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Russian and the EU: a choice between the devil and the deep blue sea?

January 23rd, 2009 by Jacques de Jong, Clingendael International Energy Programme

Was the Russia vs. Ukraine match that we were forced to watch and endure in the cold in some countries in the EU in the past few weeks a commercial dispute gone political? Or is it a political dispute with a commercial lining?

The conflict over gas between Russia and the Ukraine is becoming somewhat of a new year tradition. With the onset of winter the negotiations on price and transit fees between the various gas companies of both countries and their governments commence; some year they come to an agreement in the nick of time and twice they did not, in 2006 and 2009, leading to a disruption of the gas flow to the European Union. This year the prime ministers of both countries met early on and signed a memorandum of understanding, making it appear that this time round the countries leaders and their companies would settle their business before the expiry of the contract. Yes of course they would leave the fine details to the holiday season and as a belated Christmas gift they would settle their differences with the new year’s clock counting down. They would settle because their would be no interest on either side in repeating a disruption of supplies to the EU. Russia would not want to jeopardize its reputation as a reliable supplier, certainly not in the midst of an economic crisis, while the Ukraine would not want to antagonise the countries that it wanted to join in either NATO or the EU. Or so we thought.

And when supplies were interrupted a few days into the conflict, questions were immediately raised about EU supply reliability, including from unsuspected organisations such as the IEA (see the statement by Fatih Birol, the IEA’s chief economist) . When supplies to the EU were cut, many observers were wondering about the deeper reasons why companies such as Gazprom and Naftogaz and states like Russia and the Ukraine are managing their conflict in such an unprofessional and emotional way.

We are all familiar with case and the issue. The EU is currently importing Russian gas through pipelines of about 120 bcm a year, covering about 25 % of its total gas consumption of 480 bcm and it represents about 80 % of total Russian gas exports. Of these exports about 80% is moving through the Ukraine. The Ukrainian market is with an annual consumption of about 65 bcm one of the largest “European” gas markets and due to its falling domestic production (19 bcm in 2007) increasingly dependent on imports from or via Russia (see BP satistical review of World Energy 2008). The pricing of the gas for the Ukrainian market and the transit conditions for the gas destined to the EU market has been a continued source of conflict between the two countries since the early 1990’s. As long as oil prices were relatively low the problem remained concealed for EU eyes, but when oil prices increased in the late 1990s, and gas prices followed suit, the stress and strains of these increases began to be felt by a transition economy such as the Ukraine. And it must be said, this conflict also became more and more unmanageable since the Ukraine’s Orange revolution, when some of the Ukraine’s leadership also admitted to a more Western orientation. So it became apparent to many observers that there is also a political dimension to this conflict between two post-Soviet states.

The week-end of January 17-18, 2009 seems to have brought good news. Both sides announced that the two prime ministers had struck a deal about prices and transit fees. They said to have agreed to eliminate the intermediary companies that they had accused of funnelling profits from their multibillion dollar a year gas trade to political parties, and that final contracts were imminent. Russian television reports that the Ukraine would pay double last year’s price of $179.5 per 1,000 cm were however contradicted by Ukrainian estimates, which put the new price at less than the $250 earlier demanded. Gazprom said the new price would be pegged to a European formula and would fluctuate throughout the year. Other contentious issues, including Naftogaz’s alleged debt to Gazprom, and the question of which party would pay for the so-called technical gas that powers turbines on transit pipelines, appeared to be unresolved. It all looks as if the two sides had “agreed to agree”, risking however that further disputes might erupt again in future. Quoting Jonathan Stern in Financial Times, it would be appropriate to say that “this is not a time to be discussing academic and legal issues as we are in uncharted territory. We urgently need to get supplies started because people are cold.”

