Gas price conflict increases Russia's stranglehold on Ukraine

Transcript of Question & Answer video with Professor Stefan Hedlund on the break down of Russia gas negotiations with Ukraine and the impact this will have on the crisis and Ukraine's future.

Talks between Russia and Ukraine on gas prices have broken down, and Russia has confirmed it has halted gas supplies to Ukraine. What impact will this have on the current crisis?

Professor Hedlund:

Well, if we look at it simply in terms of gas flows then this is just more of the same. The two sides have been locked in conflict over gas pricing with periodic shut offs of gas supplies for a decade or more.

Two things make this a novel feature today. One of these is that the EU has been quite successful in reversing gas flows, meaning that gas flows to Europe and back to Ukraine, and that means that at least today, when it is sunny and warm, that Ukraine can get by without importing gas from Russia. So that sort of reduces the leverage that Russia has over Ukraine.

The other side of the question, which is not so happy for Ukraine, concerns payments and thus debts. When winter comes it will not only be the case that Ukraine will have to come up with money to pre-pay for gas deliveries from Russia. There is also the question of past debts.

There are two cases of arbitration in the Stockholm Arbitration Court where Gazprom has sued Ukraine for US$4.5billion for past violation of contract. And Ukraine has entered a counter-sue for US$16billion for alleged infarctions from the other side.

This illustrates how Russia is using gas debts as part of its arsenal to destabilise Ukraine, and to make outside investors, and domestic investors, wary of the future, to create maximum uncertainty over the future of Ukraine.

So this really is the alarming part of the gas conflict today – that it forms part of the debt burden that is going to crush Ukraine.

What are the broader implications for the debt crisis in Ukraine?

Professor Hedlund:

The broader implications are that Ukraine in March (2015) was basically bankrupt and then the IMF stepped in, with what it claimed was a US$40billion bailout package. And if you look at that bailout package a significant part – about US$15 billion or so – are assumed debt relief from private bondholders. And that is not something the IMF can dictate.

And if the bondholders don’t agree to what is known in the business as a ‘haircut’, i.e., a write-down of the debt, then the whole bailout operation comes up short, and their financing gap means that Ukraine will go into default.

The key role that Russia plays here is that Russia has a bond from December 2013 of US$3 billion, that is viewed by Russia as official debt, but viewed by others as private bond debt.

So other investors are saying if Russia can’t be forced to join discussions on write-down of the debt, then we won’t accept either.

Russia simply stonewalls, saying ‘this is not private debt, this is official debt and we’re not going to be party to it.’ So Russia here has a gun to the head of the Central Bank of Ukraine. By simply refusing to enter into negotiations it can scupper the whole restructuring deal.

And this places the IMF in a terrible position, because the IMF now has first its credibility badly shaken and its finances badly shaken by the Greek crisis, it looks like we’re facing ‘Grexit’. And it must somehow manoeuvre its way through debt negotiations with private bond holders, and with the Russians in Ukrainian mess, and that’s not an easy situation.

What is the potential impact on the European Union?

Professor Hedlund:

Well, the impact on the European Union, if there is no solution – and both the IMF and Western governments, markets, and observers keep saying that ‘as soon as the war in eastern Ukraine dies down there will be a flow of foreign investment into Ukraine, the situation will stabilise and the economy will pick up.

The question is, who is going to bring about an end to the war in eastern Ukraine?

Russia is bent on demonstrating what it has been arguing all the way – that there can be no solution to the crisis in Ukraine without including Russia.

So their interest is to keep the debt crisis going, to keep a low-intensity conflict in eastern Ukraine going, and to slowly suffocate all possibilities for a solution to the financial and macroeconomic crisis in Ukraine. And the economy in Ukraine is going down the drain now, both with inflation and negative growth.

So it is looking like we are headed, without any deal that includes Russia, for a sovereign default maybe for a Ukrainian failed state, with a second rebellion against the government.

And the costs of such a negative scenario, to German taxpayers in particular, will far exceed the costs that will come out of the Greek mess.

(Photo credit:dpa)