Factors that Could Transform the Shanghai Cooperation Organization Into a More Powerful Entity

The 14^th Summit of the Shanghai Cooperation Organization (SCO) was held from September 11^th to September 12^th in Dushanbe Tajikistan. Though security concerns resulting from the United States’ withdrawal from Afghanistan and the economic consequences of sanctions against Russia due to the crisis in Ukraine dominated the meeting, fora such as this serve as useful venues for regional powers to discuss common concerns. Given that SCO is looking to admit new members this could increase the utility of the organization. For these reasons an understanding of SCO is more important than ever.

The Shanghai Cooperation Organization was formed in June 2001 by the Republic of Kazakhstan, the People’s Republic of China, the Kyrgyz Republic, the Russian Federation, the Republic of Tajikistan and the Republic of Uzbekistan. The stated goals of SCO were to cooperate on issues of concern such as security, environmental degradation, and economic cooperation and development. Despite some successes in combating terrorism, narcotics trafficking, and smuggling SCO faces significant limitations in its ability to project power. A key limitation of the organization is its refusal to interfere in the internal affairs of other countries. All of the members of SCO have domestic problems to which they are sensitive to thus any action on the part of SCO members that could be perceived as sanctioning intervention could set a precedent that would serve as justification for the international community to interfere with the internal affairs of these countries. This is why such precedents will be avoided. This reality begs the question, "How can an entity project power if it refuses too?" This reality combined with other internal tensions, such as Russia and China’s ambition to dominate the organization, means that effective power projection is unlikely anytime soon.

Despite structural factors which limit the Shanghai Cooperation Organization’s ability to project force beyond anti-terrorism/law enforcement operations the organization’s activities should be monitored as it is possible that greater economic cooperation amongst members and neighboring states (the so-called Silk Road Economic Belt) could lead to the further development of Central Asian energy resources. Two key questions we should be asking are:

• How effective is SCO as a forum for formal and informal discussions of member and observers such as Iran, India, and Pakistan?

• What factors exist that could encourage cooperation or conflict?

The first question will be answered largely by whether or not there are enough factors to encourage cooperation (aside from border security and anti-terrorism/joint law enforcement operations) amongst states with differing interests. To a degree we might be seeing such an alignment of interests now. Essentially, we have a group of countries all of whom have a vested interest in further developing the energy sector of Central Asia while limiting Western interference in the region. There are several developments that have and/or are emerging whose implications we must ponder:

• The sanctions imposed on Russia due to the crisis in Ukraine has led Moscow to impose import bans on Western products and forced Russia to seek new markets for its oil and natural gas.
  May’s 30 year 400 billion USD natural gas deal between China and Russia is an example of this eastward shift. (Russia got a very poor deal here as Moscow was desperate to secure a deal and Beijing knew it had all the leverage).

• China is actively working towards developing its interior. Access to cheap energy is an essential component of this strategy. Central Asia can serve as such a source.

• Many Central Asian countries’ economies are heavily tied to Russia and are dependent upon remittances sent back from expatriate workers residing in Russia. A fluctuating ruble or a reduction in remittances is heavily damaging to their economies so they have a vested interest in ensuring that Russia is making money. If Moscow cannot profit off trade with the West it will have to look elsewhere. Clearly, this is what Russia is doing. Central Asian countries have an interest in facilitating this process.

• Interest in developing the energy resources of the Caspian is growing while factors that have limited development in the region are arguably diminishing. Traditionally, Azerbaijan has been the dominate player in the region vis-à-vis energy exports but if the Trans-Caspian Pipeline were built and sanction against Iran were dropped Turkmenistan and Iran could both become significant energy exporters. Russia has opposed the Trans-Caspian Pipeline as it would undermine Moscow’s ability to force countries to respect Russia’s will or risk having their energy supplies cut off. Iran has significant supplies of natural gas but due to sanctions has been unable to attract the capital and technical know-how to best exploit them. Russia will of course do what it can to prevent competition from developing however Moscow is facing constraints that it did not have to contend with prior to the crisis in Ukraine. It is not impossible that we will see greater investment in the Caspian. The question is how involved will Russia be? The Caspian 5’s summit on September 29^th could provide some answers. If some of the territorial disputes over the Caspian were resolved amicably it would set the stage for significant investment in the region. If this were to happen it would indicate that Russian companies would have a privileged position in any consortium which would exploit the resources of the Caspian.

All of these developing stories have the potential to influence global energy markets. For this reason it is more important than ever to keep tabs on summits such as the annual meeting of the Shanghai Cooperation Organization. This will become even more true if India, Pakistan, and Iran were ultimately admitted to SCO. There are of course reasons that can prevent these countries from joining the organization. Russia wants India to join to weaken Chinese influence in SCO. If this were to happen China would want Pakistan to join to offset India admission. Meanwhile no one really trusts Iran and SCO members currently use the sanctions against Tehran to justify not offering admission. Despite these challenges it is difficult to argue that SCO truly represents Eurasia if these countries are not admitted. However, one does not need to be a member of the Shanghai Cooperation Organization to work with it. It will be interesting to see if the factors discussed earlier makes SCO into a more important organization.

