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Russia Cuts Ukraine's Gas Supply Reduction Sends Ripples Westward

Posted on: Monday, 2 January 2006, 15:00 CST

By Andrew E. Kramer

Russia cut the flow of natural gas to Ukraine on Sunday as talks over pricing and transit terms unraveled into a bald political conflict with consequences for Ukraine's recovering economy and possibly for gas supplies to Western Europe.

The dispute comes a year after the Orange Revolution brought a pro-Western government to power in Ukraine; it ends a decade of post- Soviet subsidies in the form of cheap energy that allowed Moscow to retain some influence over former Soviet republics. Ukraine's economy has depended on cheap energy from Russia.

The effects began to be felt in Europe on Sunday night. The Hungarian natural gas wholesaler, MOL, said that deliveries from the affected pipeline were down more than 25 percent, according to Reuters. The news agency added that supplies had dropped 14 percent in Poland.

Polish officials said reserves were adequate for now, and the Hungarian company asked big gas consumers to switch to oil, where possible.

At the heart of the conflict is a jump in the utility bill that Moscow presents to Ukraine: Russia is asking for $220 to $230 per 1,000 cubic meters, or 35,000 cubic feet, of natural gas, up from $50 in 2005. An 11th-hour attempt to maintain the gas flow failed.

On Sunday, Ukraine's natural gas distributing company, Naftogaz, said it had faxed a draft contract to Russia shortly after 11 p.m. Saturday, agreeing to terms laid out earlier that evening by the Russian president, Vladimir Putin, according to Russian news reports.

Putin had suggested a three-month grace period if Ukraine would agree to pay the increased prices thereafter. But Gazprom, the Russian energy giant, said Sunday that the fax had fallen short of demands.

About 10 a.m. Sunday, Gazprom began cutting the pressure in pipelines at the Ukraine border, from where gas is transported into Ukraine and through to other European countries. The effect on the Ukrainian web of gas pipelines was felt later in the day.

"The formula is simple," said Gazprom's chief spokesman, Sergei Kupriyanov. "We supply Europe, minus Ukraine."

The reduced pressure will not immediately lead to gas shortages in Ukraine or in countries that receive gas exported from Russia through Ukraine, both Gazprom and independent experts said. Countries along the pipeline, including Ukraine, maintain reserves.

Still, choking the westbound pipes is a dramatic gamble by Russia, one likely to send political and economic ripples westward in the months ahead.

Russia is positioning itself to become an energy-supplying nation capable of easing dependence on Middle Eastern oil in Western Europe and even in the United States.

On the same day it cut back its gas to Ukraine, Russia assumed the chairmanship of the Group of 8, the club for the world's large developed economies, promising to push the theme of "energy security." In trips to Germany, Turkey and Japan last fall, Putin not only boldly promised a secure supply of fuel but also presented Russia as a potentially much larger exporter of energy in the years ahead.

He pushed Germany to endorse a multibillion-dollar underwater gas pipeline in the Baltic Sea. Gazprom is hoping to extend the line to Denmark, Belgium and Britain. Gazprom is also in talks with five major energy companies to develop a large gas field in the Barents Sea, far above the Arctic Circle, hoping to ship significant quantities of liquefied natural gas directly to the world's largest energy consumer, the United States.

Amid the ambitious plans, Putin has said Russia's foreign policy will hinge on energy exports. And Gazprom, 51 percent owned by the state, is Russia's largest policy instrument though the company sometimes insists it operates on business principles alone. Gazprom provides about 25 percent of Western Europe's natural gas.

The midwinter cut in gas supplies to Ukraine came as an unsettling reminder that promises of energy exports are not Russia's only method of advancing its foreign policy goals by using oil and gas. It can also turn off those exports.

The sudden loss of fuel, if it persists, could shake Ukraine's economy, just as the 1973 oil embargo helped plunge the United States into recession. Ukrainian officials said Ukraine's economy, which has been growing modestly, could contract between 4 and 5 percent in 2006.

The dispute involves complex commercial arguments by Gazprom: The company says it is charging Ukraine a price based on a basket of competing fuels on international exchanges, like diesel and bunker oil. But not far below the price dispute lies the embarrassing loss by a Kremlin-backed candidate in the Orange Revolution last year.

Tellingly, Putin, rather than company officials, made the final offer of a grace period on New Year's Eve.

The victory of Viktor Yushchenko, who became Ukraine's president last winter, pulled the former Soviet country from Russia's sphere of influence.

With its reduction in the flow of natural gas from a rate of about 120 million cubic meters per day to about 96, according to Gazprom Russia demonstrated that there is only so far Ukraine can go before Russia reacts, and that the country is still within the range of Putin's influence.

Each side blamed the other for the breakdown in talks.

"We will take all steps not to allow theft," the Russian Foreign Ministry said in a statement. "We get the impression that the Ukrainian government, feeling themselves uncertain, deliberately decided to break off the negotiation process."

Russia also sought to reassure customers in Western Europe of uninterrupted gas supplies.

"Russia counts on Ukraine to guarantee the stable supply of Russian gas to European countries in accordance with international obligations fixed in the European Energy Charter," the ministry statement said.

The complex maneuver to reduce pressure Sunday showed that the movement of the natural gas through a skein of pipes has dramatic geopolitical consequences. Gazprom said it had reduced the flow to the volume it has agreed to export to countries further to the west, cutting out what the company provides for the Ukrainian market.

Gazprom reduced the pressure in the gas mains leading to Ukraine at three metering stations and ceased boosting pressure in the westward bound pipelines from a storage system that is designed to maintain pressure during peak demand in the winter.

Ukraine also has produces gas domestically and buys it from the Central Asian country of Turkmenistan.

In Ukraine, Naftogaz officials have said exports to Western Europe will not diminish. Yet government officials have also said that the country will siphon gas from the export lines if necessary.

Source: International Herald Tribune

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