The Irony of Fate, Or How I Learned My Brother Doesn’t Love Me

ByColin Chilcoat, MA, Energy Politics in Eurasia

The resulting and unfortunately bloody struggle is difficult to pin on any one party. On November 21, 2013, Ukrainian President Viktor Yanukovych abandoned plans to sign the Ukraine-European Union Association Agreement, which sought to create a framework for both future political and economic cooperation between the two entities. The fallout was immediate and thousands of protestors took to the streets to voice their displeasure. By February, the clashes turned violent and President Yanukovych fled the country; to date the official death toll, protestors and police combined, stands at 88 with reports pushing it over 100. The recent turmoil, like much of Ukraine’s history, is for lack of a better word, complicated. Standing between the competing ideologies of the West and of Russia, the country has struggled to develop one, overarching national identity. However, concrete, or rather steel, bonds (read gas pipelines) already link all three parties, adding another wrinkle to the already complex drama.

Russia and Ukraine’s shared history dates back to the Middle Ages and the Kievan Rus’ empire. Several centuries, a number of regime changes, and a couple of world wars have developed a strong sense of brotherhood between the nations as well as facilitated significant migration of the ethnic populations. However, the history, while shared, has not always been equal. Russia has more often than not assumed the role of big brother, taking every opportunity to flex its superior strength. Following the collapse of the Soviet Union, what equality was left, all but disappeared and the wholly European Ukraine began a slow drift away from Russia’s sphere of influence. Post-soviet Russia rebounded nicely, largely on the back of climbing oil prices, which masked some of the underlying institutional deficiencies and downward trends. However, despite firm tethers in former President Leonid Kuchma and the recently ousted Yanukovych, the Ukrainian economy has floundered without such a lifesaver.

Enter the recent EU agreement; just the first of many steps towards EU integration and by no means a certainty or even a fix-all for the country’s struggling economy. However, it did represent a path untraveled, and perhaps a solution yet untried. In spite of its debt (~$35 billion), Ukraine, with it’s vast agricultural and manufacturing capacity, is a fine prize for the EU who has already snatched up a number of former-Soviet satellites. Needless to say Russia – who openly wants Ukraine in its own economic alliance, the Customs Union of Belarus, Kazakhstan, and Russia – leaned hard on its weaker brother. Ultimately, the guarantees of Russia carried more weight than the promise of the EU. Yanukovych quickly accepted Russia’s bailout package of $15 billion, plus a 33% reduction of gas prices.

The resulting and unfortunately bloody struggle is difficult to pin on any one party. Protestors are passionately defending their right to self-determination in the capital, Kiev, but violence is ultimately present on both sides of the standoff. What we are left with is an even hazier picture of the already complicated geopolitical relationships in the region. Ousted President Yanukovych resurfaced in Russia, where he reiterated his status as President, despite an awkward reference to Ukraine as “our strategic partner;” the West was quick to accept Ukraine’s interim government notwithstanding the uncertainty that a majority of Ukraine is indeed behind the current movement; and Russia, on March 1, quickly, and without a shot, took control of the Autonomous Republic of Crimea in the Southeast of Ukraine.

The clear breach of Ukraine’s territorial integrity, while hostile, is not altogether surprising or without precedent, precisely which, depends on your worldview. In any case, the predominantly Russian population in Crimea was unlikely to ever support the Kremlin-labeled coup in Kiev. On March 6th Crimea’s parliament formally asked to join the Russian Federation. The expected approval in Moscow and the pending public referendum for Crimean citizens are formalities at this point. The geopolitical repercussions, however, are ripe for speculation. Chief among them is the situation surrounding Eurasia’s tightly knit energy network and the fragile relationships behind it.