Russia’s Shift to the East and It’s Potential Impact on September’s Caspian 5 Summit

On Wednesday May 21st Russia and China agreed to a 30-year natural gas deal worth $400 Billion. This agreement serves as a clear indication that Moscow recognizes Russia’s need to diversify its client base. Though all of the terms of the deal are unclear it would appear that the Chinese were able to get the pricing that they wanted (a factor which had delayed this deal for a decade). Moscow would not have agreed to China’s price if it were not in Russia’s interest. In the past this price was not beneficial for Russia but recently a variety of factors such as Iranian-American détente, the situation in Ukraine, and the reality that Russia will be facing demographic challenges in the coming years has changed the equation. The deal will allow Russia to demonstrate that it has options other than European market as well as affording Moscow the opportunity to focus its attention on other areas where its interests are threatened. The Caspian is once such place.

On September 29th the Caspian 5 (Russia, Azerbaijan, Turkmenistan, Kazakhstan and Iran) will meet in the Russian city of Astrakhan to discuss the management of the Caspian Sea. This summit could serve as a starting point for Russia to ensure that Russian companies have a stake in any potential agreement which would see oil and natural gas pipelines running through Iranian or Turkish territory. Such a move would give Russia a degree of control over energy resources that bypass Russian territory and would presumably be lucrative. In the past it was in Russia’s interest to hinder the development of transit routes which did not pass through Russian territory. Now Moscow’s ability to interfere could be weakened especially if Turkey, Iran, Azerbaijan and Georgia cooperate. If the infrastructure is going to be built and Russia is less dependent on European markets Moscow could have a financial interest in aiding the exploitation of energy resources rather than hindering projects. It is also possible that Russia could have a degree of control over the operations of key infrastructure. Pipelines that bypass Russian territory are by no means an ideal development for Russia but if this outcome is inevitable Moscow will ensure that the situation evolves in the manner that is most beneficial to Russian interests. The fact that Russia is a significant regional player means that it has leverage. Even in a weakened state Moscow can project power. For example, in 1993 Russia demanded that Lukoil be awarded a 10% stake in a consortium to develop Azerbaijan’s offshore oil fields. Baku consented. Given that China will have a 19% stake in Rosneft means that Beijing might also become a player in the region as well if Rosneft is involved in any deals (a likely scenario). This would add an additional dimension to the geopolitical situation in the Caspian.

Wednesday’s deal allows Russia to demonstrate that in the coming years it will have alternatives to the European market. The reality is that Europe has an interest in diversifying its energy supplies while Iran, Azerbaijan and Turkey appear to be coming to some sort of agreement which could potentially see the development of transit corridors which link Caspian energy resources to the Mediterranean and the Persian Gulf. The United States also has a variety of interests in undermining Russia’s energy exports. Essentially, this shift is inevitable.  Moscow clearly understands this and is now making the best arrangements that it can. The terms of the China-Russia gas deal seem to favor Beijing. That said, Moscow is powerful enough to presumably force agreements in the Caspian that will favor Russia. September’s summit will provide insight into how this story will progress.   

Why Russia Will Ultimately Compensate Ukraine for Crimea

Currently, Moscow is facing sanctions from the West (toothless though they may be), there is a significant military build up on the Ukrainian border and, according to the IMF, Russia is in a recession with more capital expected to flee the country. For these reasons the idea that Russia would pay Ukraine for Crimea is not a widely held belief. However, in the long term there are several factors that make it likely that Moscow will ultimately offer some form of payment to Kiev.

Despite current geopolitical and economic obstacles Russia is relatively strong, however, the country is facing significant demographic challenges. Per the World Bank, 1988 was the last time the Total Fertility Rate was 2.1 (the replacement rate). From 1991 to 2011 this metric has fluctuated between 1.2 and 1.6 while the dependency ratio is 40 and growing. This means that Russia will likely be weakened both economically and militarily in the coming decades. For this reason Moscow has an incentive to cement agreements that protect Russian interests while the country is experiencing a period of relative weakness. Sooner or later legitimizing the possession of Crimea via some form of compensation will be necessary. Though the deal will have been forced, it will also have been finalized.

Ukraine owes a significant amount of money to Russian companies, such as Gazprom, as well as international lenders (e.g. the IMF), and a variety of European banks and businesses. By compensating Ukraine for the annexation of Crimea Moscow would essentially be disbursing money which would ultimately flow back into the Russian economy while simultaneously protecting the interests of its European business partners. Essentially, the end result would be that Russia forced the sale of a territory of strategic importance to Moscow since it had become clear that Kiev could not be counted on the protect Russian interests. With the deal legitimized, Ukraine’s debt would be pared down to more manageable levels. That said, a Ukrainian default is still a very real concern. The IMF did not authorize a $17.1 billion bailout out of charity. The financial contagion that a Ukrainian default would engender would be extremely problematic to say the least and thus must be prevented. The IMF deal requires raising taxes and energy prices. Given that Kiev could not afford discounted gas it is unclear how Ukrainians will deal with this price hike. For this reason continued political instability in the country is likely. Despite this problem, any capital inflow (especially a compensation package that does not need to be repaid in the manner that a loan would) could put Ukraine on a path to ultimately regain a degree of economic self sufficiency and in theory become a stronger trade partner for both Russia and Europe. This process will not be easy and will need to be monitored closely.  

