STRATFOR 700 Lavaca Street, Suite 900 Austin, TX 78701 Tel: 1-512-744-4300

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STRATFOR 700 Lavaca Street, Suite 900 Austin, TX 78701 Tel: 1-512-744-4300

GEOPOLITICAL ISSUES AHEAD:

A Monthly Assessment

Introduction

It is important to rethink some of the things happening in Russia. The reforms that are being proposed for the economy are real, but there is an added dimension to consider. There are two factions in the Russian elite. One, built around Vladislav Surkov, is drawn from the GRU -- former military intelligence officers. The second, built around Igor Sechin, is FSB -- former civilian KGB officers. These have been traditional rivals. What appears to be happening is that the FSB officials are being driven out of government jobs and that many of the businesses slated to be closed are owned by the FSB faction.

Putin came to power balancing off these two factions. At the same time, Putin is KGB. We would think that he wouldn’t want to break the balance, and if he did, it would certainly be in favor of his comrades in the FSB. But that isn’t what’s happening. One faction appears to being purged, and it is the FSB faction. There are two ways to look at this. One is that Putin has turned on his old allies -- not impossible at all. The second is that Medvedev is actually making a move against Putin. The second is not what we think is going on, but it is something that can’t be dismissed. We are seeing comments by foreign ministry officials that are contradicting each other on minor subjects, hours apart. It is actually reminiscent of times of instability in the former Soviet Union.

It doesn’t matter to NOV, in any immediate sense, which case we are seeing. Both lead in the near term to increased opportunities for business in Russia, whether Putin has changed his position or Medvedev is forcing him out. But there is one dimension to bear in mind. With a purge of FSB people going on, the chances for instability in Russia at multiple levels are not insignificant. The FSB people know how to play rough and they may not want to pass from the scene quietly. In either scenario, they will be trying to protect themselves from purge, if not at the top level, then down at the level of individual businesses. It will be very important as NOV goes forward to be conscious of which faction it is dealing with and to hedge its bets. Reviewing your portfolio of relationships at this time makes good sense.

The Iranians have refused the demands of the P5+1 on the handling of their uranium and have announced that they will build 10 additional facilities. That’s absurd for three reasons: They don’t have the resources, they don’t need 10 enrichment sites and they already have more that the U.S. knows about-- or at least they believe they have more.[TIM, I don’t understand this part of the sentence. Can you confirm its meaning?]There is no consensus among the P5+1 on what to do. The French want to talk some more. The Russians are saying they condemn Iran but at the same time don’t want sanctions and appear to be moving forward on the civilian reactor. Obama is trying to herd this group into some sort of coalition, but given that he is leaning heavily on the Europeans for help in Afghanistan, he doesn’t have much leverage. The Israelis are quiet. This is the most telling sign. The situation is moving in the direction they wanted and expected and there will be no public pressure or gloating. They are allowing the situation to play itself out. Obama has said that the end of the year is decision time. We continue to see substantial and undiminished risk here. Obama is going to have to deal with this now that the Afghan decision is made.

The Afghan decision is a decision to try for a negotiated settlement. The additional troops being sent really don’t change the strategic reality on the ground, but the hope is that it gives the Taliban a sense that the United States is not folding its hand any time soon, and that at least some of the Taliban will be interested in a negotiated settlement. To the extent that this can work, everything depends on Pakistan. If Pakistan can’t shut down Taliban logistical systems out of Pakistan, or if the Taliban can shut down U.S. supply systems on the Karachi-Khyber route, then the strategy fails.

Two serious dangers exist here. The first is that Pakistan simply destabilizes and the central government loses control over the countryside. The other is that the Iranians begin seriously asserting themselves in Afghanistan, whose western regions are Shiite. There is a danger of increased terrorism in India, as the Taliban will want to force the government into a confrontation with India, to reduce pressure on themselves. This is a supposition at this point, but it follows previous patterns. NOV personnel in India should consider taking basic precautions in the coming months.

East Asia/Oceania

China

December is the last month of a nerve-racking year both economically and politically for China. Beijing appears to have avoided the worst threats of social stability for the year, with growth rates back up to nearly 8 percent -- the official target rate for preserving jobs and to begin creating new ones. This rate was achieved through a surge of bank loans and central government disbursements, and now the urgent question remains: How -- and when -- should Beijing begin easing out of these emergency financial and economic policies to prevent the economy from overheating? December is too early for a major tightening of monetary or fiscal policy (the most likely timeframe for any big moves in that regard would be mid-2010), but the debate will dominate Beijing throughout the month.

