Gazprom Supply Threats Part of Larger Standoff

Back in August, Europeans were concerned that the brief war between Russia and Georgia would lead to cold winters in Berlin, Rome, Istanbul, and Paris. Sovereign leaders throughout the European Union are highly dependent on Russian gas exports, and the rising political tensions between Moscow and the West threatened to spill over into economic relations.

By all accounts, these concerns were legitimate. Since the 1990s, Russia's quasi-capitalist economic climate has been riddled with powerful oligarchs, corrupt middlemen, and a general proclivity for mixing business and politics. OAO Gazprom, which is Russia's largest extractor of natural gas, controls about a third of the world's gas reserves and pipes in about a quarter of Europe's supplies. To be sure, EU leaders are reminded of this market share whenever Gazprom threatens to cut gas exports. Such threats have come thick and fast over the past several years, often during price disputes with Georgia, Ukraine, Belarus, and other neighboring states.

On New Year's day in 2006, Gazprom actually followed through and shut down the Ukrainian pipeline. As much of the EU's gas comes from distribution facilities in Ukraine, major consumers faced more than two days of supply limitations. Now three years later, there are fresh concerns about gas supplies coming from Russia.

The economic backstory is familiar: for the 2009 contract, Ukraine offered to pay $235 per 1,000 cubic meters while Russia was demanding $250 per 1,000 cubic meters. Moreover, Gazprom officials claim that Ukraine has $2.1b in outstanding debt from gas imported in 2008. Ukrainian officials also want to charge Gazrpom a higher fee for transporting Russian gas into the rest of Europe.

After weeks of economic brinkmanship, Gazprom announced that its disagreements with Ukraine would not disrupt gas supplies to European markets. The news was designed to reassure both politicians and investors, but there are several complicating factors. First, the global economic slowdown has put significant pressure on commodities prices. Over the summer, the bullish futures market for oil and natural gas bouyed economies in Russia, Iran, and Venezuela, but now the bubble has burst. As a result, Gazprom (and by extension, the Kremlin) will look to wring every last penny out of gas sales.

Second, Russia's Prime Minister Vladimir Putin recently announced the formation of the Gas Exporting Countries Forum (GECF) along with Iran and Qatar. This OPEC-style cartel is designed to band together gas exporters and, in the words of Mr Putin, end "the era of cheap energy resources." Most analysts suggest that it could take some time for the group to significantly reflate energy prices, especially in the face of a depressed economic climate. Still, the GECF brings Moscow closer to Tehran, a strategic alliance that troubles many Western observers. As a consequence, future price disputes with Gazprom may bleed into negotiations with Iran.

Third, Ukraine's gas negotiations are part of a domestic political saga between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko. The two were allies in the 2004 Orange Revolution, but they have drifted steadily apart. Ms Tymoshenko has positioned herself closer to Russia, and the Gazprom price dispute has only sharpened the differences between these rivals. It is likely that the natural gas deal will be a significant campaign issue as both leaders run for the presidency in the coming year.

For its part, Europe seems prepared for a supply cut, should Gazprom reneg on its New Year's resolution. Many governments learned from the 2006 freeze and have stockpiled reserves that provide at least some stopgap measures. Nevertheless, recent political and economic developments have made for chilly relations between Russia and the West.