Russia flexes its energy muscles

Don Stowers, Editor-OGFJ

The latest geopolitical hot spot with regard to energy is the eastern European nation of Ukraine. Watch for it to be in the news for some time to come, since it is the main transit point at which Russian natural gas enters Europe (see Dec. 2005 OGFJ, “Uncertainty surrounds Russia-to-Europe gas agreements”).

Europe currently imports roughly 40% of its natural gas needs, and this is expected to rise to as much as 90% by 2020 to 2030, according to European Union (EU) estimates. Eighty percent of these Russian imports come through Ukraine, a former Soviet republic that gained its independence after the dissolution of the USSR in 1991.

As the new year broke on Sunday, Jan. 1, Russia followed through with its threat to cut off gas supplies to Ukraine in an apparent disagreement over pricing. The dispute began when Russia, which supplies a third of Ukraine’s gas, demanded that Ukraine pay $220 to $230 per thousand cubic meters - or market prices - rather than the $50 it had previously paid. This represented more than a four-fold increase, and Ukraine said such an abrupt increase would bankrupt its already shaky economy.

As negotiations wore on, both sides became intractable in their positions, and what ostensibly began as a commercial dispute over pricing became an international political crisis with European nations and even the US getting involved to resolve the dispute. Ukraine had threatened to retaliate by raising the rent that the Russian navy pays to use the Ukrainian port of Sevastopol as headquarters of its Black Sea fleet.

Within a few days, cooler heads prevailed, and Russia backed off its demand for a 400% price increase. Similarly, Ukraine retreated from its threat to skim off 15% of the gas that flows through its borders as transit fees.

The interim solution is a temporary arrangement in which Ukraine agreed to pay about $95 - nearly double what it had been paying for gas. Although hailed as a five-year deal, gas prices have been set for only six months under the terms of the pact.

The deal structure is still not clear because it involves a little-known Swiss-based joint venture called RosUkrEnergo, owned half by Gazprom, the Russian gas monopoly, and half by Austria’s Raiffeisen Zentralbank. Because the JV is private, the deal itself is somewhat murky and non-transparent, leading some to believe it could lead to corruption.

Ukraine’s President Viktor Yushchenko and the Ukrainian parliament are currently embroiled in an internal struggle over the higher gas prices. This is expected to reach critical mass when parliament reconvenes on Feb. 7.

Meanwhile, the main concern in Europe and the US is that Russia is flexing its muscles by using its energy supplies as a political tool. Although Russian President Vladimir Putin has told the EU that Russia will not use oil and gas to blackmail other countries, Europe remains dangerously dependent on a country that aspires to reclaim its superpower status.

In the post-Soviet world, oil and gas would appear to have become the most potent weapons in the Russian arsenal. $