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Russia Profile
January 16, 2009
Russia Profile Weekly Experts Panel:
Another Gas War with Ukraine
Introduced by Vladimir Frolov
Contributors: Stephen Blank, Ethan Burger, Andrei Liakhov, Edward Lozansky, Andrei Tsygankov

The year 2009 started with Russia and Ukraine in a brawl over payments for Russian gas, with Europe seeing its gas deliveries siphoned off by Ukraine. On New Years Eve, Russia and Ukraine failed to reach an agreement on prices for gas deliveries to Ukraine, and this issue remains to be resolved. What are the Russian and Ukrainian objectives in this gas crisis? Who is more likely to achieve them Moscow or Kiev? Is the issue strictly commercial or purely political? How are the Russian and the Ukrainian leaderships handling the crisis?

Gazprom initially insisted on the European price of over $450 per trillion cubic meters, but later made a humanitarian offer to sell gas to Ukraine at only $250 (last year it was $179). That price was rejected by Ukraine as too high (Kiev offered to buy Russian gas at $201). Gazprom stood to lose about $12 billion in 2009 for selling gas to Ukraine at such subsidized prices, and in these times of financial turmoil wanted a better deal.

Without the contract, Gazprom could no longer deliver gas to Ukraine, and proportionally cut the volume of gas pumped into the export pipeline system running through Ukrainian territory, while continuing to deliver gas volumes intended for European customers. Kiev immediately began siphoning off the European gas for its own needs, while a local court in Ukraine ordered a complete halt to gas transit. On January 7, Gazprom stopped all of the deliveries to prevent theft. More than a dozen EU countries felt the disruptions in supply and several struggled to maintain heat and electricity.

There is no immediate way to reroute gas deliveries from Russia to Europe bypassing Ukraine. About 80 percent of Russian gas exports to Europe, over 120 billion cubic meters a year, have to go through the Ukrainian pipeline system. Alternative routes through Poland and the Blue Stream pipeline to Turkey can handle less than 50 billion cubic meters per year. The construction of the Nordstream pipeline to Germany has just begun, and even when completed in 2011, this system will not be able to deliver more than 16 billion cubic meters a year.

What are the Russian and Ukrainian objectives in this gas crisis? Who is more likely to achieve them Moscow or Kiev? Is the issue strictly commercial or purely political? How will the crisis affect Ukraines internal political dynamics? How will it affect Russias and Ukraines standing in Europe? How are the Russian and the Ukrainian leaderships handling the crisis? Has Russian PR on the gas issue gotten better, compared to the last crisis in 2006? What lessons has Russia learned? What can be done to prevent such crises from recurring?

Edward Lozansky, President, American University in Moscow:

First of all, the gas crisis is not over yet, and contrary to some optimistic expectations it may actually continue for a long time, perhaps in a less severe but still pretty damaging way to all parties of the conflict. This will bring some additional pain to the current global economic and financial crisis, so we should be ready for the worst. However, despite all negative consequences, each crisis provides an opportunity to soberly evaluate the situation, draw proper conclusions, learn new lessons, think of the new strategies and tactics, and apply a new course of actions. Unfortunately, the September 11 crisis, despite some encouraging steps at the beginning, did not produce too much in the long term East--West cooperation agenda. Will the current crisis generate better results? No one knows for sure, but nothing will happen unless we try, and here is some of my humble advice to the powers that be.

Russia should diversify gas delivery options and diversify the economy, with less reliance on the raw materials exports and more on science, technology, and infrastructure. It should think of a better use for Russias huge agricultural land resources to become a food exporter, as global warming might actually be a positive factor here.

Instead of looking nervously at some of the CIS countries desires for integration with Europe, Russia should make its own serious effort to join the European Union. The EUs help in resolving the current gas crisis with Ukraine should be a strong indicator and additional stimulator for this direction. Russia has enough powerful friends in the EU who might help in this process.

It should also continue to push for the new European Security system with Russia as its integral part. Bear in mind that there are not too many people in the world who understand what this Russian proposal means, so it has to be explained in simple terms to the general public to generate support, both in Europe and America.

