Russia, Ukraine, and Natural Gas: Russia Misguided Pipeline Politics?

Updated December 03, 2006
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Introduction

With the breakdown in price negotiations during recent days, Russian state-owned Gazprom choose to cut the gas deliveries to Ukraine, the main conduit for exports to the rest of Europe. This is a critical situation because, as mentioned by Bloomberg, “State-run Gazprom supplies about a quarter of gas consumed in Europe and ships about 75 percent of that volume through Ukrainian pipelines.”

Washington Post provides further details on the outcome: “On Sunday, with no agreement on a new price, Russia cut by 120 million cubic meters a day the volume of gas it sent down the Ukrainian pipeline — Ukraine’s share. But there were soon reports that the volume of gas reaching Austria, Italy, France, Hungary, Poland, Slovakia, Romania and Croatia at the other end had fallen by as much as 40 percent.

Gazprom claimed that Ukraine was stealing gas — about $25 million worth on Sunday alone, according to Alexander Medvedev, Gazprom’s deputy chairman”

Russian Climbdown

But only one day after cutting the gas supply, Russia has been forced to restore the supply with mounting criticism from Europe and US on Russia’s ability to be a reliable energy partner. Gazprom, however, tried to square all blame on Ukraine:

“With the aim of preventing a possible energy crisis caused by Ukraine illegally taking gas, Gazprom has taken the decision to deliver additional gas into the gas transport system of Ukraine,” the company said in a statement.

“We stress that the additional delivery of gas is not designed for Ukrainian consumers but is meant for transit through the territory of Ukraine for delivery to consumers outside the borders of Ukraine.”

Europe, IEA and the US are placing blame on Russia for the current crisis, demonstrating the limits of Russia’s “Petro-Power”.

Russian Stabs Itself and Stumbles

In the long term, Ukraine will have to come to a compromise with Russia leading to higher prices. But more substantially, Russia’s heavy handed tactics against Ukraine will backfire throughout Europe and Russia’s energy customers. What Russia has seeming underestimated is the reaction from Europe because of its actions against Ukraine. What Russia’s hardball tactics has done for Europe is to:

  1. Highlight Europe’s dangerous energy dependency on an increasingly authoritarian Russia
  2. Confirm the fear that Russia will turn to its energy resources as its main leverage of power in the global stage
  3. Encourage European states to find alternative energy sources, away from Russia (Neighboring Finland is already building its first nuclear to move away from Russia)
  4. Highlight that Putin and Russia cannot be trusted in other important issues like Iran, North Korea et cetera
  5. Encourage speeding the process to include Ukraine in western institutions like NATO and the EU
  6. Underline that the Russian-German gas pipeline (expected to be completed by 2010) is a naked attempt by Russia to consolidate its power and influence in Europe
  7. Seals Former German Chancellor Gerhard Schroder image as sell-out for Moscow, as he is now working on Gazprom’s Russian-German Gas Pipeline
  8. Draw increasing criticism to Russia for its increasing authoritarian use of power, such as the banning of NGOs, that will only grow as Russia assumes head of the G-8 this year.
  9. Increase calls for Russia to be removed from the G-8 for not being a major world economy, a democracy or even a free-market state

This arrogant move against Ukraine amid recent criticism for restricting NGOs and holding the G-8 chair may be a signal that Putin’s consolidation of power is leading Russia to a belligerent authoritarian state, rather than a corporatist Russia (think Singapore) that can help consolidate Moscow’s power before Russia deteriorates and bring Russia back economically.

Conclusion
Ukraine and Russia are still a long way from resolving the issue, but so far we can conclude that even if Russia gets what it wants from Ukraine, it still come out loser on the world stage and its reputation as reliable energy partner is soiled. At this point in the situation, it is difficult to see how Russia stands to benefit against Ukraine and the world stage. The loss in international standing is costing a lot more than any possible gain from Ukraine.

