In the midst of world economic crisis, falling prices for oil, historical elections in the United States and another turmoil in the Middle East Russia and Ukraine went into another gas dispute rising concerns in many capitals around the globe. For those well familiar with Russian literature it is well known that there are two eternal Russian questions asked but not answered by the Russian intellectuals of the last century. Those two questions are: “Who is guilty?” and “What to do?” Well, being a Ukrainian it is not an easy task even to try to answer those questions. But in recent weeks so much attention in Turkish and international media were given to the issue of Russian-Ukrainian gas relations that it is almost impossible to stay idle. European Commission and European customers look boring again by this never-ending story. And yet it is widely recognized that this year’s sequel went far beyond its predecessors and rises questions about ability of Russia and Ukraine and the EU to work it out once and forever. Why EU is here? Because the gas equation is complete and provides a comprehensive solution if only we have producing, transit and consuming partners working in concert.

Before we embark for answering two eternal Russian questions let us clarify a couple of points. First, Gazprom accused Ukraine of non-paying for delivered gas. No question that bought commodity must be paid. But at this point one has to take into account a simple and yet very important fact that Gazprom and Naftogas of Ukraine has no direct relations in gas trade. There is at least one intermediate company between us who deliver gas to consumers in Ukraine. This company called RosUkrEnergo and it was put in between Ukraine and Russia by Gazprom’s demand in the middle of winter of 2005/2006 for no apparent reasons. At the same time by a valid intergovernmental agreement of 2001 each year in June Ukraine and Russia must negotiate and sign a bilateral protocol defining volumes of gas to be delivered for the Ukrainian customers, its price, the amount of gas for the European consumers and transit tariffs for the next year. But that did not happen at least since 2006 in spite of all efforts of the Ukrainian side. So, now we have contractual relations with and must pay to a middleman, RosUkrEnergo, and not to Gazprom and then it is a responsibility of this middleman to settle its score with Gazprom. Therefore any accusations from Gazprom attributed to Ukraine have to be attributed to RosUkrEnergo in first place. And owners of this company are well-known to Gazprom, since Gazprom owns 50% of its shares.

Second, Russia’s state-owned gas giant Gazprom is preparing for a major financial hit in 2009. The world-wide economic slowdown has diminished gas consumption for Gazprom’s European industrial customers. The price of gas, which is indexed to the price of oil, has been dropping from the current high of $460 to $500 for 1,000 cubic meters and, according to Gazprom spokesman Sergey Kuprianov, is predicted to be about $280 by mid-2009. If these predictions come true, Gazprom’s profit will drop by $20 billion in 2009. As well, in December Gazprom indicated that its natural gas production in 2008 could prove to be 3% lower than previously expected, owing to reduced consumption caused by an unusually warm weather. Then, company which last May prided itself on being the world’s third-largest company in terms of market capitalization and aimed at becoming the world’s number one company, the current place # 35 looks gloomy and disappointing. More than that, now Gazprom is on the short list of “strategic” companies seeking Russian governmental assistance. This is the only energy giant in the world asking its own Government for a bail out. Oh, no, Lukoil and Rosneft are there as well.

Low gas prices will also delay Gazprom’s investment policy and the development of desperately needed new gas fields. The state-owned gas monopoly has already requested that the government suspend tax levies on importing equipment vitally needed for the development of the Shtokman gas field project and the East Siberian fields. If this request is vetoed, these major projects might be forced to suspend their activities for some time. The crisis might also delay the North Stream and the projected South Stream pipelines, both of which are highly expensive and would serve Russian political rather than commercial needs.

A drop in the price of gas by 30 to 40 percent will reverberate throughout the battered Russian economy which already is seeing a steady devaluation of the ruble and a major slowdown in economic growth. In November Russian industrial output shrank 10.8 percent on the month and payments arrears are rapidly growing.

Gazprom’s export sales pay for the company’s contribution to the Russian budget which in 2008 amounted to about 20 percent of the budget. In addition to the looming budget shortfall, the lower gas price might force Russia’s government to consider a further price increase for domestic consumers in order to compensate for export revenue losses. The current projection is that Russian consumers in 2009 will pay an additional $10 for 1,000 cubic meters of gas. The current price is 1,422 rubles or $47.40 and these prices are only about 15 to 20 percent of what Germany and other European countries pay for Russian gas.

