Russia & Ukraine: no gas, too much hot air

Dmitri Travin
12 January 2009

The nature of this conflict is still not completely clear. Was Ukraine stealing gas intended for Europe from the pipeline passing through its territory? Or did Russia close the pipe in an attempt to shift the blame for the unfortunate consequences on to its partner?   Independent observers do not have any reliable information.  Nor do we know important details of the negotiation process between the Russian producer Gazprom and the Ukrainian purchaser Naftohaz. For this reason analysis of the whole gas dispute is as yet impossible. 

We may welcome Moscow's intention to transfer the case to the Stockholm arbitration court, and also to ensure that international observers are able to investigate what goes on in the mysterious gas pipe that runs through Ukraine connecting Russia and Europe.  We hope that in time we will gain more information. Nevertheless, we should already attempt to understand certain aspects of the conflict.

The history of the confrontation can be divided into two stages. The first is when Russia and Ukraine held talks on whether a price of $250 per 1,000 cubic metres for gas purchased by Kiev was acceptable. The second stage was when the first stage had failed and supplies were curtailed. The price proposed by Moscow suddenly rose to $418 or even (another version) $450.

During the first stage nothing particularly mysterious was happening in the Russian-Ukrainian gas trade. On the one hand, it is quite natural for Russia to want to raise the price from $180 per 1,000 cubic metres to $250: despite the preceding price rises, Ukraine still was still receiving gas at prices much lower than those paid by the European Union. Several years ago, Moscow decided that over time it would have to abandon the existing practice of reduced prices.  This ambition is quite understandable, especially given the escalating economic crisis.  Russia is losing huge volumes of petrodollars and is being forced to think of all possible options to supplement the state budget.

On the other hand, statements made by Russian Prime Minister Vladimir Putin at a press conference on 8 January that the price of $250 was extremely favourable seem unconvincing.   Gazprom itself purchases the gas from Central Asian producers for $340 per 1,000 cubic metres, and the countries adjoining Ukraine are receiving natural gas at a price of around $470 in the first quarter of 2009. The fact of the matter is that recently world oil prices have been falling dramatically. Gas prices, as Mr Putin himself noted at the press conference, are directly dependent on them. The high price of gas in the first quarter does not mean that gas will remain as expensive throughout 2009.

The renowned independent analyst Andrei Illarionov (who worked for a long time as Mr Putin's economic adviser) noted for Germany that the average price for gas supplies in 2009 is $280 per 1,000 cubic metres.  Ukrainian President Viktor Yushchenko quoted the same price when he was explaining his country's position in the gas conflict at the very beginning of January.  Illarionov and Yushchenko's assessments can probably be considered comparatively realistic.  As Germany is further away from Russia than Ukraine and transportation costs are higher, the conclusion must be that the price of gas to be paid by Kiev should be less than $280. At the negotiations Gazprom offered to sell gas to Ukraine at $250, not $450.  This is a completely sensible commercial position, and certainly not a sign of the selfless brotherly love for the Ukrainian people that the Russian leadership would have us believe. We should not think that by offering the price of $250, Gazprom intended to sell gas at a loss to itself and to the detriment of Russia.

In the talks with Gazprom, the Ukrainians stated that the optimum price was $201 per 1,000 cubic metres, $49 lower that the price proposed by the Russian side. Negotiations over a price between $201 and $250 would seem to be a completely normal economic phenomenon. Theoretically the outcome could have been an acceptable agreement, as was the case in previous years.  The current situation has been considerably complicated by the introduction of new factors, which muddy the waters.

Complicating factors

Firstly, the two sides may have different ideas about the future dynamic of oil prices.  The Gazprom chairman Alexei Miller noted that the company considers the current low oil prices to be a temporary phenomenon.  A number of authoritative analysts believe that it was in fact the incredible price rises of recent years that were temporary. In this context it is difficult to establish a price for gas for the whole of 2009 that suits everyone.

Secondly, the economic crisis makes both sides eager to fight for each cent. Ukraine is in a particularly difficult position:  it is losing revenue as result of problems in the key metals industry, but at the same time is forced to pay a higher price for gas than it did last year.

Thirdly, the complex internal political situation in Ukraine is an additional destabilizing factor.  The conflict between President Viktor Yushchenko and Prime Minister Yulia Timoshenko means that talks with Russia become a weapon which each of them may be trying to exploit. The one who manages to convince voters that the economic difficulties are exclusively the result of the opponent's political policy will receive additional points in the future battle for power. Given these restrictions, it is very difficult to take balanced decisions in talks on gas questions, although they are not technically linked to internal politics.

