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Page added on June 18, 2014
The Third Russia-Ukraine Gas War
At 10 am on Monday, June 16, 2014, Gazprom, a Russian gas monopoly, cut off supplies of gas to Ukraine. This is the third time in the last ten years when Gazprom has tried to use a cut-off to force the Ukrainian government to accept a deal it did not want to accept. In the previous two cut-offs—in January 2004 and January 2009, that is, in the middle of bitter cold winters—Ukraine bowed to the pressure and agreed to unfavorable contracts with high prices, tough clauses, and heavy penalties. Each time, Russia used Gazprom and energy prices as a political instrument to pressure pro-Western governments in Ukraine. Although the current cut-off is motivated by the same political factors, the outcome could be different this time.
In a nutshell, Gazprom wants to sell gas to Ukraine at $485 per thousand of cubic meters. Ukraine insists on the price of $285, which was roughly the price Gazprom charged Ukraine under pro-Russian President Yanukovych who fled the country in February 2014. To put these prices into a broader perspective, the current spot price of natural gas in Europe is about $230. The long-term contract price of Russian natural gas for Germany is about $385. Since the cost of transporting natural gas from the Russian border via Ukraine to Germany is approximately $90, the implicit price that Gazprom charges Germany is about $300. In light of these reference prices, it is hard to see how $485 could be a market price for Ukraine.
At any rate, Ukraine and Gazprom did not agree on any middle-ground price and the dispute became a game of attrition. In this game, who is going to win depends on who can outlast the opponent. In contrast to previous gas wars, Ukraine has a much stronger position and may emerge as a (relative) winner.
First, this gas war started in the middle of the summer when demand for natural gas is at its lowest point (there is no need to burn gas to heat houses). Ukraine extracts enough of its own natural gas to cover its needs during the summer time. Ukraine also has 13.5 billion cubic meters of natural gas in its underground reserves. As a result, the Ukrainian government estimates that Ukraine can survive without Russian gas until December 2014.
Second, Russia cannot literally stop pumping gas into Ukraine’s pipelines. Figure 1 shows that major pipelines to Western Europe go via Ukraine. The capacity of pipelines outside Ukraine is not enough to meet Gazprom’s obligations in the EU. By shutting down gas supplies completely, Gazprom is going to hurt its customers in Germany, Italy, Poland and many other EU countries. This could be a costly outcome for Gazprom because it will not get a penny of revenue in this case. The reputational costs for Gazprom could be even more severe than a loss of revenue as European customers can turn to more reliable suppliers. Finally, if Russia stops supplying gas to Europe, it will remove a key reason why the EU is hesitant to impose tougher economic sanctions on Russia. So the costs of not supplying gas are high for Gazprom. Indeed, even at the height of the Cold War, the Soviet Union continued to supply gas to the West.
Given that Gazprom must continue to provide gas to other countries, EU energy firms like RWE will still receive Russian gas and, by EU rules, these firms can sell the gas they own to anybody, including Ukraine. As I indicated above, the price for Germany is about $385. But if transportation costs through Ukraine and a few other countries are excluded, the price for Ukraine could be as low as $300. So Ukraine can get around a devastating shutdown and buy gas at a cheaper price than offered by Gazprom.
Ukraine pumped 83 billion cubic meters of Russian gas to EU countries in 2013. If Gazprom declines to pay Ukraine for transportation, Ukraine may take gas from the pipeline as a payment further reducing its need of direct imports of Russian gas.
Third, both Ukraine and Russia have filed lawsuits with the Arbitration Institute of the Stockholm Chamber of Commerce, which is a court in Stockholm specializing in resolving trade disputes. Interestingly, the court was set up to resolve trade disputes between the West and the USSR. Although it is hard to predict the ultimate outcome, there are good reasons to think that Ukraine is likely to prevail. For example, the prices for Ukraine were not market-based; previous contracts were signed under duress (recall cold winters when previous gas wars happened); Russia violated parts of its previous contracts with Ukraine (e.g., to transit a certain amount of natural gas every year); and the European Energy Charter prohibits any unilateral or concerted anti-competitive behavior in economic activities in the energy sector.
