We now know the price for the West's continuing political influence in Ukraine: $2-billion (U.S.). The Russian president has made that clear in a letter to Europe's leaders: Russia will stop supplying Ukraine with gas if the country fails to settle its unpaid fuel bill, outstanding since August last year. There are Russian tanks parked on the Ukrainian border playing an elaborate diplomatic game of "chicken," but those are probably a distraction. Though there could well be a Russian incursion into Ukraine, the weapon is more likely to be a bailiff's writ, demanding the seizure of thousands of miles of steel pipe in lieu of payment for gas.
Two trunk lines, Soyuz and Brotherhood, bring Siberian and Central Asian gas into Ukraine from the East, which then transit the country and link to a single export pipeline into Slovakia and Western Europe. In his letter, President Vladimir Putin says he wants a seat at the table in any discussion about Ukraine's economic future. Gazprom is an unpaid creditor which, he says "in the event of further violation of the conditions of payment, will completely or partially cease gas deliveries." For the avoidance of any doubt, the Russian leader reminds his European colleagues of where the last standoff ended in 2006, when Russia cut off Ukraine in the middle of winter for several weeks. He writes: "Undoubtedly, this is an extreme measure. We fully realize that this increases the risk of siphoning off natural gas passing through Ukraine's territory and heading to European consumers." The Ukraine transit pipes account for about half of Russia's exports into Europe and countries, such as Bulgaria, Hungary, Slovakia and Serbia are hugely dependant.
The circumstances are different than they were eight years ago when the supply interruption to Ukraine led to sudden falls in gas pressure in Italy, Slovakia, Hungary and Austria. Ukraine is today much more vulnerable, owing to the much larger deterioration in its public finances. But Europe is less so, in part because the winter is over, but also because Gazprom is weaker. Demand in Europe for its fuel is reduced due to the expanded trade in liquefied natural gas, and the gas price is lower. The Russian utility has lost billions of dollars in revenue, and has been forced to renegotiate contracts to include an element of spot gas pricing, eroding the certainty of its old oil-indexed price regimes. Meanwhile, the European Commission is threatening Gazprom with anti-trust proceedings, accusing the company of abusing its dominant position in some EU countries. The EC is also demanding that Gazprom comply with EU regulation and allow third-party access to its European pipeline network.
President Putin is not keen on the uncertainty of free markets and Gazprom is too big and unwieldly an enterprise to thrive in such an environment. Over the years of diplomatic posturing about the Ukraine, Gazprom's executives have wrestled with a big conundrum: How do they get access to more of Europe's energy markets while preserving price stability? For Gazprom, swallowing the bitter pill of competitive market access is made more difficult when the physical infrastructure is vulnerable and under foreign control, as it is in Ukraine. The solution, Gazprom's executives reckon, is ownership and control of the Ukraine transit pipelines – but how can that be achieved?
If you believe Gazprom's sums, the Ukraine has been propped up with $35-billion of discounted gas, "free" gas and unpaid penalties over the last four years, perhaps enough to pay for control of the pipes. In his letter, the Russian president calls for a meeting of finance ministers to sort out Ukraine's economic difficulties and the gas bill. Such a meeting must include Russia, he says. We can expect they will demand that the "bill" be top of the agenda and the threat of supply cuts. But, again, don't be fooled. Gazprom doesn't want to acquire the reputation of an unreliable supplier; the Russian utility wants a solution.
President Putin probably doesn't want to slaughter nationalist Ukrainians – his target is the pan-European nationalists in Brussels. The threat that Europe's leaders face is probably not tanks moving West but a never-ending drain of cash to the east, a euro-lifeline that will prop up the regime in Kiev. The cash underwriting of Ukraine's energy bill will profit Gazprom hugely until such time as Europe's leaders lose patience and demand that Ukraine's leaders lease the transit pipelines to Gazprom in return for an allowance of free fuel. It's the unspoken deal that lies just under the table. Slowly but surely, President Putin will gain the controlling levers that he seeks, allowing him to restore some of Gazprom's influence in European energy markets.