Another major concern will be trade relations with the United States. To get through the financial crisis, China has surged exports to keep its manufacturing centers standing. Meanwhile, in the United States,the manufacturing sector is suffering, unemployment is high, China is perceived as stealing market share for U.S. manufacturers and domestic pressure is rising for the U.S. government to do something about it. This contrast in economic recovery strategies has created tensions between the two countries, apparent in the rising number of trade disputeson goods ranging from Chinese tiresto steel pipes to U.S. cars. Both sides are making threats while trying to avoid a full trade war. At the same time, due to a bilateral agreement in November, there is some potential for major U.S. and Chinese companies to cooperate in the areas of energy, high technology and clean technology.

An international carbon emissions reductions treaty will be discussed at the U.N. climate-change summit Dec. 7-18 in Copenhagen, Denmark, that isthe proposed successor to the Kyoto Protocol. China is a critical player in negotiations over a proposed treaty because it is one of the top carbon emitters and the fastest-growing economy in the world. Regardless of environmental questions, climate-change talks are important because global energy-industry players are waiting for predictable signs of new domestic and international laws in order to structure their mid- to long-term investment plans. China has presented itself as the leader of the developing world, arguing that the developed economies should make the biggest sacrifices and investments. China does not appear willing to establish a time frame forimposing binding carbon emissions-reductions targets upon itself. Nor is it clear what the United States will be able to commit to, since the domestic policy in Washington has not been set. No final binding treaty will likely emerge from the summit, but a preliminary nonbinding agreement is possible if the United States and China can work together (so far, it has not been evident that they can).

China and Central Asia

The Central Asian Natural Gas Pipeline (Turkmenistan-Uzbekistan-Kazakhstan-China) will become fully operational on Dec. 15, with 15 billion cubic meters (bcm) of capacity coming online (to be increased to 30 billion by December 2010). Currently, natural gas is a small component of China’s overall energy mix (around 3 percent), but it will become a greater portion as the country’s economy continues to grow. Beijing is also trying to reduce its traditional dependence on coal to diversify China’s energy mix; however, this is happening slowly, with coal in abundant supply and still the country’s most reliableenergy source. Also in December, a natural gas pipeline from Qinghai to Gansu provinces will begin operating.

China also will hold a fourth round of discussions with Taiwan about opening formal negotiations for a free trade agreement (the Economic Cooperation Framework Agreement). Cross-strait relations have improved over the past year, and several major Chinese banks are preparing to invest in Taiwan following the recent signing of a financial cooperation agreement. A free trade agreement would contribute greatly to closer economic ties, though such an agreement would likely still restrict the movement of labor, agricultural goods and other items. Any trade agreement would require considerable political maneuvering on both sides.

Internationally, China will seek to learn more about the new government in Japan, led by the Democratic Party of Japan (DPJ). DPJ Secretary-General Ichiro Ozawa will visit China on Dec. 12, and China’s most likely contender to become the next president, current VicePresident Xi Jinping, will visit Japan (in addition to South Korea, Cambodia and Myanmar) beginning Dec. 17. Regional defense discussions will continue with China’s defense minister visiting North Korea, Japan and Thailand until Dec. 5. China will also watch the beginning of bilateral discussions between the United States and North Korea, which begin on Dec. 8, so as to gauge how well Washington and Pyongyang communicate.

South Korea

The government of South Korea has decided to begin enforcing the twice-delayed 1997 Trade Union Labor Relations Adjustment Act (TULRAA) in January 2010. Two key provisions of the act include ending the practice of a company paying the salary of the full-time union representative at the company and allowing a company to have more than one labor union represented. The TULRAA is seen by the major labor umbrella unions -- the Korean Confederation of Trade Unions (KCTU) and the less militant Federation of Korean Trade Unions (FKTU) -- as a major initiative to break the backs of organized labor, and to some extent they are right. The power of labor unions has waned in Korea since their heyday in the 1980s, but they still represent a formidable challenge to the government in expanding industry and inviting foreign investment, and President Lee Myung Bak's government has vowed to counter the power of the umbrella unions. The labor unions are now considering major nationwide strikes in December to protest the government actions. The Korean Metal Workers Union, whose 140,000 members include many shipyard workers and make up the largest single portion of the militant KCTU, has not yet decided whether it will participate in the strikes. Other disruptions could come from unions covering transportation or port workers. For the KCTU and FKTU, the TULRAA is a fundamental challenge to their strength, and barring a last-minute deal with government and industry, they will strike or risk seeing their power further eroded.

Thailand

The opposition United Front for Democracy Against Dictatorship (UDD) party, known as the “red shirts,” postponed indefinitely a “showdown rally” planned for Nov. 28-Dec. 2, preceding the king’s birthday. One million people were expected to take part in the protest against the administration of Prime Minister Abhisit Vejjajiva, whom they hope to see ousted from power before year’s end. In any event, the king is ill and will not be making his customary birthday address, and it is time now to monitor the king’s health and watch for any comments made by the crown prince.

