Commentary: The Russia-Ukraine Gas Crisis: The Big Picture

Publication: Eurasia Daily Monitor Volume: 6 Issue: 11

By now it should be clear that there is no quick fix for the current Europe-wide energy debacle caused by the vicious Russian-Ukrainian spat. Behind the seemingly intractable dispute over debts, gas pricing, and terms of transit lies a complex post-imperial situation in which Russia and Ukraine find themselves firmly locked. Until the overall political relationship between Moscow and Kyiv is finally settled, the energy crises wreaking havoc across all of Europe are likely to recur.

The 1991 collapse of the Soviet Union left Russia and Ukraine burdened with a very tangled legacy: almost two decades on, the two countries’ political and economic interests as well as the interests of the powerful Russian and Ukrainian clans remain exceptionally tightly intertwined. The current "gas crisis" is by nature multi-layered, precisely because it reflects this high degree of interconnection between the two nations.

The ongoing gas row, like the host of previous ones, has a solid structural foundation—what can be called an asymmetrical allocation of assets. The former Soviet oil-and-gas industrial complex was developed and maintained as a highly centralized enterprise integrating production, transportation, and distribution of fuel into a single whole. After the Soviet Union disintegrated, Russia (as well as some Central Asian nations) was left with the major gas fields and Ukraine with the major gas transportation infrastructure, which is central to shipping fuel on to the lucrative European market.

So the gas transit to Europe takes place under the condition of a dual (or two-sided) monopoly: Russia enjoys a "tap monopoly" controlling volumes of gas, while Ukraine possesses a "transit monopoly" controlling the transit pipes. Theoretically, a "dual monopoly" presupposes a high degree of interdependence, in which neither side can dictate its will to (or ultimately win over) the other. But economists have long argued that the "dual monopoly" situation is a precarious one and fraught with potential destabilization. Indeed, on the one hand, the two sides appear destined to cooperate as alternatives simply do not exist; but on the other hand, the issue of how to divvy up the fruits of such cooperation is a perennial bone of contention. When each side seeks to maximize its own share of the profit, and this is of course a natural behavior of any commercial entity, the signing of contracts and then abiding by their terms are at a constant risk of being derailed. This is exactly what we have been witnessing in Russian-Ukrainian energy relations, and not just since the 2006 "gas war" but basically from day one, that is, since 1992.

One may say that, structurally, the present stalemate has been almost preordained. The particular severity of the 2009 crisis, however, is explained by the fact that this time both Moscow and Kyiv appear to be acting out of utter desperation. Blame it on the global economic crisis. Russia’s Gazprom, the giant state-run energy monopoly, is nervously watching the plummeting commodity prices. The company’s bosses are well aware that in approximately six months gas prices are expected to fall from a current high of $480 to as low as $280 per thousand cubic meters. For its part, Ukraine is among the countries hardest hit by the world economic meltdown. The country’s currency is in a free fall as the steel and chemical industries, the bulwarks of Ukraine’s economy, have almost ground to a standstill due to the drastic drop in demand.

Under the current circumstances, Gazprom is interested in escalating the gas price, seeking to earn top dollar from Ukraine while it is still possible, while Naftohaz, Gazprom’s Ukrainian counterpart, appears to be in no position to pay it. In the "dual monopoly" situation, the pricing dispute inevitably leads to a perfect deadlock: one side cuts off the gas while the other shuts down the transit pipe. This happened many times before; the only difference is that now Moscow and Kyiv are acting with particular abandon, being engaged in what appears to be a "struggle to the death."

The very viciousness of this struggle brings us to the second layer of the continuing crisis, namely politics. The Russian-Ukrainian relationship is still going through the painful phase of post-imperial readjustment. The Kremlin views Ukraine as a key strategic region where Moscow, as President Dmitry Medvedev famously put it, has "privileged interests." The question of where Ukraine’s geopolitical loyalty lies is of paramount importance to the Kremlin strategists. Following the 2004 political upheaval in Kyiv dubbed the "Orange Revolution," the pro-Western course of the Ukrainian leadership, which seeks to integrate the country into Euro-Atlantic institutions, is seen in Moscow as inimical to Russia’s "national interests, particularly now when the geopolitical competition with the West appears to be on the rise."

Gas trade is one of the principal tools that Russia uses to increase its leverage on the Ukrainian leadership, seeking to change the country’s geopolitical direction. Being perfectly aware of its massive financial losses (every day of the shutoff costs it around $200 million), the Kremlin seems to have dug in its heels as it seeks to achieve three major goals.

First, Moscow is trying to make good use of the bitter split within the "Orange" camp between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko, including over the strategy of how to deal with the Russia-Ukraine energy ties, in order to topple Ukraine’s pro-Western leadership and help install politicians in Kyiv who will be more attentive to Russia’s strategic interests. Second, seeking to take advantage of Ukraine’s apparent insolvency, Russia wants to establish its control over the country’s prized asset, the energy transportation infrastructure. Russia is attempting to obtain a sizeable piece of the action through buying up stock (in case the currently state-owned Ukrainian gas transit network is privatized in the future), or through a long-term lease, or by participating in an international consortium that would be set up to manage the network. All these suggestions have already been aired in Moscow, and any of them would deprive Kyiv of its "transit monopoly" and thus of significant leverage with Russia. The third objective of Russia’s "gas gambit" is to portray Ukraine as an absolutely unworthy partner for Europe and an extremely unreliable transit country. This, the Kremlin strategists believe, will help boost the prospects of the alternative transit routes, such as Nord Stream and South Stream, which are specifically designed to bypass Ukraine. When Kyiv’s stranglehold on transit is broken, Ukraine will be at the Kremlin’s mercy, both economically and politically.

For its part, Ukraine, given the sorry disarray among its political elites, doesn’t seem to have any coherent strategy in the current crisis. Kyiv, it would seem, is simply going to prove that in the "dual monopoly" situation the side that formally is an owner of the product (gas) still cannot win over the side that exercises a full control over transit. The Ukrainians appear to be prepared to bleed Gazprom white (and to incur terrible damage to their country’s image as a reliable energy supplier), hoping that the mounting losses will force the Kremlin to budge and make concessions.

But there is yet another, third, layer in the unedifying Russian-Ukrainian gas saga, and that is corruption, which is, incidentally, also "dual" or "two-sided." For years the billions of dollars worth of gas trade between Russia and Ukraine has been carried out through shady intermediaries, the infamous Swiss-based RosUkrEnergo being just the latest incarnation of these middleman companies. Corruption in the gas sphere has its own two-pronged function. First, it helps the high energy officials within Gazprom and Naftohaz to milk their respective companies and line their own pockets quite handsomely. Second, corruption feeds the secret slush funds that are used to manipulate Ukraine’s domestic politics. There is no doubt that the wrangling over who will control the opaque middleman company, which, without any apparent reason, stands right in the center of Russian-Ukrainian energy relations, plays no small role in the current stalemate.

The bottom line in this whole story is this: Russia’s and Ukraine’s European partners are in serious trouble. Even if the European representatives manage to force Moscow and Kyiv to restore the flow of fuel to Europe, a permanent solution to the problem of the gas supply via Ukraine is still not in sight. The European Union will enjoy uninterrupted energy shipments only when Russia and Ukraine fully normalize their relations and the gas trade is completely decoupled from geopolitics. In a word, when the post-imperial situation morphs into a relationship between two democratically governed and friendly neighboring states.