Therefore, was the theatre that we were forced to watch and endure in the cold in some countries in the EU in the past few weeks a commercial dispute gone political? Or is it a political dispute with a commercial lining? Without going into the more fickle points of these questions, we will refer to some observations found in other sources:

In their 16.01.2009 FT commentary, campaigners from the anti-corruption watchdog Global Witness are writing a.o. “….(quoting Putin) What the Ukrainians are fighting for is not the price of gas, but a chance to keep this or that middlemen in order to use the dividends for personal ends and enrichment”, adding that also Ukrainian’s PM Julia Tymoshenko made similar comments about “senior political officials” in her country.

• In their very interesting article in the Washington Quarterly Edward Chow and Jonathan Elkind are concluding that “Ukraine (being) a country generously endowed with many assets….The current form of (its) energy sector, however, needs to be seen for what it is, a major threat to itself and to its neighbours. If Ukraine fails to modernize its energy sector practices, …..it will threaten Europe’s own energy security. Ukraine has the potential to change this story line, ….but only after the political will for energy reform is in place. (It) would not only help Ukraine but….would arguably be Ukraine’s single most important contribution to improve the security of the trans-Atlantic community. ….Continuing failure (however) ……would be a clear signal that Ukraine is not ready to pursue its stated desire of becoming a more integral part of the Euro-Atlantic community.

Two things come to mind. What should we think of this and what should be the EU reaction. Of course, from an ethical point of view, the way in which the major players have acted or are still acting in their own irresponsible way should be heavily rejected. And that goes beyond question, no misunderstanding. A more political, realistic and even cynical reaction would however be that apparently the problem with Kyev is that its decentralised organisation of corruption is more difficult to manage than Moscow’s centralised one. As to the other question, the EU reaction, three routes could be considered. Redefining the EU approach vis-à-vis Ukraine is one thing. Speeding up alternative supply routes is another question. And, finally, enhancing and deepening the dialogue with Moscow on energy matters.

In a next posting we will elaborate on these issues and explore some options for the EU to consider.

Jacques de Jong and Coby van der Linde, Clingendael International Energy Programme

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2 Responses to “Russian and the EU: a choice between the devil and the deep blue sea?”