Previous arbitration of disputes between Gazprom and its European customers in Poland, Germany, Austria, Czech Republic and other countries led to price reductions and elimination of costly penalty clauses in contracts with Gazprom. Obviously, court proceedings can take time but both Ukraine and Russia signed the Energy Charter which requires supplying energy while disputes are undergoing arbitration in courts. It is not clear that Russia is going to meet its legal obligations but violating the charter or the ruling of the court is likely to intensify anti-trust investigations and Gazprom may end up paying hefty fines measured in billions of dollars.
Fourth, Ukraine was the third largest European consumer of Russian gas in 2013. Losing a customer this large is likely to hurt Gazprom. While diversification of Ukraine’s sources of natural gas is limited in the short run, Ukraine can follow other European countries and greatly limit the market power of Gazprom over the next 5 or so years by importing liquefied gas or using its rich deposits of shale gas. For example, an LNG terminal in Odessa can become operational within a year.
Fifth, in previous gas wars, Russia portrayed Ukraine as an unreliable partner. There was a lot of pressure on Ukraine to reach a deal with Gazprom quickly. This time it is clear that Ukraine is a victim and, hence, more pressure is shifted on Russia. Ukraine has been inviting international observes to gas talks with Russia and this turned out to be helpful in identifying who does not want to negotiate in good faith. In any case, Ukraine gets a lot more help from the international community now than in the previous gas wars.
In summary, we may see a long game of attrition with an uncertain outcome. While Ukraine is an underdog in this fight, it is far from certain that Ukraine will lose. Furthermore, even if Russia wins this battle, it is going to lose the war in the long run. The three gas wars between Russia and Ukraine illustrate Russia’s willingness to use its natural resources as a geopolitical weapon, so that having European countries continue to depend on Russian gas supplies poses a significant political and economic risk for them. While these countries may be unable to substitute away from Russian gas in the immediate future, they can certainly diversify their supplies in the longer run. This path entails some short-run costs, of course, but many countries appear to be willing to pay it to avoid Gazprom’s blackmail. As a result, Gazprom will ultimately shrink and lose its potency as a weapon.
14 Comments on "The Third Russia-Ukraine Gas War"
Davy, Hermann, MO on Wed, 18th Jun 2014 6:20 am
The gas prices mention being negotiated are off per other articles I have read. They are in reality much closer to a deal. Russia is owed money and Russia should be paid for its gas. Ukraine cannot have its cake and eat it. If it wants to turn anti Russian then it should not expect Russia to subsidize its energy needs.
Arthur2 on Wed, 18th Jun 2014 7:43 am
Ukraine is broke and can’t pay and probably expects/hopes that the EU will cough up the cash. Earlier this week the Druzbha transit pipeline from Russia to Europe was blown up in the eastern Ukraine, one day after Russia stopped delivering to the Ukis. No idea who dunnit… Uki Right Sector? Russophile Uki insurgents? Russian special forces carrying out a false flag operation? It would be in Russian interest to make the Europeans feel their dependency on Russia and at the same time blame Ukis for the interruption.
Earlier today ISIS took over the largest refinery of Iraq. That’s another interruption of irreplaceble supply. Now the US needs Iran to combat a developing strategic desaster in the ME. All very good for SCO.
strummer on Wed, 18th Jun 2014 8:00 am
“Gazprom wants to sell gas to Ukraine at $485 per thousand of cubic meters”
This is also the price that was agreed in the 2009 10-year contract signed by Julia Tymoshenko. It’s not just some price that the Russians made up.
rockman on Wed, 18th Jun 2014 8:33 am
“Ukraine is broke and can’t pay and probably expects/hopes that the EU will cough up the cash.”
