How Do You Say “Holdup Problem” in Ukrainian?

Lynne Kiesling

This Russia-Ukraine natural gas situation is a total mess, and as seems to be typical when Russia is involved, it’s not clear to me who’s in the right and who’s in the wrong. Perhaps I don’t know the details sufficiently to decide, but here’s the narrative as I understand it.

Russia engages in two transactions with Ukraine: selling them natural gas for their own consumption, and purchasing their pipeline transportation for through service to end customers in Europe. Russia’s state-owned natural gas monopoly sells natural gas, and apparently has been selling to the Ukraine at below-market prices, claiming that this pricing is a relic of the old Soviet relationship. Russia also sells at below-market prices to former satellites like Belarus. According to an article in the Times (London):

Gazprom insists the dispute is purely commercial, saying it is quadrupling the price it charges Ukraine from $50 per 1,000 cubic metres to $230 to phase out subsidies to a former Soviet satellite. Ukraine says that it will pay market rates, but wants a smaller increase phased in over five years and accuses the Kremlin of punishing it for realigning itself with the West in last year?s Orange Revolution.

Here’s where things get messy. Why the timing and the urgency on Russia’s part to change the prices it charges the Ukraine? And why, as the Times article points out, should Russia go out of its way to disrupt the transportation of Turkmen gas to the Ukraine in Russian pipelines? Is Russia changing the price it charges for the transportation function? And why does it matter that, as the Times article says, the Turkmen leader is “autocratic”?

Another useful overview article comes from the Chicago Tribune.

European Union nations get about a quarter of their natural gas from Russia; 80 percent is delivered through pipelines crossing Ukrainian territory. Ukrainian officials say their country’s contract with Gazprom allows it to claim up to 15 percent of Russian gas as payment for use of those pipelines.

Data gathered at a distribution station on the Slovakian-Ukrainian border showed that gas meant for other European countries was retained by Ukraine on Sunday, said Alexander Medvedev, Gazprom deputy board chairman.

Gazprom stopped shipping natural gas to Ukraine on Sunday after Ukrainian leaders balked at Gazprom’s request for a fourfold price increase to $230 per 1,000 cubic meters. Gazprom insists the new rate reflects market prices paid by European nations; Ukraine has urged a gradual transition to market pricing.

Still messy. 80 percent of 25 percent = 20 percent of Europe’s natural gas supply flows through Ukraine’s pipelines. It may not sound like a lot, but apparently it’s enough market share to enable the Ukraine to use its pipelines strategically. And that 20 percent is not uniform; countries like Austria, Hungary and Germany get larger shares of their gas supplies from Russia through Ukraine’s pipelines.

I have one question and one observation. What’s the contract structure here? The Tribune article refers to a contract between Gazprom and the Ukraine; is it a term of that contract that Gazprom can unilaterally change the price agreed to in the contract? I’d be surprised if they could get a party to agreed to that contract. And while we’re talking about contracts, let’s talk about long-term contracts. Suppose, just suppose, that the old $50 per 1,000 cubic meters price was a long-term contract price instead of a subsidized former satellite price. If they had agreed that price back in the late 1990s, it would have been a pretty fair price. But now the spot price of natural gas has quadrupled since then, and Russia understandably would like to sell at that higher price if it can. My point is this: $50 may be a subsidized price or it may be a reasonable long-term contract price, depending on the details of the contract. What are the terms of the contract? Without knowing that, I hesitate to evaluate whether or not Ukraine is “stealing” gas, or whether $50 is a market price; yes, it’s not the spot price, but if it arose from a mutually agreed long-term contract, it’s still a market price.

Ukraine is also getting some flack for “politicizing” what is at its essence a commercial dispute. From the Times article:

Professor Jonathan Stern, director of gas research at the Oxford Institute of Energy Studies, said that Ukraine was guilty of politicising an essentially commercial dispute.

But it’s also true that Russia may be using a commercial dispute as a red herring for a political move. From the Tribune article:

Gazprom’s decision to shut down gas shipments to Ukraine came after months of negotiations. The move reflects Russia’s desire to recast its energy relationships with former Soviet states, which up until now have received Russian natural gas at large discounts.

However, analysts believe Russia’s hard-line stance with Ukraine is strongly influenced by its disapproval of Kiev’s new pro-West government, headed by Orange Revolution leader Viktor Yushchenko. The Ukrainian president has sought to distance his country from Russia’s influence and draw it closer with the EU, NATO and the U.S.

I am suspicious that this is a political move for Putin, not just a business move. Increasingly he is showing himself to be no friend of the rule of law. And in late December, his most outspoken economic advisor resigned:

Andrei Illarionov’s resignation will reinforce fears that the Kremlin is determined to flush out dissenters at a time when the Russian Government is extending dramatically its control over the country?s economy.

Mr Illarionov last year called the decision to strip Yukos, the massive oil company, of its assets as “the scam of the year”.

Mikhail Khordokovsky, Yukos’s founder, was subsequently sentenced to nine years in prison for fraud and tax evasion. His prosecution was widely regarded as politically motivated after he funded opposition groups.

After a series of similar outbursts, Mr Illarionov had already been stripped of many of his duties as an official economic advisor to President Putin. However, his resignation is likely to be taken as a sign of the Kremlin?s tightening grip on Russian economic policy.

This is why it matters that Putin makes agreements with the “autocratic” Turkmen leader to punish Ukraine, and that Gazprom is not changing the prices it charges other former satellites like Belarus: using the commercial to achieve the political, which looks suspiciously like an increasingly autocratic Russia.

Happily, there are Nordic natural gas deposits, more pipelines are being built around the Caspian, and there are large natural gas deposits in countries like Qatar, so European consumers aren’t stuck with having to buy from Russia in anything but the immediate run.