government might need to intervene if this fails.

Sources within the MoD have disclosed that its military reform and modernization program will be delayed as a result of this crisis. Initially it will postpone these plans by about six to eight months. Nonetheless, even in this deepening crisis, planned large-scale transformations, which include cutting 250,000 officers’ jobs and eliminating warrant officers, will go ahead within the announced timescale—the end of the year. This seems highly ambitious, given the announced revision of the 2009 federal budget. It seems only a question of time before more delays are announced to these plans.

It appears that the delays will mainly occur in implementing the transfer to a brigade-based manning principle. In Russia’s ground forces, the plan was to disband in a nine-month period, 23 all-arms divisions and 12 all-arms brigades, forming 39 permanent combat-ready all-arms brigades. In the Air Force it was planned to set up 55 aviation bases of different categories, based on the disbanded aviation divisions and regiments (Interfax, January 19). Transfer to the new brigade-based structure was scheduled for implementation by June 2009. Other aspects of the military reform agenda are hurriedly being revised, in light of the present financial crisis affecting the Russian state, as the planned cut in the overall numerical strength of Russia’s armed forces from 1.2 million down to 1 million scheduled for 2012, has now been postponed by presidential decree to 2016. The financial crisis has come at the worst possible time for Russian military reform.
 

The Role of Russian Organized Crime in the Gas War of January 2009

Roman Kupchinsky

On January 20 Alexei Miller, the CEO of Russia’s state-owned gas monopoly, Gazprom, made an amazing confession. He told Interfax that in late December 2008, when negotiations between Ukraine and Russia on a new gas supply contract broke down, the party largely responsible for this was RosUkrEnergo (RUE), the Swiss-based middleman company that sold Central Asian gas to Ukraine.

RUE is 50 percent owned by Gazprom and 45 percent by a Ukrainian businessman, Dmytro Firtash. “Yes, it is true that when the prime ministers of Russia and Ukraine agreed to a price of $235 for 1,000 cubic meters of gas…RosUkrEnergo proposed paying $285. This company was betting that by making such an offer it would remain in the market,” Miller stated. What Miller failed to explain is why RUE would dare undermine the Russian government.

From its inception RUE has been accused of opacity by the media and of “criminality” by Ukrainian Prime Minister Yulia Tymoshenko. Most of the charges centered on Gazprom’s partner in RUE, Dmytro Firtash, and his alleged links to a notorious Russian mobster, Semen Mogilevich. Dmytro Firtash has denied any direct links to Mogilevich. This might be true, but the indirect links suggest that Mogilevich was indeed tied to Firtash, the Kremlin leadership, and the Ukrainian elite.

The history of RUE began in December 2002 when Firtash registered a company in Hungary named Eural Tran Gas (ETG), which signed a contract with Gazprom on December 5, 2002, becoming the middleman in the Turkmen- Ukrainian gas trade.

Strange circumstances surrounded ETG’s creation: unemployed Romanians became principles of the company; an Israeli lawyer with ties to Mogilevich became a nominal director of the company; and Andras Knopp, a former Hungarian communist cultural functionary with no knowledge of the gas business became the director of the company. Even stranger was Firtash’s refusal to reveal that he was the ultimate beneficiary of ETG. Soon after the contract was signed, ETG was given a $70 million loan by Gazprom Bank, which also became the guarantor of a $227 million loan to ETG by Vnesheconombank (Moscow Times, November 27, 2003).

By July 2004 media criticism of ETG forced the Kremlin to eliminate the company and create RosUkrEnergo in its place. RUE came into being during a meeting between Russian President Vladimir Putin and then-Ukrainian President Leonid Kuchma in Yalta. At that time both leaders stressed that RUE would be a fully transparent company, tacitly acknowledging media reports that ETG was opaque. One of the two co-directors of RUE was Konstantin Chuychenko, a former KGB officer, the head of Gazprom’s legal department, and a classmate of Dmitry Medvedev (Chuychenko’s biography was posted on the Gazprom website, www.gazprom.com, but was removed after he left Gazprom to join Medvedev’s administration). The other co-director was Oleg Palchykov, the former director of the ETG office in Moscow who represented Centragas, a company silently controlled by Firtash (Izvestia, April 27, 2006). Palchykov’s appointment as co-director of RUE was met with a great deal of skepticism.

