GAS WARS

The world’s demand for energy is growing at an insatiable rate. And when you have access to the largest natural gas reserves on the planet all eyes will be on you to deliver supplies to your energy-starved neighbouring countries. Nevertheless, Russia has been accused of using its abundance of natural resources to stamp its dominance on its former Soviet neighbours. The Kremlin denies using gas as a political weapon in the region but the recent heated row between Moscow and Ukraine over prices throws Russia’s credibility as a major energy exporter into doubt. The spat came very close to sending Europe – heavily dependent on Russian gas – spiralling into a deep energy crisis. Meanwhile, Russia’s lucrative position was jeopardised as western governments and EU leaders poured scorn on the Kremlin over its decision to turn off gas supplies to Ukraine during sub-zero weather conditions.

The stand-off started in January, when Russia’s state-controlled gas giant Gazprom shutdown supplies to Ukraine after Kiev refused to agree to a 450 percent increase in the price of gas it receives through pipelines from its neighbour. The world’s largest gas company demanded US$230 per thousand cubic metres (tcm) – up from the US$50 tariff rooted in Soviet-era subsidies. Kiev refused to pay and ordinary Ukrainians were left shivering as the harshest winter for decades tightened its grip. Naftogaz, Ukraine’s state-owned gas monopoly, insisted it would not bow to pressure from Gazprom but conceded that any price rise should be phased in gradually. Officials from both sides held talks in the Russian capital but were unable to hammer out a deal before pipelines were cut off. The relationship between both sides was frosty enough when Gazprom then accused Ukraine of “stealing” gas destined for European countries. Kiev at first denied the allegation but later admitted it had withheld some of the gas bound for Europe during the –30C cold snap as its personal supplies were exhausted.

The stand-off between the two countries was a wake-up call for Europe as EU leaders suddenly realised how reliant they are upon Russia for their energy needs. Russia supplies Europe with a quarter of its gas – 80 percent of which passes through Ukraine’s pipelines. The former Soviet republic receives around 30 billion cubic metres of gas each year in return for allowing Gazprom to pump supplies through its pipelines and across Europe. When the plug was pulled, most nations in mainland Europe saw a rapid drop in gas levels with Hungary and Austria hardest hit. Serbia was forced to introduce rationing in order to conserve limited supplies, while Germany, Italy and France all saw levels fall significantly. EU leaders met to try and hatch a plan as concerns grew that the arctic weather conditions would drain the already limited supplies. In the end a face-saving deal was struck between both sides as pressure mounted from gas-dependent countries in Central and Eastern Europe. Under the new agreement Gazprom will sell the gas for US$230 per tcm to Austrian trading company Rosukrenergo, which is part-owned by Gazprom. Rosukrenergo will purchase gas from Turkmenistan for the knockdown rate of US$50, mix the two supplies and sell it on to Naftogaz for US$95 per tcm. Gazprom also agreed to pay 50 percent more for its transit fee, up from US$1.06 per tcm to US$1.60, to pump gas through Ukraine. Both Russia and Ukraine were able to hail the deal as a success.

Despite the furore surrounding the dispute, Yulia Woodruff, oil and gas analyst at the Energy Security Analysis Inc. (ESAI) doesn’t think it dented Russia’s credibility as a major energy supply. “The dispute created a lot of discussions on the subject but at the end of the day Russia is a major and reliable energy supplier, and will continue to be,” she highlights. “Supply distributions were minimal and markets have a short memory. While Russia will continue its policy toward bringing gas prices for former Soviet republics closer to that of its European customers, I don’t think that cutting off supplies will ever be used as a negotiating tactic.” Woodruff adds: “Russia learned the long way that this threat cannot be credible because it cannot be sustained. The domestic market for natural gas is highly inelastic, and it is really difficult to reduce exports for a prolonged period of time without hurting production. If the cold weather in Russia had arrived earlier, that threat would have been more and credible effective but the lesson would not have been learned.”

However, just as Europe breathed a sigh of relief at seeing the dispute’s resolultion, questions over the stability of energy supplies in the region was again put under the spotlight. Two unexplained explosions destroyed gas pipelines linking Russia to Georgia in the mountainous region of North Ossetia. A furious Georgian Government accused Russia of sabotaging the pipeline in a bid to trigger a political crisis. In response, the Kremlin strongly refuted the claims and described Georgia as being “hysterical and confused”. Russian officials blamed the attacks on pro-Chechen insurgents. Georgians were forced to queue for hours at gas stations as panic buying set in and the situation was worsened with the former Soviet republic experiencing the harshest weather for decades. After the Ukraine situation, the disruptions in supplies from Russia to Georgia had some asking whether there was more to it than meets the eye. Critics of Russia’s dominance in the region accuse Moscow of enforcing gas price hikes in retaliation to those Former Soviet Union (FSU) counties forging closer ties with the West. The old Soviet Union days are long gone but the new independent states could be forgiven for thinking that Moscow is putting up gas prices to punish them for trying to escape Russia’s influence. Those FSU states that toe the line with Moscow have not seen their gas bills quadruple or even rise. The pro-Russian regime in Belarus pays a mere US$47 per tcm compared with an average of US$240 in Western Europe.

