Did Russia come out ahead in the gas crisis?

Expanding on (and slightly copying) my comments in Edward’s post below, I was really shocked to see the spin in the western coverage of the Ukrainian gas crisis. The part that didn’t shock me – just made me groan – is the spin of a western press that seems to have decided in advance that Russia must be the bad guy, so Ukraine must be the good guy. Russia may be the bad guy, but I don’t think is Ukraine is the good guy. From what I can tell from the press, Russian claims that Ukraine was siphoning off gas seem well founded – Russia had been complaining since summer about siphoning, Gazprom was willing to let third parties audit the difference between what was going into Ukraine and what was coming out, while Ukraine refused. Also, it seems that the Russians weren’t the only ones making allegations about siphoning. Yes, Russia’s intentions towards Ukraine are not honorable, nor is this some purely commercial conflict free of political meaning. But, that does not exclude the prospect that Ukraine was screwing Russia.

But what really surprised me was the claim that Russia was the loser here.

I saw the coverage at the BBC for instance suggesting that this was a “face saving deal”. But that only makes sense if you think Russia’s goal was to get world market prices for gas from Ukraine. Russia claims it’s getting $230/1000m^3 for the gas it sells Ukraine, but clearly it isn’t. It’s getting $95/1000m^3 for a mixture of 2/3 Turkmeni gas, purchased for $65/1000m^3 and 1/3 Russian gas at the stated price, and the general agreement is that this deal is dubiously profitable at best given those terms.

But, Russia was previously seeing some $50/1000m^3, and dealing with a Ukrainian government that claimed that it had the right to siphon off up to 15% of the gas in the pipeline if temperatures drop below -3. It makes just as much sense to see this new deal as Russia selling Turkmeni gas at a mark-up of $30/1000m^3 and selling its own gas for $45/1000m^3 more than it did before. There was no possible way that Ukraine was ever going to actually pay $230/1000m^3 for gas. Even Gazprom’s earlier offers called for $160/1000m^3 and a largish loan to Ukraine to help mitigate short-term costs. The deal does raise the amount of money Ukraine gets for transporting natural gas from $1.09/1000m^3 to $1.60/1000m^3 to offset some of the price shift, but no matter how you cut it, Moscow is making more than it did before the deal and Ukraine’s prices are roughly doubling.

But, the fine print is quite interesting. The actual transaction between Russia, Turkmenistan and Ukraine is conducted by this shifty little Swiss firm RosUkrEnergo, half owned by Gazprom, half by European investors, that seems to be linked to organised crime. According to most of the folks I’ve read, RosUkrEnergo probably can’t turn a profit by actually paying the stated prices for gas and pipeline access. It can only survive as long as Gazprom is willing to extend credit to it – i.e., let a company it half owns (and probably completely controls) pay for gas with IOUs. If it ever becomes necessary to escape the deal, this little Swiss firm can simply show enormous losses and declare bankruptcy, cutting Ukraine off and forcing them back to the negotiating table.

Russia has also set out a legal justification for intervening in Ukrainian politics. The long term contracts under which Gazprom delivers gas were signed before the fall of the Soviet Union, and they require Russia to ship gas, and maintain the pipeline infrastructure, to specified locations that are approximately at the old Soviet border. This means that if Ukraine extracts gas from the lines, depriving western Europe of deliveries, Russia is contractually liable. Ukraine claims that it has a legal right to siphon gas and appears to have actually done so recently, giving Ukraine real power to impose costs on Russia. Russia can pursue arbitration, but it’s going to be hard for anyone to get away with claiming Russia should leave Ukraine alone. It has large – and by the usual international standards, legitimate – interests in Ukraine.

Furthermore, I’ll bet this is a domestic political coup for Putin. Russia has portrayed itself as subsidising the Ukrainian economy with cheap gas, and in return Russia gets nothing but the finger from Kiev. I bet Russians are eating it up. I suspect you won’t find a soul on the streets of Moscow taking Ukraine’s side. At the same time, Ukraine has shown a willingness to hold up European gas shipments that does not endear it to its ideological backers in the west. And, is the EU really prepared to admit a nation of 50 million that seems to be completely dependent on Russia to provide it with subsidised gas? Especially when it has a GDP per capita on par with most of Africa.

This crisis has put the fear of Russia back into practically all of eastern Europe, including the parts that are already in the EU, because they are totally dependent on Russian gas as an energy source. Estonia, Latvia and Lithuania are buying below market price Russian gas at $120/1000m^3, while much of eastern Europe is getting the bulk of its energy from Russian gas at something closer to market prices. Germany, Italy and France may eventually be able to replace gas with nuclear and LNG, but is that really an option for Poland?

But what I really wonder is if Putin isn’t taking a page from an old American political playbook. The US used to do this trick in Latin America where they would make plain which candidate they wanted to win an election, and subtly hint that they would – for example – continue to fund anti-government rebels, or perhaps impose economic sanctions if that candidate wasn’t elected. It used to work pretty well, like in the 1990 Nicaraguan election, although it seems to have lost its effectiveness in recent years as Hugo Chavez and Evo Morales have shown. I’ll bet that in the coming Ukrainian election, it will be insinuated that unless candidates supporting better relations with Moscow are elected, there might be unspecified gas-related consequences. Considering that pro-Moscow candidates already have quite a lot of support and that the Orangists are, as revolutionary tradition requires, in the process of tearing each other apart, gas fears might well lead to the restoration of pro-Russian leadership in a fair, democratic election. This article from before the New Year seems to suggest so.

I think that is quite a lot to gain.

2 thoughts on “Did Russia come out ahead in the gas crisis?

  1. I just want to thank Scott for this article.
    A lot of what goes in this blog, like all blogs, is just us mouthing off, spouting opinions everyone else knows, and such like. Fun, but not essential. But an article like this, at least for me, puts so much in perspective and really does a serious job of informing me of things I did not know.

  2. This analysis underplays the effect of the gas crisis on both Ukrainian and European domestic politics.

    First off, nobody likes being bullied, and it is pretty clear that the Ukrainian public was annoyed at the Russian bullying. You are right that tactics of this kind worked in Latin America, but Latin American countries had no alternative. Ukraine has a clear alternative (Europe), and that alternative is clearly better in the long run. Compare Poland and Moldova, for example. The short-term effect of the crisis has been to boost Yushchenko’s popularity in Ukraine, and he may well win the next elections because of it. This is of course exactly what happened the last time Russia intervened in Ukrainian domestic politics.

    Note also that European domestic considerations are increasingly wary of Russia, and the most pro-Russian (almost bootlicking) premier is gone (Schroeder). So this may further political considerations to seek alternate energy sources and thus largely weaken Russia’s power in the future. Russia needs to sell gas more than its customers need to buy it.

    So I don’t think this will play out the same way as in Latin America, precisely because both Europe and Ukraine have alternatives and some countervailing power of their own.

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