The Role Of The Natural Gas Industry In The Ukraine Crisis

The ongoing political crisis in Ukraine has already claimed over 100 lives and injured more than 1,075. Protests erupted when Ukrainian President Viktor Yanukovich rejected a proposed trade deal with the EU that would have partially opened borders to a freer exchange of goods between Ukraine and the EU. Instead, he turned to Russia, which received him with open arms in hopes that Ukraine would instead join a Russian-led customs union favoring Russian products and preventing EU influence in the region.

Many Ukrainian citizens felt betrayed, especially in the western regions where pro-EU sentiment is much stronger. Russia promised to lower the price of natural gas flowing into Ukraine and to graciously forgive $15 billion in government debt owed to Russia that the country had accrued over the past decade. Much of that debt was in unpaid charges for natural gas delivered by state-owned Russian gas major Gazprom (Mkt Cap of approx. $100 billion). In exchange, Yanukovich was to tow Moscow’s line and reject any future overtures from the EU.

Russia is an energy giant, supplying almost 40% of Europe’s annual consumption of natural gas, a fuel that is essential for winter heating in many European households. Because of Ukraine’s utter dependence on Russian gas pipelines, the current upheavals were not the first time that Russia used its large market share in the business to force political decisions.

Back in 2009, for example, Russia promptly shut off the natural gas supply to Ukraine in the dead of winter, leaving thousands of people shivering for over two weeks. The reason was a dispute over gas prices and debt owed by the Ukrainian firm Naftogaz to Gazprom. Since both firms are wholly state-owned enterprises, each country’s finances are essentially also those of the companies. This integration of business and politics is nothing new for the inheritors of the Soviet system in which all directives regarding economic decisions came from Communist party bigwigs. Indeed, the stubborn endurance of the Soviet legacy is apparent in many aspects of business in former Soviet republics and Russia itself.

Even the charismatic newly freed opposition leader, Yulia Tymoshenko, made her fortune in the natural gas business, helping to supply natural gas to Ukrainian heavy industries after the collapse of the Soviet Union. She made millions running United Energy Systems of Ukraine, eventually propelling her into national politics in 1996. While some see her as one of the corrupt oligarchs that took unfair advantage of ordinary people’s fortunes during the economic turmoil of the 1990s, others still believe she can steer the country onto a better path.

She has even earned the nickname of “Gas Princess” for her rapid rise to wealth and political influence. Because of her frail health she is currently not participating in the interim government and since her reputation is rather mixed, she hardly presents a unifying candidate for a stronger Ukraine in the future.

Now that Ukraine has installed a new interim government, it must decide how to reconcile its decidedly pro-EU stance with the country’s dependency on Russian gas deliveries. The dire situation of Ukraine’s finances will only exacerbate the challenges it faces with respect to ensuring a steady supply of energy for its economy. Financially, Ukraine is nearing bankruptcy, as the IMF estimates that close to $50 billion in aid will be needed to prevent a total default.

Will Russia still be willing to supply gas to a country that cannot pay indefinitely? Probably not, unless Ukraine agrees to bow to Putin’s will and place itself firmly in Moscow’s orbit. Russia will not hesitate to use its gas monopoly as a political weapon to keep the Ukraine in line if it continues to act up.

Putin already used his leverage with gas prices to demand extensions on the lease of the small territory in the Crimean Peninsula that harbors the Russian Navy’s strategically important Black Sea fleet. The only part of Ukraine with a majority of Russian speakers, Crimea is a volatile region, considering recent clashes between Russian flag-waving protesters opposing the new pro-western mood in Kiev and its Ukrainian nationalist supporters.

Many Crimeans have bad memories of Kremlin bullying, as Stalin expelled thousands in 1944 to Siberia for allegedly collaborating with Nazi occupiers during WWII. The Black Sea fleet is also essential for protecting Gazprom’s ‘South Stream’, a major natural gas pipeline currently under construction that traverses the middle of the Black Sea.

The pipeline, along with its sister project ‘North Stream’ through the Baltic, were both conceived to prevent any supply disruptions to Western European gas customers caused by Ukrainian disputes. With both pipelines in place, Ukraine will lose the one card it could have played acting as an essential transit point for Russian gas headed west.

The bypassing of Ukrainian territory for Russian natural gas deliveries to the EU strengthens Putin’s position and gives him the upper hand, allowing him to push Kiev around whenever it strikes his fancy. As shown by recent army exercises near the Ukrainian border, the Kremlin is never afraid to flex its military muscles to make sure the Ukrainian leadership remembers exactly who keeps the parliament halls from freezing.

If Kiev chooses a path that Moscow deems too radical, Russia has the power to instantaneously turn off the gas faucet, wreaking havoc on the Ukrainian economy and angering its people. Although controversial shale gas fracking presents a future possibility of some degree of energy autarky for Ukraine, the country’s current political turmoil is unlikely to retain much of the considerable investments needed to develop the extraction infrastructure on a scale that would satisfy the demand of the whole country.

Chevron and Shell may soon reconsider their plans for a $10 billion drilling project announced last November to develop the Olesska shale near the western Ukrainian city of Lviv. Plans for a new pipeline running from the West through Slovakia are also unlikely to change the current situation, since even countries like Germany import most of their natural gas from Russia. Besides the well-documented environmental risks of the industry, even full-scale shale gas development will not end Ukraine’s dependency on Gazprom’s imports and the restrictive political conditions that come along with it.

In a region fraught with a complicated history, natural gas and politics are intertwined so tightly that the future of Ukraine will be decided in no small part by the source of its natural gas.

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