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#10 - JRL 2009-12 - JRL Home
From: Mr. X
Subject: Comments on the gas issue
Date: Sun, 18 Jan 2009

I spent nearly a decade working with downstream gas industries in Ukraine & Russia (through the early 2000s) and I can state for a fact that Ukrainian factories, towns and "entrepreneurs" freely siphoned (i.e., stole) gas from the main East-West gas pipelines.

Contrary to media reports, the gas conflict is neither new, nor as alarming as portrayed. It dates to the early nineties, when the USSR fell apart. For historical and geographic reasons the Soviet government located an enormous percentage of its petrochemical and ferrous metal manufacturing in the Western Ukraine. These industries were dependent upon supplies of heavily subsidized Russian gas, a fuel and feed stock). Ukraine was the prime Soviet outlet for billions of dollars of exports (not merely gas) thanks to its location on the Black Sea, where the Soviet Union (and, later, Russia) had its only fully functional, year-round, ice-free ports. The development of this industrial corridor was vital to the economic well-being of an independent Ukraine. In that crucial transitional period, had Ukraine been administered by more competent and less corrupt leaders, it could have leveraged its critical geography and former Soviet heavy industry and favorable agriculture to build a functioning relationship with its large neighbor to the East.

Repeatedly, over this period, every 15 or so months, the Russians presented the Ukrainians with an enormous bill for unpaid gas. From my first-hand discussions with Ukrainian officials, I can state quite unequivocally that these were legitimate and undisputed debts. The Russians even excluded estimates of the value of the "stolen" gas, an astonishingly high percentage of the transited quantities. Every annual conflict over gas payments included the same threats: to shut off gas to Ukraine and to raise the price of future gas delivered to Ukraine to world market levels. (At the time this meant going from $100/thousand cubic meters to up to $200.) Does any of this sound familiar yet?

Since the Ukrainians never had enough cash to pay for the gas, a deal would be struck: Some cash would be paid and control over Ukrainian industrial assets (usually plants in the East) would be transferred directly or indirectly to Russian control in lieu of cash. Gas deliveries to Ukraine were routed through monopolistic intermediaries with sanitized connections to Gazprom. (Another fact conveniently forgotten from today's press reports is that "Ukrainian nationalist" Yulia Tymoshenko was one of the founders and beneficiaries of the original Gazprom monopoly in Ukraine in the 90s). As obligatory principals in the export of gas-derived commodities these companies compensated for losses from the sale of cheap gas to Ukraine with high profits from the exports. The Ukrainian customers-many of them horribly inefficient producers-depended entirely upon these small gas monopolies, because through them Russian gas was sold at significantly lower prices than the official list price that we read about in the press-allowing them to stay in open when simple economics would not. (Say, $45/thousand cubic meters compared to a list price was $100.) Only factories buying gas from these suppliers and exporting their products though them were offered gas at these prices. It ensured loyalty.

Excluding the obvious political motivation of controlling transit gas through Ukraine, the Russian government (through its proxy, Gazprom) has two legitimate business reasons for wanting to do this. First, the Russians need to be able to eliminate the siphoning installations (that, given the unreliability of Ukrainian payments for gas, most likely still line the route) and, second, they need to ensure reliable deliveries of gas to paying customers in Western Europe.

My confusion reading the press is two-fold. First, I really don't understand how this long history has been omitted from reporting, making it appear as if every recurrence of the gas crisis is new and terrifying. Second, US policy discourages cooperation building alternate Russian gas supply routes to Western Europe. It's a schizophrenic policy: on the one hand we don't want to encourage Western Europe to become too "dependent" on Russian gas (somehow, already purchasing up to 1/4 of its supplies is not "too dependent") and on the other, we want to guarantee inherently unreliable deliveries of gas through Ukraine. Go figure. In the end, we just create a situation that is destined to deteriorate over time, given the nature of the two key parties involved and the proximity of Europe to Russia's huge gas reserves.

The only solution is to build alternate supply routes from Russia to the West that bypass Ukraine. Given the enduringly irascible relations between Russian and Ukraine, and the two-decade long Ukrainian history of failure to pay for gas, few would call this transmission route reliable. Accusations that alternate pipeline routes would be dangerous, because they would increase European dependence upon Russian gas are blatantly hypocritical and one-sided. A dedicated pipeline will increase mutual dependence; Gazprom lost billions of dollars in vital gas sales to Europe during this recent interruption, forcing it to settle the dispute with Ukraine. An alternate pipeline routing would only increase its dependence on sales Western Europe. The hypocrisy becomes apparent when you consider that the risk of the US' enormous and growing financial dependence upon China is dismissed on these very grounds. As they say, what's good for the goose is good for the gander.