Fourthly, gas price talks were to have run concurrently with negotiations on the tariffs for the transit of Russian gas through Ukraine to the West. The desire of the Ukrainian side to raise the tariff can be understood: the price of Russian gas for Ukraine has almost doubled over the past three years, whereas this tariff has only increased by 6%.

Fifthly and finally, until recently gas negotiations between Russia and Ukraine were influenced by a strange intermediary - the company RosUkrEnergo. No one has ever been able to give a reasonable explanation as to why this intermediary was necessary at all. There have been several suggestions that the activities of this intermediary led to a considerable increase in corruption. The possibility of removing him from the negotiations was discussed during talks between Vladimir Putin and Yulia Timoshchenko on 2 October 2008.   This undoubtedly represents progress in cooperation between the two countries. However, his elimination from the negotiating parties (leaving Russian Gazprom and Ukrainian Naftohaz) could well complicate matters, as the intermediary's interests, involving sums that run into billions, would be affected.

The considerable uncertainty surrounding the situation resulted in the talks breaking down. But this should not be considered a tragedy in itself. These things happen, and there are temporary schemes for resolving the conflict.  Vladimir Milov, leading expert on energy issues (previously the deputy energy minister) talked about them recently.   At least a certain percentage of gas deliveries  to Ukraine could have been made at a temporary price for an agreed period. This would perhaps not have been very beneficial for Russia, but today even the direct losses from the conflict (not to mention damage to reputations) have proved too high.  Milov's assessment puts the losses at some $150 million per day.

However, since there was no temporary scheme for conflict resolution, escalation ensued. If Ukraine really did try to use gas purchased by European consumers for its own interests, then this could have been seen by the Russian leadership as almost a personal insult. I have already written about how Vladimir Putin perceives conflicts in the article Putin: mentality of a street fighter on Opendemocracy Russia.

The streetfighter

Putin has never really concealed his attitude to insults. On 8 February 2000, for instance, he said: "those who offend us will regret it in three days" (a milder form of the well-known Russian saying "those who insult us will not live three days").  On 4 September 2004 terrorists seized the school in the North Ossetian city of Beslan.  In a speech to the Russian nation Putin made it clear that Russia must not show weakness, as the weak get beaten. The Russian Prime Minister is extremely afraid of any demonstration of weakness.  The actions of Ukraine were perceived as a personal challenge and he took the steps he believed to be a sign of strength. This was all the more important as Putin has been stockpiling grievances against Viktor Yushchenko for some time.

We should not, however, conclude that the Russian-Ukrainian gas conflict has been brought to this serious stage only by personal considerations. Recent experience has shown that in conflicts of this kind Russians usually support their government and this accordingly strengthens the regime. The idea that Russia has many enemies (from Georgia, Ukraine and Estonia to the United States and Great Britain) gives average Russian citizens a feeling of personal importance and raises their self-esteem: if these countries are hostile towards us, they must fear us, and if they fear us, then we must be strong, and so we must still be a great power.

The economic crisis may well lead to a drop in people's real income, so it is hardly surprising that the authorities are trying to cultivate the philosophy of a "besieged camp". There have been numerous government statements to the effect that the crisis came to us from the USA.  This chimes well with the attempt to show people that Ukraine is trying to make us fall out with the EU, thus depriving us of revenue which could be used to mitigate the crisis and support living standards.

At the same time, it seems that the Russian leadership genuinely believes the gas problems of 2009 will not negatively affect relations with EU countries. The Kremlin hopes to show the West that Ukraine alone is responsible for all the problems. This approach is very similar to a naughty boy who tries to tell his parents that the other boy started the fight. The explanation may work once or twice. If the fights take place regularly (and in recent years Russia has already had several conflicts, blaming its neighbours each time), the parents will start to wonder if it isn't time to take some serious corrective measures.

It is very likely that however the EU assesses the actions of Ukraine in the current gas conflict, Russia's reputation as a reliable partner of the EU will suffer. She has been involved in too many conflicts lately. Accordingly Europe will try to reduce its long-term dependence on energy resources from Moscow.

As the dying Mercurio says in Shakespeare's "Romeo and Juliet", "A plague on both your houses". It is not important who technically started the conflict - the Montagues or the Capulets. If it ends with knife fights and deaths, everyone starts to suffer - and everyone is punished.

Dmitri Travin is Research Director at the European University in St. Petersburg's Centre of Modernization Studies

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