“His [Palchykov’s] candidacy was submitted by Raiffeisen Investment [the nominal owners of Centragas]; and we were unable to stop it,” Alexander Ryazanov, the deputy director of Gazprom and a member of RUE’s coordinating committee, told the Russian newspaper Vedomosti (www.proua.com, February 8, 2005). Why Gazprom wanted to prevent Palchykov’s appointment in the first place was not clear. Gazprom had always insisted that their partners in RUE were honest, transparent businessmen. Had this view suddenly changed?

Part of the explanation could be that the Moscow ETG office Palchykov headed was located in a building on Novy Arbat 14 that was also used by an alleged mobster, Igor Fisherman, who was wanted together with Mogilevich by the FBI. According to Vedomosti on May 30, 2006, Fisherman was Firtash’s partner in the purchase of 75 percent of a Russian company Zangas. The flow of money from RUE to Gazprom was also murky. Apparently it first went to a shell company in Cyprus and then on to Moscow to another shell company, “Rubin” (Stern, September 13, 2007). Why wasn’t the money sent directly to Gazprom?

Chuychenko, Dmitry Medvedev’s man in RUE, however, remained adamant in his whitewashing of Firtash and RUE. “Dmytro Firtash is a very well-known figure in the gas business,” Chuychenko told Ukrayina Television on December 1, 2006. “He has been working in the gas business in Ukraine for a long time, so his appearance in this field was no accident.”

On October 9, 2007, Medvedev made an incredible statement on the German television station ARD: “We will most likely review the scheme of our relations [with Ukraine] and will end the existence of middlemen structures, which we do not fully understand.” How could Medvedev, the head of Gazprom’s board of directors, not understand what RUE was?

Chuychenko’s claims about Firtash were soon disputed by Putin, who told Interfax on January 8, 2009: “50 percent of RUE belongs to Gazprom… the Ukrainian side belongs to persons we do not know…they showed us Mister Firtash once…”

A controversy over massive Ukrainian debts to RUE and RUE to Gazprom heated up in January 2008, and Mogilevich was arrested in Moscow in February 2008. He was charged with aiding a Russian businessman, Vladimir Nekrasov, the alleged owner of the chain of Arbat Prestige perfume stores, in a tax evasion scheme. Documents from the Russian business registry in the possession of Jamestown, however, show that Firtash was instrumental in creating Arbat Prestige.

The day after the Ukrainian-Russian gas agreement was signed, the Russian press reported that a Moscow court had ordered that Mogilevich and Nekrasov remain in detention until March 23 (www.newsru.com/russia/21jan2009/prodlen.html, January 21). Was the timing coincidental or was it linked to RUE’s debt to Gazprom?

The litany of contradictions voiced by top Russian officials in the RUE case, as well as documented evidence, suggests that organized crime is linked not only to RUE; it is a stark indication that corruption in the Kremlin has expanded since Putin’s election in 2000. Who stood to benefit from RUE? Putin claims it was the Ukrainian leadership—the facts suggest otherwise.
 

A Window of Opportunity for the Nabucco Project at Budapest Meeting

Vladimir Socor

The Nabucco gas transport project, whose stakeholders and institutional backers are holding a high-level meeting in Budapest on January 26 and 27, faces a unique window of opportunity in a reshaped strategic context (see EDM, January 6, 22).

The meeting is being held in the wake of Moscow’s unprecedented, two-week suspension of Russian gas supplies to Ukraine and Europe. Moscow’s brutal move inadvertently opened the window of opportunity for the Nabucco project even wider. The Russian supply cutoff demonstrated Russia’s unreliability as a supplier, the risks of dependence on Moscow, and the imperative for Europe to diversify its supply sources by gaining direct access to Caspian gas through the Southern Corridor, with the Nabucco pipeline as its centerpiece.

The Budapest meeting had been announced well before the Russian gas cutoff, but the sequence of these events should powerfully spur practical decisions at the meeting on launching the Nabucco project.

The Nabucco consortium has received a promise of partial funding through the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB); but this is insufficient, as the Hungarian government’s project coordinator, Mihaly Bayer, noted in prefatory comments. In addition to EBRD and EIB funding, the Nabucco consortium’s companies also need more substantial funding directly or indirectly from the European Commission (Nepszabadsag, January 21).

