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Hope Won't Keep Europe Warm

EU Energy Commissioner Andris Piebalgs (left) with Gazprom's Aleksei Miller in Brussels on January 8

EU Energy Commissioner Andris Piebalgs (left) with Gazprom's Aleksei Miller in Brussels on January 8

Disputes over natural-gas payment and pricing have become a recurring New Year's ritual in Russian-Ukrainian energy relations.

Russian energy giant Gazprom and Ukraine's Naftohaz squabble over the money owed from the previous year, the price that Ukraine should pay for Russian gas supplies in the coming year, and the fees Gazprom should pay for transporting gas through Ukraine.

While these disputes have been ongoing since the breakup of the Soviet Union, only once before, in January 2006, did the row end in an attention-grabbing, three-day cutoff of Russian gas to Ukraine that subsequently affected several European states. That time, most analysts and governments saw Russia as the guilty party, bullying the nascent democracy in Ukraine. This winter's row is different: the cutoff is entering its second week, and both sides have been discredited. Neither Ukraine nor Russia feel necessarily pressured to make quick amends.

Unfortunately, as in 2006, the underlying causes of their row and potential measures of redress are unlikely to be dealt with, which bodes ill for Europe's future supply security.

Leading up to this New Year, the Russian authorities appeared to have learned from 2006, employing a slew of consulting firms to promote their position. Gazprom representatives warned the EU as far back as November that there might be a problem with Ukraine, but that Ukraine would be to blame. When some European countries registered initial shortfalls in gas supplies in early January, Gazprom accused the Ukrainian gas company Naftohaz of stealing supplies destined for Europe. The Ukrainians, in turn, blamed the shortfall on "technical problems."

Once Burned...

Unlike in 2006, when Russia was unilaterally blamed for the gas shortages, Western media and politicians have been careful not to assign blame this time. The European Union stressed it did not want to get involved in a conflict between two commercial entities. However, this changed after Russian state television broadcast a discussion between Prime Minister Vladimir Putin and Gazprom CEO Aleksei Miller on January 5, during which Miller explained that Ukraine was taking gas meant for Europe and suggested that Russia might respond by reducing supplies. Putin agreed and ordered, "Yes, cut it today," creating severe shortages in several European states. Finally on January 6, the European Commission felt compelled to issue a statement condemning the situation as "completely unacceptable."

There are two interwoven stories involved in this conflict. The first is Russia's desire for higher gas revenues from Ukraine. In a memorandum of understanding signed by the prime ministers of both countries on October 2, Russia and Ukraine agreed to a gradual move toward market pricing by 2011. Gazprom's initial offer was $250 per 1,000 cubic meters of gas, more than the $179 that Ukraine paid in 2008, but much less than the average of around $500 that European customers paid. When Ukraine rejected this offer, Gazprom demanded $418 per 1,000 cubic meters.

As a counteroffer, Ukraine requested an increase in the tariffs Gazprom pays for transporting gas through Ukraine, which Gazprom rejected on the grounds that the tariffs were agreed upon in a previous contract. Transit fees are an important source of revenue for Ukraine. In 2008, it is estimated that Gazprom paid around $2.4 billion in fees to transport gas through Ukraine. With oil prices dropping, Ukraine perhaps also hoped that it could wait until Russia was obliged to negotiate a lower gas price. Moreover, unlike three years ago, Kyiv thought it could do without Russian gas for a short period, because many of its factories are working below capacity and the country has boosted stored reserves.

Wake-Up Call

The second story is why Russia decided to cut gas destined for Europe, knowing full well that European customers would suffer. It was likely meant as a wake-up call for Europe. What Russia wants most of all is direct access to its European customers, avoiding the insecure transit through Ukraine. The future of alternative pipeline projects, including the Nord Stream through the Baltic Sea to Germany or the South Stream through the Black Sea into Southeastern Europe, remains uncertain. Funding issues, environmental concerns, and alternative European proposals pose challenges.

Russia is dependent on European hydrocarbon sales for a majority of its cash earnings, and it also needs Europe as an investor, especially in the energy sector. Russia has been hard hit by the global financial turmoil and falling oil prices, and does not have sufficient funds to invest in new gas and oil fields and energy infrastructure. Russia has no interest in worsening relations with Europe, but it wants long-term stability for its gas deliveries -- and this means less reliance on Ukraine.

