Pipeline Politics: The Russian/Ukrainian Gas Dispute (guest essay)Editor’s note: While last summer’s Russia aggression against Georgia garnered international headlines, Russia’s consistent use of energy in recent years to bully other countries has also had serious ramifications. Earlier this week, Russia kicked it up a notch by slashing natural gas supplies to much of Europe due to a murky dispute with Ukraine. MOFYC's resident Eastern European Expert Mark offers his take on the situation.
Pipeline Politics: The Russian/Ukrainian Gas Dispute
Most of us appreciate the sharp decline in gas prices in recent months. However, two major geopolitical crises are responsible for the recent spike in prices, and unless both are resolved rather quickly, the upward pressure on prices will continue. After dropping to a low of around $31 per barrel, as of mid-week they are creeping towards $50 once again. The Israeli assault in Gaza is one factor, and the one most of us are familiar with; the second is the dispute between Russia and Ukraine in regards to natural gas prices for the 2009 fiscal year. While the Israeli-Palestinian conflict is a long-running and convoluted dispute in itself, the natural gas dispute is arguably just as complex, if not even murkier. Let me introduce you to the opaque world of energy politics in Europe and the former Soviet Union.
Russia has not only been blessed with among the largest natural gas reserves in the world, but plenty of energy-hungry neighbors on its borders and beyond to which to sell this resource. Currently, Russia, through its state-run energy monopoly Gazprom, provides the European Union with about one-quarter of its natural gas needs. If you break down that statistic into individual countries, things get even more impressive: according to Wikipedia, as of 2004, Gazprom is the *only* natural gas supplier to Bosnia and Herzegovina, Estonia, Finland, Macedonia, Latvia, Lithuania, Moldova and Slovakia, and provides 97 percent of Bulgaria's gas, 89 percent of Hungary's, 86 percent of Poland's, nearly three-quarters of the Czech Republic's, 67 percent of Turkey's, 65 percent of Austria's, about 40 percent of Romania's, 36 percent of Germany's, 27 percent of Italy's, and 25 percent of France's. If you think the US is too dependent on crude oil from the Middle East, re-read the aforementioned figures.
Natural gas is not that easy to transport. Due to its very low density, the most economical way of transporting it is through pipelines. However, to get to Europe, Russia must ship natural gas through several countries, particularly Ukraine. Let’s look at this map from the BBC:
80% of western and central Europe’s natural gas travels through Ukraine. That is a choke point in every sense of the word.
An independent, western-oriented Ukraine has been a thorn in Russia’s side for years. The most recent disputes between the two involve a whole list of issues, such as NATO membership for Ukraine, the status of the Russian language in Ukraine, the future of the Russian fleet base in Sevastopol, influence in Ukraine’s Crimean peninsula, the Russo-Georgian War of August 2008, recognition of the Ukrainian Famine-Genocide (the Holodomor) as an act of genocide perpetrated by the Soviet regime, etc. In the 2004 Orange Revolution, the pro-Russian government and its preferred presidential candidate, Viktor Yanukovych, were defeated and discredited in street demonstrations and new elections by the pro-western democratic forces led by current president Viktor Yushchenko.
One method of putting pressure on Ukraine has been for Russia to raise natural gas prices. It has been done before, and that appears to be the situation currently. In the most recent dispute, Gazprom began making claims in November that Ukraine owed them some $2.4 billion, and they would stop supplying Ukraine with gas unless the debts were paid off in full by December 31, 2008. This is where it gets really confusing, but bear with me.
Ukraine countered that since they technically purchase natural gas through an intermediary called RosUkrEnergo (RUE, a murky enterprise half owned by Gazprom, half by two Ukrainian businessmen, and all accused of having ties to organized crime in Russia and lining the pockets of some Kremlin officials) it was impossible for Ukraine to owe Gazprom any money. Then Ukraine admitted it owed $1.2 billion. Then Ukraine said it had paid off the full debt to RUE.(“In full” by whose standards?) Then Gazprom said Ukraine still owed them $614 million in late fees. And get this: a month before the accusations began flying around, the prime ministers of both countries had apparently signed a deal where RUE would have been abolished and Ukraine would have purchased natural gas from Gazprom directly. An agreement was signed to nix RUE (we think?), and within a few weeks new accusations about unpaid debts are made.
And then, we come to the newest part of the dispute. What price should Ukraine pay for natural gas? And what price should Russia pay to transport natural gas to its customers beyond Ukraine? As of December 2008, Ukraine was paying $179.50 per 1,000 cubic meters, and charging Russia $1.70 to transport 1,000 cubic meters per 100 kilometers. Energy analyst Roman Kupchinsky writes:
“[Gazprom] CEO Alexei Miller said in December that Ukraine would pay $450 per 1,000 cubic meters in 2009. During the unsuccessful negotiations, Gazprom demanded $250, which the Ukrainians rejected, making a counteroffer of $208. Miller responded that since they had rejected $250, they would pay $418. On January 1 Oleh Dubyna, the head of [the state-run Ukrainian energy monopoly] Naftohaz Ukrainy, offered to buy Russian gas for $235 contingent on a price increase for transporting Russian gas to Europe from the current $1.70 per 1,000 cubic meters per 100 kilometers to $1.80. Russian Prime Minister Vladimir Putin rejected this increase and insisted that transit fees were locked into a contract that is due to expire in 2010. The next day Ukrainian President Viktor Yushchenko and [Prime Minister Yulia] Tymoshenko made a joint public statement on the crisis in which they upped the proposed transit price to “not less than $2.00.” (full article here)
Ukraine denies the existence of a transit fee contract that supposedly expires in 2010, and also points out that the transit fees of Western European countries are regularly twice as much as what Ukraine charges Gazprom. If Russia wants to raise natural gas prices, why can’t Ukraine ask for higher transit fees as well?
