Eastern Ideological Differences


January 16, 2009


Ken Silverstein
EnergyBiz Insider
Editor-in-Chief
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The ideological differences between Russia and Ukraine are affecting their shared commercial interests. Previous disputes have centered on Ukraine drifting ever closer to the West -- a battle that resulted in Russia cutting natural gas shipments to Europe two years ago by as much as 30 percent.

While the issues today are similar, both sides say they want to assure that Europe gets the gas it needs. The incident, though, is already affecting supplies to the continent. But the difference between today's flare up and that of the one in 2006 is that the European nations recognize the fragility of the situation and have therefore banked enough natural gas to survive -- for the time being.


If the dispute remains unresolved, the continent would suffer the consequences and all at a time when their economies are reeling from a worldwide recession. That's not good for either Ukraine or Russia, which is already suspect because of its recent war with neighboring country Georgia.


"Naftogaz considers the actions of Gazprom as threatening the energy security of Ukraine and Europe, which could bring unpredictable consequences for the entire gas transit system of Europe," says Ukraine's state energy company, in a statement.


Russia supplies about a quarter of Europe's gas and three-quarters of that must pass through Ukraine. According to news reports, nine European countries have seen their natural gas supplies drop between 5 percent and 30 percent since the latest episode began on January 1. Greece and Romania are said to have been hit the hardest.


Russia's Gazprom accuses Ukraine of siphoning off natural gas as it makes it way throughout Europe. It also says that Ukraine owes it $600 million in late fees. Gazprom is furthermore increasing the natural gas prices it charges Ukraine from $250 per 1,000 cubic meters to $450 per 1,000 cubic meters. Gazprom, meanwhile, has withheld the supplies it sends through Ukraine to compensate for what has been "stolen."


For its part, Ukraine says that it has no intention of paying the higher prices and notes that if it did, it would be cripple its already frail economy. It says that Gazprom has drastically cut its daily deliveries headed for Europe. It denies that it has swiped any gas and adds that Russia's price expectation is unreasonable, given that it would be unable to increase its transit fees accordingly.


Russia says that its "subsidies" to Ukraine need to end. And while Ukraine does not oppose paying market-based natural gas rates, it has said in the past that any increases ought to be phased in over five years so as to avoid a rapid hit to its own economy.


Ripple Effect

Europe, which is said to pay $500 per 1,000 cubic meters for Russian natural gas, is invariably affected. Russia and Ukraine have agreed to arbitrate their differences in an international court in Stockholm, Sweden, with Russia insisting on international monitors.

"The predictable flow of energy to Ukraine and the rest of Europe under market-based, transparent conditions are essential for stability and reliability in regional and global energy markets," says Gordon Johndroe, White House spokesman, in a statement.

It's not just a dispute between two neighbors with sharp political rifts. It's also an economic matter that impacts short-term gas prices and long-term trade relations. If Russia is to be viewed as a dependable partner, then it must show that it can supply oil and gas at reasonable prices. And, the United States, which expects to buy liquefied natural gas from Russia, is also waiting to see how the matter is resolved.

Russia has dreams of becoming the world's pre-eminent energy supplier. While its lucrative oil industry was sold to private investors in the 1990s, its natural gas business is still largely state-owned and reform has proven difficult. Gazprom, which controls nearly all of Russia's natural gas while it owns a quarter of the world's reserves, is an outgrowth of the old Soviet Union. The Russian government owns 51 percent of the conglomerate.

The resulting bureaucracy has left the system antiquated. To become an energy leader, the U.S. Energy Information Administration says that between $173 billion and $203 billion must be invested in Russia's gas sector by 2020.

That's a lot of money and Gazprom can't do it by itself. It needs foreign capital. But the Catch 22 is this: Russia needs to earn market rates so that potential investors could maximize their returns. But if the current discord continues to the point where gas supplies are held hostage to political matters, those risk takers may bail out.

The challenge for Russia is a difficult one. It is paramount that it proves to the world that it is a reliable trading partner without appearing to be a bully. As such, Russia is in the midst of trying to build another link that would bypass its ideological foes and go directly into the European continent.

Ukraine also has a lot at stake. It is trying to ingratiate itself with the West and its altercation with Russia has rippled throughout Europe. Meantime, the European nations must safeguard their own interests. They have learned from the earlier Russian-Ukrainian dispute that they need to keep large reserves on hand while at the same time work to diversify where they get their natural gas.

The current situation will dissipate. But at some point in the future, it will flare up again. By broadening their energy strategies, the affected countries will in effect send a warning shot to the main protagonists to get their acts together.


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