Why Russia Is Bailing Out Iceland

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Arni Torfason / AP

A man walks out of a Landsbanki bank branch in Reykjavik. The bank, which was nationalized on Tuesday, negotiated a $5.4 billion loan from Russia to shore up Iceland's finances amid its financial crisis

At the same moment Iceland, a NATO member and until very recently a prosperous Western nation, seemed ready to bite the dust in the global financial crisis, a cavalry rode to the rescue, just as it does in the movies. Except the cavalry in this case came from an unexpected direction: Russia.

Why would Russia promise $5.4 billion to bail out Iceland, when Iceland's traditional allies weren't offering the money? After all, Russia has its own grave financial issues to deal with. Does the country really expect to be paid back in "the famous Icelandic herring, popular in Russia since Soviet times?" as Victor Tatarintsev, Russian ambassador to Iceland, noted in an interview on Russian television. More likely, this act of benevolence is being viewed as a way for Russia to help secure a bridgehead for an advance into the Arctic regions to claim the vast hydrocarbon and other mineral deposits there. Iceland also happens to possess a once vital NATO base, which has been in mothballs since 2006, and the Russians may be eyeing that as well.

There is a growing sense of urgency in Russia about all of this. Oil companies are posting declines in production as onshore oil and gas fields are getting depleted. Oil revenues account for 60% of Russia's budget, which has been calculated for 2009 on the basis of $70 per bbl. But if the price goes below that, the country's petroleum windfall may be drastically reduced, and the budget could go into deficit.

That is why the Arctic looks so enticing. Energy experts say the Arctic's continental shelf may contain up to a quarter of the world's undiscovered oil and natural gas. "The use of these energy reserves is a safeguard for Russia's energy security," Russian President Dmitri Medvedev said. "It is our duty to our descendants. We have to ensure the long-term national interests of Russia in the Arctic." Thus, the $5.4 billion — under terms more favorable than Moscow has extended to recapitalize one of its own major banks — seems a modest price to pay. Even if ordinary Russians may have to live off Icelandic herring for years as more conventional foodstuffs are already disappearing from stores.

Russia first lay claim to the Arctic in July 2007, when Vladimir Putin signaled his intention to annex the entire North Pole, an area twice the size of France, Belgium and Switzerland combined. Currently, five countries — Russia, the U.S., Canada, Norway and Denmark — each control a 200-mile economic zone along their coasts in the Arctic region. None of these economic zones reach the North Pole. Under the current U.N. Maritime convention, one country's zone can be extended only if it can prove that the continental shelf into which it wishes to expand is a natural extension of its own territory. In August 2007 two Russian submersibles reached the bottom of the North Pole and left a titanium-made Russian flag there. Putin alleged that the expedition delivered proof of Russia's claims, though few believe it is good enough to substantiate Moscow's claims under international law.

Still, as late as last month, Medvedev continued Putin's line, telling the country's security council that it was imperative that Russia immediately begin marking its claims in the Arctic. Medvedev described the region as "strategically important" and crucial to Russia's economic future.

The current state of the Russian economy is worrisome enough. Since August, the Russian stock markets' capitalization has dropped from $1.5 trillion to less than a third of that. Trading had to be stopped last week and again on Monday for fear the markets would dissolve into thin air. Some Russian banks have started calling in credits before they are due; others have stopped issuing credits altogether. Layoffs are expected, and Big Business even wants the government to reduce the required two months' severance pay for laid-off workers to a single month. Meanwhile, in the past two months, Russia's hard currency reserves have plummeted $51 billion down to $546 billion. Putin has just given another $50 billion to Gazprom, Rosneft, Lukoil and other energy conglomerates to pay their accrued foreign debts by the end of this year. Russian companies and banks are to pay yet another $115.7 billion by the end of 2009. Furthermore, Moscow will have to pick up the tab for debts accrued by regional governments.

(Click here for a photographic journey to the Arctic.)