Russia is the world’s largest exporter of natural gas, Europe their number one client. Expected to climb following the Fukushima disaster, European gas consumption has largely stagnated due to the prolonged financial crisis. We can expect this demand to remain steady as the nuclear phase-out persists and incentives for coal consumption decrease. Additionally, OECD Europe’s own natural gas production has been in decline for a number of years. A substantial increase in supplies from Russia has thus far supplemented the region’s declining production. Roughly two-thirds of Russian gas in route to Europe travels through Ukraine, a transit relationship with lots of baggage. Pricing disputes between the two countries in the winters of 2006 and 2009 led to failed deliveries and gas shortages across Europe. The stoppages raised serious doubts regarding Russia’s political objectivity as an energy supplier and Ukraine’s reliability as a transit nation.

Mired in debt, Ukraine is locked in another dispute with Russian national gas giant Gazprom, who claims $1.55 billion in unpaid debts stemming from gas purchases in 2013 and 2014. In the past, Russia’s heterogeneous, and sometimes politically motivated, gas-pricing schemes have favored Ukraine, among other post-soviet nations. However, European aspirations mean European prices and Gazprom has sought to bridge the gap in recent years. The status of Russia’s bailout package is unclear, but comments from Putin suggest they won’t see money any time soon. Gazprom has already formally cancelled the 33 percent discount on natural gas prices it was prepared to offer Ukraine as part of the package. In its stead the United States has prepared a $1 billion loan. While significant, Ukraine is still anxiously awaiting loan guarantees from the EU and International Monetary Fund.

There is no easy out for Ukraine and each foreign aid scenario cannot save the country from the tough economic measures that lie ahead. In addition, cash-strapped Gazprom can ill-afford a prolonged nonpayment situation. However, it is unlikely we will see the kind of shut down, however brief, we witnessed in 2006 and 2009. Firstly, the previous stoppages were simply too costly for all parties involved, especially Gazprom who lost out on nearly $2 billion in revenue. Furthermore, Ukraine is in no position to turn away the transit fees. Secondly, Russia and Gazprom have worked hard to diversify their transit portfolio. Completed in 2012, Gazprom’s Nord Steam pipeline cuts through the Baltic Sea on its way to Germany. It’s counterpart South Steam, while still a few years from being realized, addresses Southern Europe through the Black Sea. Upon completion, the two pipelines will effectively end Ukraine’s transit relationship with Russia. Stoppage or not, Europeans may have to settle for higher prices in the short-term as the crisis continues to unfold. Natural gas prices reacted violently to Russian intervention in Crimea, rising nearly ten percent at exchanges in the UK and Holland.

The public referendum to determine the status of Crimea is less than one week away, but the results are unlikely to provide any closure. The West and Ukraine have deemed the pending referendum illegitimate and threatened heavier sanctions, citing the heavy Russian military presence and lack of observers as obvious red flags. In any case, the interplay of Russia’s economy globally will make it difficult to hand out meaningful sanctions without repercussions on both ends. What we may see however, is an expedited attempt to make Europe less dependent on Russian gas.

Following the shale gas revolution in the United States and the significant drop in prices at Henry Hub, the US set its sights on liquefied natural gas (LNG) exports to more lucrative markets abroad. Cheniere Energy’s Sabine Pass facility in Louisiana will likely be the first to ship gas abroad in 2015, with additional plants not coming online until 2017. However, government officials along with American producers are aiming to have significant volumes crossing the Atlantic in the more immediate future. Such a move not only seeks to undermine Russian energy dominance in Europe, but also provides relief to domestic producers who have struggled to turn profits with America’s lower natural gas prices. The window of opportunity will very likely be short lived, as competing LNG terminals in Africa and the Middle East, as well as Azeri gas from the giant Shah Deniz field will all be vying for European market share.

The political crisis in Ukraine is a watershed moment for the region. However, the rhetorical conflict between the West and Russia has overshadowed the nation’s fight for greater independence. Bridging the ideological gap is a delicate balance of trade, especially in oil and gas. Russia’s overt seizure of Crimea has, understandably so, raised fears regarding Europe’s energy security. The EU and US have somewhat limited options in terms of a forceful response. However, as LNG continues to attack more exploitative pipeline-based trade relationships, a slow and steady approach may win the race. Russia appears poised to add Crimea to it’s vast federation, but the cost may be far greater than Putin anticipated.

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