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#18 - JRL 2009-9 - JRL Home
Subject: Gas Wars - comments
Date: Wed, 14 Jan 2009
From: "Andrei Liakhov" <Andrei.Liakhov@withersworldwide.com>

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 publicised by Russia, but initially largely ignored by its neighbour customers who assumed that it would be business as usual for the time to come.

As Ukraine was not on the top of the list of customers with whom contracts had to be re-negotiated (Armenia, the Baltic States, and former Warsaw Pact countries were a priority) it enjoyed heavily discounted prices for several years longer and assumed that the prices will always remain low. In addition the new Government wanted to have the best of both worlds: to be a part of the "Western world" and retain competitevness of the principal sectors of its economy which was based largely on low cost of energy. This is unacceptable for Russia both economically (it needs as much money as it can for rebuilding its economy) and politically (the mantra in Moscow is "why we should prop up an openly hostile regime?"). Furthermore, the 2004 regime change in Kiev was seen in Russia as an opportunity to get rid of several intermediaries and make the relationship with Naftogas more transparent and commercial. As a side benefit, Russian steel and chemical companies are posed to gain an immediate benefit from gas price increases, as domestic Russian prices will remain lower than the world market at least until 2011.

Kiev's objectives, particularly political, are less clear. Generally industry commentators tend to agree that a switch to full market prices is tantamount to a 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. Russia seemed to have accepted that and several documents providing for a staged increases in gas prices were signed betweeen 2005 and 2008. However, as Ukrainian metals and chemicals sectors need to be radically reformed anyway, the gas price increase may offer an excuse to do that with a minimal loss of face for any Government. It is also evident that politically relationship with Gazprom is being primarily used as a tool in the struggle for presidency with little regard to 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 re-start of transit of Gazprom gas to its EU customers and EU diplomats are shuttling between various European capitals in a desperate attempt to persuade the parties to resume gas transit with no apparent success. 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 which, if achieved should give Yuschenko's tough Russia policies some credibility with Ukrainian elites and electorate. However in the battle fervor both parties have demonstrated their willingness to ignore interests of their EU customers which will inevitably worsen both parties' long term relations with Europe. While Russia, being a stronger country could risk such storm, it cannot be said about Ukraine. In addition, Gazprom's position looks slightly more justifiable and transparent, but only just and the longer Gazprom continues to use technological excuses to delay re-commencement of transit (as Ukrainians now seem to claim) in hope that Brussels will force Ukrainians to cave in to its demands, the less support it is likely to get from freezing Europeans. At the same time sanity of Ukrainian government and its ability to run the country are being questioned in Europe. It is more than likely that both Gazprom/Russia and Ukraine/Naftogas will come out of this literally cold war as losers, irrespective of the gas price which will be agreed between the parties at some (probably quite distant, given the volumes stored by NG) point in the future. Armies of lawyers will previously happily engaged in floating Russian companies on various European exchanges which were scraping for work, now will be earning huge fees representing every conceivable party in what promises to be several years of intense international dispute resolution processes.

Europe will scramble to court Central Asian states to make them to 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 European gas market, more highly dangerous LNG tankers will be built and operated in the Mideterrainian complicating further navigation in these busy maritime highways. Europe will finally come around to working out and implementing radical energy saving measures, possibly renewing expansion of nuclear energy, it will also seek to diversify their energy supplies away from Russia and the CIS generally. This is likely to cause European energy companies to divert their attention away from projects in the CIS. This should lead to decrease in FDI into the CIS countries. The current gas war is likely to have a domino effect on the Russia-EU relations. However as all these (and other) measures will require huge investment and will take a long time to implement there will be a relatively short period of time for Russia to seek to repair the damage caused to its relations with the EU.

In the short term, this could persuade the Europeans to support Gazprom's Nord Stream, but it is likely that this will be achieved on 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 70s 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 the proportions and being used by both parties to achieve their respective political ends. Political shenanagins around the dispute are likely to have long term geopolitical consequences, one of which is a serious blow to Russia's reputation as EU's trade partner. As to Ukraine - it is just another demonstration of Ukraine's total unsuitability for membership in any European institutions and should strengthen EU's resistance to US 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 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 2006 crisis "lawyered up" way in advance. Ukraine failed to take notice of the fundamental shift in European perception of the "Orange team" - thus making their 2006 tactics of "small but brave nation being terrorised by 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).