There is an informational war against Russia in the Western media which, in my view, is lead by the Washington Post and Wall Street Journal, whose editorial pages pretty much resemble the style of the now-deceased Pravda. Russia quickly learned the free market mechanisms and I am sure it has enough talent to successfully engage in this informational war as well.

Europe should draw a roadmap for Russias integration with the European Union, both in economic and in security terms. It is time to accept the reality that for Europe, it is more beneficial to have Russia in than out. It should also freeze future NATO expansion until Russia is given a real chance to become a part of the European Home.

The United States should go back to the original idea by George Bush Sr. of the new security system from Vancouver to Vladivostok. The process of NATO expansion and Missile Defense Installation in Eastern Europe should be placed on hold, in exchange for Russias substantial help in Afghanistan and Iran. The flawed and dangerous policy of further dividing Russia and Ukraine should be reconsidered. These two countries are united by strong historical, cultural, economic, and demographical ties, and everyone who is trying to break these ties apart, including domestic or foreign politicians, is playing with fire.

Summarizing the above, no matter how severe the gas, economic, and financial crises are, if as a result, both the East and West will turn toward a long-term partnership, well all be winners after all. If, however, the West chooses a policy of isolating Russia, for example, through new pipelines that bypass its territory and by encircling Russia with new NATO members, this may turn Russia to retrenchment and nationalism. In this case, God help us all.

Andrei Liakhov, Partner, Withers LLP, London:

For many reasons, including compliance with Russia's WTO accession obligations, a decision was taken in 2000 (with active EU participation) to gradually eliminate discount prices charged to former Soviet republics. This decision was publicized by Russia, but initially largely ignored by its neighbors.

Ukraine enjoyed heavily discounted prices after the decision was announced, which lead it to believe that this decision did not concern it. In addition, the new government wanted to have the best of both worlds: to be a part of the "Western world" and to retain competitiveness of the principal sectors of its economy, which was based largely on the low cost of energy. This is unacceptable for Russia both economically (it needs as much money as it can get for rebuilding its economy) and politically (the mantra in Moscow is "why should we prop up an openly hostile regime?"). Furthermore, the 2004 regime change in Kiev was seen as an opportunity to get rid of several intermediaries, and to make the relationship with Naftogas more transparent and "economical." As a side benefit, Russian steel and chemical companies are poised to gain an immediate benefit from gas price increases.

Kiev's objectives, particularly political, are less clear. Generally, the industry commentators tend to agree that a switch to full market prices is tantamount to political suicide of the current Ukrainian regime, as, if sanctioned, it is likely to result in massive job losses, particularly in Eastern and Western Ukraine. Thus its desire to avoid, or at least to postpone, the hike for as long as possible, is understandable. However, Ukrainian metals and chemicals sectors need to be radically reformed, and the gas price increase may offer an excuse to do that with a minimal loss of face. It is also evident that politically, the relationship with Gazprom is being primarily used as a tool in the struggle for presidency, with little regard for economic and/or political fallout, both domestically and internationally. That would seem to be the case, unless there is some truth in several conspiracy theories circulating in the media.

The most recent twist in the "battle for transit" shows that both sides are quite entrenched in their positions. Gazprom has done what it has never done (but should have in my view) before - it has started litigation against Naftogas and the state of Ukraine. However, in practical terms, this will not lead to a re-start of Gazproms gas transit to its EU customers. The "battle for transit" is seen as Ukraine's weapon of last resort to force Gazprom to agree to continue supplies to Ukraine at discount prices. Both parties have demonstrated their willingness to ignore the interests of their EU customers to make their points. Gazprom's position looks slightly more justifiable and transparent, but the longer Gazprom continues to use technological excuses to delay re-commencement of transit in hope that Brussels will force Ukrainians to cave in to its demands, the less support it is likely to get from the freezing Europeans.

At the same time, the sanity of the Ukrainian government and its ability to run the country are being questioned in Europe. It is more than likely that both Gazprom/Russia and Naftogas/Ukraine will come out of this literal Cold War as losers, irrespective of the gas price which will be agreed on between the parties at some (probably quite distant, given the volumes stored by NG) point in the future. Europe will scramble to court Central Asian states to make them agree to pump gas via Nabucco, which will be re-routed to bypass Ukraine (and, possibly, Bulgaria), Gazprom will have to shut (hopefully, temporarily) a number of wells, will be able to retain a much lower share of the European gas market, and more highly dangerous LNG tankers will be built. All of these measures require huge investment, will take a long time to implement and will lead to the decrease in the importance of the EU-Russia and EU-Ukraine relations.