The necessity of such intervention is increasingly understood in Brussels and elsewhere in Europe with regard to infrastructure and energy projects at the present time. But that understanding has not yet translated into EU funding for Nabucco or related projects for gas in the Southern Corridor While the EU has subsidized construction of highways and railroads for years from ample, specially earmarked funds, it has not subsidized pipelines and is only now considering this possibility.

The EU Commission recently created a €5 billion ($6.6 billion) energy development fund, some €3.5 billion ($4.03 billion) of which have already been assigned for wind and solar energy projects in northern and southern Europe, respectively. At least 30 other projects are listed as possible candidates for the remaining Euro 1.5 billion. From an energy security perspective in the gas sector, where dependence on Russia is the most fraught with risk, three projects stand out for their urgency: inter-connector Poland-Slovakia and Slovakia-Hungary pipelines and a liquefied natural gas (LNG) terminal on Croatia’s Adriatic coast.

Those two inter-connectors relate to Nabucco and the Southern Corridor for natural gas while also reflecting the EU’s policy goal to interconnect the national pipeline networks in Europe. In Central-Eastern and Southeastern Europe this means building north-south pipeline links, given that the Soviet-bequeathed transit pipelines run east-west, exposing the unconnected countries to grave risks as the recent crisis demonstrated. The proposed Poland-Slovakia and Slovakia-Hungary inter-connectors answer to that necessity. Moreover, Hungary is already building inter-connectors jointly with Croatia and with Romania, which could add up to a north-south interconnected system encompassing those five countries.

For its part, Slovakia, which suffered the most from the Russian cutoff, has announced its intention to join both the Nabucco project and the Hungarian-initiated NETS (New European Transmission Systems) regional interconnectivity project (SME, January 26).

Poland has announced that it is analyzing the possibility of linking up with the planned Nabucco pipeline. The working hypothesis is a link via Slovakia to Baumgarten, Nabucco’s designated terminus near Vienna. Given, however, the Austrian OMV’s cession of 50 percent ownership in the Baumgarten platform to Gazprom since 2007, Baumgarten seems less appropriate than a Hungarian location for a Polish hook-up to Nabucco via Slovakia.

The proposed LNG maritime terminal in Croatia could help a number of countries reduce their dependence on pipeline-delivered Russian gas. Moscow’s recent supply cutoff has spotlighted the need to create LNG options for import diversification, particularly in Central and Southeastern Europe, where dependence on Russia is highest and LNG development is practically nil.

In Hungary itself, some officials in the Socialist minority government seem to cast doubt on the government’s commitment to Nabucco. Finance Minister Janos Veres, Energy Minister Csaba Molnar, and Hungary’s ambassador to Moscow Gyorgy Gillian have all made favorable references to Gazprom’s South Stream project, the rival to Nabucco, on the eve of the Nabucco meeting in Budapest. The technique of such statements is to endorse both South Stream and Nabucco in the same breath, as if ignoring the fact that the two projects compete against each other for Caspian gas, regional markets, and investment funds (HIR Television, January 21; Nepszabadsag, January 22; Interfax, January 24).

Such statements elevate Gazprom’s South Stream to the same level as the Western-backed Nabucco, creating the impression that the Hungarian government wavers yet again between the West and Russia on energy policy. One year ago, Veres and the Hungarian embassy in Moscow pushed strongly for Hungary’s accession to South Stream. Prime Minister Ferenc Gyurcsany caved in at that time but shifted course again toward Nabucco by mid-2008 and has stayed this course since then. The opposition Fidesz party has led the way in forming a national and parliamentary consensus for the Nabucco project since 2007.
 

Can the “Gaza damage” to Turkish-Israeli Relations be reversed?

Emrullah Uslu

During Israel’s incursion into Gaza, Turkish Prime Minister Recep Tayyip Erdogan harshly criticized the operations. His condemnation received the applause of a majority of people in the Muslim world; but it has created concern about the Jewish communities in Turkey (see EDM, January 7, January 15). In response to Erdogan’s human rights remarks about Israeli policies in Gaza, The Jerusalem Post ran an editorial saying:

We're not convinced that Turkey has earned the right to lecture Israelis about human rights. While world attention focuses on Gaza, Turkish jets have bombed Kurdish positions in northern Iraq. Over the years, tens of thousands of people have been killed as the radical PKK pursues its campaign for autonomy from Turkey (The Jerusalem Post, January 5).

