Putin Loosens the Spigot but Not the Reins

Winter is coming.

Russia's agreement to restart flows of natural gas to Ukraine, halted since June, comes as enormously good news. Failure to strike a deal would have left Ukrainians to freeze and deepened a crisis that has already fractured the continent. It doesn't, however, signal any "thaw" in relations between the two ex-Soviet nations, as the European Union's energy commissioner, Guenther Oettinger, optimistically suggested. And it should prompt the EU to accelerate, not relax, efforts to improve Europe's energy security.

This has been, in one narrow sense, a simple dispute over price. A compromise figure was found, and Russia agreed after getting assurances from the European Union that Ukraine will have the money to pay its gas bill.

Regrettably, though, this has no bearing on the conflict still rumbling in the east of Ukraine, where Russian-backed separatists have been fighting government forces since April. Nor does it indicate any change in Russian President Vladimir Putin's ultimate intention to subordinate Ukraine to his control. Recent events provide strong indications to the contrary.

Russia has said it will recognize illegal parliamentary elections being held Sunday in separatist Donetsk and Lugansk -- a poll that wasn't provided for in the Minsk cease-fire agreement and represents a clear move toward secession. There's also evidence that regular Russian troops remain in Ukraine, and local rebel leaders have been promising a major assault to expand the territory they control.

More important, the Ukraine gas deal is a reminder of how vulnerable Europe remains to Russian pipeline politics. By negotiating with its European customers individually, Gazprom is able to charge widely varying prices to countries that have little or no access to alternative supplies, and at times it uses that power as a tool for Russian foreign policy.

Things may not be as bad today as they were five years ago, when Russia cut off the gas transiting Ukraine for two weeks in January, leaving swaths of Europe to shiver. Since then, more storage capacity and a series of pipeline interconnectors have been built, linking some isolated national gas grids. This week Lithuania took its first delivery of liquid natural gas, after building a terminal capable of supplying all three Baltic states, which until now got 100 percent of their gas from Russia.

But Europe is far from being able to switch to non-Russian sources of gas. Contractual and mechanical obstacles remain. And Europe's domestic production continues to decline. Indeed, 2013 was a record year for Russia's share of gas imports to Western Europe, nudging 30 percent. And this will only increase, unless Chinese demand falls drastically and U.S. exports of LNG to Europe increase enormously.

Yet in many ways, this debate misses the point. There is no reason for Europe to avoid buying Russian gas. It only needs to escape its vulnerability to monopoly pricing and supply manipulation. That means pushing ahead with the EU's so-called third energy package, a set of rules designed to separate distributors from suppliers and create competitive EU gas and electricity markets. It also means completing the pipelines, interconnectors and other projects that would create a single market for gas in Europe. Here, the obstacles are cost -- as much as $70 billion -- and political will.

The temptation is to take a less challenging route, namely building the South Stream pipeline across the Black Sea. This would eliminate Europe's vulnerability to disputes between Russia and Ukraine. But it would do nothing to reduce Europe's exposure to price gouging and political mischief from Russia. And it would cripple Ukraine's $3 billion-a-year gas-transit business.

Not surprisingly, Russia strongly favors building South Stream. The right choice for Europe should be obvious.

--Editors: Marc Champion, Mary Duenwald.

To contact the editor on this story:
David Shipley at davidshipley@bloomberg.net