Does your head hurt yet? The media has had just as much trouble as you and me in trying to keep track of all these threats, statements and deals. There were times at which, if you went on Google or Yahoo news for updates, you would literally see contradictory headlines on articles written merely a few hours apart. All of this is a symptom of the lack of transparency in the negotiating process.
Since Ukraine and Russia could not agree on the debt nor the 2009 gas price, Russia cut supplies to Ukraine… sort of. They simply deducted from the pipelines the amount of gas Ukraine regularly receives, and kept the rest flowing west. (A full cut would obviously cut all supplies to western and central Europe.) However, Russia now claims Ukraine is illegally siphoning large amount of gas from the pipes, some 65.3 million cubic meters between January 1-4. Ukraine counters that a much smaller amount than that is being siphoned by their state energy monopoly, but only enough to maintain pressure in the pipes for the Western consumers. It is also entirely plausible that some Ukrainian companies, particularly in heavy industry, are taking gas from the pipelines without permission from the Ukrainian government to keep their own factories on line.
In response, the Kremlin ordered an even greater cut in the amount of natural gas shipped west, and now nearly a dozen European consumer countries are reporting that the amount of natural gas reaching them has decreased or been completely halted. The EU, which has been calling this a commercial dispute between Ukraine and Russia, is finally being, ahem, motivated to do more. Fact-finding missions have been sent to both Kyiv and Moscow to figure out what the hell’s going on. Gazprom says it will re-supply the west through pipelines in Belarus and Turkey, but, logistically speaking, cannot make up the difference. Luckily for everyone, negotiations are supposed to resume tomorrow in Moscow. But will they succeed?
The Ukrainian economy is reeling from the global financial crisis. The currency has lost some 60% of its value, and steel production, a key component of its economy, is down over 40%. Ukraine qualified for over $16.4 billion in IMF loans, but it may not be enough to keep the country from falling into an economic depression and/or social instability. Ukraine has stated that it cannot afford to pay $250 for natural gas, never mind $450.
When a private individual is in debt, normally the creditor can suggest a deal where the debt is renegotiated or even lowered, because the creditor would prefer to retrieve some money than no money from the debtor. But when it comes to the situation between Ukraine and Russia, rather than Ukraine going bankrupt and not repaying Russia, the Kremlin probably hopes for a different outcome- the fall of the current government. If the Ukrainian public sentiment against the pro-western government rises high enough, it can mean a return to power of a more agreeable, pro-Russian government. Yanukovych lost the 2004 presidential election, but if the crises with Russia continue and Ukraine’s economy keeps faltering, he may take office in just over a year.
Russia also has many problems of its own: the collapse in energy prices has shaken the economy to the core. The stock market has lost 75% of its value in less than five months, and the currency is down some 25% to the dollar. The market and ruble would have fallen even further if the Kremlin had not sunk tens of billions of dollars from government coffers into subsidizing the market, the currency and many large companies (including Gazprom!) as a last resort. Russia needs oil prices of at least $70 a barrel to balance a budget, and the recent downturn has many Russians very worried about their economic prospects and yes, even questioning their own government’s competence.
According to Pavel Baev of the International Peace Research Institute of Oslo, “One direct consequence of this [Russian economic] downfall is the new Russian-Ukrainian “gas war,” which Moscow has launched this year out of desperation rather than arrogance as was the case in 2006. In autumn Gazprom was reaping record profits from exporting gas to Europe, because the price of gas follows that of oil with a lag of six to nine months. These increased prices are set to disappear in 2009, so Gazprom wants to fix the price for Ukraine at the current European level, which Kiev [sic] has every reason to consider too high.” (full article here) The collapse of oil prices has been hard enough on Russia; a collapse in natural gas prices would hurt Russia even more.
Ukraine needs to undergo two sets of reforms to get out of this predicament: energy use reform and energy politics reform. The country’s Soviet-era industries and factories are among the least energy efficient in the world, and Ukrainian consumers pay rates that are highly subsidized by the government. Industry must be modernized and made more energy efficient, and gas prices must be raised to reflect market rates; the Ukrainian government recognizes this and has proposed a transition over the next several years to higher prices, but a hike to $250 or more for natural gas in the short term could crush the economy. Ukraine, and the rest of Europe, should also strive for energy source diversification, so as to not rely almost entirely on the whims of an increasingly authoritarian and belligerent Kremlin for their energy needs. Secondly, the corruption and serious lack of transparency in the energy market of the former Soviet Union is a plague upon the entire region. Deals and contracts are made, money is transferred, but few really know what is going on. Until the industry’s accountability standards and local judicial system can be improved, future energy contracts between Ukraine and foreign entities such as Gazprom must be made open to oversight, preferably through a trusted third party such as the EU, OSCE or WTO. A neutral referee can make sure funds are correctly transferred and contracts are properly made and fully upheld.
Mark is a recovering blogger who quit cold turkey in the summer of 2007. Currently he is an irregular guest analyst of international affairs, particularly on Eastern European happenings, for Musings of a (Fairly) Young Contrarian Mark has led a full and productive life ever since he suspended full-time blogging: he has argued with Ukrainian election officials as an accredited international observer, seen the inside of an Eastern European maximum security prison, toured the Lower Ninth Ward after Hurricane Katrina and lent a hand in the city’s reconstruction, was nearly trampled by a pack of New Orleans police horses, completed an MA in history, sampled Germany’s finest beer, and climbed a 5,600-foot peak in Bavaria without provisions. For his next act, Mark is plotting a week long excursion to Slovenia at the end of this month. For pictures of these adventures and more, go to: http://community.webshots.com/user/shukhevych