Aslund on Russian-Ukrainian gas war

I’m posting this article by Anders Aslund in the ’Moscow Times’, in full, in case it goes to ’subscribers-only’

Will the Real Gazprom CEO Please Stand Up

The great Russian-Ukrainian gas war is over, and it is time to assess the outcome. On the surface, the result looks promising. Finally, Russia and Ukraine have concluded a normal long-term gas agreement. Both gas prices and transit tariffs are market-related and based on clear principles without shady intermediaries or arbitrariness. The gas prices will probably average $230 per 1,000 cubic meters in 2009, while investment bankers had expected $250.

Prime Minister Vladimir Putin claimed that Ukraine had an obligation to guarantee transit of Russia’s gas since Kiev ratified the Energy Charter Treaty (which Moscow has not ratified). Putin lamented that the "European Union is placing Russia and Ukraine in the same category," but the supplier in this transaction is also obligated to deliver. Vedomosti perhaps put it best : "Gazprom’s reliability as a supplier is inseparable from Ukraine’s as a transit state."

Corruption and Ukrainian domestic politics were major factors in a conflict in which the prime antagonists were Prime Minister Yulia Tymoshenko and Dmitry Firtash, partial owner of the shady intermediary RosUkrEnergo. Both Tymoshenko and Putin claim that RosUkrEnergo through Ukrainian President Viktor Yushchenko’s administration disrupted the gas negotiations on Dec. 31.

Tymoshenko walked away from this conflict with an outstanding victory. RosUkrEnergo has been excluded from the Russian-Ukrainian gas trade, losing profits of at least $1 billion a year. At his news conference on Jan. 8, Putin implausibly denied that he knew Firtash, although both were co-founders of RosUkrEnergo in July 2004. Subsequently, Gazprom sold RosUkrEnergo’s debt of $1.7 billion to Naftogaz, allowing Naftogaz to squeeze Firtash out.

"Finally, we eliminated a big political slush fund, which fed several political forces," Tymoshenko said. Firtash has spent lavishly on Ukrainian politics, mainly on former Prime Minister Viktor Yanukovych’s Party of the Regions but also on Yushchenko’s administration. The elimination of RosUkrEnergo will cleanse Ukrainian politics of gas money. Although Yanukovych has sensibly kept a low profile, his campaign financing will most likely dwindle in the end.

Gazprom’s cost in the gas war was very high. Its direct financial loss was about $2 billion, but its reputation has suffered even more since the gas monopoly has proven itself an unreliable supplier. Its customers will try to reduce their dependence on the state-run gas monopoly, but when Gazprom is the problem new pipelines are of little help.

Before the conflict broke out, Gazprom opened a web site that criticized Ukraine. This suggests that Moscow was gearing up for a fight. Gazprom and Putin pulled no punches in going after Kiev. "The current situation shows a high degree of criminalization of power in Ukraine," Putin said.

During the January 2006 Russia-Ukraine gas conflict, Gazprom’s stock price skyrocketed because investors were impressed when the company pushed for higher export prices at a time of rising energy prices. During the latest gas war, however, Gazprom’s stocks plummeted as investors objected when the company treating its customers recklessly by demanding unrealistically high prices at a time of sharply falling energy prices.
Meanwhile, European gas consumers suffered considerably, and the European Union looked terribly weak, having failed to learn anything from previous gas wars.
But one European politician stands out as a true leader — German Chancellor Angela Merkel. During Putin’s news conference with Merkel on Jan. 16 in Berlin, Merkel lectured him like a teacher to a schoolboy, placing the responsibility on Moscow, and Putin ate his teacher’s humble pie.

Austria, France, Hungary, Germany and Italy have quietly built up gas reserves that could last for three months ; they have learned the lesson from 2006. Now, other European countries are likely to build up large reserves and further diversify their energy supplies, although this is very expensive.

Putin has the most complex motivation in all of this. By directly commanding Gazprom and taking over the negotiations, Putin confirmed the old assumption that he is the real CEO of Gazprom. Although Ukraine had paid its gas bills by Dec. 30, Putin ordered the disruption in the gas supply, making him the main culprit.

Gazprom’s damaged reputation will likely impair its stock price and debt rating. The conflict was also a disaster for Russia’s foreign policy. President Dmitry Medvedev’s hastily arranged "gas summit" attracted no heads of state and was the largest snub to Russian diplomacy in recent memory.

Putin has been identified as one of RosUkr-Energo’s main beneficiaries, but now he has accepted the fact that this middleman will have to be eliminated from gas transactions. Moreover, he looked panicky when he lost himself in technical details, accusing Ukraine of "theft" of tiny gas volumes, far smaller than customary losses.
In the end, the gas war had to be settled by Russian and Ukrainian prime ministers. The press photos showed a strident Ukrainian prime minister, while Putin looked increasingly frustrated.

So why did Putin instigate the gas war in the first place ? My suspicion is that his main purpose was to whip up Russian patriotism against Ukraine and enhance support for the government in a time of economic decline. This was perhaps his only success. According to the state-run pollster VTsIOM, 63 percent of Russians believed that Ukraine was solely responsible for the conflict.

Another suspicion is that Putin hoped to destabilize Ukraine by exploiting its domestic divisions and its severe financial crisis. If this were his goal, he failed. Tymoshenko had little choice except to liquidate RosUkrEnergo since it was an issue of her political survival.

After Putin and Tymoshenko signed the gas peace treaty, Ukraine has eliminated a major source of corruption. Now it should reform its distorted energy sector to improve efficiency and save energy. Ukraine must stop subsidizing its imports of gas, and it should also raise the government’s purchasing price for domestically produced gas to stimulate domestic production.

And the EU should get more serious about its own energy security. Whatever Putin’s motive was, he is likely to offer more shocks as the situation grows worse for both Russia and Putin in a deepening economic crisis. The EU must realize that it needs a Russia policy no less than it requires an energy policy.

Only two winners are apparent — Tymoshenko and Merkel. There are many losers : Firtash, European gas consumers, Gazprom, its shareholders, Yushchenko and, last but not least, Putin.