Europe’s annual gas row

Andrew Wilson offers solutions on the Ukrainian front to prevent a gas crisis next year

This article was published in ABC on 8 January 2009.

Recent headlines about the Ukrainian gas crisis have a familiar ring – ‘Russia cuts off the gas supply to Ukraine’, ‘Blackout fear for EU as gas row escalates’, ‘Energy crisis in Europe as Putin cuts gas supply’. The supposed threat to Europe’s gas supply has become an annual ritual every January since 2006.

Nervous customers in Italy, Germany or Eastern Europe should therefore draw certain conclusions from this ever constant experience. First, nothing is likely to alter until the main actors change, which means most probably until the problem is in some way internationalised. Any other ‘solution’ to the current crisis will be patchwork, and the problem will recur again in a year’s time. Second, this year’s gas row signals a crisis in Ukrainian politics rather than a real change in Russian tactics. Third, the annual ritual is precisely that – the gas rows have always been to an extent artificial.

The gas rows between Russia and Ukraine occur so often because nothing has been done to change the standoff between the two states since the USSR collapsed in 1991. Russia has Ukraine over a barrel supply-wise. Ukrainian heavy industry uses enormous amounts of gas. The population may be only 46 million, but Ukraine is the seventh biggest gas consumer in the world, burning some 80 billion m3 a year. A series of scandals (on-off production licenses for the UK-based Regal Petroleum and for Vanco Energy, registered in Texas but allegedly linked to Russian or east Ukrainian mafia interests) have limited foreign investment in the energy sector, so Ukraine has failed to exploit existing and rumoured gas reserves. Annual domestic production remains stuck around 20 billion m3.

But Ukraine has Russia over a barrel transit-wise. Until new pipelines like Nord Stream or South Stream are built, Russia has no real alternative but to supply its lucrative West European markets through Ukraine. The parallel pipeline through Belarus can take 10% of the strain a best. Past disputes have therefore usually been short. The tap has never really been turned off. The typical pattern is that Russia cuts the total gas flow, and Ukraine is accused of siphoning off the difference. On 1 January the daily westward flow was down from 390 million m3 to 300 million m3 – the 90 million being Ukraine’s agreed supply for 2008 – although Russia cut an extra 65.3 million m3 on 5 January.

This basic pattern of incentives will not change until the structure of the supply and transit system is changed. One possibility is a genuinely tripartite consortium involving Ukraine, Russia and Europe that could jointly run the pipeline (a previous proposal from 2002 floundered because Gazprom’s influence grew too great). A second idea would be to agree a specific ‘Transit Security Treaty’ to supplement the current Energy Charter, which Russia opposes because of its attempt to open up Russia’s domestic market. Or the EU could explore ways of bringing Ukraine into the newly-proposed ACER (Agency for the Cooperation of Energy Regulators), once it has an effective independent domestic regulator securely in place.

Nor is the mess that has plagued Ukrainian politics since 2006 likely to be cleared up any time soon. Russia exploited the original crisis in January 2006 to promote its favoured candidates at elections two months later, but its motives are different this time. Gazprom is highly leveraged, owing around $60 billion, and is seriously short of cash. It may not even have enough to pay for ongoing acquisitions such as BelTransGas (the pipeline through Belarus). Global gas prices may be falling, but this is precisely what makes it sensible to close the gap between the $500 per 1,000 m3 that most West European customers pay and the $179.50 Ukraine paid in 2008. Gazprom’s other sister companies are also hoping to win a greater share of direct gas sales in Ukraine. Finally, Gazprom is using the crisis to push the image of Nord Stream as a cheaper and safer route.

This year the Ukrainians are perfectly capable of making their own misfortune. Not only are there the traditional rivalries between President Yushchenko, Prime Minister Tymoshenko and opposition Party of Regions based in Russian-speaking east Ukraine, but the global economic crisis has hit Ukraine particularly hard. A corruption scandal at the National Bank meant that Kiev took its eye off the ball when it should have been making end of year payments to Gazprom.

But the biggest problem is that the row is exploited by the shadowy intermediaries that dominate the Russo-Ukrainian gas trade. There have been many of these over the years: Itera in the 1990s and EuralTransGas in the late Kuchma era. The latest is RosUkrEnergo, which presides over a shady regime of uncertain gas origin (gas is mixed between Russia and Turkmenistan), political influence and price arbitrage to earn hundreds of millions of dollars for uncertain services. RosUkrEnergo is based in Switzerland, which meant that its ownership structure remained a matter of conjecture until the summer of 2006 when it was revealed to be a joint venture between Ukrainian oligarchs like Dmytro Firtash and senior Gazprom management with good links to the Kremlin.

Prime Minister Tymoshenko has long sought to get rid of RosUkrEnergo. But the company actually extended its influence at the 2007 Ukrainian elections, and now has powerful contacts both in the President’s entourage and in the Party of Regions, where Firtash has linked up with the group led by the former head of Oil and Gas of Ukraine Yuriy Boyko and his colleague Serhiy Lyovochkin. The current row most likely involves an attempt to find still more friends elsewhere, and undermine the apparent promise made after a private summit between Tymoshenko and Putin last October at Putin’s dacha to remove all gas ‘intermediaries’. It is also alleged that Boyko and Lyovochkin helped prevent the creation of a broader government coalition last December between Tymoshenko and moderates from the Party of Regions, which would have given the Prime Minister more freedom of manoeuvre than the current micro-majority.

Meanwhile, it appears that Ukraine’s arrears, supposedly $614 million, are owed to RosUkrEnergo. Significantly, Gazprom has run a much more sophisticated PR campaign this time around; but has blurred the distinction between attacking Ukraine for siphoning off gas and attacking the Tymoshenko government, without mentioning its campaign against RosUkrEnergo.

The good news is that all three factors – the Russian-Ukrainian gas standoff, Ukraine’s tortuous domestic politics and the need for international involvement – are linked. If the shadowy intermediaries were to be removed, then Ukrainian politics would be much cleaner and foreign involvement in the energy sector much more likely. Or cause and effect could work from the opposite direction, with an international agreement to clean up the system helping to break the deadlock – a better a virtuous circle than the current vicious one.

The European Council on Foreign Relations does not take collective positions. ECFR publications only represent the views of their individual authors.


Senior Policy Fellow

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