Post-Script: A Contrarian View, Russia Exerts Power?
To keep the analysis balanced (since events are too early to call), Putin could be purposely timing the move against Ukraine because of its G-8 chairmanship.

It is possible that Putin wants to demonstrate that Russia is willing to flex its economic muscle regardless of its cost to the world stage and that in the face of an increasingly energy vulnerable Europe, Russia’s power is very much real. True, states like Finland are increasingly promoting nuclear energy as an alternative, but they take years to build and Russia has the largest natural gas reserve while Norway and the UK’s has dwindled.

In short, this event could be a move to show that Russia is not to be taken for granted as the world “natural gas tank station” to be tapped freely by Europe or its other customers. Raw/Single commodity export states are viewed somewhat disparging as backward states for advanced states to exploit – this is something that obviously Putin would not like Russia labeled as.

However, such increase in fear and power would only be a short/medium term gain. In the long run, such hardballing tactics would likely motivate Europe to move away from Russia – be it using nuclear power or alternative sources of natural gas. Thus, this is a risky gamble for Russia to make, if indeed this is Putin’s intentions.

Other Related Issues
Below are some related points to the Ukraine-Russia issue and maybe of interest to StrategyUnit readers.
1. Punishing a former-Client State or Adjusting to New Realities?
There has been much criticism that Russia is merely being a bully because: 1) since the Orange Revolution, Ukraine has reoriented itself to the West (including NATO and EU); and 2) The previous contract locked in prices at $50 tcm from 2004 to 2009.

It is both true that the current $50 tcm is below market price and that Russia does vary its prices – ranging from $160 tcm for Moldova (also aligning itself to the West) to $47 tcm for Belarus, a firm Russian ally. The Russian-Ukrainian contract did set the price at $50 tcm, but it also mentioned the need for annual negotiations. This is typical of many energy contracts.

As for “Russia punishing West-tilted Ukraine” that is mentioned in the Western media, this must be placed in a larger context: If Ukraine is no long aligning itself with Russia, why should Russia continue to subsidize natural gas to Ukraine?

Additionally, Ukraine is selling Russian subsidized gas to other neighboring states at a profit. The idea of Ukraine profiting and potentially buying NATO equipment by selling subsidized Russian gas is not something Russia should tolerate.

Where Russia has gone wrong is the use of heavy-handed tactics, instead of agreeing to gradual price increases to Gazprom’s demanded “market” rates.

2. Russia and Limits to Geography

Despite its size, Russia is confounded by problems similar to other energy exporting states like Uzbekistan and Kazakhstan: It is a largely landlocked state with limited export options.

Additionally, natural gas is more difficult to export than oil – where tankers can more easily transport crude oil to ports. Liquefied Natural gas tankers and ports require extensive investment into infrastructure. See the map below, which shows the major gas pipelines from Russia to Europe (from DOE).


Click here to Enlarge

With Ukraine being the main transit route for Russian natural gas to Europe, Ukraine has far larger leverage than as seen on the surface. As the only main transit route to the West (besides the smaller Belarus pipeline), Ukraine has some room to manuevre against Russia.

Indeed, we see that Russia cannot act against Ukraine without putting its relationship with the rest of Europe at risk. Despite Russia’s blame on Ukraine for decline of gas elsewhere, teh rest Europe will not accept itself as “collateral damage” in this dispute. These European states do not care if Ukraine is “stealing” the natural gas, it will pressure both Ukraine and Russia (more so) to resolve the difference. And in this game, Russia (with its great power ambition and high dependence on export) has more to lose than Ukraine.

3. Impact on planned German-Russian Gas Pipeline?

On the impact on the German-Russian pipeline, it is too soon to say which way things will go but there are some obvious paths:

  1. Germany will become reluctant to build a pipeline that will only increase its dependency on Russia
  2. Germany will continue to go along with the pipeline, but with high priority in finding alternative sources of natural gas or its substitutes

A contrarian path would be “Germany sees the need to speed up building the pipeline, so that the rest of Europe will not be effected by Russian actions against Ukraine and former-Warsaw states” – but such a move would only embolden Russia and will look foolish to Germany.


