15. A RUSSIA-UKRAINE GAME OF CHICKEN

NEWS ANALYSIS: By Judy Dempsey,
International Herald Tribune, Europe, Friday, December 16, 2005

BERLIN – A year after Russia failed to get its favorite candidate elected as
president of Ukraine and instead had to settle for the pro-Western leader
Viktor Yushchenko, Moscow is at it again, this time using natural gas as a
weapon to wield influence over its neighbor and former satellite.

Both countries are playing a high-stakes game of chicken that could have
unpredictable consequences for the region and for Europe. In dispute are

the price Ukraine pays for the natural gas it imports from Russia and the
transit fees it receives from Russia for the Russian gas piped across
Ukraine and into Western Europe.

The battle pits Gazprom, the Russian state-owned energy giant where the

big decisions are made by the Russian president, Vladimir Putin, against
Naftogaz, the gas pipeline operator owned by the Ukrainian government.
Not for the first time, Putin is using Gazprom as an instrument of foreign
policy – this time tightening the noose around Ukraine by insisting that the
price of natural gas exports to the country be raised from the equivalent of
$50 per 1,000 cubic meters, or 35,300 cubic feet, to more than $220.

But unlike several other former Soviet republics that have had to swallow
such increases, Ukraine is in a strong position to fight back: It owns one
of the biggest gas transit routes to Europe. More than 80 percent of
Russia’s natural gas exports to Western Europe have to pass through

Ukraine.

If Russia increases its gas prices to Ukraine, then Kiev can push up the
transit fees it charges Gazprom, from $1.09 per 100 kilometers for 1,000
cubic meters of gas to perhaps as high as $2. (Gazprom has already said it
is willing to raise the transit fees to as much as $1.75.)

This dependence on Ukraine explains why Gazprom, with financial support

from Germany, decided to build a pipeline under the Baltic Sea that would
allow Gazprom direct access to its West European markets. But since the
North European Pipeline will not be completed until 2010, and even then
will not be able to accommodate all of Europe’s natural gas needs, Russia
will only have diminished its reliance on Ukraine, not ended it.

As Ukraine digs in its heels, Gazprom has appealed for support from

European Union countries, particularly Germany, its largest market.

Gazprom says Ukraine is threatening to cut off supplies to Western Europe,
which obtains a quarter of its natural gas from Russia. Ukraine says it is
only responding to Gazprom’s threats to stop delivering natural gas to
Ukraine – 29 billion cubic meters per year – if the two sides cannot reach a
deal.

Alexander Medvedev, deputy chairman of Gazprom, denies using such crude
tactics, or that the Russian government is using his company to blackmail
other countries. Gazprom is simply applying market rules, Medvedev said in
an interview in Berlin.

“The EU said Ukraine was a market-status economy and it wants to join the
World Trade Organization, so we are simply applying commercial criteria,”

he said. “That means paying world market prices for gas.”

Few experts in the region believe the threats from either side. They say
that if energy supplies to Europe were disrupted, the credibility of both
countries would be undermined.

Igor Burakovsky, director of the independent Institute for Economic

Research and Policy Consulting in Kiev, says the threats were nothing
more than posturing.

“It is all propaganda that Gazprom will charge Ukraine $220,” Burakovsky
said. “It will be lower. I can’t say how much, but Ukraine will have to
start paying higher prices for its energy. It is also propaganda that
Gazprom would threaten supplies to Ukraine and Europe. Its credibility as

a reliable supplier of energy to Europe would be at stake.”

Still, Putin has in the past used Gazprom as his foreign policy instrument,
albeit with mixed success. Gazprom raised natural gas prices to Poland,
forcing Poland to seek other suppliers and develop alternative sources of
energy. It raised gas prices to Georgia, which forced that country to
introduce economic reforms. And this month Gazprom announced it would

raise prices for the Baltic states and Moldova, whose government has been
tilted toward the West.

“Russia was punishing Moldova for its pro-Western stance,” said Iwona
Wisniewska, an energy expert at the Center for Eastern Studies in Warsaw.

But Ukraine is different. The former Soviet republic is richly endowed with
iron, aluminum, metals, grain and coal, and it has a substantial armaments
industry, as well as an extensive gas transportation system. Ukraine was
once the second-largest contributor to the Soviet economy, after Russia, and
Russia remains its biggest trading partner. Ethnic Russians make up more
than one-sixth of the population.

It was Ukraine’s independence in the early 1990s that dealt a deep
psychological and political blow to Russia’s prestige and status as a great
power. Russia has tried to woo back its former satellite, but Yushchenko

has committed Ukraine to joining NATO and the European Union.

The EU’s decision this month to give Ukraine market-economy status and
support its entry into the World Trade Organization was a welcome lift for
Yushchenko but a blow to Russia. It was then that the polemics between
Gazprom and Ukraine escalated.

Alexander Rahr, a Russia expert at the German Council on Foreign Relations,
said the game may be over for both sides. “These developments with the EU
showed Putin that he can give up the idea of rebuilding the Commonwealth of
Independent States in the old fashion,” Rahr said.

“Putin is now saying, You have to choose between going to the West or else
supporting the idea of a Single Economic Space under Russia,” Rahr said,
referring to a proposal made in 2003 at a summit of the Commonwealth of
Independent States, which is made up of 11 former Soviet republics. “Anyone
outside the Single Economic Space will be treated as a foreign capitalist.”
Ukraine, too, will have to accept that the old days of cheap Russian gas are
over.

Despite all the rhetoric on both sides, Ukrainian economists have said there
could be a silver lining in Russia’s plans to raise energy prices.

Burakovsky said pressure by Russia could finally speed up reforms of the
energy sector, which he said was corrupt and inefficient. Cheap energy, he
added, has given the energy-intensive manufacturing industry no reason to
modernize.

“We have been talking about raising energy prices and introducing a cash
payment system for our energy imports from Russia for many, many months,”
Burakovsky said. “Nothing was done. Maybe now, finally, the inevitability of
higher energy prices will precipitate some reforms.”

Politically, higher energy costs could play into the hands of those
pro-Russian parties competing in Ukraine’s parliamentary elections,
scheduled for March, because they could blame Yushchenko’s pro-Western
stances as the reason for Russia’s move.

In that case, Rahr said, there is a chance for the EU to play a role, by
opening up its markets to Ukrainian commodities. “If Europe goes on about
closer relations with Ukraine,” he said, “here is a chance to lift some of
the trade barriers.” -30-

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