The Russia-Ukraine Natural Gas Squabble

by Andrew Jack

Much hot air has been generated in recent days by the New Year’s dispute between Russia and Ukraine over gas prices. The saga has highlighted, to misquote Winston Churchill, commercial interests wrapped up in economics, and justified by politics.

On the surface, the squabble looks ugly and one-sided: the great Russian bear bared its teeth, demanding a four-fold increase in the price of gas at short notice, and unilaterally punishing Ukraine for the “western”-oriented Orange Revolution of one year ago that spurned Moscow.

The tactics appear particularly unseemly as Russia begins – for the first time – a year presiding over the G8 group of leading nations, with President Vladimir Putin inviting top heads of state to St. Petersburg this summer. His key theme, ironically, is that of “energy security”.

Russia is freshly assertive, with the state more actively intervening in recent months in the energy sector. Most notably, it has effectively appropriated the privately-held oil company Yukos, triggering a corporate break-up and renationalisation, and the banishment of its convicted chief executive to a Siberian jail.

The heavy presence of Russian television cameras in the gas control rooms a few days ago as workers flicked the switch to turn down pressure in the pipelines to Ukraine, made it clear how far the Kremlin wanted to send a message to its own citizens of its tough stance against a former satellite state.

Unfortunately for Russia, in the era of media globalisation, such pictures were also quickly transmitted elsewhere around the world, if only because the threat of winter chill and Christmas discontent was compounded by a lack of news happening elsewhere.

There is no doubt that Moscow was partly playing this saga for political purposes, demonstrating that it could prove aggressive towards Ukraine, a year after the Orange Revolution elected a more pro-western leader than the candidate of choice of Vladimir Putin.

In cynically brilliant diplomatic terms, Moscow can stress its G8 market-oriented credentials in the gas dispute. After all, Ukraine currently benefits from heavily-subsidised gas prices. Why should Russia not demand higher, more commercial, prices from a neighbour, especialy one that has turned less friendly towards it?

The dispute is not entirely one-sided, however. Ukraine has also exploited the situation for its full political worth. By standing up to Moscow in the fight over prices, it helped stoke some nationalist feeling at a time when many supporters of the Orange Revolution are beginning to feel that it has not lived up to its promise.

And, as the primary transit route for Russian gas to points further west, the Ukraine has the scope to extract gas destined for onwards shipment, reminding western European nations very directly of the risks to their energy supplies from a resurgent Russia.

While western politicians could not ignore the media noise that the dispute has generated, this is first and foremost a dispute among Slavic neighbours. And most such fights in this part of the world – particularly those involving money – get played by the rules of extreme brinkmanship.

Long after the initial threats, and only at the height of conflict, do they get resolved – as they did shortly after the gas was finally cut at the start of the year. The compromise deal – with Ukraine paying twice what it currently does but half the amount Russia demanded – is no great surprise.

At root, the dispute is likely less about general principles of market economics, or even about nationalistic sentiment, and more about threats to an opaque system for the pricing of gas that benefits individual political and corporate figures in both countries.

The compromise reached leaves intact a curious web of obscure companies, their ownership concealed behind trusts, which determine the prices to be charged and channels the revenues generated. After initial threats of a change to the system by the new regime in Kiev, this mechanism remains in place.

In an ideal world, such arrangements would be made far more transparent. And if Russia was truly concerned about the principles of market prices for gas, it should be applying them consistently to all its neighbours. That would include the more pro-Moscow, and distinctly authoritarian, Belarus – as well as Russia’s own industrial and domestic consumers, who benefit from substantial subsidies.

The positive outcomes from the gas dispute include the reminder to European nations about the potential risks – commercial as much as political – around gas supplies from Russia. That could help stimulate greater reflection about energy security.

But compared with alternative energy sources in North Africa and the Middle East, Russia still looks a relatively reliable bet. Policy makers might do as well to push for greater clarity in the mechanisms governing gas pricing from existing sources as much as trying to look elsewhere for supplies.

In the meantime, western politicians should not panic too much about Russia cutting off supplies to them in the short term. Moscow may have gas that Europe needs. But Europe has the money and the demand that Moscow seeks. It will be several years before Russia could find alternative purchasers, even if it was tempted to switch supplies elsewhere.

And in the new Russia, the replacement of state ideology with individual vested interest in most transactions means that economics could well hold sway over politics, even if anti-western sentiment started to grow.

Andrew Jack is author of Inside Putin’s Russia: Can There Be Reform without Democracy?