The Daily Reckoning PRESENTS
Accompanied by his new Estonian wife, our favorite resource expert, Kevin Kerr, spent the holidays sharing Christmas cheer with his in-laws. But being a commodities fanatic, he, of course, also jumped at the chance to check out new trading opportunities in one of Eastern Europe's busiest seaports. Read on...

Diminutive and beautiful, the Republic of Estonia has always been an easy target for the region's bullies. Suffering a long history of heavily armored 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.

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 Harbor, 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 U.S. 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 the 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 last year. The Ukraine finally threw in the towel to Russia's price gouging - leaving it vulnerable to a major economic meltdown. By ending subsidized 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-subsidizing neighboring economies is gradually passing. We must think about our own interests."

As with many things Russian, subtlety takes the form of a baseball bat on the negotiating table.

In its negotiations with the Ukraine, Russia's nationalized Gazprom proposed that natural gas should jump from $50 to $160 per 1,000 cubic meters, which would pile on nearly $1 billion to Ukraine's annual bill for heating homes and powering factories.

Finally, in December, Gazprom said that it was sick and tired of what it characterized as foot-dragging. It said that if no deal were reached, Jan. 1, 2006, would see an extreme form of capitalism at $200-230 - the same price Russia obtains in Western Europe.

As I tuned into the news the other night here in Estonia, my wife Katrin translated for me. "Ukraine has wasted time in these talks, and now there can be no talk of $160," Alexander Medvedev, deputy chairman of Gazprom, said on Russian television. "The market situation has changed, and it's continuing to change."

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.

Unlike the Ukraine's spanking, Gazprom plans to continue subsidizing 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.

But puppetry aside, the real market force here is bartering. The Ukraine pays most of its natural gas bill by allowing Gazprom to use Ukrainian-controlled gas pipelines for about 80% of Gazprom's exports to Western Europe. This gives Ukraine potential leverage in the negotiations; Ukraine's Yushchenko has ruled out any interruption of gas to Europe. Still, the battle is just warming up.

For example, radical Ukrainian politicians and analysts have suggested pressuring Russia into renegotiating a lease for Ukrainian bases used by Russia's Black Sea naval fleet. A lunatic fringe has gone so far as to remove Russia's early-warning radar systems from Ukrainian territory. Given that such a move is possibly illegal, a more businesslike approach to the negotiations would likely prevail.

In fact, Yushchenko has said he would accept a gradual transition to market prices, but not the kind of sudden, drastic increase proposed by Gazprom. We wait to see how this saga further unfolds.

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.

Regards,

Kevin Kerr
for The Daily Reckoning

P.S. The one thing that resource traders can be certain of is that this region is the new hotbed for commodities and this is where the battleground is being set for resource profits. Not just in energy, but in all raw commodities.

© 2006 Kevin Kerr
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As Russia and the Baltics seek out more Western investments, opportunities will abound for saavy and informed investors. I, for one, plan to bring you all the information you can use from here to help grow your own resource wealth...you can start with my free special report: Get Rich Trading Real Resources

Editor's Note: 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, and he's even traded commodity derivatives in London. Over Kevin Kerr's career he's dealt with everything from cotton to currencies to oil and natural gas. Kevin Kerr's unparalleled expertise in futures and commodities has made him a regular contributor to news outlets like CNN fn, CNBC and Marketwatch, where he's been quoted in over 500 articles.