Actually they do have so money. The IMF transferred about $4 billion to the Ukraine a month ago with the promise of another $14 billion if the Ukraine gov’t cleans its operations up.
As far as the price Russia wants to sell to the Ukraine that is the market price. I sell NG as part of my work. My production isn’t priced the same for each of my buyers. The price is negotiated. The negotiations hinge on the options of both the seller and buyer. Typically I’m limited in who I can ship my production to so I often can’t push for a higher price. But if I have a buyer with limited options for getting the NG they require I use that leverage to extract a higher price.
And that is THE definition of the “free market price”: I’m free to try to charge as much as I can for my NG and the buyers are free to try to pay as little as possible. BTW the Russians are being rather nice to the Ukraine IMHO by just asking for partial payment of Ukraine’s NG debt: I don’t sell to any buyer if they are in arrears. And even if they pay up I may still not sell to them even if they prepay for future purchases if I have other buyers. IOW I don’t do business with problem buyers if I don’t have to. Life is to short for such hassles.
It isn’t personal…just business.
penury on Wed, 18th Jun 2014 9:29 am
You must understand, the object of propaganda is to vilify your opponent in this case Russia must be seen as picking on poor desperate Ukraine to justify NATO action against the evil GASPROM who actually wants to get paid for their product. If Russia would only demand that all of their exports would be paid for in dollars most of these problems would disappear.
Perk Earl on Wed, 18th Jun 2014 10:22 am
“The gas prices mention being negotiated are off per other articles I have read.”
Right there Davy. I just tried to find the article on how close they got and couldn’t find it, but from what I remember Russia dropped it’s 100 dollar export fee, to bring the price down to 385. The Ukraine brought their price up from two hundred something to 326 as a temporary price until a long term price could be negotiated. Not a big gap, but Russia declined.
Why this latest article is so far behind the curve on the negotiations is anyone’s guess, but at minimum it is piss-poor reporting.
tahoe1780 on Wed, 18th Jun 2014 10:32 am
We hear a lot about Russia raising gas prices to Ukraine. Not so much about the 30% discount it had been offering. http://www.cnn.com/2010/WORLD/europe/04/21/russia.ukraine/index.html No need to lease that base now….
davew on Wed, 18th Jun 2014 10:56 am
General Motors: Ours cars cost $25,000.
Customer: I only want to pay $15,000.
GM: No deal. How about $20,000?
Customer: Waaah! You’re trying to politically pressure me because you don’t like my President! The spot price is only $18,000 right now.
GM: Then go to the spot market and buy a car.
Customer: That’s not fair! The last car you sold me was only $15,000. You sold a car to that German customer for only $18,000.
GM: My costs have increased. I would be foolish to sell to you at a loss. Please make up your mind. I have other customers waiting to buy my cars. If you want to hedge against the spot price going up in the winter, you should lock in the current offered price now.
Customer: Waah! I’m entitled to buy a car at whatever I think the fair price should be. Waah!
davew on Wed, 18th Jun 2014 10:58 am
GM: Also, you never paid for that last car I sold you.
Juan Pueblo on Wed, 18th Jun 2014 11:11 am
Perk, I remember reading that, too. The temporary price Ukraine offered was for 18 months.
The people in power in Kiev seem to be deeply disconnected from reality. I believe Ukraine has become a failed state and will decend into civil war and break in pieces.
In the east there is much talk about creating a new Novorossiya from Luhansk to Transdnistria, including Odessa, for Russian Ukrainians who want to be independent from both Kiev and Moscow.
edboyle on Wed, 18th Jun 2014 1:18 pm
Article translated from German(Voice of Russia also in English but not htis article):
Not always good translated by google but the idea under people is that the Ukrainians are reacting very weirdly and that it is clinical:
VOICE OF RUSSIA in Moscow was the declaration of Ukraine that it will take “unilateral demarcation” of the Ukrainian-Russian border, taken with full astonishment.
