Ukraine and rise of gas prices [NGW Magazine]

When it was part of the USSR, Ukraine received its gas from the Russian heartland and central Asia; and from its borders, the gas went further west. This arrangement worked for a while during the early post-Soviet era despite periodical “gas wars.” In the course of these conflicts, Russia accused Ukraine of not paying for the gas and even stealing it. Ukraine made her own complaints. The tension intensified during the presidency of Victor Yushchenko, who had conducted a strong anti-Russian policy.

At that point, it is quite likely that Moscow started to think about limiting its dependence on Ukraine as the transit territory, and in 2011, Russia built Nord Stream, which delivered gas directly to Germany, its major customer. Neither Washington nor Kiev protested much, although Warsaw was aggrieved as it had expected the Yamal-Europe line to be boosted.

The reason seems to be clear: all of them believed that Nord Stream would not annul the old Soviet-era gas lines, which flowed through these eastern European nations’ territory. But after the 2014 conflict with Ukraine, Moscow changed its mind more decisively. On one hand, Moscow forgot about the years-long and seemingly fruitless negotiations with China and clinched the deal. It also engaged in building Nord Stream 2, with the clear goal of bypassing Ukraine and, of course, other eastern European countries. From the very beginning the project faced bitter resistance from Kiev, for it would deprive it of considerable transit fees.

It looked as if Moscow was winning as Berlin was supportive as it wanted to receive gas directly from Russia and not to be at the mercy of a highly unstable regime in Kiev. This goal was more important than any desire to avoid a clash with Washington and eastern European countries, such as Poland. The economic benefits of NS2 were clear for Germany, which has also more recently discounted Trump’s promises to deliver LNG. Berlin also understands well that the US sees Germany as a major economic rival and would not provide LNG in Marshall Plan fashion, when the US actually subsidised Europe’s economic recovery after the second World War. In addition, LNG tankers are not gas lines. They are not bound to particular ports and sail to the places where prices are highest. Germany does not have many alternative sources of gas. It is true that in August, Germany’s chancellor Angela Merkel travelled to the Caucasus with Azerbaijan as one of her ports of call. She discussed in Baku the possibility of gas deliveries from Azerbaijan to Germany, but nothing was fixed. There were several reasons for this. One is that Azerbaijan is already committed to piping its gas to Italy, whose interests do not necessarily coincide with those of Germany.

Second, Berlin understood that after completion of NS2, Germany would emerge as the major gas hub in Europe, and this would increase its economic and geopolitical clout. These considerations predicated Berlin’s approach to the project and led to a certain ambivalence in Berlin’s dealings with Russia. During the spring 2018 crisis, when Western countries expelled Russian diplomats in retaliation for the attempt to poison the ex-Russian spy, Berlin followed suit. But it also granted permission to build NS2 in its territorial waters; and did nothing to hinder the award of construction contracts for the onshore, Eugal line, which will carry nearly all the gas from NS2 south to the Czech Republic.

It looked as if the building of NS2 was unstoppable. One could also assume that it would be built on time, by 2019, when the current contract with Kiev expires. But recent events have shown that not only can the construction be delayed, but the Kiev/Moscow conflict will lead to unexpected turns.

Denmark has still not granted permission for the use of its own territorial waters and the fear of American sanctions has also weakened the resolve of some of the companies involved in the project. They sent signals that they could drop participation if American sanctions threatened them. In addition, American sanctions have weakened the ruble, impacting Gazprom’s ability to finance its half of the line’s cost.

Ukrainian economic problems and gas prices

Ukraine is different from Russia and most other post-Soviet states in one important way: it has become a politically unstable country, with frequent changes of regime. The government’s geopolitical orientation also changed rapidly. Some senior politicians were basically pro-Russian or at least tried to be balanced in their geopolitical orientation. Others were strongly anti-Russian. But all had a common denominator: belief that changes in geopolitical orientation or, to be precise, the skillful “multi-vectorism” would provide Ukraine with the opportunity to enjoy profitable relations with both East and West, and achieve economic progress. This, however, did not happen.

