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Putin’s energy play in Ukraine: follow the money

If there is hope that Ukraine will not collapse into chaos and civil war, it is because both Russia and Europe have too great an interest in preventing such an outcome. The Russian interest is not, as you might think, the military swagger of the Black Sea fleet. The Russian naval base at Sevastopol has become the focus of political attention as ethnic Russians seize control of the Crimean Parliament building, but the underlying Kremlin concern is more prosaic. If Russian President Vladimir Putin's language is acquiring a Cold War tinge, it is because something more vital is at stake than the battleship hulks rusting in the Black Sea. His real anxiety – and the concern of every government west of Moscow – is over the pipelines that traverse Ukraine, bringing Russian natural gas into Europe.

OAO Gazprom is Europe's biggest gas supplier, accounting for roughly a quarter of demand. Gazprom earned almost $60-billion (U.S.) last year from selling gas to European utilities. Germany is the largest market, where about one out of every three gas molecules comes from Siberia, and Russian volumes are becoming much more important, rising by a fifth last year after a slump in 2012. Last year, just over half of the Russian gas sold to Europe, some 86 billion cubic metres, was shipped via pipelines traversing Ukraine.

In the recent past, the Ukrainian pipelines have been commerically and politically contentious. On New Year's Day in 2006, Gazprom for the first time shut the taps on gas exports into the Ukrainian transit system in a dispute over bills unpaid by Ukraine. Gazprom accused Ukraine of stealing gas destined for Europe, and major utilities in Central and Western Europe experienced a sudden loss of pressure. A deal was eventually cobbled together but the row over Ukraine's gas supply continues to this day. Energy bills are the first casualty of Ukraine's ramshackle economy and Naftogaz, the Ukrainian utility, is owed $3-billion by its major customers. In turn, Naftogaz owes its Russian supplier $1.6-billion for gas delivered in 2013 but still not paid for – and the deficit is growing.

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Gazprom would love to be rid of this transit problem and it is doing something about it, having built Nordstream, a pipeline along the Baltic seabed to supply Germany and northwest Europe. Southstream, another pipeline, will traverse the Black Sea by 2015, bringing gas into southeastern Europe, avoiding the troublesome neighbour. Still, Ukraine remains an important customer, accounting for more than 10 per cent of Gazprom's exports – an income that Russia needs. Ukraine is already benefiting from a one third price discount, paying $268.50 per 1,000 cubic metres, compared with average European prices of $380 to $400.

Ukraine is virtually bankrupt, with almost $6-billion of external debt. It is not only hugely dependent on Russia for energy, but the overbearing neighbour is its major customer, accounting for a quarter of Ukrainian exports. The two countries are locked for the forseeable future in a commercial embrace, one which could become deadly for Ukrainians and disastrous for both Russia and Europe, if a political peace is not agreed between the West and East of Ukraine.

Were the internal conflict to become more violent, and if Russia felt compelled to protect its Russian language compatriots, it has more than tanks at its disposal to assert its political interest. A threat to reduce the gas pressure to Europe would certainly concentrate minds in Vienna, Berlin, Rome and points even further west. It might be enough to prompt heavy arm-twisting on the Ukrainian nationalists who are hoping for many billions of dollars in financial aid to support their democratic revolution.

Expressing his contempt, Josef Stalin once asked rhetorically, "How many divisions has the Pope?" Today, President Putin might ask, "How much gas do the Europeans need?"

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About the Author

Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K. With a career spanning investment banking, journalism and consulting for global companies, he was for many years a financial writer and columnist for The Times of London. More

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