On 17 June, the government in Kiev has been commissioned to work through the practical aspects. The President Poroshenko will then sign a decree, and it will remove the border posts. Russian experts say that such an approach in international practice is never something to the demarcation of the boundaries between state existed before. In Russia, experts doubt taking into account the other recent escapades of the Kiev junta already open because the government minister Arseniy Yatsenyuk are adequate and normal.
“There is no” unilateral demarcation of borders, “and Russia will never recognize such limits,” said the chairman of the Committee of the State Duma International Affairs, Alexei Puschkow.
The give and Ukrainian experts are aware of the complicated work to mark the boundary lines between two states. The former first deputy of the Council for National Security and Defense of Ukraine, Stepan Gawrisch, said in his interview for Ukrainian TV: “Russia, in the case of the unilateral demarcation of the Ukrainian-Russian border by our state Ukraine the occupation of part of its territory blame. “” This process can not be one-sided, “Gawrisch said. He recalled that the line of the border between Ukraine and Russia extends in some places in the middle of places, railways, bridges and farms “cuts”. This intention had no practical sense, that is “a purely political statement”.
In the Russian expert community is in assessing the actions of the Kiev “Maidan-Cabinet” increasingly, the syndrome “of the affect of the absence of adequacy” mentioned. Psychiatry appointed him as “an inadequate, affective response to a lack of success in achieving the set goal. ‘Its main manifestations are increased sensitivity, stubbornness, negativism and taciturnity. It mainly suffering children, but also adults.
All the symptoms are. Prime Minister Arseny Yatsenyuk sensitivity to Russia increased so much that he on 16 June, after the complete failure of gas negotiations, stated that “Kiev, Gazprom will no longer subsidize.” This Naftogaz Ukraine owes Russia $ 4.5 billion after overdue payments. Interior Minister arsenic Awakow increased its “reticence” so strong that it communicates with the Ukraine and most subordinates exclusively on “Facebook”.
But the behavior of the former incumbent Foreign Minister Andrei Deschtschiza was the highlight. He drove on the night of the pogrom on June 15 to the Russian embassy and approved the actions of hooligans. He brought his “emotional affectation” in the form of couplets of a lewd song about Russian President Vladimir Putin expressed.
Russian Foreign Minister Sergei Lavrov said that he “does not want to talk to the person Deschtschiza”. The Russian Ambassador to the UN, Vitaly Churkin, adding that Russia will feel without Deschtschiza not a “lack of communication”.
“Mister Deschtschiza no longer exists for us. Its only function was to American translation instructions in the Ukrainian language. So the loss is not great. ”
Russia Today wrote Arsen Awakow Minister and the governor of the Dnepropetrovsk region, Igor Kolomojski, from war crimes to the international manhunt. Kolomojski formed at its own expense from nearly 10,000 murderers a private army and promised for every killed Russians to pay thousands of dollars. Russia has accused both of the crimes against humanity, the bomb attacks on peaceful cities of the southwest Ukraine and the Organization of kidnappings and murders of Russian journalists.
Read more:
http://german.ruvr.ru/2014_06_18/Die-Behorden-in-Kiew-und-der-Affekt-des-Fehlens-der-Adaquanz-4412/
Makati1 on Wed, 18th Jun 2014 8:53 pm
Sounds like the same kind of government in Kiev that we have in the US. Psychopathic idiots led by the greedy corporate elite. Not a rational thought to be found in either place.
rockman on Thu, 19th Jun 2014 12:12 am
I still suspect most of the rhetoric flowing out of Kiev is to remind the EU that the Ukraine has them by the balls when it comes to their NG supply. Which is the same position Kiev is in with respect to Russia. Both the Ukraine and Russia are negotiating with the EU from a control position. All the EU has to fight with is the prospect of “loaning” money to Kiev IMHO.
Arthur2 on Thu, 19th Jun 2014 6:30 am
Rockman, Germany has direct gas supply via Northstream, that is now showing it’s real value these days. Most hurt will be eastern Europe, Poland for starters.