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Moscow Times
January 13, 2009
Observers Say Gas Deal Should Be Linked to Oil

LONDON -- Europe faces potential gas supply crises every winter unless Russia and Ukraine agree on a long-term oil-linked gas contract that might require financial help from Europe, analysts said Monday.

Russia has not offered Ukraine the kind of long-term deal enjoyed by its customers in Western Europe, which might settle the dispute for good.

Analysts said that to do so would remove Moscow's favored method of exerting political pressure on the pro-Western government in Kiev.

"There has to date been little incentive to come to an amicable long-term relationship with Ukraine, so this is going to happen again and again. It suits Russia to return repeatedly to this gas relationship because it's a way of further destabilizing the existing regime," said Dieter Helm, professor of energy policy at the University of Oxford.

"The Russians are holding them on a short-term exposure to the spot market, and that's why we have this annual event," Helm said. "What is needed is a stable long-term pricing formula. That has to be pricing gas in relation to oil prices, which have fallen sharply."

Ukraine's main objection to Gazprom's price demands is that Western European buyers should see their bills halve by summer as a slump in oil prices since July feeds into oil-linked gas contracts.

Many analysts expect oil prices to remain low this year and possibly beyond as recession weighs on global demand.

This could give Ukrainian more time to recover from its worst recession in over a decade and give it a better chance of paying bills next winter.

But neither side of the bitter gas dispute has said publicly that a long-term deal is under discussion, posing the real threat of another crisis next year.

"They may well fudge a deal again this year, like they have done for the last three or four years, but then the same problem will crop up again next year until there is probably some help," said David Cox, chief consultant at Poyry Energy Consulting in London.

"It is in Western Europe's interest that the Ukraine does start to pay market prices, and the sooner the better. But in terms of making them move to fully market related prices, they can't really do that in one step or even in a couple of years -- it needs to be phased," he said.

"If we want the Ukraine in the EU and we want them on our side, rather than [Prime Minister Vladimir] Putin's side, maybe we have got to pay a cost for that, and that is partly helping them with the transition," Cox said.

Helm warned against Europe subsidizing anybody's energy bills but said the European Central Bank could give additional funds to Ukraine, in addition to the $16 billion from the IMF, to help Ukraine get through its economic crisis.

Russia's price demands for this year have varied from $250 to $450 per 1,000 cubic meters of gas, with Moscow raising the price each time Kiev rejected its previous offer.

Analysts estimate that the latest Russian offer of $450 per 1,000 cubic meters is much higher than other European countries will be paying for their Russian gas over the next few months.

They say Ukraine should not be expected to pay the same price as buyers in Germany or Austria because Russia uses Ukraine to ship 80 percent of the gas that it supplies to Europe.

"The Russians are trying to raise the prices to the same level at which they sell to Western Europe. That's always been their intention," said Niall Trimble, director of the Energy Contract Company in London. "Obviously, Ukraine does not have the wealth these countries have, so it's very hard to do that."

But some kind of oil-linked formula should ensure reliable winter warmth across Europe for years to come.

"That's what the rest of Eastern Europe's contracts are linked to as well, it's not just Western Europe," said Noel Tomnay, principal global gas research for Wood Mackenzie. "There are reasonable arguments being made here, and it's really up to the sides to conclude them."