Why high oil prices are good for Estonia

Russia's recent strong-arm tactics over Ukraine have cast a shadow over all the former Soviet countries of Eastern Europe. But Estonia is taking steps to ensure that it can survive even if its energy supplies are cut off by Moscow, says Kevin Kerr in The Daily Reckoning.

Diminutive and beautiful, the Republic of Estonia has always been an easy target for the region's bullies. Suffering a long history of heavily armoured invaders such as Germany and Russia, the tiny republic has endured as a colonial territory for nearly a thousand years.

Estonia's main attraction to invading armies is its seaport, Tallinn. Extremely deep and ice free, Tallinn has been a major hub for shipments between the Baltics, Russia and the West.

Even as Estonia tries to grow a high-tech industry, the port continues to serve as the primary source of economic growth. Through it flows 30 millions tons annually - some 75% of it cargo. And the thing you really need to know is that the biggest moneymaker is oil.

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And Estonia's biggest oil carriers are Pakterminal and Estonian Oil Service (EOS). Bringing up the rear as No.3 is Eurodek. All of these heavy fuel oil operators are headquartered in Muuga Harbour, which is part of the Port of Tallinn. By posting record profits, Pakterminal, EOS and Eurodek have attracted a slew of regional competitors. As the shares of the pie grow smaller, we can expect this market to sustain growth of approximately 7%.

Originally, the railroads carried crude from the Russian oil fields. Since then, the facilities have evolved with the times. Today, Estonian oil terminals handle more profitable shipments of refined products.

The lone holdout is Lonessa AS. It is owned by Nordic Terminals BV, which in turn is a holding of Taurus Petroleum Ltd. Unlike other regional terminals that are connected to the Russian pipeline system, crude shipments are carried by rail through Estonia to Tallinn. That has not deterred Lonessa from building a new $30 million oil terminal in Tallinn, however, in February 2005.

Quoted in InternationalReports.com, of The Washington Post, Lonessa's director John Madsen said: 'We decided two years ago that it would be an extremely good idea to go through Estonia...Tallinn has the best port in the Baltic States; it's deep, ice free and accessible.

'Access for big ships is, of course, extremely important. This is a very competitive business, and big ships means lower transportation costs per ton. Every cent that we can gain is important. Our terminal will be dedicated to crude oil, because that's the Taurus business.

'However, having said that, we will build the terminal according to the most modern standards and make it flexible, which means we will install the tanking capacity so that it could take fuel. Maybe Russia cuts off the supply one day. We are preparing for that as well.'

While a $30 million expansion for a US oil giant would barely draw a second glance, Lonessa's current project makes it one of the five biggest investments in Estonia - ever! What Lonessa will get for its money is a terminal with a 3 million ton annual capacity, most of which will be fuel oil. That amounts to 12.5% of Estonia's 24 million tons shipped through the port last year.

Seesawing oil prices have impacted global profits, but it's surprising that among the Baltic countries, Estonia fared better than most. Estonia's oil transport industry, and economy in general, have stood up well against market forces.

Unfortunately, other former Soviet states are getting hit hard by geopolitical shockwaves. The bare-knuckled fight between Russia and Ukraine over natural gas prices has dominated oil-industry headlines. And the consensus is that Russia is trying to pound the Ukraine into submission after it elected pro-Western President Viktor Yushchenko in 2004.

Ukraine finally threw in the towel to Russia's price gouging - leaving it vulnerable to a major economic meltdown. By ending subsidised natural gas prices to the Ukraine, Russia stands to extract an extra $1 billion in lieu of political influence.

Now we can expect similar Kremlin strong-arm tactics in other former Soviet states that have turned pro-West, pro-NATO and pro-European Union. Among them are Estonia, Georgia and Moldova.

Taking it straight from the horse's mouth, Russia's Finance Minister Alexei Kudrin recently told the RIA Novosti news agency, 'The time when we built relations by quasi-subsidising neighbouring economies is gradually passing. We must think about our own interests.'

But unlike Ukraine's spanking, Gazprom plans to continue subsidising natural gas prices for Belarus, for which it charges $47 per 1,000 cubic meters. Russia's party line is that prices are kept low because Belarus has allowed Gazprom to own a gas pipeline there and to lease the land it uses long-term. Many political analysts, however, attribute the friendly pricing to the country's firm political alignment with Moscow. The leader of Belarus is a puppet dictator himself, whose strings (or chains) are pulled (or yanked) by the Kremlin.

As with many things Russian, subtlety takes the form of a baseball bat on the negotiating table. In short, the message is that any pro-Western Baltic country still lives in the shadow of the Kremlin. Just the way Russia wants it.

In the meantime, a $1 billion increase in natural gas could nearly cripple the Ukraine's slow-growing economy. The country's chemical and metal industries, which are heavily dependent on natural gas, would be particularly devastated.

The Kremlin has no reason to be charitable or cooperative. It knows quite well that a backlash to higher home heating bills could undermine the Ukraine's parliamentary elections in March.

In the end, 'comrade' could be the new operative word in the Ukraine later this year.

By Kevin Kerr for The Daily Reckoning

With 15 years of experience, Kevin Kerr is a true veteran of the commodities markets. A licensed commodities trader since 1989, he's worked the trading pits in Chicago and New York with legends like Paul Tudor Jones. Over Kevin Kerr's career he's dealt with everything from cotton to currencies to oil and natural gas. Today he's co-editor of Outstanding Investments, the natural resources advisory. Its track record for recommending stock market investments topped an independent table of US newsletters in 2005.

If you'd like to learn more about Outstanding Investments, see below...