Maintaining a favorable buffer against neighboring countries has long been a key concern of Russia. This is why ensuring the compliance of states such as Ukraine and Belarus has been a strategic imperative for Moscow. The leverage that comes with controlling the energy supply for many of its neighbors has been a useful foreign policy tool for Moscow in recent years. Not surprisingly Russia’s neighbors do not like this dependency. There are movements to undermine Russia’s leverage which naturally goes against Moscow’s interests and if Russia is distracted with Ukraine it has fewer resources to undermining these movements. There are numerous areas of concern for Moscow. For example, it is likely that US-Iranian détente will result in the development of energy pipelines linking the Caspian to the Persian Gulf and the further development of infrastructure connecting Azerbaijan with Turkey. We are already seeing some improvements in Azeri-Iranian relations that testify to this. September’s meeting of the Caspian 5 (Russia, Azerbaijan, Iran, Kazakhstan, and Turkmenistan) will be an important summit to monitor. Another story to follow is the memorandum of intent that Ukraine and Slovakia signed on Monday April 28^th. If the deal goes through the reverse flow of gas from Slovakia into Ukraine will commence in October. This will reduce Ukraine's dependency on Russian gas. Presumably, Moscow will try to undermine this deal.

While compensation for Crimea will not likely be paid out anytime soon such an action would help legitimize Russia’s claim to Crimea and could help ensure potential investors that the country is safe for business. Keep in mind it is in both Moscow’s and Western businesses’ interest to keep political instability in Russia at a minimum. Compensation is a means towards that end. For this reason, if Moscow starts making noise about offering some form of compensation for Crimea it could be a sign of improving business conditions in Russia.  

The Potential Impact of Improving Azeri-Iranian Relations on the Extraction of Oil and Natural Gas from the Caspian Sea

Last week Azerbaijani President Ilham Aliyev met with his Iranian counterpart Hassan Rouhani and Iranian Supreme Leader Ayatollah Ali Khamenei in Tehran. These meetings mark a significant step towards improving relations between the two countries which have been strained in recent years due to Iran’s displeasure with Azerbaijan’s positive relations with the United States and Israel, Azerbaijan’s distaste for former Iranian President Mahmoud Ahmadinejad, and accusations from both sides that the other side was interfering with their internal affairs. The potential for US-Iranian détente and fear over Russia’s actions in the Caucasus have removed an impediment for dialogue and created an incentive to cooperate respectively. Such cooperation could have a significant impact on regional energy cooperation which will likely affect global energy markets.

One result of improved Azeri-Iranian relations could be the development of oil and natural gas pipelines that link the Caspian Sea to the Persian Gulf. Such a route was not feasible in recent years for a variety of reasons such as poor relations between Baku and Tehran, US Sanctions, and Russian pressure. Now we find ourselves in situation where Azerbaijan has an interest in improving relations with Iran while knowing that such an attempt is unlikely to damage Baku’s relationship with Washington. In fact Washington will likely support such a move as the US has an interest in undermining Russia’s energy policy. The EU and Turkey will also support an improvement in Azeri-Iranian relations as Brussels and Ankara  have a long-term interest in diversifying their energy supplies. Such a move goes against Russian interests. It should be noted that during the visit President Aliyev was quoted as saying, "Many powers do not want a friendship between Iran and Azerbaijan, and are after disrupting this relationship. The officials of the two countries must make efforts to counter these steps." Presumably he was talking about Russia.

Russia’s regional military presence puts pressure on Azerbaijan which forces Baku to exercise caution with regards to any actions that could undermine Russia's energy interests. Currently, Russia has troops based in neighboring Armenia and in the Georgian break away republics of South Ossetia and Abkhazia. At the present there is no indication that Moscow has any plans to invade Azerbaijan. That said, Russia annexation of Crimea and the 2008 Russian-Georgian War serve as testaments that Moscow will act decisively to protect Russian interests. Suffice it to say Russia's regional military presence does not sit well with Baku. By improving relations with Iran and maintaining positive relations with Turkey and Georgia, Azerbaijan could gain support against Russia. An indicator that will likely precede significant energy cooperation is a security agreement between Tehran and Baku with the potential involvement of Ankara and Tbilisi. The reality is that significant cooperation in the region goes against Russian interests thus a credible deterrent will need to precede any developments in energy policy that go against Moscow’s interests. Azerbaijan by itself is too weak to counter any threats from Russia, however, if Baku is credibly backed by Tehran and Ankara, Moscow will have to be more careful in how it responds to any shifts in Azerbaijani energy policy that go against Russian interests.