Analysis: Russia squeezes Mongolia

Oil surged to more than $126 a barrel Friday. As consumers around the world wrung their hands in despair, unease extended to governments under the political influence of larger, energy-rich states, which in the past might have provided energy at subsidized prices in return for political fealty.

In Eurasia, the changing dynamic of the patron-client relationship is nowhere more apparent than in the affairs between the Russian Federation and Mongolia, where the government has been reeling from massive energy price increases. In 2006, inflation in Mongolia, driven by rising food and fuel prices, reached 15.1 percent, its highest level in a decade. Now energy price increases are threatening to push the inflation rate even higher. Since March, Russia's Rosneft, which supplies more than 90 percent of Mongolia's oil, has increased oil prices to Mongolia by 14 percent to 26 percent. In an ominous development for the Mongolian government, last month 20,000 Mongolians demonstrated in the capital, Ulaanbaatar, over rising food costs.

It is ironic that in the post-Soviet space, Russian energy producers have become capitalists par excellence, embracing free-market principles with the fervor of a born-again true believer.

According to the Mongolian media, Russia increased cost for oil products for supply to Mongolia by $54 a ton in April and $62 in May. Mongolian airlines, which import their fuel from Russia, have been similarly squeezed over the last six months, with aviation fuel costs surging by $137-$225 per ton.

Rosneft is not without heart, however, and has offered to lower the price of oil imports if the Mongolian government would allow Rosneft to build 100 gas stations in the capital Ulaanbaatar, Darkhan and Erdenet and some provinces.

It was precisely to ward off this kind of economic mugging that last month Mongolian Prime Minister Sanjaa Bayar made a three-day official visit to Moscow at the invitation of Russian Prime Minister Viktor Zubkov.

In 2007 bilateral trade between Russia and Mongolia amounted to about $670 million, an increase of 28 percent from 2006, with Russian imports accounting for approximately 34.2 percent of Mongolia's foreign purchases, well behind China, Mongolia's leading trading partner. The figures show a lopsided trade imbalance, however, as Russia supplies the strategically critical items of oil and wheat.

During an interview with Itar-Tass, Bayar diplomatically alluded to some of the difficulties in the nations' bilateral trade, saying, "Levying by the Russian side of high customs duties on goods of Mongolian traditional export, high transportation tariffs through the territory of Russia and a necessity in receiving various types of permissions and licenses all hinder the development of trade and economic ties." Ever the optimist, Bayar added that Ulaanbaatar and Moscow intend to increase the annual bilateral trade to $1 billion and Russian investments in Mongolia to $3 billion to $5 billion.

The problem for Mongolia is that Russian control over the country's economy is likely to intensify, not shrink. Sergei Chemezov, head of the state firm Rostekhnologiia, wants to form the world's largest mining and metals company. On April 14 he wrote to Russian President Vladimir Putin that Russian shares in Mongolian Erdenet (49 percent), Mongolrostsvetmet (49 percent) and the Ulaanbaatar Railway (49 percent) should be transferred to Rostekhnologiia. Putin forwarded the letter to Zubkov for consideration. The prize that Zubkov is angling for is the license for Mongolia's Udokan, the third-largest copper field in the world, which has been put up for bidding. Bids are due by May 14, with the Mongolian government making its decision on July 17. If Rostekhnologiia's bid is successful, the company would have a significant impact on the nation's economy, as the mining sector remains the most important branch of Mongolia's national economy, with Erdenet, Mongolrostsvetmet and the Ulaanbaatar Railway providing almost 20 percent of Mongolia's gross domestic product.

Such naked avarice has produced a political backlash among the descendents of Genghis Khan, with the Mongolian government drawing up a bill to submit to Parliament to regulate foreign companies seeking to sell oil in Mongolia. Under the proposed legislation, it would be necessary for foreign oil companies to negotiate sale terms through an approved government office. In an attempt to ward off monopolies, the legislation also proposes that no single oil company would be allowed to sell more than 30 percent of the oil required by the Mongolian domestic market.

During the Soviet era, assistance from Moscow at its height provided one-third of Mongolia's gross domestic product; however bitter Ulaanbaatar may find it, at least in the short term, history seems to be repeating itself. The most notable result of Bayar's trek last month to Moscow was a Russian agreement to supply Mongolia immediately with 100,000 tons of wheat on preferential terms, approximately half of Mongolia's annual needs of 240,000 tons. In an attempt to stave off a crisis, on Wednesday the Mongolian government announced strict price controls on both stored and imported wheat, as well as continuing subsidizing wheat to maintain current prices.

At this point however, the Kremlin has Mongolia over the proverbial barrel. Given the country's extreme geographical isolation, its options are extremely limited, especially as Mongolia's other neighbor, China, in 2004 surpassed Japan as the world's second leading oil importer after the United States. Moscow's capitalists should remember their history before attempting to squeeze Mongolia much further, however. In the 13th century, Mongol armies under Baty and Subedei swept into Russia from the east and conquered the nation, with the subsequent 2-1/2 centuries coming to be known as the Mongol "yoke."