TCS Daily

Pipeline Politics

By Marcus Stober - January 3, 2006 12:00 AM

KIEV -- At 10 in the morning on New Year's Day the Russian gas giant and state monopolist Gazprom switched off its natural gas supplies to Ukraine. This astounding move came after a few hectic weeks of intense negotiations over the pricing of Gazprom's natural gas supplies to Ukraine and what it perceives as heavily subsidized rates. Clearly, Ukraine has benefited from favorable conditions but this harsh treatment of a huge neighboring country by the Russian energy giant has little to do with economics. It's all about geopolitics. It is retaliation for last year's humiliating defeat of the Russian backed presidential candidate during the Orange Revolution.

And so a commercial dispute between a Russian company (Gazprom) and its Ukrainian counterpart (Naftogaz) has developed into a duel between Russian President Vladimir Putin and his Ukrainian counterpart Viktor Yushchenko. The issues at stake are the political influence of Russia over its neighbors and Ukraine's ability to conduct an independent foreign and economic policy directed towards closer European integration. Unfortunately, the risks are high and the likely loser of this game is the Ukrainian economy, which has experienced a substantial down-turn during the last year.

Russia inherited the bulk of the Soviet Union's gas reservoir and transportation capacity and has subsidized the supply of natural gas to its former "compatriots" in the USSR. This is true for Ukraine as it is for the Baltics, Belarus, Azerbaijan, Moldova, Georgia and other ex-Soviet states. The Russians themselves argue that pricing is not calculated on commercial grounds but on political considerations. So when they announce a 400-percent overnight increase in the price of gas to Ukrainians, few doubt the real reasons for it.

In a recent article on the Ukrainian internet news site, Putin's former economic adviser Andrei Illirionov said he resigned from his post partially because he was asked to provide free-market justification for economic warfare on Ukraine. Adding to the absurdity is the fact that the original commercial agreement the Russian side now defends so vigorously was championed by the former Ukrainian pro-Russian government, which now scores political points by blaming the current government for the crisis. That this should happen just three months before the Parliamentary election in Ukraine is obviously no mere coincidence.

True, the Ukrainian side of the argument is also based on politics. The current pro-western government has said that it champions the introduction of market prices and just recently was awarded "market economy status" by the US and the EU. Now, it sees itself squeezed on the one hand between agreeing to pay more for natural gas deliveries from Russia, and on the other hand making the case for why this price offer by the Russians is nothing more than robbery. The dramatic price hike does not reflect the market value, Ukrainian Prime Minister Juriy Yehanurov argued after the valves were shut on January 1. But just what is the correct price level is probably difficult to say as politics govern the current negations. Besides, Naftogaz is a monopoly with its own pricing of transit fees on deliveries through Ukraine, which has a tendency to "disappear" in Ukraine, spurring suspicion of theft.

Then, there is the European angle to the crisis. Currently, 25 percent of EU gas supplies comes from Russia. The bulk of this transits through Ukraine and although both the Ukrainian and Russian governments have said Europe will not be affected many countries already report a drop in supplies. Gazprom has accused Ukraine of stealing and the question is how the EU will react to the current stand-off.

The EU can hardly be seen as taking sides and argues against introducing market prices, but should it and can it allow energy blackmail? If Russia is allowed to assert its influence by starving-out its political foes on suspicious commercial grounds, this should at least raise some alarms with policy makers in Brussels and European capitals. At the moment it seems like the EU is betting its energy future on a swift solution to the crisis by the parties themselves. The EU's lack of a credible strategy in the region is all too clear.

Meanwhile, here in Ukraine as the row continues and as the pressure in the pipelines is diminishing, fear is growing of how long reserves can last should the winter really start to kick-in.


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