The big freeze

The gas dispute between Russia and the Ukraine earlier this year is symptomatic of rising regional tensions around the issue of energy security. Irrespective of where the blame lies, such instability could prove damaging to Russia’s long-term energy plans, argues Senior Writer Tom Benson.

On the morning of January 7th, Russian gas supplies to Europe via Ukraine were halted completely. Precisely which party was responsible for the shutdown is unclear. Gazprom claimed that Naftogaz Ukrainy unilaterally closed its export pipelines to Europe; Naftogaz, meanwhile, retorted that Russia had turned off the taps despite receiving full payment of outstanding debts. But since neither the Euro-Ukraine nor Russo-Ukraine gas metering stations are independently monitored, there is no way of verifying either party’s claim.

What is clear – regardless of who initiated the suspension – is the impact the decision had on the wider region. For nearly two weeks during the standoff, the supply of Russian natural gas was completely cut off in Greece, Hungary, the Republic of Macedonia, Moldova, Montenegro, Serbia, Croatia, Bulgaria, Slovakia and Romania, while eight other EU countries experienced some degree of gas loss. With Russia and most of Eastern Europe reeling from the global economic crisis – not to mention the fact that winter was closing in – the incident could not have come at a worse time for all involved.

The standoff was just the latest in a long line of wrangling between the two nations over gas supplies. Ukraine has been a transit venue for Russian gas for three decades, since the former Soviet Union built pipelines through Ukraine to supply European countries with gas from Siberia. But frosty relationships between Russia and Ukraine over the pipelines began almost immediately after the collapse of the Soviet Union. Since becoming an independent state, Russia has not been satisfied by the fact that it supplies gas to Ukraine at a cheaper price than the rest of Europe; it has also repeatedly accused Ukraine of siphoning gas from export pipelines for its domestic needs. Meanwhile, Ukraine has demanded Russia pay higher fees to use its pipelines for transit to Europe. Currently, 80 percent of Russia’s exported gas is transited through Ukraine, and the rest of the gas is supplied to Europe through Belarus and a smaller pipeline in Turkey.

The latest dispute began when Gazprom officials made statements on Russian television saying Ukraine had neither paid its gas debt owed to Russia, nor signed a gas supply contract for 2009. During December 2008, Ukrainian President Victor Yushchenko and Russian President Dmitry Medvedev traded barbs over the claims. Yushchenko denied reports Ukraine was in debt of close to $1.6 billion, indicating that the figure was much less, while President Medvedev warned that Russia would use its “entire arsenal of possibilities” if Ukraine did not pay its full debt.

Unable to resolve the dispute, Russia cut off its gas supply to Ukraine on New Year’s Day, while continuing to supply the rest of Europe through the Ukranian pipelines. Then one week after the initial cut-off, the pipelines to Europe stopped flowing. Russian TV channels stated that Ukraine had blocked the transit of the gas, with reports implying that Ukrainian officials had admitted to shutting down the pipeline. However, other sources claimed that Russia had been the one to shut off gas supplies, in retaliation for Ukraine’s alleged gas stealing.

On January 11, Russia and Ukraine signed an agreement to allow international teams to monitor the pipelines. However, two days later, when Russia attempted to restart transmissions of gas, it found the pipeline still non-functioning. This led to yet another public dispute, with both sides blaming each other in the media. Russia claimed Ukraine had not opened the export valves and was not admitting Russian observers to the gas transmission stations, while Ukraine stated that Russia’s transmission attempt had been without any preliminary agreement.

Finally, on January 20, Russia’s gas supply to Europe was restored after an agreement was reached by Russian Prime Minister Vladimir Putin and Ukranian Prime Minister Yulia Tymoshenko. The new agreement stated that Ukraine would not raise the fee for Russian gas transit, and Ukraine would receive a 20 percent discount on the basic price for gas.

But despite both countries claiming victory in the aftermath of the dispute – Putin suggested that in 2010 the two nations would switch entirely to European standards of pricing and pumping tariffs that would put an end to the days of cheap gas for Ukraine, while Tymoshenko said the 20 percent discount granted to Ukraine would give the country a year of opportunity to work on diversifying its energy sources – the net result is that both Russia and the Ukraine have come off badly in the conflict.

