Why Europe faces new tensions over Russian gas

Russia has turned off the gas to Ukraine. What happens next?

Professor Stefan Hedlund:

Well, the first thing that will happen, obviously, is that the gas will stop flowing to Ukraine. That will not have an immediate effect because Ukraine has, over the past weeks, been putting a lot of gas into its underground storage tanks – about 11.5 billion cubic metres that it has not paid for, making Gazprom very angry.

And also it’s summer. The main use for this gas is domestic heating, and that need is very low during summer. So it will be around two or three months before they start feeling the pinch.

So the immediate effect of the shutdown is not going to be felt in gas shortage in Ukraine, that’s going to be a few months down the road.

What will happen immediately is that we will now see the beginning of a very long process of legal wrangling. Immediately after they shut down supply of gas to Ukraine, Gazprom filed a lawsuit with the Stockholm Arbitration Court suing Ukraine for US$4.5 billion in payments they have not received for gas that has been delivered.

In return, Ukraine has filed a lawsuit in Stockholm, same court, against Gazprom to review the 2009 agreement that Gazprom bases its prices on - arguing that those prices need to be revised.

So, it's not an immediate gas problem, but it's the beginning of a long period of legal wrangling, and down the road, if there is no solution, Ukraine will end up without gas when it becomes very cold. And that will be a very serious challenge to the government in Kiev.

Why was it so difficult for Russia and Ukraine to reach a compromise?

Professor Stephan Hedlund:

Well, I would say, on this count I’m on Gazprom’s side.

The side that’s not been willing to negotiate in good faith is Kiev. The Kiev government argues that Gazprom has hiked prices for political reasons. And it is true that gas prices in April were hiked from US$268 per 1000 cubic metre to US$485, which is an 80% hike. And that makes it very difficult for Ukraine to pay.

Now this is true, but that’s not political in the sense that the Kiev government argues. In December 2013 the Russian side offered Ukraine a package deal to keep Ukraine within the Russian orbit and not turn to the EU. That included buying US$15 billion of Ukrainian government bonds and offering a 33% discount on gas.

Prior to that, the Russian side had offered a further discount on gas in return for the Sevastopol naval base on Crimea, which is now in Russian hands.

So what happened in April was not that the prices were raised, what happened was the political discounts were removed because Russia felt that Ukraine was no longer giving its part of the bargain – ‘We gave you low gas prices, you give us something in return.’ Now they are not getting anything in return, so they return to the gas price of US$485 per 1000 cubic metres that was agreed in 2009.

And whether or not that is a fair price is a different matter. What Gazprom has argued is that ‘we can discuss the price if you pay your debts for deliveries that have been made.’ And Ukraine is holding out saying ‘we will not pay our debts until we get a reduced price.’

Now, no household, no company in the EU would get away with not paying their electricity bills for six months without having their power turned off. And that is now what has happened to Ukraine. And Ukraine will probably continue feeling that ‘we have enough gas to last for a few months, and in the end the EU will probably step in and help us get a lower price’. I think that’s a miscalculation from Kiev.

How will this impact on the EU?

Professor Stefan Hedlund:

Well, the last time there was a gas crisis in 2009, the EU was very, very dependent on Russian gas supply, we had a 13-day crisis that hit Bulgaria and Slovakia very badly. But since 2009, which was a wake-up call for the European Union, a lot has been done.

There is now a much larger readiness to counter shortfalls in Russian supplies by a variety of both technical and economic means. There’s also the case that, since then, Russia has opened its Nord Stream pipeline that goes across the Baltics.

So the European Union gets about one third of its gas from Russia. Half of that is via Ukraine and half other directions. So Russia has the potential to redirect from transit via Ukraine to supply Europe via other ways. And the European Union has a lot of means at its disposal to substitute for gas shortfall from Russia. So the European Union will not suffer very greatly even if there is a complete shutdown through Ukraine from gas shortage.

What the European Union will suffer from is the fallout from the political crisis that now will erupt as Ukraine refuses to pay, and Russia shuts off the supply.

And we are now looking at a very, very difficult fall and winter if there is no resolution to the crisis before October/November, when it starts getting very cold.

Then this baby will be a ‘Brussels baby’ as well, and that will create new tensions between Russia and the EU, new demands for sanctions, new problems trying to reverse gas flow from Russia to the European Union and back to Ukraine. If we do that, Russia will say ‘this is not in good faith, we sell you gas not for you to re-export it to Ukraine, so we may shut that down as well’.

So all the really serious problems are a couple of months down the road – three months maybe – and meanwhile it is really, really important that the actors get their act together, that Brussels and Moscow start realising that Ukraine is a common problem, it’s not a zero sum game where one side can win and the other can lose.

Unless we get together and solve the Ukrainian problem jointly, we will all suffer. And I get the feeling that we are heading for a train wreck here.

(photo credit: dpa)