The Gas Conflict between Russia and Ukraine

On January 1, 2009, Gazprom cut off natural gas deliveries to Ukraine claiming that it had failed to pay for gas deliveries in 2008 and for the penalties exacted from these delayed payments, and because no agreement had been reached on the price for deliveries in 2009. After Ukraine began charging gas as payment for its transit services, Prime Minister Putin ordered drastic cuts.

Gazprom’s action was no surprise. Top Russian officials had given loud warnings and Gazprom has repeatedly cut off its gas deliveries to all its post-Soviet customers: Estonia, Latvia, Lithuania, Belarus, Ukraine, Moldova, Georgia, Azerbaijan, and Armenia. Ukraine faced the same fate three years ago. Gazprom is notorious for its aggressive, monopoly pricing and for disrespecting its customers.

Yet it is amazing that Gazprom could treat Ukraine, one of its largest customers, like this. By December 30, Ukraine had paid for all the gas it had imported in 2008. In spite of Ukraine’s prepayment, Gazprom claimed penalties first of $450 million and now of $614 million without any public explanation. On Christmas, before the negotiations had failed, Gazprom even opened a website abusing Ukraine.

The commercial dispute is rather elementary. Prime Minister Vladimir Putin has publicly offered Ukraine a gas price of $250 per 1,000 cubic meters, while in a joint statement on January 1, President Viktor Yushchenko and Prime Minister Yuliya Tymoshenko argued for a price of $201 per 1,000 cubic meters, in comparison with $179.50 in 2008. Another dispute concerns the transit tariff Gazprom pays Ukraine for its deliveries to Europe. Currently, this is $1.70 per 100 km per 1,000 cubic meters, but Ukraine wants to raise it to at least $2.

The commercial differences are small, and an agreement should be possible. Ukrainian Deputy Prime Minister Oleh Dubyna has been quoted as accepting a gas price of $235 and a transit tariff of $1.80.

On October 2, 2008, Putin and Tymoshenko signed a memorandum of understanding on Russian-Ukrainian gas relations. Over the course of three years, Ukraine would gradually move to West European prices, paying 50 percent of them in 2009, 75 percent in 2010, and 100 percent in 2011. Since the European price is $418 at present, both parties were in the same ballpark.

But Russia’s abrupt disruption of all gas supplies to Ukraine when an agreement was so close suggests that the reasons for this action are not strictly commercial. The vehement comments against Ukraine by top Russian officials, notably Prime Minister Putin, reinforce these suspicions.

A political explanation is that the Kremlin wants to destabilize Ukraine, showing how bad democracy is for Eastern Slavs, while arousing Russians to a patriotic cause: “The Ukrainians must pay us!” Russia has been badly hit by the international financial crisis, but the only source of legitimacy for Putin’s authoritarian government is high economic growth. Putin has become notorious for provoking fights with independent, democratic neighbors, such as Georgia, Ukraine, and Estonia for apparently domestic reasons.

Another explanation is that the Kremlin wants to maintain RosUkrEnergo, the nontransparent trading intermediary that sells Turkmen gas to Ukraine through Gazprom’s pipelines. UkrGaz-Energo, its joint venture with the Ukrainian state gas company Naftohaz, controls the profitable part of Ukraine’s domestic sales of gas. RosUkrEnergo is owned by Gazprombank, a mysterious, privatized bank related to Gazprom, and two Ukrainian businessmen, one of whom is Dmytro Firtash, a major source of financing for former Prime Minister Viktor Yanukovych’s Regions party.

RosUkrEnergo is important to the Kremlin, providing some high Russian officials with substantial personal revenues and financing much of Ukrainian politics. Prime Minister Tymoshenko has campaigned for the exclusion of RosUkrEnergo. She has largely managed to oust it from the domestic Ukrainian market, and on October 2, 2008, she and Putin agreed to eliminate RosUkrEnergo from the Russian-Ukrainian gas trade as well. In fact, Ukraine has no direct financial relations with Gazprom, rendering the company’s complaint that Ukraine owed it money absurd.

Ukraine’s commercial interests are substantial. Its acceptance of a low fixed transit tariff of January 2006 makes little sense, since Russia has not guaranteed gas prices. With falling prices and reduced demand for natural gas due to the global economic slowdown, Ukraine is likely to get a lower price later on. Because of its precarious financial situation, it needs to cut its gas consumption drastically. The country has a strong negotiating position, since 80 percent of Russia’s gas exports to Europe travel through Ukraine and no substantial alternative will be available for years. Moreover, its reserves are sufficient for three months of domestic consumption.

Gazprom’s neglect of its European customers is all the more perplexing. Gazprom’s main customers, having already experienced the company’s unreliability, have built up buffer stocks of three months. Gazprom’s production fell by a whopping 10.6 percent in November 2008 over November 2007 because its Central European customers cut purchases from its most unreliable and expensive supplier. Gazprom behaves as if it had a monopoly over the EU market; fortunately it does not.

Most amazing is the European Union’s passivity, despite the fact that it receives 20 percent of its total gas supplies through Ukraine. How can the European Union tolerate a corrupt intermediary such as RosUkrEnergo gambling with Europe’s energy security? The European Union cannot act like a frail victim. It needs to assume the role of an energetic mediator to solve the Russian-Ukrainian gas conflict and finally adopt an energy policy.

Originally published at the Peterson Institute and reproduced here with the author’s permission.