In the short term, this could persuade the Europeans to support Gazprom's Nordstream, but it is likely that this will be achieved against the background of a strong opposition, the main argument of which is likely to be "Europe should not be held hostage by Gazprom." It is fair to say that this argument was raised in the 1970s, when the first gas pipeline to Europe was being constructed, but now its supporters seem to have more arguments to back it up.

As was stated above, the core of the dispute is undeniably commercial. However, it is being blown out of all proportions and being used by both parties to achieve political ends. Political shenanigans around the dispute are likely to have long-term geopolitical consequences, one of which is a serious blow to Russia's reputation as the EU's trade partner. As for Ukraine -- it is just another demonstration of Ukraine's total unsuitability for membership in any European institution, and should strengthen the EU's resistance to U.S. attempts to drag it into NATO. The scope of the blow to their respective reputations will become clearer in the coming weeks, but judging by the noises emanating from European capitals, the damage is serious.

It also looks like the Russian leadership is using the Ukrainian mistake of engaging in the "battle for transit" to its full advantage, and is handling the crisis much better than its Ukrainian counterparts. It was better prepared for the transit war and, unlike the 2006 crisis, lawyered up way in advance. Ukraine failed to take notice of the fundamental shift in the European perception of the "Orange team," thus making their 2006 tactics of a "small but brave nation being terrorized by the Russian bear" redundant.

However, Russia's obvious PR victory will soon pass, as mainstream Western media is generally unfriendly to Russia. Unfortunately, the only lesson Russia is likely to learn is how to conduct successful PR campaigns, and the real long-term importance of the crisis and its consequences for Russian business (particularly of the "battle for transit") will be lost on the current Russian leadership (which would like to forget this nightmare as quickly as possible).

Andrei Tsygankov, Professor of international Relations and Political Science, San Francisco State University, San Francisco, CA :

Russias objectives are both commercial and political. Commercially, the Kremlin seeks to improve conditions of selling gas to Ukraines long-subsidized energy consumers and to strengthen the determination of Europeans to diversify transportation routes away from Ukraine. Europeans have a tendency of blaming Russia for a number of things in the post-Soviet world, and may need a nudge to see the bigger picture. Politically, Russia wants to reiterate that it will do everything in its power to protect itself by preventing Ukraines movement to NATO. The Kremlin apparently feels that it is cheaper to fight a gas war than to have another military confrontation similar to the one in the Caucasus.

However premature it may be to assess Russias policy record, at this point the Kremlin is halfway through in achieving its objectives. It is closer to getting a better price for selling gas to Ukraine, although the price is certainly not going to be as high as Gazprom wants it to be. The message about diversifying away from Ukraine is also sinking in. Those who pay attention to the prospects of diversifying away from Russia by building the Nabucco pipeline are correct. But they should also consider that Ukraine is increasingly viewed as a non-reliable transit route, and in the mid-term there are no feasible alternatives to Russia as a supplier of gas. These two facts are likely to work in favor of building the Northern pipeline, and at least not objecting to the Southern one.

On NATO, the picture too is not necessarily against Russia. Here, the most important message is for European members of the alliance who also happen to be consumers of Russian gas. Simply put the message is: if you pressure Ukraine to join NATO, you will end up having problems with gas supplies. Whether or not you want to blame Russia or Ukraine for the crisis, the reality is that when the two post-Soviet nations fight, Europe suffers too. While the reputation of both nations suffers, the Kremlin seems to care more about security from NATO encroachment than the already damaged energy image.

Ethan S. Burger, Adjunct Professor, Georgetown University Law Center, Washington, D.C. :

While a ceasefire may have been reached in the dispute over Gazprom's gas exports to and through Ukraine, ceasefires often represent merely breaks in, as opposed to a succession of the fighting. Political struggles seldom disappear rapidly without a trace. Recall that Waterloo -- constituting the final defeat of French Emperor Napoleon -- occurred after his escape from Elba.