  1. Diana Khuzhina Says:

    The article is reflecting a geopolitical evaluation of the recent gas conflict between Russia and Ukraine from the point of view of a European consumer. It’s interesting to know though and consider quite contrary opinions on this event of the both sides of the main actors of this conflict- the Ukrainian gas transit system “Naftogas” and the Russian giant gas monopolist “Gazprom”.
    From the beginning the author is wondering about the “habit” of doing “Christmas gifts” of Russia and Ukraine to Europe. I would say that for both of these countries the end of December is still not holidays but working time and the conflict is evidently coming because of the previous contract termination. Moreover the European press is not always being aware of the conflict taking place during the whole year, it’s just in winter the problem is coming sharper.
    Undeniably the question of gas export is crucial for both Russia and the EU as “the EU is currently importing Russian gas through pipelines of about 120 bcm a year, covering about 25% of its total gas consumption of 480 bcm and it represents about 80 % of total Russian gas exports”. The origin is coming up from the past of the USSR gas pipeline system when most of the “European channels” were constructed through the Ukrainian republic territory although being not always rational decision. Thus in some mass media sources of Russian and Ukrainian emigrants it was already mentioned the fact, that in case of the collapse of the USSR Ukraine will possess enormous advantages and control of the gas delivery in Eastern Europe. The prediction came out to be true in these days and surely the local conflict of gas transition causes relationship problems between Russia and its final customer –the countries of the European Union.
    According to Medvedev, speaking at a conference on the North Stream project “From its viewpoint Gazprom has called Ukraine “transit blackmailer”. “Gazprom” is called an unreliable supplier, but given the example of the gas conflict with Ukraine in 2006 and 2009. The latter led to a transit stop for two weeks. We have not heard any evaluation of the leaders of EU and the EU Energy Charter. In 2006, the leadership EU, probably afraid of spoiling relations with the “orange” government, tried to avoid those assessments. Similarly, it happened and in 2009”. The Russian president suggested that if the EU leadership will undertake a thorough investigation into the causes of the gas conflict 2009, the membership of Ukraine in the EU would be in question. “Such an investigation would be complete at the same time showing the reliability of Gazprom as a supplier of gas”,-said Medvedev. According to him, Gazprom in the last three years has invested more than $ 30 billion in support of the transmission system of Ukraine. “Unfortunately, our Ukraine partner chose to use its monopoly for Russian gas transit to Europe for a frank blackmail. At the beginning of January, Ukraine opted for a domestic market, forgetting its commitments”, – said Medvedev. However, he insisted that neither political nor economic reasons could be essential for reducing the procurement of the EU countries of the Russian gas. “Even if we do not enter into new contracts, the share of Russian gas to European market grow from 26 to 33% in 2020”, – said Medvedev. He called on the EU countries not to discriminate against the supply of russian gas, as it has no merit.
    To my mind, the real solution of this for both of the sides is forcing the alternative ways of gas deliverance- by sub sea pipelines of Black sea from the south and Baltic Sea from the north. I agree with the author about the urgency of the diversification of transport risks. The additional transit system will support the permanence of gas transportation and won’t depend on the problems of the “third parts”. However the traditional transport through Eastern Europe should be continued under conditions of negotiation on time not to repeat the previous mistakes.
    The other point is direct 3 side contracts between Russia, Ukraine and EU so that each bloc has the right to be considered. I would make an accent on this suggestion taking into consideration the latest events of March 2009 when a declaration between Ukraine and the EU was signed in Brussels without participation of Russia. The declaration is mentioning the permission of separation of the Ukraine – Europe gas transporting system “Ukrtransgaz” from the company “Naftogas” having signed a gas contract with Russia before. Thus “Naftogas” can still purchase the gas with discounts from Russia by contract while “Ukrtransgaz” can ask for higher gas transit prices being independent. Quite an obscure step, isn’t it?
    A small remark for the author is to be added. As reading Russian press I would say that it was rather officially said in every Russian report about the real price for Ukraine- 250 dollars- the price is corresponding to European formula. However the final price came out to be of 360 dollars per 1000m3 taking into account the debt of the last year. The price for the second quarter would be less- about 280 dollars per 1000 m3. Such a statement at a conference in Brussels was made by vice-chairman of Gazprom Valery Golubev (the agency “Interfax” referring to Bloomberg). A concession in the volume of gas imported should be considered – 33 billion m3 instead of planned 40 billion m3. The Russian side is still thinking.
    In conclusion, every dispute will find its solution by publicity, honesty and justice. This is the way to avoid more conflicts because of misunderstanding and considering just a small side of the problem, accusing the powerful part of being “devil” just because of its truth.

  2. Yves YOBOUET, Master Energy Strategy at Mines Paristech Says:

    Three solutions are possible to improve the E.U gas security of supply:
    • A redefinition of European relation with Ukraine
    • The systematic search for new routes of supply and,
    • The renegotiation with Russia about the safety and security of supplies

    In my opinion, the predominant part should be the negotiation with Russia in order to reach the accord that such kind of incident will never take place in the future based on the recognized conditions. Since is known to all, Russia boasts an exaggerating quantity of reserve of gas. It leads to the fact that Europe should support projects Northstream and Southstream, covering the sensitive areas of Eastern Europe.

    As for the other possible candidates of suppliers, Europe would never give up easily some sensitive areas of the world, the Middle East for example. Even though compared with Russia, a country like Iran is not so reliable, since its thirst for nuclear project is never quenched out.

    On the other hand, the re-modification in terms of relation between EU and Ukraine means something special to Brussels: the ability to save the EU from this gas crisis is a reason strong enough for Ukraine to join EU!! Thus, the entry of Ukraine in the EU will cause repercussion to its neighbors. But first of all, Ukraine should modernize its gas pipeline, since some of which dated backed to the Soviet times.

    Last but not least, if EU can find some new sources of energy, serving to replace the gas, it will allow the leaders to redefine the policy of energy for the future.

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