TCS Daily


The Globalization Difference: The End of the Abusive State

By Melana Zyla Vickers - January 4, 2006 12:00 AM

Like a flashy celebrity caught smacking his ex-girlfriend in public, Russia's Vladimir Putin has had to retreat from his decision Sunday to blackmail Ukraine by cutting off the country's natural gas supplies. Following an outcry from West Europeans, Russia resumed piping 100 percent of the required gas through Ukraine on Tuesday.

The lesson? Length of time autocratic Russia could put the screws to a neighbor in the imperial and Soviet era: decades. Length of time autocratic Russia can put the screws to that neighbor in an era of globalization: three days.

Just as Russia last year discovered it couldn't hand-pick a communist to serve as the Ukrainian president, it cannot now use gas prices to punish Ukraine for asserting its political independence. The broader lesson for Russia's neighbors -- or any expansionist bully's neighbors -- is that you must integrate in the region beyond you, economically and politically, so that you spend as little time as possible with the bully behind closed doors.

Of course, behind the politics of the gas shutoff is a pricing issue with some economic merit. Russia's state-owned gas monopolist (and proxy foreign ministry) Gazprom has decided that if Ukraine is going to engage in independent-minded behavior, it will hike Ukraine's gas prices to match West European prices rather than the prices enjoyed by Russian consumers and more Moscow-obedient ex-Soviet republics such as Belarus or Armenia.

Ukrainian negotiators say fine, hike them, but not by 400 percent in one day. (A price hike anywhere near double digits leads to government investigations in the West.) Russia says yes, 400 percent, Ukraine says no. Russia turns off the pipes. The Gazprom technique is tried-and-true: it was used to get Belarus into line several years ago. And to keep Turkmenistan in check, Russia has at times cut off Turkmen gas, which flows across Russian territory. The trouble is Russia's gassy diplomacy with Ukraine has consequences that spill into Western Europe, whereas cries of gas blackmail on the frozen steppes of Belarus, where the still-Communist government is pro-Moscow, or cries of blackmail in Turkmenistan, which is isolated and land-locked, can't be heard for miles.

Globalization helps Ukraine. Almost all of the Russian natural gas used by Western Europe, 80 percent, comes through the same Ukrainian pipelines to which Russia cut supplies on Sunday. So within hours of the cut, Slovakia, Austria, and Germany further down the line were squealing: Their supplies were down, and supply disruptions to European industry could harm national economies. Ukraine, for its part, called for international mediation of the gas dispute at the Stockholm Arbitration Institute -- attempting a kind of globalization of its negotiations.

The Europeans were primed to react negatively to Russia's move. They were already worried about the fact that they're dependent on Russia for roughly 25% of their gas. Not only had they seen the Ukraine-Russia conflict simmer, with its threats of supply cuts, but Russia had tried to throw its monopolist weight around with them directly, too. Here's how:

- Russia wants to form a gas cartel. Russia, which together with Iran has 45 percent of the world's natural gas, has since 2001 been instrumental in creating and strengthening an international Gas Exporting Countries Forum, and exploring the GECF's potential to be an OPEC-style cartel. The forum has no European or North American members, and has a majority of Middle-Eastern or rogue states.

- Russia fights the liberalization of gas markets and prices: Russia has sought to prevent European countries, which have pledged to liberalize their gas markets, from ending the use of "destination clauses" that forbid companies from reselling gas to a third party. Naturally, such clauses protect monopolists, keep prices high, and prevent new entrants into the market.

- Russia resists the development of a risk-managing market for natural gas: In the U.S. and Canada, gas exploration, gas pipelines, and gas delivery are largely privately owned. Gas prices are determined and supply risks are managed in functioning markets such as the New York Mercantile Exchange. Russia, meanwhile, has reasserted control over its gas resources through state-owned Gazprom, and uses bilateral contracts that don't shelter the buyer from risk and that serve the interests of Gazprom. As a peculiar aside, Russia even hired German ex-Chancellor Gerhard Schroeder, a socialist and no friend of market reforms, to carry its water at West European cocktail parties.

Given these Russian tendencies, the Europeans were primed to react negatively to Russia's gas blackmail in Ukraine. President Vladimir Putin's meddling in the Ukrainian elections last year, right under the nose of European election monitors, didn't help matters, either. In a sense, Ukraine is enjoying a new identity as a canary in the coalmine of Russian misbehavior.

That position won't necessarily last. Russian politicians are sure to go back to the drawing board for new, more stealthy ways to punish their wayward southern neighbor. And West Europeans don't have a terribly consistent record of caring about abusiveness outside their universe.

But in terms of gas politics, Russia has been exposed. If there's now a redoubling of effort by Ukraine and the West Europeans to find alternate sources of energy (nuclear, coal, electric, liquefied natural gas, gas from non-Russian pipelines), or to find financial instruments to hedge Russian price-setting if they can't actually wean themselves of Russian gas in the near term, then the politicians at Gazprom will have been duly punished. If the U.S. can do anything to assist this weaning, it ought to.

In an ideal world, Russia will lose the energy-blackmail arrow in its quiver. And that will be for the best.

Melana Vickers is a TCS columnist.

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4 Comments

But why did Putin back down?
Good article, but I couldn't find an explanation as to why it took only three days for Putin to turn the tap back to on? It doesn't show him to be much of a strategist. If he was just making a point - the point he makes, as the article states - is that Europe must redouble its efforts to become less reliant on his gas. So I'm not sure we really know why Putin turned the gas off, or turned it back on.

He turned it off becuase Ukarians were stealing gas.
The stated reason was becuase the Ukarians were taking gas from the pipeline in order to stop them they switched it off. It just so happens that the pipline also services their other European customers. They turned it back on before anybody run out of gass.

The Author has written the piece with his blickers on there is more to the story then this.

99
One explanation is the it was gazprom who decided, reasonably if you believe in capitalism, to raise Ukraine's price to the going market rate & that only subsequently, under political pressure, did putin review & reverse this.

In any case this is not a case of freedom lovers defeating a political attempt to manipulate prices & steal gas, it is the exact opposite.

And now, the rest of the story
The reason why Moscow was selling oil to the Ukraine at below market rates was because that was the deal the two countries arrived at. Ukraine let the Russians run a pipe through their country, and Russia sold gas to Ukraine at reduced prices. Russia decided unilaterly to renege on their side of the deal.

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