Azerbaijan LNG Deal Boosts Ukraine's Energy Leverage

 This article first appeared on World Politics Review. Republished with permission. For more from worldpoliticsreview.com, sign up for free trial access.

The perennial standoff between Ukraine and Russia over natural gas prices will be accompanied by an added wrinkle this year, with news that Ukraine plans to ink a deal for a joint venture with energy-rich Azerbaijan for supplies of liquefied natural gas (LNG). The partnership, which will finally introduce unconventional energy sources to Ukraine, underscores the flagging fortunes of Russia’s pipeline monopoly and the dwindling leverage it commands.

According to Vladislav Kaskiv, the head of Ukraine’s State Agency for Investment and National Projects, the formal announcement between Baku and Kiev for the arrangement will be made later this month at the World Economic Forum gathering in Davos, Switzerland. 

“According to our expectations, a number of documents on gas supplies [to the LNG terminal currently being built in Ukraine] and the creation of the Azerbaijani-Ukrainian company on gas supplies are to be signed in Davos,” said Kaskiv. “Relevant documents have been initialed, and they are just waiting for the official start of implementation.”

Kaskiv also noted that the agreement opens the spigot for 2 billion cubic meters (bcm) of gas by as soon as 2014 and for 5 bcm in 2015, before growing to meet the LNG terminal’s expected capacity of 10 bcm annually. Presumably, the Azeri gas would be transported through the territory of Kremlin-foe Georgia by pipeline and liquefied in the planned Kulevi terminal, from which it would be shipped across the Black Sea to Ukraine.

While 10 bcm pales in comparison to the approximately 150-200 bcm of Russian gas that flows into the Ukrainian pipeline network, it nonetheless represents a sizable chunk of Ukraine’s modest domestic demand of 50-60 bcm annually. If the current plans come to fruition, it will be more than just an energy supply coup for Ukraine, which has historically fared relatively poorly in its perennial price showdowns with Russia. The LNG arrangement also heralds the rise of unconventional energy sources and the concomitant decline of pipeline power. 

In recent years, Russia has insisted that favorable gas rates for Ukraine would be conditioned on the sale to Russia of Ukraine’s outdated but expansive pipeline network -- Kiev’s only bargaining chip. Although the 2010 election of ostensibly Moscow-friendly President Viktor Yanukovich contributed to hopes -- and fears -- that future gas negotiations between the two neighbors would go differently, national interests seem to have trumped ideology.

But unlike previous winters, Ukraine is entering this year’s round of dickering with some major developments on its side. The rise of unconventional energy sources, especially LNG and shale, is giving importing nations in Europe more freedom from Russian-dominated pipelines than ever before. 

Gazprom and Russia’s traditional business model has relied almost entirely on the presumption that the large volumes of gas needed to supply much of energy-hungry Europe were best transported via extensive pipeline networks. Control over these pipelines meant leverage over Europe’s economic lifelines, contributing to charges that Moscow practiced “pipeline diplomacy.” However, shale’s newfound viability as an increasingly available energy source combined with vast supplies of LNG has, almost overnight, rendered Gazprom’s centralized delivery strategy obsolete. Instead, increasingly disaggregated -- and inexpensive -- energy sources are giving Europe its latest and best chance for relative energy independence.

“Russia now faces real competition from LNG and from shale gas, which the Europeans have access to,” said Wood MacKenzie’s Graham Freedman in a New York Times article. “[Russia] should be worried.”

As for Ukraine, the deal with Azerbaijan and the global rise of alternative energy sources seems to be fueling new self-confidence, as underscored by Kiev’s decision to cut its Russia imports by half. Besides the LNG agreement, Ukraine is expected to increase its domestic coal output by 2.4 percent this year and dramatically expand shale explorationin the country, following worldwide shale exploitation trends. Talks are also reportedly in the works about bringing in gas from Turkey, despite the lack of pre-existing transit infrastructure. 

The sheer volume of energy ferried by Gazprom, Russia’s state-owned gas company, through Ukraine and on into Europe makes true energy independence an improbable goal in the short term. However, the rather suddenly changing economics of energy -- spurred by a shale gas revolution in North America -- is rapidly altering the economic and political geography of Europe. 

The Eurasian pipeline network to Europe, entirely Russian-controlled save for a lonely route through Georgia, has functioned as an economic artery and geopolitical fault line in recent years. However, the Ukrainian-Azeri agreement is only the latest sign that Russia’s all-in program to monopolize the energy flow to Europe may be finally coming to an end. 

Of course, it remains possible that Kiev’s announcement of an announcement of a partnership with Azerbaijan could be serving as a tactical feint to extract concessions from Moscow, whose once-unassailable energy position has taken a hit recently. But even if this were the case, time is working against Russia’s pipeline-oriented approach, which needs to lock up continental supply deals quickly before shale developments yield fruit. Further complicating the picture, it must do so during a time of radical decoupling of gas and oil prices, while faced with price pressures due to a worldwide LNG supply glut.

With so much to lose, Russia is unlikely to abandon its preferential position quietly, which could mean increased geopolitical tension and hardball tactics in the short-to-medium term. But the changing nature of the energy market is working as a disruptive variable, meaning that Moscow will have to either adapt to the new conditions or face a quick decline. Whether Russia responds to this new environment with grace, innovation or aggression is likely to affect the future of Eurasian geopolitics for years to come. 

Michael Hikari Cecire is a freelance writer and independent analyst focusing on the South Caucasus and Black Sea region. He blogs at Evolutsia.Net.

Photo: Ukrainian President Viktor Yanukovych (photo by Wikimedia user Igor Kruglenko, licensed underCreative Commons ShareAlike 2.5 Agreement).