There are additional stressors in the mix. Tensions between Cambodia and Thailand that have been simmering for months over border demarcation spiked recently when Cambodian Prime Minister Hun Sen offered ousted Thai Prime Minister Thaksin Shinawatra a position in the Cambodian government as an economic advisor. Also exacerbating tensions was the recent ax murder in Thailand of a Cambodian worker by his Thai co-worker over political differences. Hence, the UDD rally could trigger nationalist backlashes, with localized violence spreading rapidly with little central control.

Eurasia

Russia
In recent months, Russia has been discussing major economic reforms that envision privatizing thousands of companies and bringing foreign investment into strategic industries, particularly the energy sector. These discussions were officially endorsed during the 11th national congress of the ruling United Russia party in St. Petersburg, which concluded Nov. 21, with both Russian President Dmitri Medvedev and Prime Minister Vladimir Putin stating that the reforms will be enacted. The details are still being debated and will be further hashed out in December, with the first new energy laws likely to take effect in January. Meanwhile, asset-swaps and investment deals are already starting to be proposed with such Western energy majors as Total, GDF and E.ON. Putin has put his weight behind the reforms, but he will be careful to control how quickly and how deeply they are carried out due to their political undertones and the resulting clan war that is now taking place.
Ukraine
Ukraine's monthly natural gas payment will again come due on Dec. 7, this time with only a little over a month before the Ukrainian presidential election is scheduled to take place. Ukrainian Prime Minister Yulia Timoshenko has already wrapped up a deal with her Russian counterpart Vladimir Putin that lays out terms for natural gas purchases in 2010. These terms include removing the 20 percent discount off European prices that Ukraine receives and instituting a 60 percent increase in transit fees that Ukraine will charge Russia. This deal has ostensibly stabilized the energy relationship between the two countries, but Ukrainian President Viktor Yushchenko has called for the terms to be changed. With an eye toward undermining Timoshenko's candidacy in the election, Yushchenko has gone so far as to take control of the National Bank of Ukraine (the country's central bank, which transfers funds that the state oil and natural gas firm Naftogaz uses to make payments) in order to prevent Timoshenko from making payments. This has caused Timoshenko to seek other payment methods, and it is sure to make Ukraine’s energy relationship with Russia more volatile as the election approaches.
Central Asia
December will be a month in which two significant Central Asian natural gas pipelines are set to come online. The first, a pipeline from Turkmenistan to Iran, is projected to supply 6 bcm of natural gas to Iran in 2010 and could double its capacity in the coming years. The second is the natural gas pipeline from Turkmenistan to China (mentioned above) that will send 10 bcm of natural gas the first year and has the capacity to send 30 bcm. Both pipelines -- and particularly the Turkmen-Chinese line -- are significant in that that they are the first real projects that serve to divert Central Asian energy supplies away from Russia. The two pipelines present the region with many opportunities, such as hooking its vast resources and infrastructure with energy-hungry China.Azerbaijan is also interested in sending its natural gas to China via the Trans-Caspian pipeline project.

But the pipelines pose issues and challenges as well. Azerbaijan and Turkmenistan have had bitter disputes over legal boundaries on the Caspian Sea and in natural gas fields in the area, making cooperation between the two countries difficult. Also, Russia owns the majority of Turkmenistan’s energy infrastructure and would ultimately be in control of energy flows to China as well as to Iran. This means Moscow could turn off the spigot if it deemed it politically necessary. Yet another problem is that the Turkmen-Chinese pipeline could give rise to regional tensions in Central Asia. The line transits Uzbekistan and Kazakhstan and will earn the two countries generous trans-shipment revenues. This gives both countries substantial leverage, especially Uzbekistan, which Russia views as a rising star in the region and a substantial threat. STRATFOR will continue to monitor the situation closely for any potential roadblocks as the pipelines come online.
Nord Stream
Significant headway has been made on the Nord Stream pipeline, with countries such as Sweden, Finland and Denmark all allowing their territorial waters to be used in the joint venture between Russia and Germany. STRATFOR sources have reported that technical issues have largely been settled, with the initial projection of $20 billion for the pipeline being revised to a more manageable $12 billion. Russia has agreed to provide 68 percent of the financing, roughly $8 billion, while Germany would cover approximately $3 billion to $4 billion and the Netherlands would provide around $1 billion. Construction is now expected to begin in December and the first leg of the pipeline could be operational by late 2010. If construction costs exceed expectations, France and Austria would likely be eager to step in with extra financing in exchange for stakes in the project. The Nord Stream pipeline, which represents the growing economic relationship between Russia and Germany as well as Europe’s willingness to work with Russia on energy projects, also will increase Russia’s geopolitical influence in Europe.