Third, what we were talking about recently, are volumes of gas delivered to Ukraine last fall and put into underground storages. Because of warm weather and economic crisis those volumes of gas were not consumed as it had been envisioned. But the gas is a unique commodity – you cannot stop deliveries of it, since it is impossible just to put it on the rack neither by producer nor by consumer. As well, this commodity cannot be returned to the shop and yet Naftogas of Ukraine cannot re-export it because of the existing restrictions of the contract signed in 2006. Those volumes of gas constitute a small fraction of what Gasprom produces and delivers to its consumers and definitely nobody was affected when the delivered gas had been put into storages. Probably that was a commercial miscalculation on the Naftogas side, who was asked to pay for gas instead of its consumers. No doubt the gas will be consumed in January-February and debt will be paid to RosUkrEnergo and then to Gazprom, but for the above-mentioned reasons Gazprom insists on immediate payments in the middle of the strongest ever financial crisis which is very hard on Ukraine. It is hard on Russia too – Russian Government lost 250 billion of USD from 750 billion stockpiled during recent years of high oil prices, but nevertheless this is not a good way to conduct business. If creditor wants to receive credit back he would not bankrupt his client. And this is exactly what we were trying to negotiate before the New Year. We did not succeed and paid to Gazprom in full. The gratitude went beyond the ceiling: Gazprom switched off gas for Ukraine. So, for some time the Ukrainian customers will be consuming gas from storages and not from the current deliveries. Nobody is going to use gas from the pipe transiting the territory of Ukraine to Europe, including Turkey. Therefore there is no reason to accuse Ukraine for the wrongdoings that did not happened. The only reason of doing this is politically motivated practice when energy resources are being consistently used as a foreign policy weapon. And such a practice is not a policy of Ukraine.

During the past few years, the European Commission attempted to develop a common EU energy policy. This policy in its present form includes a set of background vision documents and practical measures designed to guarantee a stable and secure supply of energy resources to the European Economic Area. There is a wide spread understanding that a wake-up call for Europe was mastered during the winter of 2005/2006 when gas supplies were interrupted because of the so-called first Russia-Ukraine “gas dispute”. During that winter it was – 27C in Kyiv. There could not have been a better time from the Gazprom’s perspective for a “dispute”.

It now seems appropriate to examine where we are now. Since we are in mid-winter again, another “gas dispute” is taking place. Ukraine is not a part of the EU, but definitely a part of Europe, and as such, constitutes an important member of the energy equation involving the EU and Russia. Moreover, Ukraine cannot fight alone against one attempt after another to use energy as a political leverage. Therefore whether the EU has a strong energy policy is not an idle issue for Ukraine. This is especially important in view of aggressive expansion of Gasprom in many European states. This has prevented not only a common EU stand, but any effort to diversify energy supplies to Europe.

In Europe politicians love this word – diversification. It brings the feeling of security. The country which is lucky enough to have a diversified energy mix feels secure compare to one dependent on a monopoly. From a diversification point of view, there are different groupings of countries: those who import modest amounts of Russian gas, such as Great Britain, Netherlands, Portugal; several more heavily dependent countries, including Italy, France, Germany, Romania and a large group who depend almost entirely on Russia, such as Turkey, Latvia, Lithuania, Estonia, Bulgaria, Austria, Finland, Greece and Slovakia. Public discussion is primarily about natural gas. There is no worldwide market for this commodity. Each country has its own price arrangement with its gas suppliers. For example:

In Lithuania there are five companies negotiating separate deals on gas supplies from Gazprom for a total consumption of less than 4 bcm. The average price in 2007 was $200 per 1,000 cubic meters.

In Germany there are two importers of Russian gas (35% of total gas consumption) and the price during 2007 was about $300 per 1,000 cubic meters. Germany has a price formula that takes into account an oil equivalent price and seasonal differences.

In Slovakia the 2007 price was fixed at $250 per 1,000 cubic meters and there is only one national supplier, while in Hungary there are two suppliers, who deliver about 8.6 bcm of Russian gas but the price is $300 per 1,000 cubic meters.

In most cases, it is hard to find a reasonable explanation as to how the price is being determined. Therefore, it is almost impossible to understand why Europeans so easily accept Russian proposals for the construction of new gas pipelines that are not economically feasible, but are proposed for political advantage. It is worth explanation why.

