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Russia-Ukraine gas row highlights EU’s dependency - analysis

  Russia’s decision to cut off gas supplies again to Ukraine underlines the urgent need for Europe to reduce its dependency on Russian supply, because the annual row over payments seems unlikely to end soon.

Russian gas export monopoly Gazprom cut off Ukraine in the middle of winter for the second time in three years on Thursday over a contract dispute. Although both sides said they would not jeopardize supplies to the rest of Europe, and Gazprom increased the flow to other European countries, the continent remains vulnerable.

The European Union receives a fifth of its gas from pipelines crossing Ukraine, and a similar dispute in 2006 caused a brief fall in deliveries to the bloc. The EU has urged a quick resolution and called for the two sides to reach a long-term agreement which ends the regular rows for good. The International Energy Agency said commercial disputes should not be allowed to affect Europe’s gas supplies, but analysts warn that payments are only part of the problem.

“They have had three years to come up with an arrangement with Ukraine and of course they could have at any time in the summer not supplied the gas. They choose January 1 to sharpen up the issue,” said Dieter Helm, professor of energy policy at the University of Oxford. “What this tells you is that politics are to the fore in Russian gas supply ... (Prime Minister Vladimir) Putin will be seeing how far the European Union will let him play his policy out regarding Ukraine ... And Europeans will be reinforced in their desire to diversify away from their increasing dependency on Russian gas.”

Analysts agree that Russia sees its position as the world’s largest gas exporter as a powerful political tool. But some blame Ukraine’s reluctance to pay for energy on time and at a price comparable to what western European buyers pay. “Ukraine simply has to pay what it has agreed to pay when the contract says it should pay. This then avoids any repercussions,” said Jonathan Stern, director of gas research at the Oxford Institute of Energy Studies. “If Ukraine refuses to act in a correct commercial manner, then we shall return to this situation every year.”

Stern warned that while Kiev has assured the EU it will not divert any of the Russian gas flowing across its territory to the rest of Europe, it is technically able to. “Ukraine has the ability, although not the contractual right to take gas destined for Europe and nobody can stop them.”

Ukraine has already begun drawing down its gas stocks to meet domestic demand for the key winter heating fuel. It says it has stored 17 billion cubic meters – 22% of its annual consumption. But if it failed to reach agreement with Moscow before those stocks ran out it could be faced with the choice of letting its own people freeze or diverting Europe-bound transit gas -- despite its promises not to.

MILD WINTER

By chance, a relatively mild start to winter and falling industrial energy use in Europe because of recession means there is plenty of gas in storage to meet demand for at least a week if the halt in Russian exports to Ukraine has the knock-on effect of reducing flows further west.

Three years after the last such dispute, European energy security still depends largely on the safe passage of gas pumped across Ukraine. The growing use of gas to make electricity, as old coal-fired and nuclear power stations are closed down, threatens to increase Europe’s reliance on gas to meet its energy needs. New projects aimed at diversifying supply routes are still a few winters away from being completed.

A few liquefied natural gas (LNG) terminals have opened over the last three years but they are a relatively expensive way of meeting growing demand for gas. New EU-backed pipeline projects aimed at bypassing Ukraine or bringing fuel from other countries have made slow progress as individual member states have defended their own interests.

The Nord Stream link, which would run under the Baltic Sea from Russia to Germany, has been opposed by Poland, Sweden and Finland and will not be ready for at least another two winters, even if objections to the project are dropped as a result of the latest supply scare.

Winter 2005-2006 was one of the coldest in decades and supplies of gas, used to heat many northern European buildings and fire power stations across the continent, were tight even before Russia turned the taps off.

This year storage levels across most of Europe, including Ukraine, are higher even than they were last winter -- one of the warmest on record -- because of falling demand. But if European energy suppliers are forced to use a lot of the gas they stored last summer to help top up supplies to overcome any fall in imports from Russia, wholesale gas prices for the rest of winter could soar, resulting in bigger household bills.

“Europe should have enough gas overall to survive a few days’ disruption, perhaps even a week or so,” said Andrew Morris, European gas director at Poyry Energy Consulting. “However, much of the gas in store is also kept in reserve for cold spells later in the winter, so there is a reluctance to use too much now, so such an event would also cause prices to spike in north-west Europe.”

Stocks across Europe were still 73-86% full on December 22, compared with just 41-78% full at the end of 2007, according to gas storage operators. Industry observers say while this should keep Europe comfortably supplied for what is likely to be a brief cut, stocks and LNG could not make up for losing 20% of Europe’s gas over an extended period. (Reuters)