Nineteenth century Prussian military theorist Carl von Clausewitz observed that war is a "continuation of politics by other means." If he were alive today and attempting to analyze the present state of relations between Russia and Ukraine, he might be perplexed. Traditionally, wars were fought between states. On occasion, "wars" could be fought by governments against separatists, pirates or other non-state actors, although such actions might be termed "policing" actions. While he might be familiar with states using military force to advance the economic interests of certain corporations or individuals, he might not have contemplated a "war" being fought between a corporation and a state.

Since Clausewitz would have known about the history of mercenaries fighting on behalf of states, he might even see some of Gazprom's recent actions toward Ukraine and its other customers as having some common features with the mercenaries of yore. He probably would be reluctant to describe the situation as constituting a "war" at this stage, although he might see the logic behind using its customers to pressure Ukraine to acquiesce to Moscow's dictates. At the same time, he might be shocked to learn that the former German chancellor Gerhard Schrder was employed by Gazprom to serve on a supervisory board of a consortium that sought to build a natural gas pipeline under the Baltic Sea from Russia to Germany.

Gazprom "is the worlds largest gas company basically focused on geological exploration, production, transmission, storage, processing and marketing of gas and other hydrocarbons. The [Russian] state owns a 50.002 percent controlling stake in Gazprom. . . . [its goal] is to provide effective and well-balanced gas supply to Russian customers and to safely implement long-term gas export contracts. Gazproms strategy is to acquire the leading position among the global energy companies by entering new markets, diversifying core business activities and ensuring reliable supplies," the Gazprom Web site states.

Nonetheless, if Clauswitz were alive today, he would probably assume that Gazprom was part of the Russian Government's Ministry of Energy or Foreign Affairs, rather than a commercial entity organized as a joint stock company under Russian law that has private (including foreign) shareholders. Eventually, Clauswitz might come to accept that Gazprom energy exports were in fact an instrument of war -- how else could he explain the Russian leaderships remarks concerning Ukraine?

Clauswitz would be in good company in having difficulty understanding Gazprom's attitude toward its foreign customers. According to the New York Times, "the line between state-owned Gazprom and the Russian state is often blurry, and became more so in 2008, when Gazprom's former chairman of the board, Dmitry Medvedev, was sworn in as president of Russia. Several board members wear two hats and also work in government."

Furthermore "[w]hen Vladimir Putin was Russia's president, Gazprom functioned as an instrument for centralizing authority, buying up opposition television stations and newspapers, which quickly became compliant. And abroad, the line between Gazprom and the Russian state's foreign policy is sometimes so thin as to be almost nonexistent." This situation continues today, even though Vladimir Putin in now Russia's prime minister and Dmitry Medvedev--its nominal president. I have never understood why the former Russian prime minister and former Gazprom chairman is Russia's Ambassador to Ukraine. Was he meant to be Russia's potential plenipotentiary in Kiev? One might wonder what he does on a daily basis. Has he improved Russian-Ukrainian relations since he assumed this post? Is he irreplaceable?

Clearly, Gazprom's controlling shareholder is using the company to further the Putin leadership's perceived foreign policy objectives. Emphasis should be placed on the word "perceived" -- perceptions vary within the Russian elite (and middle class), particularly during these trying economic times.

Whether Gazprom's gas export policy benefits all of its shareholders is not yet clear -- it will take years to determine the impact of the present situation. Perhaps Gazprom's failure to deliver natural gas to all of its European customers will force them to pursue alternative energy sources at an expedited rate, while at the same time depriving its largest shareholder of needed export taxes/fees/dividends in the near-term (estimated by Putin to have cost Gazprom the equivalent of at least $800 million).

Gazprom has never been an opaque entity known for its transparent corporate governance. As a general principal, a corporation's board of directors should function in the interest of its shareholders, as if all the shareholders had a unity of interest -- in most cases, this would entail maximizing shareholder value in the company. Is this occurring? There remain many unanswered questions the answers to which we are unlikely to know for quite some time. For example, in an economic sense, which individuals or legal entities are benefiting from the present situation? Since the Russian state is the largest stakeholder in Gazprom, are the Russian people accruing concrete benefits (other than any "psychic" benefits that their government might impose hardship on Ukraine and other governments)?