For one thing, with both sides already disagreeing about the deal’s economic implications, the possibility of future disputes arising between the two countries cannot be discounted. As Chris Weafer, chief strategist at Russia’s Uralsib Bank, noted in a recent briefing: “The big question mark is what happens if Ukraine again runs into arrears.” Moscow has been accused of using Gazprom as a political tool – the company was reported to have lost an estimated US$140 million per day during the standoff, and by its own estimates the Ukrainian dispute cost Gazprom more than $2 billion in lost revenue – and with the EU increasingly concerned about being held to ransom over gas prices, Russia’s stock is falling as a reliable gas supplier. “We must not allow ourselves to be placed in this position in the future,” said European Commission President Jose Barroso as gas started flowing again through Ukraine’s pipelines in January.

Kiev’s intransigent stance in the affair may also have come at a cost. During the 2006 crisis, Ukraine attracted far more sympathy for its predicament than today; Russia’s actions then were seen by many as a form of punishment for the Orange Revolution. This time, however, the bitter divisions that mark Ukrainian politics have precipitated a clear readiness amongst the Ukrainian elites to exploit the situation and score points. Such pettiness has allowed Moscow to frame the conflict as partly the fault of Kiev and cast Ukraine as an unreliable transit state, unfit for EU accession. Barroso went so far as to suggest that such games may delay Ukraine’s accession to the EU – something both Tymoshenko and Yushchenko would urgently seek to avoid.

The risks of such heavy reliance on Ukraine as a transit state have also become clear. Ukraine is continuing to fight having to accept European netback parity prices for its gas supplies as a way of preventing the total collapse of its economy, and while it still may be successful in the long run in this regard, the country’s strategic role as a transit state for Russian gas to Europe is deteriorating the longer such wrangling drags on. The likely formation of an international consortium to provide the technical gas needs of the Ukrainian GTS, together with the deployment of European monitors to key metering stations and gas compressors, has already begun to ‘internationalise’ the transit role for which Ukraine has sought to retain full control under Naftogaz. Continuation of such gas wars could thus lead to the actual management and operation of Ukraine’s GTS ending up in the hands of an international consortium.

The flip side is that Gazprom could well benefit in the long term if this dispute helps build support for its proposed ‘Ukraine bypass’ pipelines to supply Europe, including Nord Stream and South Stream. Despite the major financial losses Gazprom is currently suffering, realisation of these two pipeline projects, together with a commitment by the EU to reduce reliance on Ukraine as a transit state, could be at least one positive outcome as far as Russia is concerned. The potential upside of the gas war is less clear for Ukraine, although one hope is that the dispute ties Ukraine closer to Europe, boosting the country’s prospects of eventual EU membership.

Russia is the EU’s single biggest source of natural gas, with roughly one quarter of all the gas burnt in the EU coming from Russian sources. In return, natural gas is one of Russia’s biggest export earners, with oil and gas together accounting for two-thirds of its income.

A European perspective on the crisis
From Andris Piebalgs, EU Energy Commissioner

On the negative side, the crisis showed openly the dangers of our foreign dependency. Currently we are importing 50 percent of the energy that we consume, and this makes us vulnerable. This is particularly so for those member states that are dependent of one single supplier for a particular source of energy. It has also showed that situations that are completely alien to us can have huge impacts in the life of our citizens.

This is for me the most important lesson that we have to learn. It is not acceptable that one single European is left in the cold even when the cause of the problem is outside our borders. My first reaction is to come up, as a matter of urgency, with a new directive on security of gas supply. It has to be strong enough to prevent once and for all the sufferings that we have seen this winter in Bulgaria, in Slovakia or in the Balkans.

However, I would like to share with you also some positive lessons of this crisis. First is that the EU has been able to cope with such a serious gas cut much better than expected. Thanks to the combined efforts of the industry, the member states and the European solidarity mechanisms, the damage to our population and our industry have been limited. The conclusions of the Gas Coordination Group were very encouraging. With the measures taken by member states and solidarity mechanisms we even could have been able to live without Russian gas throughout the winter, and even prepare for next season.

I have been very moved by many examples of real solidarity among member states. Czech Republic granted its reserves to Slovakia, while it was receiving extra gas from Germany; Hungary was feeding Croatia, Serbia and Bosnia, while it was supported in its needs by Austria and Italy. The Netherlands and Norway increased production in order to cover the needs of others, while Greece was working on ways of supplying Bulgaria from its own LNG terminal.

And this was possible, in part because we have a real internal energy market which is not only essential from a competition point of view, but also for our security of supply. The internal market package that the Commission presented in September 2007 will make this integration even stronger. I hope we will see it approved as soon as possible.