Russia has also promised Central Asian gas suppliers higher prices in 2009 for the gas they ship through Russian pipelines -- $340 per 1,000 cubic in the first quarter of 2009, according to Putin. Most of this gas is later sold to or transited through Ukraine. As the price of oil has dropped dramatically since August, so too will the price of gas at the European border in the first quarter of 2009. Thus, Russia will likely see its profits from gas exports drop.

In addition, Gazprom last month announced record losses due to decreased demand from a number of Central European states. Gazprom, whose shares have fallen by three-quarters since last autumn, simply cannot afford to lose its profits from sales to Ukraine and gas transited through that country.

Resolving the transit and pricing issue is complex. An essential prerequisite to any real solution is addressing the problem of the opaque and unaccountable intermediary arrangement between Gazprom and Naftohaz. Contrary to most current media reporting and Russian and Ukrainian official statements, it is, strictly speaking, not Naftohaz that owes Gazprom money. In fact, it can be called a dispute between intermediaries. Or, more accurately, a dispute between Russian-owned companies. UkrGazEnergo (jointly owned by RosUkrEnergo and Naftohaz) owes money to RosUkrEnergo (jointly owned by Gazprombank, with a majority of private shares, and two Ukrainian businessmen). Essentially, it could be said that RosUkrEnergo owes RosUkrEnergo.

While Gazprom sells its gas via Ukraine to Europe, RosUkrEnergo buys the gas from Central Asia, ships it through Russian territory via Gazprom-owned pipelines, and sells it to Ukraine. Despite the fact that Ukrainian Prime Minister Yulia Timoshenko has long lobbied to get RosUkrEnergo out of the Ukrainian gas business altogether, it remains the key player in the Russian-Ukrainian gas business.

Kyiv's Concerns

This creates at least three challenges for Ukraine. First, it has never been clear in Russian-Ukrainian relations how the debts are accrued, by whom, and how the payments are meant to be transferred. Second, the opacity of cash transactions has allowed vested interests in both countries' energy sectors to benefit, preventing the resolution of ongoing issues. For example, the stakeholders in Naftohaz use their positions to generate personal wealth through the use of UkrGazEnergo for industrial sales of gas on the Ukrainian market. Finally, it has long been speculated that these cash flows allow Russia to provide financing to Ukrainian groups it wishes to influence, beginning with former Ukrainian Prime Minister Viktor Yanukovych's Party of Regions.

All this leaves Ukraine vulnerable in negotiations to such things as debt-for-equity swaps of its gas-indebted industries, mortgaging future sales of gas for payback of debt, or allowing RosUkrEnergo to manage its domestic market sales.

Officials in Brussels and Washington have both stated that the gas cutoffs are unacceptable. To be sure, no other major gas company employs cutoffs as a bargaining tool. What is surprising is that -- given the 2006 cutoffs -- there are not well-rehearsed pan-European contingency plans. Some of the countries that suffered during the last crisis are prepared this time with extra reserves and alternative suppliers. However, only now are the Europeans discussing how to help those countries experiencing the most severe conditions.

However, the EU continues to lack transparent figures for storage or available volumes at trading hubs. Nor has it reached agreement on flexible transborder shipments. Since January 1, Gazprom claims that 65 billion cubic meters of gas it pumped into Ukraine's pipeline system has failed to be delivered to Europe. And yet, the Europeans are only now threatening an emergency summit with Russian and Ukrainian officials. They seem to be hoping, as with the last crisis, that an agreement, however opaque, will be reached between the two sides in the coming days without their intervention. But hope isn't much of a policy.

Jeronim Perovic is a senior researcher at the University of Basel's Institute of History and a visiting fellow at the Center for Security Studies, ETH Zurich. He is co-editor of the book "Russian Energy Power And Foreign Relations: Implications For Conflict And Cooperation" (Routledge, forthcoming in February). Stacy Closson is a trans-Atlantic post-doctoral research fellow at the German Institute for International Affairs in Berlin. The views expressed in this commentary are the authors' own and do not necessarily reflect those of RFE/RL
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