Relations between Russia and Ukraine are at a new low after serious gas shortages in Europe this winter. Olga Shumylo-Tapiola argues that the interests of Ukrainian oligarchs will continue to put pressure on the government to demand lower prices, a demand that Russia is unlikely to acquiesce to. The only long term solution is for Ukraine to do more to reduce its dependence on Russian natural gas

Shumylo-Tapiola, Olga

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blogs.lse.ac.uk http://blogs.lse.ac.uk/europpblog/2012/03/24/russia-ukraine-gas-row/In their row over gas prices, Russia has no reason tomake concessions to Ukraine. There is little to suggestthat an end to the conflict is in sight.Mar 24 2012Relations between Russia and Ukraine are at a new low after serious gasshortages in Europe this winter. Olga Shumylo-Tapiola argues that the interestsof Ukrainian oligarchs will continue to put pressure on the government to demandlower prices, a demand that Russia is unlikely to acquiesce to. The only long termsolution is for Ukraine to do more to reduce its dependence on Russian naturalgas. Russia and Ukraine are engaged in protracted negotiations over a gas dealoriginally concluded in 2009 by Russian Prime Minister Vladimir Putin and then Ukrainian PrimeMinister Yulia Tymoshenko. Current Ukrainian authorities consider this deal unsustainable for theircountry and, with the Kremlin seemingly unprepared to make significant revisions, there seems tobe no easy solution to the problem.After taking office in spring 2010, Victor Yanukovych promised to improve Ukraine’s relations withRussia, especially in the energy sector. Two years on however, relations are worse than ever.Moscow is frustrated with Yanukovych’s pursuit of his own personal and corporate interests.Yanukovych, in turn, is frustrated with Russia’s unwillingness to make concessions to him in thename of Slavonic brotherhood.From his first day in office, Yanukovych wanted to re-negotiate the 2009 gas deal. Three elementsof the agreement are problematic for him and his fellow oligarchs: the price Ukraine pays for gas,the volume of Russian gas that Ukraine is obliged to buy on an annual basis, and the fee that Russiapays to use Ukraine’s gas transit system (GTS).Kyiv feels that the first two figures should decrease dramatically, while the third should go up. Atalmost USD $400 per thousand cubic meters, Ukraine pays one of the highest prices for Russiangas in Europe—especially given its proximity to Russia. In addition, despite being the least efficientenergy consumer in Europe, it is unlikely that Kyiv will need the 52 billion cubic meters of gas theagreement with Moscow stipulates in 2012. Moreover, European and Ukrainian experts agree thatthe transit fees Russia pays to Ukraine are low in comparison to those paid to other transitcountries.Will Russia and Ukraine be able to reach an agreement on a revised gas deal?Some in Moscow say that an agreement addressing Ukraine’s concerns could well be reached.However, it would come at a high price. By granting Russia a twenty-five year lease extension on itsBlack Sea Fleet base in Crimea, Yanukovych attempted to use the carrot in his negotiations withthe Kremlin. Moscow responded with a small discount, knocking $100 off the price per thousandcubic meters of gas.But this was not enough for Ukraine. Ultimately,Russia will need a far larger carrot—control overUkraine’s GTS or Kyiv’s membership in theCustoms Union or potentially even the EurasianUnion—to make any meaningful concessions. When“the carrot” failed, Yanukovych resorted to “the stick.”His government publicly blackmailed Moscow byclaiming the 2009 gas agreement was illegal,arresting Tymoshenko, and threatening to takeGazprom to the Arbitration Institute of the StockholmChamber of Commerce (SCC).When Moscow still refused to revise the contract,Ukraine opted to unilaterally reduce the contracted volume of gas it would purchase from Russia bynearly 50 per cent. Russia now has three options:The Kremlin could accept Ukraine’s demand to import less gas;It could demand that Ukraine pay the penalties the 2009 contract stipulates; or, as a lastresort;It could take Ukraine to the SCC.At present Russia is warning Ukraine that it may take legal action, but has not acted so far. In fact,Moscow is continuing to loan money to Ukraine to pay its bills with Gazprom—Ukraine paid its gasbill in October 2011 with money borrowed from Russia’s Gazprombank.The two partners are in aprotracted process of negotiations as opposed to a full-blown conflict, which neither side can affordat the moment. As it stands, Russia simply has no reason to make any concessions to Ukraine. It isno secret that Moscow uses the price of gas as a political tool in its immediate neighbourhood. Withthe leadership of neighbouring countries reluctant to end their addiction to cheap gas, Russia hasno reason to stop this practice. Energy relations between Russia and its neighbours will onlybecome more equitable once neighbouring elites instil some transparency in their own energysectors and stop treating them as their personal fiefdoms.Moscow, however, needs European support for alternative transit routes, such as South Stream, apipeline connecting Russia and Bulgaria. Moreover, it would like to take control of Ukraine’s GTSwithout facing accusations of bullying. The Kremlin can therefore ill-afford the bad publicity.  