Beyond the Spook Spat: An Expose, and Prophecy, of Russia's Gas Policy

There’s more than Cold-War nostalgia in the fascination with the Russia-Georgia face-off. The West looks for signs of Moscow’s energy-policy temperament.

The ongoing Russian-Georgian face-off conjures nostalgia for Cold-War lore and makes for good headlines. The brinkmanship-with Georgia apprehending alleged spies, Russia responding with an economic blockage, Georgia standing down but the provocations still escalating-naturally capture the world's attention.

The underlying and broader interest in that spectacle remains, though, what the showdown signals about Russia's current inclination to project its power toward its Western near abroad. To what extent, and how, will Moscow jockey to secure its own interests in neighboring states? How will that jockeying affect Western interests? The West, particularly Western Europe, watches the Russian-Georgian spook spat with so much interest because it is trying to discern what it might signal regarding Russia's current temperament towards the region, particularly in regards to its energy policy. Here, of course, Ukraine, through which most Russian gas towards Western Europe flows, remains paramount-and what a labyrinthine gas arrangement it is!

With Moscow clearly unafraid of flexing its muscle in Eurasia, many are wondering: could the West's bad boy of Ukrainian politics, Prime Minister Viktor Yanukovych, ultimately be the one to deliver stability to the long-standing Ukrainian-Russian gas price and supply conflict? Such a feat would certainly benefit not only Ukraine, but also the West.

Surely Moscow would favor handing Yanukovych a quid for his pro-Moscow quo. But simple economics will probably restrain the Kremlin's ability to thus oblige its favored leader.

Demystifying the Deal

Russia never did apply its announced price increase from the current $95 for 1,000 cubic meters of gas to $120-130, announced on May 22 by Aleksander Ryazanov, Gazprom's deputy CEO. Some interpreted that reprieve as an indication that Russia was tailoring its gas pricing policy towards Ukraine in 2006 for geopolitical reasons. Yanukovych, after all, was experiencing a political comeback and Russia did not want to be seen as pressuring Ukraine once again by raising prices.

Geopolitics or not, though, in the long run price increases appear inevitable. On September 5, Alexei Miller, Gazprom CEO, agreed to buy 50 billion cubic meters (bcm) of gas from Turkmenistan at $100 per 1,000 cubic meters of gas, up from $65 per bcm. Gazprom resells the bulk of this Turkmen gas to Ukraine as part of a basket of supplies from other Central Asian countries and Russia. Russia uses the remaining 9 bcm for Russian domestic consumption.

With the recent price increase for Turkmen gas, it is inevitable that Ukraine will pay at least $135/1,000 cubic meters in 2007. Furthermore, under the new contract scheduled to begin in 2007, yearly deliveries from Turkmenistan to Gazprom would be some 10- 30 bcm less then an earlier Russian-Turkmen gas contract signed in 2003 called for.

Russian gas strategy has been to buy Central Asian gas (which is cheaper than Russian gas) for domestic use, thus allowing Gazprom to sell its own gas to Europe and make a substantial profit without disrupting domestic supplies. Since Turkmenistan will be delivering less gas to Russia in 2007, Russia may have less gas available to sell to Ukraine and, by extension, the European Union.

What Russia Requires

In August, German Gref, the Russian minister for economic development, warned that in 2007 Russia might experience a shortage of gas for domestic consumption. Such a prospect would cause Europe a serious supply problem.

Most experts concur that Gazprom is strapped for the cash required to bring the needed new gas fields online to just meet rapidly rising domestic consumption. And Russian gas industry studies project that from 2007-2010, Russia needs to invest some $37 billion to develop new fields and build the infrastructure needed to sell gas to China and South Korea and to gasify Siberia and Russian Far East.

It seems highly unlikely that Russian energy managers would agree to sell Ukraine cheap gas in order to reap uncertain political benefits in the future.

The Bargain for Ukraine

Even at the price of $135/1,000 cubic meters, Ukraine is buying gas far below world prices. The price Turkmenistan is charging Russia, $100/1,000 cubic meters, translates into a price of about $2.75 per million British thermal units. On New York futures markets, the price of natural gas stands at about $6 per million BTUs.

Turkmenistan has been forced to sell its gas to Russia cheaply because it is dependent on the main gas trunk pipeline going through Russia and controlled by Gazprom, to transport its gas to market. The Turkmen do not have an alternate gas transportation system to handle such a large capacity. The only other customer for Turkmen gas today is Iran, which buys in limited quantities and pays more than Russia.

Ukraine's Great Gas Heist

Before the new deal with Turkmenistan was signed, Yanukovych visited Moscow, where he set an upbeat tone by promising Gazprom that Ukraine would not siphon any Russian gas from its pipeline that delivers most of the Russian gas bound for Europe. Yanukovych's promise not to steal gas from Russia is not a new one. Viktor Yushchenko, during his tenure as prime minister during Leonid Kuchma's presidency, made the same promise. At that time, high ranking officials of Naftohaz Ukrayina, the Ukrainian gas monopoly, were diverting large quantities of gas from the main pipeline and selling this gas to companies in Poland, Romania and Hungary at below-market prices, pocketing the profits. This practice did not end and Rem Vyakherev, then the head of Gazprom, complained of continued theft.