14 Responses to "The Gas Conflict between Russia and Ukraine"

  1. Anonymous   January 14, 2009 at 11:28 am

    Sadly, maybe Russia has enough money to grease the hands of many European politicians…

  2. Gennady from Moscow   January 14, 2009 at 11:33 am

    Mr. Aslund, for me it is amazing how this whole gas row can be misinterpreted like this. Maybe my English isn’t good enough but I’ve never heard of ‘prepayment’ of an overdue debt. Then there has been now row on the price of the transit. There has been a valid contract on transit between Russia and Ukraine which was suddenly ruled out null and void by a Kiev court in January. Another stunning thing is blaming Russia for using RosUkrEnergo intermediary. You can easily find on the web that RosUkrEnergo is linked with shady dealings of Ukrainian President Yuschenko and this politician isn’t exactly well known for being a big friend of Russia. You’re calling what is actually a blockade of Europe by Ukraine ‘Gazprom’ neglect of its customers. This is simply ridiculous.

    • Stalin   January 14, 2009 at 8:41 pm

      Good boy Gennady!

  3. Anonymous   January 14, 2009 at 10:28 pm

    Gennady and Stalin…time will prove you are idiots. Western Intelligence agencies know the complexities of what is really going on, and time will show Mr.Aslund as on track of the real deal.

  4. whoever   January 15, 2009 at 4:33 am

    Just another article that does where God allmighty, in this case Aslund, decides who is a saint and who is a villain. However, this messiah is a bit illogical, a bit delusional or simply put immoral

  5. Guest   January 15, 2009 at 6:11 am

    I generally trust RGEmonitor. This post is a turning point. Now I know that I have to be careful what I read here.After all, this is disinformation in its purest form.

    • Guest   January 15, 2009 at 11:58 am

      +1, definitely agreed, this piece is the most biased one I’ve ever seen, arriving to a pre-arranged conclusion in the first 3 sentences.

    • Guest   January 16, 2009 at 3:56 am

      +1, but the RGE has always been somewhat Russophobic, so it’s a spectacular folly, rather than a turning point. Being biased is one thing, inviting Aslund is another.

  6. Dimitry from SpB   January 15, 2009 at 12:04 pm

    This story is overly emotional, perhaps it’s that time of the year for the author. If not, he/she (along with RGE) should be ashamed.Despite the poor insight, it is true that the conflict is mostly non-commercial, but rather geo-political. Russia is bent on demonstrating to the West that if US/EU want to have the Ukraine in their camp, they will have to pay for them, rather than Russia subsidizing the Ukraine’s gas. The only acceptable resolution for Putin is Yuschenko’s impeachment, which is about to happen in the next couple of weeks, at which point the gas flow will resume

  7. Anonymous   January 16, 2009 at 2:48 am

    The analysis in the article is a bit of raw, which makes it unworthy of publishing here.

  8. Guest   January 16, 2009 at 3:44 am

    God, they invited Aslund! Is RGE crazy? They take too much money from subscribers for making such follies. The guy is loon, as anybody who follows up on Eastern Europe knows.This “analysis” recycles a lot of old crap first used during the first gas cut off to Ukraine several years ago. If RosUkrEnergo is important to anybody, it is Mr. Yuschenko. For the Kremlin, it is too little a business, I’m afraid. I don’t know if it finances Regions but a popular view in Ukraine is that it finances Yuschenko. Anyway, there is no slightest evidence that the recent spat had something to do with the future of this entity. The other claims made in this “anaysis” are equally tweaked. Ukraine did not pay Gazprom its debt on time, commercial differences of up to 25 percent are hardly small, Gazprom has not cut off gas to “all” Russia’s neighbors (a claim that the author should be encouraged to document). Finally, the crysis became acute due to Ukraine’s seizing gas directed to Europe, rather than due to the lack of agreement on the price for Ukraine, which Mr. Aslund somehow forgets to mention.

  9. Anonymous   January 16, 2009 at 12:13 pm

    Aslund should be able to discuss political issues with some expertise, but the notion that he understands the intricacies of a natural gas transportation row is ludicrous.Exhibit A: Mentions the reported price dispute without mentioning that a) the actual contract in dispute has not been seen by anyone but the disputants, or b) that natural gas contracts are usually not flat fee/unit contractsBasically, he doesn’t know what he’s talking about … but since energy is so critical to understanding the politics of the FSU that were he to admit that he isn’t conversant in energy issues, he would be admitting he doesn’t understand how the most critical part of the Russian economy functions, and thus is at a loss to discuss the way that interplays with Russian foreign policy intelligently.

  10. viktoria   January 19, 2009 at 6:55 am

    One should pay a tribute to Messrs. Medvedev and Putin – unlike our politicians, they do not grudge the time for the detailed conversations with the technical specialists of Gazprom, entering into all the details of gas transportation. That’s why they have prepared a sabin card to beat in advance – the export gas feeding procedure into Ukrainian gas transmission network under which the Ukrainians THEMSELVES would refuse to pump this fuel, in such a way once again proving their transit insecurity to Europeans.

  11. alex   February 7, 2009 at 11:11 am

    The former Soviet territory always had two troubles: roads and fools. But life goes on, and the list of troubles gets certain national colour. It seems, that in Ukraine now it is necessary to be afraid not only of “fools” and “roads”, but “ crisis struggle” and “Euro 2012 preparation”.