The reason was simple. The Ukrainian economy, no less than the economies of other former Soviet republics and Moscow’s European satellites, were deeply integrated with Russia in one economic body, with a well-defined division of labour. Dismembering this body led to a deep economic crisis, especially in countries lacking marketable raw materials, such as gas and oil. Ukraine clearly fell into this category, and changes in the government did not improve the situation. The pro-Western Yushchenko failed to deliver, and was replaced by the mostly pro-Moscow Yanukovich, who was removed by force owing to his pro-Russia stance at a time when many Ukrainians believed that their living conditions would improve dramatically through affiliation with the European Union.

Petro Poroshenko’s new government in Kiev tried to demonstrate that Ukraine followed Western rules and to discard those traditions that might create problems with the West. But the economy and living standards plummeted and the uprising in Donbas made the situation worse, cutting its coal output; and conflict with Donbas insurgents – implicitly a conflict with Russia – demanded more military spending. The government decided not to buy comparatively cheap coal from Donbas and replaced it with much more expensive imports. Kiev also decided not to buy gas from Russia, but from Europe. The point here is that Europe does not produce its own gas, at least not much; most European gas is actually Russian. It simply cost Ukraine much more, as its new suppliers, such as Poland, knew a distressed buyer when they saw one.

At the same time, corruption and mismanagement worsened the economic situation. The EU and IMF, anxious to prevent economic and political breakdown, provided Kiev with loans. Still, it became increasingly clear that they would never be paid back. In addition, the IMF and even the US, oblivious to the political repercussions, demanded higher gas prices.[1] And it looks as if a considerable rise in gas prices, both for industry and consumers, is imminent.[2] It was clear that Poroshenko, facing elections, was coming under very heavy pressure to act.

Feeling the inevitable financial crash and a variety of political repercussions that could lead to another revolution, Kiev engaged – or at least thought of engaging – in an economic and geopolitical gamble. It assumed that NS2 would not be finished by the end of the 2019, and Moscow would have to deal with Kiev after that point.

If so, some say, Kiev could dramatically increase transit fees. The assumption was that Moscow will have no choice but to pay them to fulfill its contracts with European customers. At the same time, the new income could make it possible for the Ukrainian economy to stay afloat. Another alternative would be to link up with central Asia, most likely Turkmenistan, from which Ukraine received gas through the old Soviet-era gas lines during the Soviet and early post-Soviet era. Kiev assumed, and certainly not without grounds, that Ashkhabad might be interested in this proposal.[3]

Indeed Turkmenistan has lost its Russian and Iranian markets and the Turkmenistan-Afghanistan-Pakistan-India line is hardly likely while there is such instability in Afghanistan. And the August 2018 Caspian Sea agreement is hardly a breakthrough. On paper, everything looks encouraging, as Turkmenistan has the formal right to build a subsea gas line. But most observers doubt if the agreement was a true breakthrough for Ashkhabad. First, the bottom of the sea was not divided, and there is no clear plan of how to do this. Second, states can object to a line on environmental grounds, giving an excuse for a veto. Last but not least, the balance of power in the Caspian Sea was tilted toward Moscow, which has the strongest navy in the Caspian Sea and wants to make the Russian presence even more visible by building a port in Kaspiisk. At the same time, Moscow and Tehran wrested from the other participants at the meeting the agreement that there should be no foreign military on the shores of the Caspian Sea. It became clear that Moscow had the biggest club and is prepared to would wield it if its interests were crossed. Turkmenistan apparently has no illusions about that, and its only option is to build yet another gas line to China – line “D.” And of course Beijing here would set the price. Ukraine’s proposal to buy gas from it would be quite handy in these circumstances.

Not only could Ukraine receive gas from non-Russian sources, but it could also play the role of a transit country, sending Turkmen gas further to Europe. But it is unlikely that either of those options would be acceptable to Moscow. Not only would Moscow be loath to give huge additional sums to Kiev, and subsidise gas delivery to Europe. In addition, Moscow became extremely irritated by Ukraine’s victory in the Stockholm Court, which decreed that Moscow was required to pay several billions to Kiev. Neither side is ready to compromise, and this has created an unpredictable situation, if NS2 is not built on time.