Woodruff believes politics were not behind the surge in tariffs but other FSU countries should prepare themselves for hefty bills this year. “I don’t think that the decision to increase prices to Ukraine was politically motivated – many other former Soviet republics will pay much higher prices for natural gas this year,” asserts Woodruff. “And if Ukraine was punished for disobedience, it was not because of its intent to join the EU, but rather for its unwillingness to create a friendly working environment for Russian businesses in Ukraine. As messy as it was, this conflict, played out in the public domain, was actually beneficial for both countries. It clearly demonstrated their high degree of mutual dependency. Russia cannot supply Europe without Ukraine, and Ukraine has no alternative to Russia as a supplier of both oil and gas. They have to continue to work together to find a price equilibrium, which will work for both countries.”

Up until recently Russia provided cheap energy to all its former Soviet neighbours in return for political loyalty and economic preferences. However, the pro-Europe government in Ukraine has angered Russia with its efforts to forge closer ties with the EU and NATO. Ukraine’s president Victor Yushchenko led the ‘Orange Revolution’ into power in 2004 after mass protests forced the re-run of the election initially won by Moscow-backed Viktor Yanukovych. Relations between the countries have been tense since the election and the Kremlin makes no effort to hide its dislike of Ukraine’s new leadership. The situation is similar in Georgia where the Government has been outspoken in its western-leaning stand and support of America. At the end of last year Gazprom raised gas prices for Georgia to US$110 per tcm – up from US$63. The gas company revealed that it was interested in buying Georgia’s gas pipeline network. Similarly, Gazprom originally asked Kiev for US$160 per tcm but this was suddenly hiked up to US$230. Gazprom would have settled for a lower amount if Ukraine had sold its pipelines to the gas giant.

The argument re-ignited almost Cold War-style mistrust of Russia in Europe, while the US hit out at Gazprom, saying the move raised “serious questions about the use of energy to exert political pressure”. Russia says that it is no longer viable to supply independent states like Ukraine and Georgia with cheap gas now that they are both economic rivals. The timing of the fallout could have been better for Russia, however, having just taken over the presidency of the G8 club of industrial powers for the first time. “My guess is that this dispute will lead to accelerate the movement to seek alternative, competitive sources of supply, such as from Caspian region counties,” says Wilf Gobert, Vice Chairman and oil and gas analyst at Canadian-based investment bank Peters & Co. “I believe the North Americans are much more suspicious of Russia than Europeans are. This suspicion is re-enforced by recurring events where contractual obligations are repeatedly ignored, with poor legal recourse to the legal system.” Gobert says the EU needs to act upon the row. “This dispute is a wake-up call for FSU countries that wish to improve relations with the West in that this movement will not go unchallenged by Russia. It is also a wake-up call to the West that Russia still does not have the legal infrastructure to overcome political interventions in business contracts.”

The only alternative pipeline in the region runs through Belarus and Poland while the recently agreed route passing through the Baltic Sea connecting Russia directly with Germany will not be operational until 2010. The EU is now discussing ways of sharing gas in case of emergency, while the dispute fuelled debates in some countries about building more power stations. Also more liquefied natural gas (LNG) could be shipped between nations in order to bypass pipelines. However, energy experts warn that LNG has serious downfalls and due to its highly inflammable nature, security issues will be raised. Terrorists could target LNG terminals and ships. Whatever the solution, European leaders are in agreement that the Russia-Ukraine situation must not be allowed to happen again. Austria’s Economics and Labour Minister Martin Bartenstein says Europe needs to deal with the issues of gas supplies sooner rather than later. “The events at the beginning of the year have shown that Europe cannot take secure energy supplies for granted,” he commented recently. “The appropriate lessons must be learned from these events and action taken to secure Europe’s energy supplies in the long-term.”

The disputes between Russia and its neighbours have ultimately had a knock-on effect on oil prices. Russia is the world’s second largest oil producer with around eight million barrels a day – accounting for 40 percent of the country’s GDP. And experts were questioning whether the West should be relying upon politically unstable countries for its energy needs. Nigeria, the eighth largest producer of oil, has seen recent kidnappings of foreign contactors, Iraq is in turmoil and plans could be in the pipeline to impose sanctions on Iran. The Russia-Ukraine row could signal a new era where potential political conflicts flair up over energy concerns. Woodruff says: “Unlike crude oil, natural gas is a contractual commodity by nature. The ‘fair price’ for gas is the price two parties find acceptable, since there is no easy way to transport it and there are very few big sellers and buyers. The Russian-Ukraine dispute is far from over but I consider it to be a normal, even if painful, negotiating process two countries have to go through in order to move to more pragmatic economic relations.”

Russia holds all the aces when it comes to providing energy for Eastern and Central Europe. The gas pipelines cross FSU neighbours but any break in the chain can have a disastrous knock-on effect on other countries. Whether the decision to switch off supplies was politically motivated or not the move made EU members sit up and take note. The problem is that many European countries have little alternative than to import gas from Russia. Eurogas, which represents the industry in Europe, predicts that the EU will import up to 75 percent of its natural gas by 2020. Globally, we will witness a driving quest for more oil and gas in the next few years as industrialised nations such as China and India increase their demands. And this surge in consumption, coupled with the larger natural energy reserves being located in sometimes politically instable counties, could spell disaster for the rest of the world.