Russian roulette sparks cold front

Russia’s bitter row with the Ukraine over gas prices has marred the energy giant’s reputation as a reliable supplier, and will force Europe to re-evaluate its long term security of supply situation.

Siàƒ¢n Green

European governments breathed a collective sigh of relief in early January when the dispute between Russia and Ukraine over natural gas prices came to an end. The uneasy compromise deal between Moscow and Kiev left both sides claiming victory in a long-running power struggle which culminated in Russia cutting off gas supplies to its neighbour.

At the heart of the dispute was Russia’s desire to increase the price paid by Ukraine for natural gas four-fold, bringing it closer to market rates. Ukraine, which previously paid just $50/1000 m3, refused the higher tariff, using its position as a major gas pipeline transit route to Western Europe as leverage. As Moscow reduced the flow of gas into the pipelines, Kiev accused it of punishing Ukraine for the ‘Orange Revolution’.

Russia accounts for around one-quarter of total world natual gas resources
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Details of the deal struck between the two countries remain sketchy, but it seems that Ukraine will receive a mixture of Russian and Central Asian gas. It will pay $230/1000 m3 for Gazprom’s gas – as demanded – and much less for the Central Asian gas, the net effect being an average price of $95/1000 m3.

While Moscow’s moves appear on the surface to be politically motivated, there are rational elements to its strategy, says Jayesh Parmar, partner with Ernst & Young’s Energy Advisory Service. “It is clear that gas supplies to the Ukraine [from Russia] have been priced well below market rates, and this is replicated across the Former Soviet Union,” commented Parmar. “Moscow is also negotiating gas prices with other satellite countries, and the dispute with Ukraine only escalated because it is a key transit route.”

In fact, Moscow is now locked in a similar dispute with Moldova, Bulgaria and Turkey, with supplies to Moldova reported to have been suspended by Gazprom.

While Moscow’s desire to bring prices more in line with market rates is understandable, its willingness to cut off supplies to its neighbours – the net effect being reduced supplies to other countries – came as a shock to governments and utilities across Europe. Moscow may have flexed its muscles to prove its power to Ukraine, but in doing so has shot itself in the foot.

Russia holds around one-quarter of the world’s proven natural gas reserves, and as gas becomes an increasingly important commodity, the European markets offer Russia the opportunity to secure foreign investment and promote trade. It must therefore convince these countries that it is a reliable energy supplier.

Although the dispute between Russia and Ukraine had little perceptible impact on energy prices in Western Europe, it will certainly give European governments, regulators and utilities cause to assess the security of the region’s energy supplies, as well as the role of natural gas from Russia in the energy mix.

In the European Union (EU), dependency on energy imports currently stands at around 50 per cent. This is projected to rise to 70 per cent by 2030, according to the European Commission. Russian gas currently accounts for 40 per cent of gas imports to the EU, followed by Algeria (30 per cent) and Norway (25 per cent). By 2030, over 60 per cent of EU gas imports are expected to come from Russia, with overall dependency expected to reach 80 per cent. Among the largest EU importers of Russian natural gas (by volume) are Germany, Italy and France. In Finland, Russian gas accounts for 100 per cent of gas consumption, while in Greece and Austria it accounts for 81 and 74 per cent of consumption, respectively.

The exact extent to which Europe’s dependence on Russian gas will increase is hard to determine due to factors such as the rate of decline of North Sea supplies and competition between piped gas and LNG, says Parmar. “However, the perception of Russia as a reliable supplier of natural gas has suffered a blow. Governments and regulators will now look at the mixture of gas supplies, and while they won’t diversify totally away from Russia, they will rethink the balance and will consider how best to manage the share of Russian gas.”

The event has led to calls for a more comprehensive approach to security of supply in the EU, particularly from Energy Commissioner Andris Piebalgs. “It is clear that Europe needs a clearer and more collective and cohesive policy on security of energy supply,” said Piebalgs. “To date, the issue of security of energy supply is really only considered at national Member State level; but in reality we need a much greater European-wide approach on this issue.”

Russia will have the opportunity to convince other nations that it is a reliable, long-term energy supplier through the EU-Russia Energy Dialogue as well as through the G8, the presidency of which Russia took over in January. Ironically, Russia has said that energy security will be one of the main issues of its 2006 G8 presidency.

Russia already holds an uneasy relationship with it G8 partners, largely due to a questionable human rights record, Chechnya and its strong ties with Iran. Now it has added energy supplies to this list, it will be interesting to see how it plays its cards in St Petersburg later this year. Watch this space.

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