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|  | JANUARY 3, 2006
By Stanley Reed This Gas Dispute Could Burn RussiaThe supply cutback resulting from Gazprom's pricing fracas with Ukraine does little to bolster confidence in the energy giantRussia and its gas giant Gazprom have spent decades establishing a position as suppliers of gas to Western Europe. On Jan. 1, they jeopardized that lucrative position by purposely disrupting supplies of natural gas through a pipeline transiting Ukraine. While the Russians have accused the Ukrainians of "stealing" gas destined for points further west, what's clear is that utilities across Europe saw their pressure gauges drop. How much damage has been done? In the short-term not much. Gas prices in most of Europe have barely moved because they're indexed to oil prices with a six-month lag. Even in Britain, which has a freer market, prices are still well below their November peaks. But over the longer run, the consequences could be more serious if Moscow, which has in recent years become more willing to cut off gas supplies in disputes with its neighbors, allows disruptions to happen again. Russia and Gazprom may find their reputation for reliability tarnished, and, ultimately, they could drive their customers to seek other suppliers. CUTOFF RISKS. "I think the Russians would probably recognize that they have done some damage to themselves here," says William C. Ramsay, deputy executive director of the Paris-based International Energy Agency, which monitors energy supplies and orchestrates responses to crises, such as the one caused by the U.S. hurricanes last year. "We would rather see commercial disputes resolved in a commercial way without prejudice to other people's commercial interests," Ramsay says. Of course Europe, which gets about 50% of its gas imports and a quarter of its energy supplies from Russia, has few alternatives in the short run. But as time goes on, it will develop other sources of supply from Algeria, Egypt, and Qatar. Higher risks of cutoffs of gas from Russia may well accelerate these efforts, says IEA gas analyst Daniel Simmons. But he points out that it's hard to see how Russia, with 25% of the world's gas reserves, can ever be brushed out of the energy picture. Gazprom had threatened to slash shipments to Ukraine on New Year's Day if the Ukrainians did not agree to a steep price increase from $50 per 1,000 cubic meters to around $230. When no deal was reached, that's exactly what it did. But Ukraine was far from the only country to feel the impact. All across Europe utilities in Hungary, Germany, Italy, France, Austria, and elsewhere saw their gas supplies from Russia drop. Gaz de France, the big French utility, was typical in reporting a 25% to 30% decline. Like most other companies it reported that deliveries were back to normal on Jan. 3. On Jan. 4, the two sides reached a complex, face-saving five-year agreement. Under the new arrangement, Gazprom will sell the gas at $230 per 1,000 cubic meters, the price it wanted, but Ukraine claims it will still be able to supply its customers gas at $95 because of mixing with cheaper gas from Turkmenistan. Despite the deal, Europeans are still questioning their dependence on Russia. "INSTRUMENT OF STATE POLICY." Russia has a point in wanting Ukraine to pay closer to world rates for natural gas. Indeed, global gas producers are seeking to boost prices for their product, which is cleaner and growing faster as a fuel than oil is. But the Russia-Ukraine dispute seems to be about more than just money. It's hard to avoid the appearance that the Kremlin is trying to put pressure on Ukrainian President Victor Yuschenko, who came to power in the so-called Orange Revolution of late 2004 and has been trying to steer Ukraine more toward the West. Moscow also may be trying to influence Ukraine's parliamentary elections, scheduled for later this year. But in playing rough with its neighbor, Russia risks shooting itself in the foot. President Vladimir Putin's government's increasing tendency to interfere in Russia's energy industry has already likely contributed to a slowdown in the country's oil production growth. Indeed, Gazprom's manuever gives the lie to the gas giant's ongoing campaign to portray itself as an independent, profit-driven enterprise, rather than a Kremlin pawn. "This situation demonstrates that Gazprom isn't fully a commercial company. It's also an instrument of state policy," says Stewart Gray, an analyst at energy consultants Wood Mackenzie in Edinburgh. The incident could set back Gazprom's efforts to recruit Western companies to help develop a liquefied natural gas business based on deposits beneath the Barents Sea in the Arctic. Estimated cost: $10 billion to $20 billion. Companies that may be interested in taking up to a 49% stake in the project, which could send gas all the way to the U.S., include ConocoPhillips (COP ), Chevron (CVX ), Total (TOT ) of France, and Statoil (STO ) and Norsk Hydro (NHY ) of Norway (see BW, 10/24/05, "A Russian Giant Tromps Onto The World Stage"). ARBITRATION? If playing politics with gas becomes a Kremlin habit, Gazprom's potential partners and customers may begin to rethink their approach to Russia. Gray of Wood Mackenzie thinks if Russian gas becomes more politicized, other energy sources including nuclear power, coal, and liquefied natural gas will get a boost. The Russians may have blinked, but there's no sign of a resolution to the current dispute. An adviser to the Ukrainian government says his country planned to take the battle to international arbitration in Stockholm. In the meantime, Ukraine would substitute other fuels for gas. But he conceded that the country's gas-intensive chemicals industry would be hurt by supply disruptions. Both countries -- and Europe -- would be better off swallowing their pride and settling.  Roman Olearchyk in Kiev Reed is BusinessWeek's London bureau chief
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