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Unfiled December 28, 2005
Gas Attack! The Ukraine Gives Itself Indigestion
By Kirill Pankratov Browse author

Hey you armchair strategists, fans of the Exile's own War Nerd! Do you still remember the strategic war games of the Cold War era - the deterrence, the missile crisis, big power interests clashing in barely-recognizable Third World countries? Guess what - it's coming back. The bluffing, the posturing, the ultimatums, the game theory for which quite a few Nobel prizes were awarded - ah, the glory of it all. Only this time the dotted lines you watch on the map are not potential missile trajectories, but pipelines delivering Russian gas to the Western Europe through the battlefields of countries caught between.

It is worth remembering that nukes are not the only WMD in existence. The first one used in the fields of Europe was gas - tons of foul-smelling iprite crawling like a morning fog along the Belgian plains. And it is gas again today. Well, there are other things, to be sure - for example germs. We'll probably have a full-blown bird flu pandemic some day, but not yet. The Ukrainian websites already have hurrah-patriotic flash animations and Java games where a user can throw flu-infested chicken eggs at a caricature of Putin as he stands at a gas pipeline switch. Nail him before he turns off the tap!

The battle is, admittedly, more civilized today - no agonizing choking-to-death in the muddy trenches. Instead it's going to be another Cold War - just like in the good old days. Cold - as in zero degrees centigrade inside an apartment block, as in winter wind blowing through the abandoned steel mill in a Ukrainian industrial city. It's official now - gas, hydrocarbon fuel, is the Weapon of Mass Disruption of today. Today we have a full-blown crisis between Russia and Ukraine over the huge Soviet-era gas pipeline, affecting the supply of gas to the whole EU, the world's biggest economic block.

The stoppage of Russian gas deliveries to Europe is almost like the nuclear strikes everybody feared back in the early 80's, like neutron bombs. It wouldn't lead to a total collapse, sure, but it would be a really huge disruption nevertheless. The European Union is not exactly looking forward to it. The last time something this threatening hit was the 2000 New Year, with the supposed Y2K bug that was going to wreak havoc on all control systems. It turned out to be a huge swindle perpetrated by the computer industry. Now it is different. There are no technical obstacles, but two sides are at total loggerheads just a few days before the January 1st 2006, when Russia will implement new rules on gas delivery, which Ukraine claims are totally unacceptable.

The gas war has its roots in the messy Ukrainian elections last year, which brought to power leaders of the "Orange Revolution," perceived to be anti-Russian compared to the previous government of Leonid Kuchma. When the current government came to power at the beginning of this year, like any revolutionaries worth their salt they said and did a lot of really stupid things. One of them was to put the most rabid nationalists in charge of economic relations with Russia, particularly on energy issues. Bad tactics. You can put a fiery nationalist in charge of some internal policy areas, perhaps even the foreign ministry. But you don't put a nationalistic nutcase in charge of very difficult and technical negotiations with a more powerful neighbor on issues where you have very weak hand. And that's exactly what the Yushchenko's government did.

One of these anti-Russian nationalists was then-Deputy Prime Minister for energy policy Alexiy Ivchenko (since then demoted to a lesser-job as a chief of the NaftaGas consortium). When he visited Russia for crucial talks back in March of 2005, he brought with him a Russian-Ukrainian translator. Since some 95% of Ukrainians speak fluent (if accented) Russian - and those who don't are overwhelmingly village hicks from Galicia - so the decision to only speak to his Russian counterpart through a translator had the main effect of pissing off the counterparty right from the start. But this was only the beginning. Claiming to "break the Russian shackles" and bring in a new, more pragmatic era in joint relations, Ivchenko declared that the Ukraine want to scrap the previous arrangements on gas deliveries, based on barter trade and reduced prices.

Since the previous agreement, valid until at least 2009, was in fact hugely favorable to Ukraine, Russians could not believe their luck. "Are you sure you want to do this?" they asked Ivchenko.

"Of course we do, we're a proud, independent Ukraine," was the essence of Ivchenko's reply.

"Then so be it, we'll start market-pricing gas exports and transit through the Ukraine." The details of the new "realistic" terms remained vague and the issue was shelved - until a couple of months ago, when Gazprom announced a big price hike for the gas supplies to Ukraine, though still well below the European prices.

By early September the "Orange" government lost much of its popularity, the coalition of Yushchenko-Timoshenko had collapsed, and Yulia Timoshenko was forced out as Prime Minister and became a fierce critic of President Yushchenko. Russia, meanwhile, began a new strategy, trying to woo separately Timoshenko and Yushchenko and play them against each other. At first Yushchenko seemed to be in a compromising mood. He appointed a new Russian-born technocratic Prime Minister: Yuri Yekhanurov, an ethnic Buryat (one of the indigenous peoples from Siberia). But almost right away he also upped his hostility towards Russia, trying to forge an anti-Russian coalition with Moldova and Georgia, and accelerating moves towards NATO membership (even though this is highly unpopular in Ukraine, even among most supporters of the "Orange Revolution"). Putin's government decided to strike back where it hurts - in energy prices.

The current price of Russian gas to Western Europe is about $230 per 1000 cubic meters. This is well below the price from Europe's other sources - the continental deposits, the Norwegian gas from the North Sea, or limited supplies from the North Africa. But it is well above the price of Russian gas provided to the post-Soviet space, even to the least friendly regimes. Until now the price of Russian gas to these countries was about $50 per 1000 cubic meters - give or take a dozen bucks. The main reason was that these countries on the periphery of the former USSR had critical pieces of the oil and gas export infrastructure, built back in Soviet times - pipelines, compressor stations, seaport terminals. Russia has only recently begun to build alternative pipelines through neutral or friendlier territories, and to increase export prices to the ex-USSR countries.

Next year the gas prices to the Baltic countries, Moldova, Georgia and Armenia are going to increase to $110. Since this is still well below the European price, there has been relatively little complaining from all of them. Except the Ukraine. Ukrainian heavy industry - its economic backbone - has horrible energy efficiency, much worse than Russia itself. At prices well above $100 per 1000 cubic meters, most steel and chemical plants are going to be money-losers. Ukraine itself, however, produces more than 50% of the gas it consumes. Funny thing, it even exports some gas to Romania - at $265, even above (!) the price of Russian gas to Europe.

Gazprom suggested a price of $160 to Ukraine for 2006. Ukraine said: No way, we don't want any hike at all. Then it hinted it is open to negotiations towards this price over the period of several years. Gazprom replied that the offer of $160 lapsed already, now it is $230 - the average European price - or no gas at all. Ukraine cried foul: We'll appeal to the arbitrage court at Stockholm, we'll increase the lease price for the Russian naval base at Sevastopol (currently about $100 million a year) by twenty times, or we'll just steal some gas from the pipeline, as Ukraine actually used to do back in the 90's.

All of these options have dubious legal merits. The Russian threat to keep delivering gas to Europe but not to Ukraine will be also difficult to implement. Both sides are preparing for a trade war now, and have built up some gas reserves - in Europe and in Ukraine. Meanwhile, the Bush Administration and the Washington Post, among others, are decrying Russia's attempt to raise gas prices as an attempt to quash democracy in Ukraine - without ever mentioning all of these inconvenient details about Ukraine paying well below market prices and constantly, foolishly provoking its gas-providing neighbor.

So, armchair strategists, prepare for this Cold War Superbowl. It's going to be interesting few weeks to watch at the beginning of 2006.

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