Ukraine can annually transit about 178 bcm of natural gas, although in 2007 only about 118 bcm was shipped. Yet we are continuously told that Europe needs more. But instead of using this existing spare capacity in Ukraine, Gazprom decided to construct several new pipeline, including North Stream, South Stream, Blue Stream I, Blue Stream II. All, or most of these pipelines, are designed to avoid Ukraine. Surprisingly, their construction is supported by several EU member states. If one assumes that Gazprom succeeds, Germany will pay for additional volumes of Russian gas through the immensely expensive (and world’s longest) North Stream. Serbia, Bulgaria, Austria and Hungary would be consuming gas from Novorossiysk, delivered through South Stream (the world’s deepest and the most dangerous environmentally). Thus Europe would increase its dependence on Russian gas from 25 to 35%. Does that mean that Europe would feel more secure? Of course not! It is not transit countries like Ukraine who generates shortages. It is Gazprom with the power of the Kremlin guiding its way. Unless Gazprom becomes a private, open and transparent company oriented toward following market policies, nobody is safe from its political influence. Ukraine as well as other transit states has nothing to do with European energy insecurity.

The usual argument in this respect refers to the need of “diversification of the transit routes”. It is a very tricky argument, indeed: first of all Europe needs diversification of hydrocarbons suppliers, while different transit routes from the monopolist supplier would contribute much less to energy security. There has never been a single case when the energy flow from Russia to Europe was disrupted because of a disruption by the transit country. In the past two years alone, several supply disruptions were caused by Gazprom.

The only genuinely European project that would bring diversity to the European market is the Nabucco pipeline project. It was initially intended to bring Central Asian, Caspian Basin and even Middle Eastern gas through Turkey to Europe. Recently this project got a new start when Germany’s Rheinisch-Westfaelische Elektrizitaetswerk (RWE) joined the Nabucco Consortium of five founding companies -- Austria’s OMV as project leader, Hungary’s MOL, Romania’s Transgaz, Bulgaria’s Bulgargaz, and Turkey’s Botas. RWE is Germany’s largest energy company overall and second-largest gas distributor. Each partner would own a one-sixth stake (16.67%) in the pipeline as it moves Caspian gas through Turkey to Austria. This January all participating countries will meet in Budapest to discuss how to move forward. Those are good news. But there is bad news as well. Last year the OMV signed a very tricky agreement to turn Nabucco’s planned European terminal and main storage and gas distribution centre Baumgarten near Vienna into a joint venture with Gazprom. The Austrian government and OMV -- including the general manager of Nabucco -- proposed allocating part of the Nabucco pipeline’s capacity to Gazprom for its gas, which would negate the EU and U.S. strategic rationales for supporting the Nabucco project. Also, Bulgaria signed an agreement with Russia to build the South Stream pipeline through Bulgaria en route to Central Europe. Hungary expressed hopes for Gazprom’s South Stream line to reach Hungary. Paradoxically, since the main goal of the South Stream line is to stop the construction of Nabucco.

Those Russia’s offers are misleading. Gazprom cannot in fact provide the declared gas volumes for all of its existing and planned pipelines to Europe: North Stream, Yamal, the Ukrainian system, Blue Stream, and now South Stream with its variously offered extensions. In the short-to-medium term, Russia is likely to fall short of meeting its rising internal gas requirements and multiple gas export commitments at the same time. And here we come to a very important issue about availability of the resources.

In 2007, Europe reduced its gas consumption significantly, particularly Slovakia, France, Germany, and Italy. This was a reversal of a 50-year trend of increasing consumption. This will continue, taking into account the ambitious goal set by the Union to reduce total energy consumption by 20% by 2020. It is not certain that Europe needs the large volumes of gas that the proposed pipelines from Russia would bring.

Russia itself is in very difficult situation. With its gas output almost stagnant, internal consumption rising, a crunch is anticipated by 2011-2012. Thereafter, Gazprom is unlikely to be able to supply the current and planned routs simultaneously, certainly not at anywhere near full capacity.

At this point everyone is looking at Turkmenistan. In 2006 Turkmenistan produced 62 bcm of natural gas, second only to Russia. With domestic consumption estimated at around 17 bcm, approximately 45 bcm, or more than two-thirds of Turkmen production, was available for export. Being short of Russian gas, Gazprom reached an agreement with Turkmenistan to buy all gas available for export until 2029. Price is not an issue, since the Europeans will be the ones who pay for the Turkmen gas.

