Russia-Ukraine gas feud stands by for damage control

By Celestine Bohlen
Bloomberg News
Tuesday, January 20, 2009
PARIS: If you had a neighbor who cut off the heat in your building in the depths of winter, would you want him as a star guest at your party?

Probably not, but business is business, so the corporate hotshots who will gather this month at the Alpine resort of Davos will surely hear out Prime Minister Vladimir Putin of Russia.

Unless he cancels at the last minute, Putin will be the opening speaker at the World Economic Forum on Jan. 28, which gives him a splendid chance to reassure nervous investors that Russia is a reliable partner and a stable environment for the world's shrinking pool of capital.

Or not.

The damage caused by this winter's gas war between Russia and Ukraine may already be too great for Putin to restore whatever good reputation Russia had.

"Russia's image has really suffered, and the image of Ukraine will suffer, too, at a time when both have liquidity problems," said Thomas Gomart, a research director at the French Institute for International Relations in Paris. "That's why this has turned into such an arm-wrestling match."

Since Dec. 31, Russia has been playing a game of chicken with Ukraine over gas prices, transit fees and unpaid debts. On Jan. 7, after each side accused the other of cheating and stealing, Russia's Gazprom, the world's biggest natural gas producer, suspended supplies to Ukraine's transit pipelines, sending a chill through much of southeastern Europe.

The supplies were to resume after the two sides signed 10-year natural-gas contracts on Monday. Putin said gas shipments to the 27-nation bloc would resume in "full volumes" through all export routes.

Russia had the most to lose from the feud, according to Jonathan Stern, author of "The Future of Russian Gas and Gazprom" and director of gas research at the Oxford Institute for Energy Studies.

"If it is correct that Ukraine was siphoning off gas, then the Russians had no choice to do what they did," he says. "If the Ukrainian version is true, then this is astonishingly reckless behavior by Russia."

Russia accused Ukraine of taking 65 million cubic meters, about 85 million cubic yards, of gas destined for Europe in the first days of January, and an additional 50 million on Jan. 6, Stern says. Ukraine said any missing gas was needed to maintain its compressor stations. Gazprom lost about $100 million for every day it wasn't pumping gas through Ukraine, by Stern's reckoning.

Besides the lost revenues, Gazprom risked being charged damages for non-delivery by furious customers. Most importantly, certainly in the public's eyes, Russia was losing - perhaps forever - its reputation as a reliable partner.

This kind of risk is hard to fathom if Gazprom didn't believe it was being ripped off. And yet it wouldn't be the first time Russia has put its bullying tactics ahead of its own long-term interests.

Some analysts said Russia was seeking to discredit Ukraine as a reliable transit country, with the goal of picking up political support for alternative pipelines that would bypass Ukrainian territory altogether.

Either way, Europe is stuck with both - Russia as a supplier, and Ukraine as a transit corridor. Getting the two to work out their dysfunctional relationship is critical for everyone. Europe relies on Russia for a quarter of its gas, 80 percent of which is carried through Ukraine.

Even after the Czech prime minister, Mirek Topolanek, negotiated an arrangement to put international monitors along the gas-pipeline routes, the ill will on both sides was palpable.

"These two states are playing with their credibility," Martin Riman, Czech Minister of Industry and Trade, said during the negotiations in Brussels.

The timing couldn't be worse. Both Ukraine and Russia have been hurt by the global economic crisis. Ukraine, whose crucial steel production has dropped by half, had to seek a $16.4 billion loan from the International Monetary Fund. Ukraine collects about $3 billion in fees each year for the transit of Russian gas to customers in the West, which helps explain its stake in maintaining the current route.

As the price of oil plummets below $40 a barrel, Russia's fortunes are also deteriorating. The ruble has lost 29 percent of its value against the dollar since the beginning of August. Russia's foreign-currency reserves have shrunk 29 percent in the same period, prompting Standard & Poor's last month to cut the country's debt rating to BBB.

The drop in oil prices, from a high of $147 last July, is hurting Gazprom, which last year boasted that it would become the world's largest corporation, valued at $1 trillion, by 2014. Since January 2008, Gazprom shares have fallen 69 percent.

Now, with a market value of $75 billion and debts totaling $55 billion, Gazprom is poised to absorb the shock of falling gas prices, which historically lag behind oil by about six months. Gazprom's European customers last year paid on average $420 per 1,000 cubic meters; this year, the price is set to fall to between $260 and $300.

Until December, Ukraine was paying $179.50, a relic of Soviet-era subsidies that Moscow announced two years ago it would eliminate, in response to Ukraine's tilt to the West.

Russia offered Ukraine a price of $360 per 1,000 cubic meters for the first quarter, according to a statement from Bohdan Sokolovskyi, energy aide to the Ukranian president, Viktor Yushchenko. That may be out of reach for Ukraine's stumbling economy.

Maximizing revenues may make sense from a financial point of view, but as Putin this month faces a sea of anxious faces at Davos, he might ask himself whether it is worth the price.