Behind the Russia-Ukraine Gas Conflict

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Its shares, which once valued the company at over $300 billion, making it the world's third largest, have fallen 76% since the financial crisis hit in September.

Eager to distract an increasingly worried population from the problems at home, Russia has filled the airwaves of state-run television with anti-Ukrainian propaganda. Yearend programs wrapping up 2008 gave equal coverage to political discontent in Ukraine as to the war with Georgia. One program ran a 10-minute profile of a Ukrainian man who spent the last year building life-sized dolls of Yushchenko and Tymoshenko and placing them in coffins. For its part, Gazprom has appeared eager to capitalize on Ukraine's political instability to get a better deal.

This year's row began in December, when Gazprom accused Naftogaz of failing to pay a $2 billion debt for gas delivered in 2008, precluding the start of negotiations on a contract for gas delivery in 2009. Naftogaz disputed the debt, finally caving in on Dec. 30 and taking loans from state banks to cover the payment. On New Year's Eve, Gazprom acknowledged that Naftogaz had transferred the payment to RosUkrEnergo, a middleman gas trader it half owns, but the funds had yet to appear on the company's accounts in Moscow. Further, Gazprom charged that Ukraine still owes $600 million in fines. Gazprom has also accused Naftogaz of threatening to siphon gas meant for Europe if the dispute wasn't resolved.

Europe Better Prepared This Time

Naftogaz has publicly denied Gazprom's allegations. But in January 2006, the company did tap pipelines destined for Europe to cover its own shortfalls in the midst of a harsh winter. Supplies dipped across Europe, sparking a loud outcry that pushed Kiev and Moscow to solve the dispute quickly.

This time around, Europe is better prepared. The economic downturn means less demand for gas, and most countries have built up storage capacity and reserves to last through a short disruption. If the dispute drags on for weeks, however, those supplies will run out. Britain, for example, has storage to weather a complete cut in supplies for 10 to 12 days. France and Germany could last as long as two months.

On Jan. 3, Gazprom said it had boosted supplies to Europe through three alternate pipelines that bypass Ukraine. But countries in Central and Eastern Europe are already feeling the crunch. By Jan. 5, Bulgaria, Croatia, the Czech Republic, Greece, Hungary, Poland, Romania, and Turkey already had registered dips in supply. "If the Russian side does not provide more gas [to EU member states] than at the moment, then in around 10 days there could be very serious technical problems," Yushchenko's energy adviser Bogdan Sokolovsky warned at a briefing in Kiev on Jan. 3. While Ukraine argues that it has slightly reduced the flow of gas to maintain pressure in its network. Russia says that its neighbor is stealing gas meant for paying customers in Europe and says it plans to take Naftogaz to international arbitration court in Stockholm.

On Jan. 5, Putin ordered Gazprom to cut supplies through Ukraine by 20%—withholding the 65.3 million cubic meters that Russia alleges Ukraine has illegally siphoned off. Gazprom said it would further increase shipments through alternate pipelines in Belarus, Poland, and Turkey, but they are far smaller than the ones crossing Ukraine.

Plans to Bypass Ukraine

The Czech Republic, which took over the rotating EU presidency on Jan. 1 and has its own tense relationship with Russia, called an extraordinary session of EU envoys on Jan. 5 to address the crisis. But few analysts expect the dispute to be resolved quickly. No talks between Gazprom and Naftogaz are scheduled. And Gazprom has increased the price it wants Ukraine to pay from $250 per thousand cubic meter to $450, compared to the $179.50 it paid in 2008. Ukraine says it can pay as much as $235, but only if Russia agrees to pay more in transit fees for sending gas to Europe. Gazprom argues that Ukraine's leadership has failed to forge a unified position so that it can approach the negotiating table with one voice.

Eventually, Gazprom hopes to solve its annual problem with Ukraine by shipping gas directly to Europe. The company has grand plans to build pipelines that would send gas straight to Germany and through the Balkans to Western Europe. But the economic downturn has cast doubt on these projects. That means Europe will be getting much of its gas via Ukraine for years to come—once full shipments resume.