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

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.

In January 2005, during the short period when Russia cut off supplies to Ukraine in order to pressure the country into accepting minimal prices increases, Ukrainians were accused of stealing gas in order to keep their homes warm and industry working. 

Russia's primary goal in its dealings with Ukraine is to have a measure of control over the pipeline, which supplies over 80 percent of Russian gas destined to Europe. An underwater northern pipeline to Germany, now under construction, will not replace the Ukrainian trunk pipeline-it will only diminish its importance to some degree.

Feeding the Oligarchs

And then there is RosUkrEnergo (RUE). The company serves as a intermediary in bringing Russian gas to Ukraine; is registered in Switzerland; was created by Gazprom (with Putin's blessings) and a private Ukrainian businessman; and was approved by then-Ukrainian President Leonid Kuchma in 2003.

RUE does not own any gas or control any pipelines. It is designated as the "operator" of Turkmen gas to Ukraine. But just what "operator" means has never been defined by either Gazprom or Ukraine.

RUE made close to $1 billion in 2004 and close to $2 billion in 2005.

Despite an investigation into the circumstances surrounding the creation of RosUkrEnergo and questions on why Ukraine agreed to allow a private entity to represent Ukrainian state interests (and earn close to $500 million per year while doing so), no answers have been provided.

Both Yushchenko and Yanukovych have sought to pacify Moscow and Ukrainian oligarchs by turning a blind eye to the continued use of RosUkrEnergo. In a typical post-Soviet maneuver, the investigation into the company ended, allegedly at Yushchenko's orders.

For over 15 years both countries have approached the gas business as if it were a giant milking cow for their political elites. As a result of such opaque deals, the Ukrainian-Russian gas relationship appears doomed to periodic bursts of confrontation and delivery disruptions for years to come.

Meanwhile, the Ukrainian side continues to delay costly energy conservation measures or finding a source of alternative gas supplies and seems indifferent to the fact that it is one of the most energy intensive countries in the world. Graft in the gas business depends to a large degree on volume-the more gas sold, the greater the take.

Gazprom's critics have accused it of using a large part of the middlemen's revenue to pay for political campaigns and as a secret slush fund for high level, pro-Kremlin Russian officials. And critics also allege that high level officials in Ukraine, some aligned with Yushchenko and others in the Yanukovych camp, also receive informal disbursements of cash by Gazprom or Ukrainian gas monopoly Naftohaz, in return for protecting such companies as RosUkrEnergo from criminal investigations.

The Geopolitics of Gas

The use of gas as a geopolitical lever to force Ukraine into having a more pronounced pro-Russian orientation is an idea that has dubious merit even with Yanukovych as prime minister. Ukrainians, despite their squabbles over such issues as the status of Russian as a second state language, by and large do not want to be ruled from Moscow. And Ukrainian leaders largely do not wish to be seen as a "governor" of Malorossiya (little Russia) as Ukraine was dubbed during czarist times.

Likewise, even Ukrainian businessmen in the "Donetsk clan", seen as aligned with Moscow, do not wish to be bought out by their wealthier Russian oligarch-cousins, nor do they want to suffer Mikhail Khodorkovsky's fate. Any attempt to pressure them with threats to shut off the gas valve could trigger a backlash, with potential scenarios ranging from a shutting down of the gas pipeline to Europe in order to deprive Russia of income or kicking out the Russian Black Sea fleet from Sevastopol in the Crimea.

Most Russian officials understand this. Despite the recent spook spat with Georgia and some of the hyperbolic predictions it has inspired regarding Russia's role in its sphere of the world, Moscow will respect Ukrainian independence as long as the Ukrainians do not overstep the informal boundaries, such as NATO membership-or, for that matter, apprehending Russia nationals it claims are spies. As to the gas business between the two countries, it is most likely doomed to many more years of opaqueness and back-room deals. Woe be it to anyone attempting to change this entrenched system.