As machine guns mounted on armored trucks signaled Russia's takeover of Ukraine's Crimean peninsula, Moscow this weekend unsheathed a more subtle, but well-proven, weapon against its insurgent neighbor. (See related, "After Ukraine Crisis, Why Crimea Matters.")
Sergey Kupriyanov, spokesperson for Gazprom, Russia's giant state-owned monopoly, on Saturday ominously reminded Ukraine that it owes the company $1.55 billion—a "huge" debt that it "must" pay back. What's more, he announced that Gazprom might reconsider the steep discount that ousted Ukrainian leader Viktor Yanukovych arranged in December with Russian President Vladimir Putin. That deal allowed Ukraine to tap its leading fuel supplier at a price of $268.50 per thousand cubic meters of gas instead of $400, adding up to $2 billion in savings a year for the cash-strapped government. (See related "Quiz: What You Don't Know About Natural Gas.")
Now, with central Kiev smoldering from the chaotic uprising that deposed Yanukovych, and Russian troops expanding control over Crimea, Ukrainians face the prospect of energy woes. (See "Photos: Ukraine's Ring of Fire.") Twice in the past decade, Russia cut off vital fuel supplies to Ukraine, causing repercussions throughout Europe. Today, Europe is far less dependent on Ukraine as a transitway for fuel, but if Gazprom tightens the screws it could further complicate Ukrainians' efforts to form an interim government. (Related: "How History, Geography Help Explain Ukraine's Political Crisis.")
"Russia is already deploying its gas weapon against Ukraine," said Fiona Hill, senior fellow at the Washington, D.C.-based Brookings Institution and director of its Center on the United States and Europe. Words like Kupriyanov's, she added, are "destabilizing."
On the Edge of Insolvency
Ukraine's reputation as a nation that pays for its gas late, and even steals gas shipped from Russia across its territory to Europe, leaves Gazprom with legitimate concerns. Alexey Grivach, director of the Moscow-based think tank and consultancy, the Fund for National Energy Security, noted that, "While anything is possible, [Kupriyanov's statement] was intended to remind them that they do have to pay. And that if they don't, they may lose their discount."
The threat looms as Ukraine teeters on the edge of insolvency. The newly appointed prime minister, Arseniy Yatsenyuk, took office last Thursday and discovered his country was destitute. "The state treasury has been robbed and is empty," he declared. In December, Russia had agreed to lend Ukraine, even then nearing bankruptcy, $15 billion, but with Yanukovych's removal, the Kremlin has decided to withhold disbursement until a transitional government—presumably one favorable to its interests—is up and running. (See related, "Ukraine's People Power in Photos.")
Ukraine is in no position to bargain. In Soviet times, the country exploited its internal gas fields, which were sufficient to meet domestic demand. But after independence came in 1991, the government let the energy industry decay, with corruption and inefficiency dramatically lessening its output. These days, Ukraine depends on Gazprom for the vast majority—70 percent in 2011—of the gas needed to heat homes and keep its industry functioning. This is a matter of no small import given its usually harsh winters. "Ukraine just hasn't paid attention to the gas problem at all," Hill said. "It's had too many people getting rich acting as middlemen for Russian gas."
It might take Ukraine three to five years to bring its gas sector up to speed, she added. But Clifford Gaddy, a Brookings Institution economist who specializes in Russia, pointed out that "Ukraine . . . has not found alternatives to Russian gas, and it will not be able to. They are too expensive. Gas is and will always be a Russian lever." (See related, "Photos: With Ukraine in Disarray, Crimea Heats Up.")
The Gas Weapon
Ukraine's overwhelming reliance on Russia for hydrocarbons gives rise to serious questions about its viability as an independent state. Will the Kremlin end up determining the country's future by withholding gas from Kiev?
In 2005-06 and 2009, Western observers believed that Moscow had cut off midwinter gas shipments to punish Ukraine for its 2004 Orange Revolution, which thwarted the instatement of pro-Russian presidential candidate Yanukovych. (At the time, Ukraine was insisting on a sizable discount that Moscow was not inclined to offer, with Putin pointing out that Ukrainians would end up paying less for Russian gas than Russian consumers.) In 2009, Russia turned off the taps for Ukraine's nonpayment of already received gas supplies. (See related, "Q&A: Ukraine's Dangerous Turn Has Roots in History.")
The impact was felt across Europe, which relies on Russia for about a third of its natural gas supplies. Through Ukraine, Russia pumps gas to 12 European countries (plus Turkey) via two major pipelines, so in previous years price disputes and Russian accusations of gas theft led to supply disruptions that left Western Europeans with their houses chilling and stoves going idle. When Russia turned off the taps in 2009, countries such as Croatia and Serbia lost all gas from Russia, while France and Austria lost 30 percent.
At the same time, the economies of both Russia and Ukraine reportedly suffered substantial losses, and Ukraine lost an estimated $100 million in transit fees for 2009 alone. Ukraine also had to shut down temporarily its steel and chemical plants, the backbone of its economy.
Another repercussion, with great significance today: As disputes between Russia and Ukraine receded after pro-Kremlin Yanukovych's election in 2010, Russia and Europe intensified work on alternative pipelines that would bypass Ukraine.
A Changed Landscape
The result is a much-altered energy-delivery landscape over the continent, and the changes bode ill for Ukraine.
In the early 1990s, Russia sent almost 100 percent of its Europe-bound gas through pipelines crossing Ukraine. By 2013, it shipped just 52 percent of its Europe-bound gas via its southern neighbor. Much of that reduction stems from the opening in 2011 of the world's largest offshore pipeline, the Nord Stream, which runs 1,224 kilometers (761 miles) beneath the Baltic Sea from Vyborg, Russia, to Greifswald, Germany.
So now, if Russia cuts off supplies to Ukraine, it will hurt Europe less than it did during the winters of the previous gas quarrels. Moreover, the South Stream pipeline, now under construction, is set to come online in 2015, passing directly south of Ukraine beneath the Black Sea, through the offshore territory of Turkey and Romania before crossing Bulgaria, Serbia, Hungary, and Slovenia, en route to Italy. This development will give the Kremlin even more influence over Ukraine, because it will be able to shut off the gas tap without worrying about repercussions from the European Union. (See related, "Pictures: At Five Years Old, BTC Pipeline Moves Oil, Culture.")
Economic factors also give good reason to suspect that, where gas is concerned, Russia will deal more harshly with Ukraine than it has in the past. In recent years, Gazprom has seen prices for its commodity fall, and it has ceded to European requests to renegotiate contracts.
"If Gazprom, on account of its problems, is being more flexible," Ildar Davletshin, an analyst at Renaissance Capital, told the BBC, "that's only with European consumers . . . With Ukraine it is becoming more aggressive," in a bid to recoup lost revenues.
For now, though, Ukrainians have other things to worry about. This winter, Ukraine is enjoying unusually mild weather, which has lowered its need for natural gas. Also, the Ukrainian government has taken measures to reduce the wasteful gas expenditures of previous years. Ukrainian gas reservoirs now contain enough fuel to satisfy both private and industrial demands, at least as long as the weather remains mild.
"The anomalously warm winter period of 2013-2014 has allowed us to use 37 percent less [than in previous years]," according to Ukraine's state-owned energy company, Ukrtransgaz.
But counting on warm winters is no strategy.
"A return of acute cold this winter," said Hill, "would put Ukraine in real trouble. The real question is, does it have the political will to develop its gas sector?"
That is a question Ukraine's new leaders need to answer, before the chill deepens.
This story is part of a special series that explores energy issues. For more, visit The Great Energy Challenge.
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