Ukraine Gazprom

5 January 2006

Gazprom: What Were They Thinking?

By Gwynne Dyer

It was a Ukrainian triumph, and a Russian foreign-policy disaster. Ukraine gets cheap supplies of natural gas for five years. Russia loses a big chunk of the European energy market forever.

The giant Russian natural gas producer Gazprom is effectively an arm of the Russian state, and its decision to cut off gas supplies to Ukraine on January 1st was entirely political. Russia continues to supply natural gas at subsidised prices to obedient parts of the former Soviet Union — Belarus gets it for only $47 per thousand cubic metres — but the price goes up as foreign policies diverge.

Georgia and Armenia have to pay $110 for their gas. Moldova, which has been drifting out of Moscow’s orbit, was hit with a demand for $160. (Moscow cut its gas supply on New Year’s Day, too.) Ukraine, under the former, Kremlin-friendly regime of Viktor Yanukovych, signed a five-year contract to buy Russian gas for $45 only two years ago — but then came the “orange revolution” of December, 2004, and the price changed.

Last year, Gazprom served notice that the price Ukraine paid for gas would go up by 400 percent on 1st January. If Ukrainians were going to be too friendly with the countries of the European Union, then they would have to pay the same “full market price” of $230.

Ukraine, with three years still to run on the existing contract, replied that it would pay the full market price eventually, but wanted phased increases to give its energy-dependent heavy industries time to adjust. No, said Moscow, we want a new agreement by 31 December. Either Ukraine starts paying $230 by the end of March, or it gives us full control of all pipelines crossing its territory (in which case it can go on paying the old price until the existing contract runs out), or else Russian gas stops flowing on 1st January.

Why the rush? Because parliamentary elections are due in Ukraine in two months, and the Kremlin wants to punish President Viktor Yushchenko and his party. If he agrees to a fourfold increase in the price of gas, he loses. If he gives away Ukraine’s pipelines, which carry 88 percent of Russia’s gas exports to the European Union and entitle Ukraine to take 15 percent of that gas as a transit fee, he loses. And if Russia cuts off the gas, he loses.

Just in case Yushchenko decided to tough it out, the Kremlin’s strategists leaned on Turkmenistan to break its Ukrainian contracts, and bought up all those supplies too. Ukraine buys only one-fifth of its natural gas from Russia and could do without it long enough to find other sources, but half its total gas comes through Russia from Turkmenistan. So now Moscow could cut off 70 percent of Ukraine’s supply, and really bring it to its knees.

The geniuses in the Kremlin thought of everything — except that almost all of Russia’s natural gas exports to the rest of Europe pass through Ukraine. Did they imagine that the Ukrainian government would just let its people freeze in the dark?

On 1st January, Moscow cut the gas flowing through the Ukrainian pipelines by 95 million cubic metres a day, the amount that Ukraine normally imports from Russia AND from Turkmenistan. Kiev stopped siphoning off the amount it normally buys from Russia — but feigned ignorance of the fact that Moscow had hijacked its contracts with Turkmenistan, and went on withdrawing that much larger amount. So of course the pressure in the pipelines dropped drastically, and Russia’s customers in the European Union started running out.

One-fifth of the gas consumed in the EU already comes from Russia, so a wave of outraged protests hit Moscow. Within 48 hours Gazprom had restored the normal rate of flow — and by 4 January, in a desperate attempt to repair the damage to Russia’s reputation, Moscow signed a new five-year contract that will provide Ukraine with the same amount of gas that it used to buy from both Russia and Turkmenistan for $95 per thousand cubic metres. Nonetheless, the damage to Russian interests has been extreme.

Imported Russian gas is the cheapest energy option for many European countries, but reliability of supply is a critical issue for the consumers, and Europeans are now questioning their increasing dependence on Russian gas. Germany’s economy minister, Michael Glos, said on Tuesday that his country should now rethink its decision to phase out nuclear power. Britain, facing an inexorable decline in its own North Sea gas reserves, now wonders aloud about the wisdom of switching to Russian gas. Russia suddenly looks less like a dependable commercial partner, and more like an unpredictable, essentially political player.

President Vladimir Putin has persuaded most Russians to accept authoritarian rule in return for increased prosperity: per capita Russian income is up from $80 a month five years ago to about $200 today, and the grateful voters loyally support Putin’s party and his policies. But that relative prosperity at home depends heavily on huge exports of Russian oil and gas — and he is creating big problems for himself on that front.

Russian gas is cheaper than other energy alternatives for most EU countries, but Europeans have not yet locked into that option. There will now be considerable reluctance to let the EU’s dependence on Russian supplies get any higher. Putin’s foreign-policy strategists are not nearly as clever as they think they are.


To shorten to 725 words, omit paragraphs 8 and 11. (“The geniuses…dark”; and “Imported…player”)