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    The Effects of the Ukrainian Crisis on Europe's Energy Security



EU seeks liberalization in the European gas market to weaken the advantages of Gazprom's monopoly position.


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The Effects of the Ukrainian Crisis on Europe's Energy Security

With the elections of May 2014, with part of its lands annexed, economic problems, and security issues resulting from rebellions in the eastern provinces, the country of Ukraine has elected Petro Poroshenko as its president. Considering that heavy industry in Ukraine is located in its eastern provinces, security and economic issues are interlaced. In this regard, the armed struggle taking place around the towns in the east of the country is occurring on delicate ground in terms of territorial integrity and economic considerations.

Economic issues are not limited to the non-functionality of the economic institutions. Since the New Year, there has been a serious problem arising from disagreement over prices in the Russian-dominated energy sector, and this problem transformed into a crisis by June.

Subsequent to the political crisis, Russia has increased the price per thousand cubic meters of gas from $268.5 to $485. The change of government in Ukraine and its failure to pay Russia for gas influenced this hike in prices. Russia applied the new prices and billed the Ukrainian government $4.5 billion for gas. The Kiev administration, faced with the sudden increase in cost, has found this price unacceptable and has refused to pay. This circumstance risks a new crisis evocative of the 2006 and 2009 crises. While Gazprom ceased gas transport to Ukraine starting on 16 June, the company also declared that gas transport would continue thereafter dependent on payment in advance.

The main concern of experts in the last few months has been the possibility of the situation deteriorating. The Ukrainian government and Gazprom worked for an extensive amount of time on an agreed price for gas, along with help from the EU. Ukraine indicated that a price of $326 per thousand cubic meters was acceptable; Gazprom reduced its original price to $385. During these negotiations, Ukraine made a payment of $786 million to Gazprom.

Nonetheless, the Ukrainian government did not accept a temporary agreement because the discount of $100 per thousand cubic meters was contingent on Ukraine changing its customs rates. Therefore, the current arrangement is not permanent and the discount must be institutionalized by an official agreement. This process did not result in a solution and the subject was brought before the International Court of Arbitration in Stockholm. Gazprom is prosecuting Ukraine for the amount of $4.5 billion while Ukraine claims that due to Gazprom's monopoly it overpaid $6 billion resultant of price increases and is further demanding that Gazprom provide compensation therefore.

But the issue goes beyond the disagreement concerning payment. Russia reduced its gas prices for Ukraine in December 2013, only to raise the price again shortly afterward. Russia claims that this increase was only according to economic principles, but actors in Europe refute this claim. These European actors consider Russia to be using energy as a political instrument. The EU is considering these emerging risks from a security perspective, and expediently published a new energy strategy in May. Another concern of Europe is that the current disagreement over gas prices will continue into the winter.

New energy strategy of Europe

In the strategy paper prepared by the EU Commission for the European Council, while possible gas interruptions in the winters of 2014 and 2015 were also discussed, some suggestions were made for managing interruptions in gas supply such as revision of storage capacities, reductions in the demand for gas, and use of reverse technology in gas pipelines. At the same time, the question of how consumption patterns should be changed in the medium-term was also discussed in the paper.

In this regard, renewable energy technologies become prominent, and the necessity of different energy sources for the healthy management of demand for gas is emphasized. At the same time, gas imports in the form of liquefied natural gas (LNG) are also being granted importance, and new explorations in North America, Qatar, Australia, and East Africa are expected to be prioritized in the European market.

In addition, an LNG plant with a capacity of 24 billion m3 being built in the eastern US, and to become operational between 2015 and 2017, has led to an expectation of gas trade between the US and EU. Moreover, the dialogue between the US and the EU about energy security in the context of the G7 seems stronger.

In this context, in the declaration dated May 6 that was published subsequent to the meeting of the G7 countries’ energy ministers in Rome, it is indicated that energy shall not be used as a kind of political pressure or instrument to threaten security, and that the diversification of natural gas sources and that the diversification of natural gas sources should be pursued in two main ways. The first corresponds to taking the necessary steps to improve the LNG market in the upcoming period, and the second refers to developing new routes of gas delivery to Europe via the Southern Gas Corridor.

Correspondingly, in the declaration published subsequent to the summit of leaders in Brussels, the central location of energy security on the collective agenda was emphasized, and the diversification of energy resources and necessity of modernizing current infrastructure was mentioned. The points stressed in the declaration can be considered a sign that these subjects are becoming more important in the political sphere.

Reaction of Russia

Russia is disturbed by the developments toward liberalization in the European market. In particular, strengthening dynamics of competition in the market, and eliminated barriers to gas trade among the European countries weaken the advantages of Gazprom's monopoly position. Correspondingly, the average price paid for Russian gas in the European market has declined from $400-410 to $350-360 in 2012. This adversely affects Gazprom’s profits.

Intending to operate in Europe despite all these changes, Russia faced another problem after the Ukrainian crisis, namely, the EU's changing attitude toward the South Stream gas pipeline project. The EU decided to suspend the project while Russia tried to continue its activities through Bulgaria and Serbia. It then faced a new issue when Bulgaria decided to cooperate with the EU on the matter. Gazprom, determined to pursue its activities in Serbia, announced in June that it will finish construction in the country by 2015, adhering to the old timetable. After this, it once again demonstrated its determination to continue its project, despite the EU, via the agreement signed with the Austrian company OMV on July 24.

On a different note, Russia states that it has an alternative market in Asia. In May, Russia responded to the EU's policy of discourse without action with the critical and concrete move of inking a $400 billion energy agreement with China. Amid doubt about the future success of the EU's complex strategic goals, Russia solidified its long-term relationship with China.

Considering all these developments, it can be said that both Russia and the EU are searching for important openings for 2015. However, while the gaps in the EU decision-making mechanisms (due to its composition of 28 member states) cause some disruptions in the process of implementation, Russia's vertical government structure seems to exhibit significant advantages when it comes to decision-making. Russia’s weakness is that it could not foresee the transformations in its energy-dependent economy. In this respect, it seems difficult to predict which side will be a in a better position after 2015.

Hasan Selim Ozertem

Source: The Journal of Turkish Weekly   This article was firstly published in Analist Monthly Journal's July Issue.