In the following days, the American Jewish Committee (AJC), B'nai B'rith, the Anti-Defamation League (ADL), the Conference of Major American Jewish Organizations, and the Jewish Institute for National Security Affairs signed a letter expressing their concerns about the possibility of rising anti-Semitism in Turkey (Milliyet, January 23). President of the ADL Abraham Foxman said that Turkish Jews felt they were under siege and threatened, and Erdogan’s harsh criticism toward Israeli policies played a role in this (Hurriyet, January 23).

In a cabinet meeting on January 26 ministers discussed the Jewish concern. Deputy Prime Minister Cemil Cicek stated that “The Turkish government has no problem at all with citizens of Israel, Jewish people across the world, and Turkish Jews. Turkish politics [toward Gaza] is directly related to Israeli policies. All Turkish citizens have the same rights, and their security is the responsibility of the Turkish Republic” (Sabah, January 27). Foreign minister Ali Babacan also stressed that Turkey’s position was against Israeli policies, while acknowledging that the criticism of Israel could harm Turkish-Israeli relations in the short run. Babacan thought, however, that Israel would not want to harm relations because Turkey and Israel had mid-term and long-term strategic commitments (Sabah, January 27). Babacan further stated that “Turkey does not approve of what Hamas does; however, it is a fact that without taking Hamas into consideration, a permanent peace is not possible (Radikal, January 27).

As the Justice and Development Party (AKP) government tries to ameliorate the negative effects of Erdogan’s harsh censure of Israel, the Turkish media have started criticizing Erdogan’s anti-Israel rhetoric. Journalists have pointed out that once people have lost their confidence in the system, it is too hard and too late to restore it. Erdogan’s rhetoric had caused Turkish Jews to lose their confidence in the system (Hurriyet, January 27). Editor in Chief of Milliyet Sedat Ergin wrote an editorial outlining Erdogan’s mistake in his position against Israel. Ergin argued that Erdogan should have warned Hamas about its rocket attacks on Israel, asked Hamas to stop its terrorist strategy, and pursued a policy to balance Fatah and Hamas. Erdogan should not have equated Jews with Israeli policies (Milliyet, January 27).

Perhaps Erdogan has finally realized that his rhetoric could potentially harm Turkey’s vital interests and endanger Turkish Jews. He is planning to meet with Israeli President Simon Peres at the World Economic Forum in Davos, Switzerland, on January 29 (Hurriyet, January 27). Given the fact that Erdogan had rejected Israeli Prime Minister Ehud Olmert’s offer to discus the Gaza crisis during the war, the Erdogan-Peres meeting could be a sign of reinitiating Turkish-Israeli relations.

Given the fact that during the election campaign President Barack Obama indicated to Armenian communities that he may recognize the 1915 events as “genocide,” the Turkish government needs the support of its traditional ally, the Jewish lobby, more than ever. Furthermore, the president of the ADL already made the controversial claim in 2007 that "on reflection, we have come to share the view of Henry Morgenthau, Sr. [the U.S. ambassador to the Ottoman Empire during World War I] that the consequences of those actions were indeed tantamount to genocide. If the word genocide had existed then, they would have called it genocide" (The Jerusalem Post, August 23, 2007). The tension caused by Erdogan’s statements about Israel could further separate Turkey from the Jewish lobby in Washington.

Moreover, in terms of the domestic political power struggle between the powerful military and the AKP, the Jewish lobby could ally itself to the military. If Jewish organizations in the U.S. for some reason decide to support the military against the AKP government and if the military generals wanted to cooperate with an angry Jewish community, which is likely, the AKP could enter into political turbulence trying to maintain its unquestioned power. It has already been reported that:

While Prime Minister Erdogan refused to meet or talk with top Israeli politicians until Tel Aviv agreed to a cease-fire, the Turkish General Staff accepted a briefing on the Israeli version of the Gaza offensive given by Israeli military officials last week. The Israelis firmly believe that the Turkish military is a solid anchor for them (Today’s Zaman, January 15).

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