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February 18, 2005

America on a Collison Course with Russia
by T. Stein / S. McIntyre

In 1941, it was oil that prompted both Germany's invasion of the Soviet Union and Japan's attack on America. The United States had recently imposed an embargo on petroleum exports to Japan after concern arose about Japanese attempts to gain control over the oil reserves of the Dutch East Indies. This emboldened Japan to go to war with America. In the War's European theater, the German Luftwaffe & mechanized armored forces were extremely concerned about the depletion of their oil supplies. An attempt to capture the Soviet oil stronghold of Baku was Hitler's answer to Germany's desperate need for petroleum. Although both Axis powers' invasions ultimately failed, the idea of oil being the lifeblood of combat and commerce became universally accepted around the world in the years ahead. Access to petroleum and other natural resources were critical in the negotiations among the "big three" victors of World War II.

Two generations later, the United States finds itself as the world's largest importer of oil by a wide margin. The USSR has collapsed and the various former Soviet republics found themselves sitting on enormous reserves of oil and natural gas ready to be exploited by Western energy firms. As a side effect of the War on Terror, America was able to use its invasion of Afghanistan as a pretext to increase its military presence in the Caspian Sea basin of the former Soviet Union.

The Caspian Sea, surrounded by Russia, Iran, Azerbaijan, Kazakhstan and Turkmenistan contains the one of the world's largest untapped supplies of petroleum and natural gas. Given that the House of Saud is teetering on the brink of collapse, American leaders have sought to lessen their dependence on Persian Gulf oil by developing Caspian energy resources. Russian leaders don't exactly see it this way as they worry about what they perceive as America attempting to diminish Russia's control of the region's pipelines. America has made no secret that it desires Western oil companies to bypass Russia when new Caspian pipelines are created. An infuriated Russia has responded to these attempts by challenging the Caspian territorial claims made by its former republics as well as trying to disrupt pipeline creation in Georgia.

Of all the Caspian Sea Basin states, the Republic of Georgia has perhaps received the most attention from the United States. In an effort to lessen the country's dependence on Moscow, the U.S. dramatically increased its military & economic assistance to Georgia in the late 1990s. Stability in Georgia is essential for the construction of an American-backed pipeline that would run from Baku, Azerbaijan through Georgia to Turkey's Mediterranean port of Ceyhan - avoiding Russia & Iran.

Russia realizes this, and has done and will continue to do what it can to prevent stability in Georgia. Russia maintains a large "peacekeeping" troop presence in Georgia's two autonomous republics of Abkhazia and South Ossetia. Many Ossetians do not see themselves as Georgians and are fighting (with Russian acquiescence) against Georgia's attempts to reintegrate South Ossetia into its territory. Georgian president Mikheil Saakashvili (who came to power in a Western-backed coup) has repeatedly accused Russia of doing what it can to promote crisis in South Ossetia. Russia of course denies this, but the evidence shows that Russia has been illegally using the Rocki Tunnel, a roadway connecting the Russian autonomous republic of North Ossetia with South Ossetia, to move military supplies into the territory. Another interesting and little known fact is that the US already has (since 2002) a troop presence of its own in Georgia, which is on its way to becoming a NATO member.

Russia's main Azerbaijan-Novorossiysk pipeline route transits through its breakaway republic of Chechnya. Similar to how instability in Georgia is detrimental to America's pipeline plans, the crisis in Chechnya is devastating for Russia's oil transport system. Despite America's broad condemnation of terrorism, the indirect beneficiaries of the Chechen war are the American energy companies competing for control over Caspian pipeline corridors. Russian president Vladimir Putin, who has accused the West of giving asylum to Chechen terrorists, has recently warned America "not to interfere in our Russian internal affairs."

In 1921, Iran and the USSR signed a treaty providing for shared jurisdiction of the entire Caspian Sea with a tiny exception for coastal fishing zones. When the Soviet Union broke up, Russia (with Iranian support) insisted that the 1921 treaty remain in force while the new nations in the Caspian (with U.S. support) wanted to evenly divide up the sea among the littoral states. While some negotiating goes on, Iran and Russia continue to insist that they get in on all the action through joint development of all offshore areas.

In addition to drilling politics, Russia and Iran have recently increased military cooperation. Moscow has ignored Washington's repeated protests over the proliferation of its advanced weaponry and technology to Iran, particularly technology that could be used in producing nuclear weapons. The U.S. State Department has repeatedly urged Russia to cease all such cooperation with Iran, including its assistance with the light water reactor at Bushehr. On the State Department's Web Site, it says, "we believe Iran uses Bushehr as a cover and a pretext for obtaining sensitive technologies to advance its nuclear weapons program." The administration has said it "will not tolerate" a nuclear Iran, which means that it may try to destroy what Russia is building.

Just days before the U.S. invasion of Iraq in 2003, pictures on the Gazeta.ru Web Site showed two retired Russian generals receiving medals from Iraqi officials, including the Iraqi minister of defense. One general an AAA specialist, the other an expert on Special Forces operations, the two had made 20 trips to Iraq over a two year period to train the Iraqi army in their fields of expertise. Add to that a Washington Times report that Russian Spetsnaz (special forces) troops "moved many of Saddam Hussein's weapons and related goods out of Iraq and into Syria" in the weeks before the war, and one can clearly see that Russia was part of an organized effort to move weapons out of the country in order to prepare for a pro-Saddam insurgency. The Times article goes on to say that "Defense officials believe the Russians also can explain what happened to Iraq's weapons of mass destruction programs."

In December, you can probably remember the heated run-off election in Ukraine between Viktor Yushchenko and Viktor Yanukovich. Yushchenko was backed by the West while Yanukovich (the current Prime Minister) was backed by Russia. You could recognize Yushchenko supporters on television in their trademark orange garb. Yanukovich supporters had taken up light blue as their color of choice and seemed to be concentrated in Ukraine's Eastern industrial regions.

It was discovered that Yushchenko was poisoned (by dioxin) several months ago in an apparent attempt to knock him out of the race. Yushchenko's face became littered with pock-marks and the 50-year-old pro-Westerner had been spending lots of time in an Austrian hospital receiving treatment. Yushchenko had become somewhat of a hero in the Western press while Yanukovich was seen as some sort of evil tool of Russia and its KGB remnants.

You can probably guess that the Yushchenko victory was a severe blow to Russia and a windfall to America and the West. Various oil pipelines that were originally intended to transport Caspian oil to the West (but instead pumping oil into Russia) will be redirected. One of these is the Brody pipeline which runs between Brody, Ukraine and the Black Sea port of Odessa, Ukraine. Also, Mr. Yushchenko will likely seek to bring Ukraine into NATO and the European Union. Ukraine's capital Kiev, once a Russian city and older than Moscow, is seen by Vladimir Putin as an important frontier of Russian economic and geopolitical power.

So what is the next flashpoint in the series of Russian-U.S. conflict? Will the mighty Russian bear launch an all out attack on American interests in Eurasia? We do not think so. In fact, recent actions by the Russian Central Bank may give us a clue. On December 8th, the chairman of the Russian Central Bank, Sergei Ignatyev, told members of the State Duma that the Central Bank is considering a change in the composition of its foreign exchange reserves, decreasing the shares of U.S. dollars. This is the same type of economic warfare we expect from China in the coming years. The first point: the dollar decline we have seen over the last two years may just be getting started. The second point: expect to hear more about an energy-inspired alliance between Russia & China, and possibly Iran.

Todd Stein & Steven McIntyre
Texas Hedge Report

Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets. For more information, go to http://www.texashedge.com

Copyright © 2004-2008 Todd Stein and Steven McIntyre

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