Ukraine pact between Germany and Russia may deal blow to dollar

By Chris Cook

The shape of a German/Russian energy security for land security deal – a “Resolution Trade” – is becoming clearer by the day.

As reported in the Independent, a “peace plan” for Ukraine being discussed by German Chancellor Angela Merkel and Russian President Vladimir Putin aims to stabilize Ukraine’s borders and boost the country economically, with an energy agreement to ensure gas supplies. If Merkel’s deal “were to be acceptable to the Russians, the international community would need to recognize Crimea’s independence and its annexation by Russia”, the report says.

Having achieved resolution, a broader future energy diplomacy based on the “Transition Trade” – the exchange of the value of knowledge and knowhow (IP) for the value of carbon fuel saved – is then possible.

End of dollar diplomacy
In my analysis, US dollar hegemony came to an end in Iraq in 2007 in a “Suez Moment” – when China exercised a similar economic veto over US energy adventurism to that exercised in 1956 by the US over the UK over Suez. From that point on, I believe, the world has been militarily unipolar and economically bipolar.

Since the collapse of Lehman Brothers in 2008, the global dollar economy has been functionally dead and in zombie mode. Those who believe that the BRICS countries – Brazil, Russia, India, China and South Africa – are capable of creating an alternative bank-centric global reserve currency simply do not understand how deficit-based money creation systems work.

In relation to the Ukraine, there are two key factors to consider. Firstly, the US is no position to intervene militarily. Secondly, the trusting relationship between Chancellor Merkel and the US was terminally destroyed by the Snowden and subsequent US spying revelations.

As a result, Germany is now both politically willing and economically able to pursue its own energy diplomacy on whatever terms Merkel thinks fit. Crimea is ethnically Russian; was the subject of an internal transfer to Ukraine within the USSR by Khrushchev; and whatever the US and UK choose to make of it, Merkel is quite prepared to cede it to Russia in exchange for suitable guarantees.

Ukraine politics has only ever been about control of gas resources and flows, and battles between oligarchic factions seeking control of the revenues. What we have been seeing in eastern Ukraine is what happens when the Mafia gets tanks.

A political deal between Russia and Germany along the lines of that reported in the Independent will definitely occur and will provide at least a temporary resolution. What is less clear is exactly how the current oligarchic structures will transition into the emerging networked economy. Some fear a 1930s-style outbreak of fascism and nationalism, but in my analysis global politics is making the very concept of nation states obsolete in favor of more fluid and border-less institutions based upon mobile communications and pervasive direct instantaneous connections.

Energy cooperation
The sheer scale of the opportunities for energy co-operation in the Ukraine were illustrated in a presentation by top Ukraine gas officials at an oil and gas conference in Istanbul last year.

One of them made the staggering admission that of the Russian natural gas which enters the east of Ukraine only 50% exits western Ukraine to European Union buyers. While some is diverted who knows where, most is either used profligately by a population used to free Soviet era gas, with the rest wasted in enormously inefficient – but reliable – Soviet-era gas transmission infrastructure.

An EU funded report by the global engineering consultants Mott MacDonald demonstrated how 3.2 billion euro (US$4.3 billion) investment in upgrading Ukraine’s pipeline infrastructure would pay for itself in a minimal time-frame, and this was just the beginning. The problem for technology providers such as Siemens – whose state-of-the-art gas compressor technology was on show in Istanbul – is how to successfully engage and be paid in countries like Ukraine with problematic legal and financial infrastructure.

The current gas market model is for Russian gas to be sold as a commodity through a chain of Ukrainian and EU intermediary middlemen who extract profits either opaquely or relatively transparently.

This is no longer sustainable, and the solution is now for a market model – “Gas-as-a-Service” – whereby neutral gas market service providers receive an agreed payment for developing and operating the necessary infrastructure and market platform.

The enabling financing and funding comes not from conventional equity and debt finance capital – which are useless where the rule of law is weak – but rather from the use of prepay credit instruments issued by suppliers like Gazprom and returnable in payment for natural gas supplied.

Through this simple but radical mechanism – which has already been the subject of a direct US$85 billion crude oil transaction between Russia’s Rosneft and China’s Sinochem – it is possible for producers to financially engage directly with end-user consumers.

This then opens the way firstly to networked Eurasian physical energy markets and pricing hub benchmarks and secondly to a financial “Energy Clearing Union” agreement whereby energy producers and consumers engage in mutually guaranteed generic energy and value exchanges.

The use of generic energy credit instruments for financial settlement enables bank-manufactured currencies such as dollars and euros to be dispensed with other than as a unit of account or numeraire.

There is no reason why such a unit of account must necessarily be the dollar: and Chancellor Merkel would appreciate the possibility of euro pricing.

Chris Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and commentator.

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