ButMoscow may still intensify the trade war with Kyiv. Exports of Ukrainian cheese to Russia havealready been banned. Other exports, such as confectionery, dairy products, and meats may also betargeted. And, although it is unlikely that Russia will cut gas to Ukraine now, this generosity may notpersist after the presidential elections.The situation in Ukraine is slightly more complicated. The country’s leadership desperately needscheaper gas to satisfy the needs of the oligarchs who support it. With parliamentary electionsrapidly approaching, re-election campaigns will rely on the financial support of these businessmen.The Russia-Ukraine gas deal was negotiated by then Prime Minister Yulia Tymoshenko, who iscurrently the leader of Ukraine’s opposition. In October of last year, Tymoshenko was sentenced toseven years in prison following what the majority of European politicians and observers deemed aselective, politically motivated prosecution. Against this background, it is highly unlikely thatUkraine’s case against Russia will be treated as purely commercial.Ukraine may also be forced to default on its financial obligations to Gazprom. The country’s coffersare virtually empty. The International Monetary Fund is unlikely to offer any assistance before thegovernment raises domestic gas prices, which is unlikely to happen before the Octoberparliamentary elections. Kyiv could continue borrowing from Gazprombank to cover its bills withGazprom.The experience of neighbouring Belarus provides a cautionary tale. President Lukashenka washeavily subsidized by Moscow and even succeeded in ensuring the cheapest gas supply in Europe—$164 per 1000 cubic meters in 2012. But he had to give up full control of the country’s pipeline toRussia.Protracted negotiations between Kyiv and Moscow are therefore likely to continue. The country’sleadership and fellow oligarchs benefit the most from Ukraine’s transit system, with its undergroundstorage facilities and access it provides to Ukraine’s domestic market. Membership in the CustomsUnion would effectively lead the president to lose political control over the country as greater controlover the country’s trade and economic policy are ceded to Moscow. Yanukovych will thereforecontinue his balancing act, insisting for revisions to the 2009 gas deal, while avoiding moves thatmight push Russia to escalate.Ukraine needs to decrease its dependence on Russian gasHaving concluded the gas deal with Russia in 2009, Kyiv had an opportunity to overhaul its energysector, but, thus far focused on short-term solutions, such as the unsuccessful attempts to revise thegas contract with Russia. One of the clearest examples of Ukraine’s underwhelming performance inthis area is its membership in the Energy Community. The mission of this organization is to extendthe EU’s internal energy market to southeast Europe and ultimately to ensure the security of thesupply in wider Europe. In 2010, Ukraine committed to implementing the relevant EU directives andregulations in the sphere of gas, electricity, and renewable energy resources.According to a group of independent Ukrainian energy analysts, however, the country has not fullyimplemented a single obligation. Experts suggest that the Ukrainian authorities saw membership inthe Energy Community as a safeguard against the South Stream project and a source of additionalfinancial support from the EU. For its part, the EU hoped that Ukraine’s commitment and extrafunding would finally push Ukraine to reform its energy sector. Mutual disappointment is growing.Ukraine feels that the EU is not being supportive in the country’s talks with Russia, and that this canbe attributed to Moscow’s warm relations with some EU member states. However, the EU is simplyreluctant to become embroiled in escalating tensions between Kyiv and Moscow. The EU, in turn,feels frustrated by the lack of reform in Kyiv, and now has little reason to support Ukraine in thisbattle. Failure to implement the Energy Community Treaty obligations was merely one incident in anegative trend in Ukraine that is sending a clear signal to the EU: the country’s leadership is notinterested in further integration with the Union.Please read our comments policy before commenting.Note:  This article gives the views of the author, and not the position of EUROPP – EuropeanPolitics and Policy, nor of the London School of EconomicsThis article was first published by Carnegie Europe on 21 February. _____________________________About the authorOlga Shumylo-Tapiola – Carnegie EuropeOlga Shumylo-Tapiola is a visiting scholar at Carnegie Europe in Brussels. She isthe former director of the International Centre for Policy Studies, a leadingindependent Ukrainian think tank that specializes in economic and political reform inthe Ukraine and relations between the European Union and Ukraine. She is alsodeputy head of the board of PASOS (Policy Association for an Open Society), anetwork of European civil society organizations.Related posts:1. Brussels blog round up for 10-16 March 2012: Concern over the Ukraine, Sarkozy gets toughon Schengen, and how big is Greece’s bailout?2. Book Review: The Strongman: Vladimir Putin and the Struggle for Russia by Angus RoxburghThis entry was posted in Eastern Neighbourhood, Energy, science and technology, Olga Shumylo-Tapiola and tagged energy, Eurozone, gas, natural resources, oligarchs, politics, Russia, Ukraine.Bookmark the permalink.

In their row over gas prices, Russia has no reason to make concessions to Ukraine. There is little to suggest that an end to the conflict is in sight.

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