Gazprom's Board of Directors consists of Viktor Zubkov, Alexey Miller, Alexander Ananenkov, Bergmann Bruckhard, Farit Gazizullin, Elena Karpel, Viktor Khristenko, Elvira Nabiullina, Mikhail Sereda and Igor Yusufov. I would be interested to learn how these aforementioned individuals came to be nominated to serve on the Gazprom board? How are they remunerated and in what manner? Are Gazprom shareholders (particularly minority shareholders) content with their performance? One would expect that if Gazprom is indeed a commercial entity and not a tool of state power, foreign governments should treat it as such. Article 15(4) of the Russian Constitution provides that commonly recognized principles and norms of international law and the international treaties of the Russian Federation shall be a component part of its legal system. When Gazprom uses natural gas as a political instrument against foreign states to influence the outcome of Russia's dispute with Ukraine, it runs the risk of running afoul of commonly accepted principles of private international law, as well as applicable competition or anti-monopoly legislation.

Thus, depending on the text of the relevant energy gas supply contracts, Gazprom may be found liable for causing harm to its customers, and also be subject to sanctions established by its customers governments. The potential plaintiff(s)/foreign governments are almost certainly aware that Gazprom has significant assets located outside of Russia to pursue.

Returning to our military metaphor -- the Putin leadership and his allies at Gazprom acting on its behalf should not be surprised if they find that, like Napoleon, they might be able to win battles, but lack the capacity to win a war. This is the intellectual construct in which Clauswitz analyzed international politics -- it is one to which the Russian national security community can relate.

Professor Stephen Blank, the U.S. Army War College, Carlyle Barracks, PA:

Russian objectives are quite clear. Firstly, Moscow wants to undermine the Viktor Yushchenko government and increase its capability for keeping Ukraine more dependent on Russia. Secondly, Gazprom is now desperate for cash. The gas it sells Ukraine comes from Central Asia, and last year Moscow had to recognize Central Asian producers' combined power and agreed to pay them market prices of (approximately) $300 per every trillion cubic meters of gas. Now that the price of gas is falling like a stone, Gazprom will be selling Ukraine gas for less than what it cost to buy it--hardly a sound commercial practice. Thirdly, Russian "businessmen" are no less involved in Rosukrenergo than is Firtash et al., and those middlemen stand to make millions by charging more for gas and by preserving intermediaries in the business.

It should be understood by everyone that Gazprom knows full well what goes on with Ukrainian gas, and its leaders and friends benefit just as much as do corrupt businessmen in Ukraine from it. Indeed, that corruption funds numerous political projects for Russia. Thus, Russia is not innocent here. There are, on the other hand no visible Ukrainian state objectives that are not mixed with the personal objectives of the rival Ukrainian players. This is another way of saying that Ukraine cannot come up with a national interest other than to assert its independence from Russia. But Yushchenko's brother, if not other members of his team, is tied to Rosukrenergo. Finally this crisis highlights the crying need for reform in both countries, and the danger to Europe of Russia's use of energy as a weapon.

Inherently, this cannot be a purely commercial crisis, but a political one involving Russian efforts to corrupt Ukraine and to weaken it. Ultimately, it is unlikely that either side has gained or will gain much from this, because the solution of a transparent energy business without intermediaries is not in anybody's immediate interest. Any deal Moscow signs with Yulia Timoshenko (herself no innocent in this business, as it is the source of her wealth from the 1990s) will also probably be riddled with corruption.

Russia's "spin" or PR has been of no avail. Nobody is surprised that both governments are corrupt or that Ukraine exists in an advanced state of political paralysis, but Russia's aggressiveness and willingness to plunge Europe into a gas embargo for no good reason and make unsubstantiated claims about Ukrainian theft have only served once again to remind people of Russia's aggressive intentions and capabilities. Clearly, Putin and Medvedev will complain about the Western media and double standards, but they have nobody to blame but themselves. Indeed they would be well advised to remember the Russian proverb that if you don't like the reflection, you shouldn't blame the mirror.