The Russia-Ukraine Gas Dispute

The dispute over the price hike for Russian gas deliveries to Ukraine was settled on January 4, 2006 , when Russian energy giant Gazprom and Ukraine ‘s state oil and gas company Naftogaz reached an agreement on the supply of Russian natural gas to Ukraine through a joint-venture company Rosukrenergo. It focused international attention on Russia ‘s current policy shift and the mechanisms of its implementation. Russia ‘s cut-off of gas supplies and increasing manifestations of a more assertive policy towards Ukraine were mainly intended to limit Ukraine ‘s pro-Western foreign policy orientation and its European aspirations.

Russia has the largest natural gas reserves, with 1,700 trillion cubic feet of the fuel or 27 per cent of the world’s total. Ukraine consumed about 80 billion cubic meters of natural gas in 2004-05, of which some 20 billion was domestically produced and roughly 36 billion bought from Turkmenistan . It received approximately 17 billion from Russia in lieu of payment for transporting Russian gas to Europe and purchased the rest (6-7 billion cubic meters) from Moscow . Ukraine is the fourth largest importer and sixth largest consumer of natural gas in the world. The dispute between Ukraine and Russia reached the crisis point during January 1-3, 2006 . More importantly, it was not merely limited to these two countries alone, but also threatened long-term repercussions for Europe . The dispute arose when Ukraine refused to agree to a fourfold hike in the price for deliveries in 2006 at the rate of $230 per 1,000 cu m, i.e. more than four times the price charged in 2005. It considered this hike as economically unreasonable and politically charged. But Russia claimed that Gazprom’s subsidies to the Ukrainian economy amounted to billions of dollars and that Ukraine should pay the market price.

Gazprom began reducing pressure in the natural gas pipeline to Ukraine on January 1, and cut supplies by 120 million cubic meters a day, though deliveries to Europe continued. Nonetheless, this led to a disruption of imports across Europe. Several European countries reported shortfalls in the gas flow from January 1. Europe receives about a quarter of its gas from Russia , with some 80 per cent of it coming in pipelines across Ukraine . Russian gas goes to West European countries like Germany , Italy , France , Austria as well as to a number of Central & East European countries like Poland , Hungary , Romania , Slovakia , Slovenia , Bulgaria and Croatia . This crisis demonstrated not only Ukraine ‘s but also Europe ‘s dependency on Russian gas supplies. European countries are also now becoming concerned about being overly dependent on Russian gas supplies. The European Union has even thought of asking for more gas from other suppliers like Norway and the Netherlands to safeguard supplies to industrial consumers. The EU has also started thinking of following in Finland ‘s footsteps, which is moving ahead with plans to build the world’s largest nuclear reactor to lessen its reliance on Russian gas. Germany, which has close ties with Russia and has generally been viewed as being in a secure position as far as oil and gas supplies are concerned, has also became cautioned and is considering alternative transport routes, viz., an additional route from the North European Gas Pipeline, which will link the massive Russian gas fields with Germany under the Baltic Sea. By using this route Germany and Europe would achieve considerable independence and would not get affected by political instability in the neighbourhood.

Though Russia suspended gas supplies to Ukraine , it expected the latter to ensure un-interrupted natural gas transit via its territory to European Union countries in line with its international obligations and take every measure to prevent gas flows to Europe being tapped. During the course of the dispute, Gazprom blamed Ukraine for siphoning off 118.7 million cu m of Russian export gas as well as of stealing 104.8 million cu m of Russian export gas. But Naftogaz contended that it was the cut-off in Russian gas supplies that resulted in the reduction of deliveries to Europe . Ukraine moreover claimed that it was only using Turkmen gas when Russia cut off gas supplies.

This move by Russia to increase gas prices during the winter season may have gained some popularity for its President at home but its reputation as a reliable natural gas supplier has been compromised. The Russian action was a reflection of its goal of using energy supplies as a tool to control and maintain its influence in the region, though Moscow has strongly rejected allegations of any political motives behind the gas price hike and stoppage. Ukraine , however, has questioned the favouritism shown by Russia towards other former Soviet republics, which continue to pay much lower prices. Armenia , Georgia and the Baltic States will pay $110-125 per 1,000 cubic meters in 2006, while Russia ‘s closest ally Belarus will pay only $47 per 1,000 cubic meters. This could be because Belarus has signed over 100 per cent ownership of its pipeline network to Russia, while the Baltic states have permitted Russia to own significant stakes in their domestic energy systems including the pipeline networks, which has not been the case with Ukraine.

Under the new deal, which is valid for five years, Gazprom has agreed to sell gas to the Rosukrenergo trading company for $230 per 1,000 cubic meters and Ukraine has agreed to buy gas from Rosukrenergo for $95. The two companies have also agreed to raise the transit fee that Gazprom pays to send gas through Ukrainian pipelines from $1.09 to $1.60 per 1,000 cubic metres. The new deal with Ukraine is quite favourable to Russia . It ensures greater say for Moscow in Ukraine ‘s foreign policy orientation. Moreover, it has brought to an end the old barter system, which Moscow has been intent on doing away with for some time now. This would also make it more attractive for foreign investors – who have been averse to the barter system – to buy minority stakes in Russia ‘s oil and gas sector, thus further boosting Moscow ‘s overall market share of energy resources. In contrast, Ukraine was wracked by internal political upheaval within a week of the new agreement. Fuelled by widespread apprehensions that the deal would prove to be economically damaging and provide too much leverage to Moscow , the Supreme Rada ( Ukraine ‘s Parliament) voted on January 10 to dismiss the government.

While the agreement will ensure stable gas supplies to Ukraine as well as to Europe , the dispute demonstrates the dangers of dependence. A similar turn of events in future could force price hikes across Europe and as a fallout in Asia as well. The dispute caused considerable concern in Europe about the future of secure energy supplies and the dangers of relying upon Russia . The shock caused by the Russia-Ukraine dispute could well act as a trigger for a restructuring of European energy policy.

The most plausible explanation for Russia ‘s action is its concern about Kiev ‘s pro-Western stance and the loss of political influence in Western and Central Ukraine . Additionally, through this move, Moscow can also be said to have tried to demonstrate to other former Soviet republics its capability and desire to play big brother and maintain its hegemony in the region. Another aspect that lends weight to this argument is Russia ‘s offer to Ukraine during the course of the dispute a $3.6 billion loan to finance gas imports during 2006. Kiev turned this offer down to avoid assuming further obligations towards Russia . Moreover, Moscow ‘s tough action, which began on the day Russia assumed the chairmanship of the Group of Eight, also seems to have been intended as a demonstration of its major power status. As the G8 focuses on energy security, Russia has shown where the balance of power lies. It does not merely wish to win friends with its energy potential but is intent on buying influence as well.