Russian Natural-Gas Dispute With Ukraine Threatens New Cutoff to Europe

Ukrainian President Viktor Yanukovych visits Moscow tomorrow to spar over natural gas contracts as the two former Soviet states risk their third gas war in six years and another disruption to Europe’s supplies.

Yanukovych, who will meet his Russian counterpart Dmitry Medvedev and Prime Minister Vladimir Putin, is angering Russia with ambitions to move his country of 46 million into the European Union, while cutting dependence on imports of Russian gas, 80 percent of which is shipped via Ukraine to the EU.

A pricing dispute between Russia and Ukraine disrupted deliveries to at least 20 countries for two weeks amid freezing temperatures in January 2009. It also drove up next-month gas prices in the U.K., Europe’s biggest market, as much as 15 percent and prompted Slovakia’s government to consider a restart of Soviet-era nuclear reactors which it shut after joining the EU in 2004. A new dispute would come as economies in the region slow because of the effects of a sovereign-debt crisis.

“It’s shaping up as having all the potential for a conflict,” Julian Lee, senior energy analyst at Centre for Global Energy Studies, said Sept. 21 by phone from London. If supplies to the EU were cut, “it would be very damaging” to European confidence in Russia’s reliability as a gas supplier.

Russia, whose once close ties to Yanukovych have soured, insists that Ukraine must stick to a 10-year agreement signed in 2009. It has said that a supply reduction may be granted if Ukraine, which plans to import less gas from Jan. 1, drops its objections to joining a Russian-led customs union.

Cutting Costs

Ukraine is seeking to cut costs and to decrease by two- thirds purchases of the fuel in a three-year move starting from 2012. Russian state-gas monopoly OAO Gazprom says it will continue to charge Ukraine the full price for contracted deliveries.

A renewed cutoff would be the third since 2006 and may encourage the EU, which relies on Russia for a quarter of its gas needs, to accelerate plans to secure alternative gas supplies from the Caspian via the proposed Nabucco pipeline, said Lee. It would also make EU support for the Russian-led South Stream pipeline to Europe via the Black Sea less likely, he said.

“If there was any suspicion that Russia was manipulating the situation to make a conflict worse than it needed to be, then it would seriously undermine EU comfort with dependence on Russian gas,” Lee said.

‘Unfair and Enslaving’

Ukraine’s Prime Minister Mykola Azarov said Sept. 20 he “hopes” that the talks in Moscow will “start a review of the 2009 gas contract,” which his country considers “unfair and enslaving.”

The contract was signed by former Premier Yulia Tymoshenko, who’s in jail awaiting trial on charges including abuse of power by agreeing to pay too much for Russian gas. It requires Ukraine to buy no less than 33 billion cubic meters of gas each year.

The eastern European country, which relies on Russia for more than 60 percent of its gas needs, is seeking to reduce imports to 12.5 billion cubic meters by 2015 from 40 billion cubic meters this year. It also wants to cut the price from next year’s expected level of $415 per cubic meter to $230.

Increased Leverage

Russia’s leverage in the talks was bolstered earlier this month when Gazprom began pumping gas through the $10 billion subsea Nord Stream pipeline, which bypasses Ukraine by running under the Baltic Sea. The project will be able to carry enough supplies for 26 million European homes when it’s fully up and running next year and is the first direct link between western Europe and Russia.

The International Monetary Fund postponed a visit to Ukraine planned for early September to late October citing the need for stronger government policies. The Washington-based IMF’s second review of a $15.6 billion loan with Ukraine has been delayed since March since the Cabinet failed to increase domestic fees for natural gas.

Yanukovych, who replaced his Western-backed rival, Viktor Yushchenko in 2010, is asserting Ukraine’s independence from its neighbor by rejecting an offer to hand over control of Ukrainian state gas company NAK Naftogaz Ukrainy in return for a new contract.

He’s also refusing to join a customs union with Russia, Kazakhstan and Belarus, in return for subsidized gas prices, as this would jeopardize his efforts to negotiate a free-trade accord with the 27-nation EU as a first step toward membership.

‘Absolutely Unrealistic’

Putin on Sept. 16 said it was “absolutely unrealistic” for Ukraine to seek EU membership because of the monetary union’s debt crisis. It will benefit more from regional integration with Russia than from joining the bloc, Putin said at an investment forum in the Black Sea resort of Sochi.

The EU, while not willing to accept Ukrainian membership, wants to resist Russian influence in the former Soviet Union and has made it clear that Ukraine has to keep out of the Russian- led bloc, Alexander Rahr, an analyst at the Berlin-based German Council on Foreign Relations, said by phone on Sept. 21.

Yanukovych, who was a Russian-backed candidate against Yushchenko in 2004, is refusing to back down with Russia and has threatened to sue Gazprom in international court should talks over gas supplies fail.

“The legal battle is likely to be drawn out, which will poison bilateral relations between Kiev and Moscow,” said Lilit Gevorgyan, a London-based analyst at IHS Global Insight. “Ironically, Yanukovych, who prior to his election was thought to be the Kremlin’s man, faced with resurgent Russian foreign policy toward Ukraine, could be the leader who brings Ukraine closer to the EU than the previous reformist leaders.”

To contact the reporters on this story: Daryna Krasnolutska in Kiev at dkrasnolutsk@bloomberg.net; Henry Meyer in Moscow at hmeyer4@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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