WASHINGTON, June 16, 2014 – Russia and Ukraine failed to reach a deal on payment of Ukraine’s unpaid gas bills, leading Russia’s gas giant Gazprom to cut gas supplies to Ukraine today. Gas continues to flow to Western Europe, and Ukraine has sufficient supplies to last until December.
Ukraine is one of the most energy inefficient nations in the world, and by far the most inefficient in Europe. In 2010, the U.S. used 7,329 BTU per dollar of GDP; Germany used 4,744, Italy 4,380, Russia 34,390, and Ukraine – 56,271. Only Kyrgyzstan, Tajikistan and Uzbekistan were worse. Ukraine remains saddled with an infrastructure that, in the Soviet period, was designed without regard for energy costs.
Ukrainian consumers pay a highly subsidized price for gas. Ukrainian gas company Naftogaz has been charging customers one-fifth the price it pays for Russian gas. The result has been to pile up government deficits, while consumers have little incentive to economize on gas usage. No matter how this impasse is resolved, Ukrainian consumers will have to pay more for gas, and in fact the government is raising prices to comply with the requirements of the $17 billion loan it received from the IMF.
It will take a few months for the cutoff to bite. The move has provoked sharp words, but no sense of panic in Ukraine; the concern is more acute in the European Commission, which is working frantically to resolve the issue. Ukraine’s gas reserves stand at 13.5 billion cubic meters, but they need to be at least 18 billion cubic meters in August to get Ukraine through the winter.
Gazprom spokesman Sergei Kupriyanov said that henceforth, Ukraine has no credit; it must pay for future deliveries of gas in advance. Ukraine owes about $4.5 billion for gas delivered since January, 2013. The prepayment system began at 7 a.m. London time. Kupriyanov said that if payment for June wasn’t received by 10 a.m., “we obviously will deliver no gas.”
Ukrainian Prime Minister Arseniy Yatsenyuk equated Gazprom’s move with the Russian annexation of Crimea. “We won’t subsidize Gazprom,” he declared. “Ukrainians won’t take $5 billion … to let Russia spend this money on weapons, tanks and planes to bomb Ukrainian territory.”
Gazprom had offered to sell gas to Ukraine for $268.50 per thousand cubic meters in December, but after Ukraine’s President Yanukovych was ousted in February, Gazprom raised the price to $485.50 per thousand cubic meters.
If the standoff continues, it has the potential to interfere with gas deliveries to Europe. Thirty percent of Europe’s gas comes from Russia, and half of that goes through Ukraine. Half of Ukraine’s gas consumption comes from Russia as well. In the past, when Russia has cut Ukrainian supplies, Ukraine has taken some of the gas flowing to Europe, since it all flows through the same pipelines.
Gazprom CEO Alexei Miller warned today, “The risks to the (gas) transit are there and they’re significant.” If Ukraine does siphon off gas meant for Europe, the effects won’t be felt right away, but they will become acute by the end of winter. Hence European Commission concern, and its heavy involvment in the dispute.
Ukraine’s government wants the price of gas to be cut to $326 per thousand cubic meters; Russia’s President Putin has insisted that the price fall no lower than $385. EU Energy Commissioner Guenther Oettinger has suggested that Ukraine accept the $385 figure for the winter months, then get a rate closer to $300 next summer. Ukraine is willing to accept that deal, but Russia is not.
The situation wasn’t helped when Ukraine’s acting Foreign Minister Andriy Deshchytsya called Putin “a prick.”
Russian Foreign Minister Sergey Lavrov said that Deshchytsya “allowed himself to … cross all lines of decency.” He added, “I do not know how we are going to work with him from now on.”
At the same time it cut off Ukraine’s gas supply, Gazprom filed suit for its $4.5 billion in a Swedish arbitration court. Neftogaz filed a countersuit, demanding $6 billion for overpayments.
Neither side is inclined to budge now. The shooting down of a Ukrainian military transport with the loss of 49 lives has stiffened the hostility between the two sides. Ukraine will siphon off some European gas, and it will ask the Europeans to provide it with substitutes for Russian gas.
This situation has been created by shortsighted leadership in Kyiv for the last 20 years, by Russian prickliness over Ukraine’s political and economic movement west, and by West European dependence on Russian gas. A long-term solution demands that Western Europe begin finding substitutes for Russian gas, and that Ukraine get its energy and fiscal houses in order.
A solution for Russian prickliness will be harder. Mr. Deshchytsa will almost certainly be removed as foreign minister – not because President Poroshenko disagrees with his assessment of Putin, but because he will want his own man in the job – but that won’t improve Putin’s disposition. It may be a long, cold winter in Europe.