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Comments

9 responses to “Russia, Ukraine, and Natural Gas: Russia Misguided Pipeline Politics?”

  1. IJ

    Lots of good research. It raises questions about the integrity of globalisation.

    Others are questioning it too. The President of Russia (G8 chair for 2006) addressed the National Security Council in the Kremlin last month.

    The theme was international energy security:
    >“This energy set-up should be equally fair for the producers and consumers of energy resources for the sustained economic growth in the world,” he underscored.

  2. sun bin

    after some googling myself. i came to this conclusion.

    1. russia is justified in raising the price, and its asking price is reasonable. (I compared this versus EU, Romania, and futures prices in NYMEX)

    2. Russia has contract obligation to supply EU up to the former USSR border. i.e. if Ukraine/Belarus steal the gas, EU will sue Russia based on the contract. But if Poland steals the gas, EU would sue Poland.
    This makes Russia’s accusation quite plausible.

    I have some maps and links (to oil and gas journal) about the situation in my blog

    Therefore, Ukraine has a pretty strong position in hijacking Russia’s gas. Unless Russia can ask EU to force Ukraine, or use the alternative route via Poland to supply EU (bypass Poland), Russia couldn’t do much to Ukraine except suing it or asking EU observer to monitor the taps in Ukraine.

    Putin acts too hastily.

  3. sun bin

    i tend to think the new German-Russia pipe under the Baltics makes much more sense now, as it would not be hijacked by a third country.

  4. sun bin

    after some googling myself. i came to this conclusion.

    1. russia is justified in raising the price, and its asking price is reasonable. (I compared this versus EU, Romania, and futures prices in NYMEX)

    2. Russia has contract obligation to supply EU up to the former USSR border. i.e. if Ukraine/Belarus steal the gas, EU will sue Russia based on the contract. But if Poland steals the gas, EU would sue Poland.
    This makes Russia’s accusation quite plausible.

  5. sun bin

    some map and source in my blog
    http://sun-bin.blogspot.com/2006/01/ukraine-gas-price-industry-unit.html

    Therefore, Ukraine has a pretty strong position in hijacking Russia’s gas. Unless Russia can ask EU to force Ukraine, or use the alternative route via Poland to supply EU (bypass Poland), Russia couldn’t do much to Ukraine except suing it or asking EU observer to monitor the taps in Ukraine.

    Putin acts too hastily.

  6. sun bin

    couldn’t post link here. you can see my blog for the source of the russian contract obligation.

  7. sun bin

    i think russia made a bad move, without carefully review its contract with EU, and without securing the alternative delivery via Belarus/Poland pipe.

    I also think Russia is a bad bully.

    However, I disagree with your 9 accusation on Russia based on this particular case. (same as I believe Saddam should be killed 100 times, and Iraq should be invaded. But the reason used was wrong)

    What Gazprom asked Ukraine is exactly what a market economy would do. What German did was exactly to mitigate itself from such risk.

  8. StrategyUnit

    Sun Bin, on item 9#: The more I think about it, the more I think it cuts both ways:
    1. I think we are seeing more vocal calls to get Russia out of G-8, but mostly from the pundits.
    2. But, also by exposing Europe’s vulnerability and dependency on Russia, Russia has enhanced its position as a state with power over Europe and partly justifies its position in G-8.

    Also it sets the agenda in the G-8 that Russia’s concerns need to be taken seriously by Europe and that Russia cant be taken for granted.

    I will update further later tonight.

  9. sun bin

    sorry about the repetitive comment. some showed and some didn’t. please deelte the redundant ones.

    yes, i agree with you it draws attention to some issues that is previously hidden.


    p.s. i read somewhere else that Ukraine has ’siphoned’ gas a few times in the past, and russia had to increase supply to EU. it was during the 1990s and drew little media attention.

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