But if the Turkmenistan-China pipeline comes online in 2009, as it is planned, then its 30 bcm commitments must be added to Turkmenistan’s contracts with Gazprom amounting to 50 bcm. Therefore, Turkmenistan’s export requirements to these two countries alone will reach an astounding 80 bcm per annum versus Turkmenistan’s current output of slightly over 60 bcm, producing a deficit of nearly 20 bcm. Add in domestic consumption of 17 bcm and annual exports to Iran of approximately 7.6 bcm, and Turkmenistan in the next two years must ramp up production by 44.6 bcm, or 71% over its current rate of production, in order to satisfy both its domestic consumers and export contracts. Turkmenistan’s leader has already taken steps to uncover additional natural gas reserves including ordering of an audit of all hydrocarbon deposits in 2008, so availability of resources is yet to be confirmed in spite the audit brought very promising results already.

Europeans should hope that Turkmenistan discovers more gas deposits. Its participation in the Trans-Caspian pipeline is vital for Nabucco, which needs more gas available, since even full capacity operation of the Shah Deniz field in Azerbaijan is not enough to fill the pipeline. However, Turkmenistan recently agreed with Russia to build an additional By-Caspian pipeline, in order to increase volume of gas which would be exported to Europe through Russia. Both the EU and the U.S. and very recently Turkey are trying to get Turkmenistan’s commitment for the Trans-Caspian route. If they succeed, a substantial amount of investment and new technology would be needed in order to double production in Turkmenistan, to enable the country to meet its commitment to Russia and to Nabucco. It is important that recently three presidents – of Turkmenistan, Azerbaijan and Turkey agreed to cooperate in this project.

At this point, the European Union and, probably the United States must come into the picture. It would be grave mistake to postpone major diversification projects because of the financial crisis. Money did not disappear from the world and ways to bring them back must be found. And yet, for some reason Russia, which made about $750 billion in “oil dollars” is not investing them either in national infrastructure, nor in upstream development. Instead, Gasprom had been hungry for every piece of energy distribution systems everywhere – from Belarus and Moldova to Britain with the most recent acquisition of Gazprom in Serbia. And this is easily explainable: if resources are scare and you own the downstream part – you create a deficit-like situation and you control the distribution of this deficit and you have a long line of consumers bagging for a gas. That is a very good policy for Gazprom. It is hardly so for its customers.

If new deposits are being discovered in Russia and routes for alternative gas supplies are being constructed, there would be much less means to control the distribution side. An open, transparent energy market constitutes a serious threat to monopoly suppliers. Both the United States and the EU understand that well, and they must encourage new investment and technology to enter the upstream part of the energy equation in the Caspian region. The U.S. will never receive any of Caspian gas, but bringing alternative gas to the European market will contribute substantially to local and global energy security, thereby diminishing chances gas being used to gain political advantage or to establish control over the markets by creating “Gas OPEC”. The EU on its side can do a lot on the downstream part. Energy efficiency policy, unbundling, enforcing the Energy Charter and the Energy Community Treaty are vital for the future gas market in Europe. Recent initiative of the Hungarian energy company MOL to unify gas transmission pipeline systems in Central and Southeastern Europe within a new and independent regional gas transmission network NETS is worth serious consideration. If created, NETS could compete successfully against Gazprom or other Russian companies’ attempts to “privatize” national transmission systems in Central and Southeastern Europe.

The European Commission has initially welcomed the proposal. But the EU definitely can do more. Ukraine as well as Turkey should not be left outside of the EU’s energy programs and strategies. In addition to opening free trade negotiations with Ukraine, the European Commission must engage Ukraine in the development of a common European policy which takes into account the vital interests of transit countries. A southern transit route through Turkey must not overshadow a Caspian-Black Sea-Baltic transit corridor which has proved its importance and reliability for Europe in spite of all accusations of Gazprom. It is time to encourage major energy companies to move into the region and built a modern upstream and transit infrastructure, including upgrade of the Ukrainian transit network, thus contributing not only to the region’s economic development, but to political stability as well. But first of all it must be clear to everybody that Russian-Ukrainian gas disputes have nothing to do with commerce. Commerce means negotiations and not a dictatorship and intimidation. If the EU comes to the picture and embrace Ukraine into European Energy Area, Russia will have to abide the common contractual practice. If consumers of Russian energy resources will seat around the table with transit states and producer then together we will be able to negotiate with a monopoly normally. Then one could claim that Europe has an effective common energy policy. And it is a good business, after all.

By Dr.Sergiy Korsunsky, Ambassador of Ukraine to Turkey