The New Year began in Europe with a looming energy crisis but the crisis passed as rapidly as it had developed. The episode threw a rare light on the intimate links between energy supplies and international politics as well as the mutual interdependency created by gas pipelines.
On New Year's Day, Russia cut off supply of natural gas intended for Ukraine, following the latter's rejection of Russia's demand for a price increase from $50 to $230 per 1,000 cubic metres. Ukraine is heavily dependent on Russia and Turkmenistan for natural gas supplies. The termination of the Russian contract could have, therefore, precipitated a crisis in the already fragile Ukrainian economy. Moreover, a gas shortage at the height of the icy cold Ukrainian winter would have disrupted heating systems in homes and offices, causing severe suffering to ordinary people.
What led Russia to jack up the price of natural gas by 450 per cent' The answer lies in the realm of international politics. As a former Soviet republic, Ukraine was, until very recently, treated by Moscow as a neighbour with which it enjoyed a special relationship rooted in the history of the former Soviet Union. Even after the break-up of the Soviet Union, Russia continues to supply natural gas to some friendly neighbouring countries that were formerly part of the USSR. Thus, it supplied natural gas to Ukraine at a small fraction of the price it charged to west European consumers.
Last year, however, the political background changed dramatically. With active Western encouragement, the 'Orange Revolution' in Ukraine resulted in the installation of a new regime led by President Viktor Yushchenko, whose declared objective is to take his country into Nato. Last April, Nato proposed a dialogue with Ukraine concerning its entry into the alliance. Even though its protests have been ineffectual, Russia is strongly opposed to Nato's eastward expansion, particularly to countries that were formerly constituent parts of the USSR.
Russia's stakes in Ukraine are particularly high. The Russian Black Sea fleet is based in Sevastopol. Though its population is predominantly Russian, Sevastopol was transferred to Ukraine in 1954 as a result of a re-drawing of internal boundaries in the USSR and it thus belongs today to the independent republic of Ukraine. In 1997, Russia and Ukraine concluded an agreement under which the former maintains its Black Sea fleet in Sevastopol on payment of a stipulated rent. Ukraine is now demanding a hefty increase in the rent. Significantly, the demand was made on December 8, within a few hours after the visit of the American secretary of state, Condoleezza Rice, to Kiev. The Ukrainian foreign minister, Boris Tarasyuk, even claims that it is 'absolutely abnormal that Russia illegally holds 148 hectares of land in Ukraine's Sevastopol'. In short, Yushchenko's Nato ambitions endanger the future of the Russian navy.
After the 'Orange Revolution', Russia no longer had any reason to sell gas to Ukraine at a heavily subsidized price. Last March, Moscow informed Kiev that the price for 2006 deliveries would have to be renegotiated. Moscow initially asked for $110 per 1,000 cubic metres, but the price was subsequently raised to $230, as positions hardened. Furthermore, the Russian state-owned gas company, Gazprom, entered into a deal to buy an additional 30 billion cubic metres of natural gas from Turkmenistan in December, thereby limiting Ukraine's access to gas from this alternative source. On December 29, in a last minute attempt to find a solution before the year end, President Vladimir Putin offered Ukraine a loan of $3.6 billion to cover the costs of transition to market prices. In the absence of a satisfactory response from Kiev, Russia cut off natural gas supplies to Ukraine on January 1.
The fallout of the dispute between Russia and Ukraine affected the whole of western Europe. Russia is the major exporter of natural gas to the European Union. Around 80 per cent of Russian supplies to the EU are delivered through pipelines traversing Ukraine. When Russia cut off supplies to Ukraine, many west European countries (including Austria, France, Germany and Italy) complained that they were experiencing shortfalls in delivery of Russian gas. Moscow declared that it was supplying the full contracted amounts to these countries, accusing Ukraine of illegally siphoning off deliveries for its own use. Ukraine rejected the charge, claiming that it was merely taking the quantities it had earlier contracted to buy from Turkmenistan and the percentage of gas due to it as transit fees for Russian gas exported to the West. Kiev, however, refused to allow inspections to verify the quantity of gas entering the pipeline from Russia and the quantity issuing from Ukraine to the EU.
The EU, therefore, brought pressure to bear on both Russia and Ukraine to resolve their differences and restore normalcy in natural gas supplies. The economic ministers of Austria, France, Germany and Italy warned Kiev that their relations with Ukraine might be affected if it failed to deliver the full quantity of gas meant for the EU. At the same time, the EU energy commissioner warned Moscow against making the EU a 'hostage' to its dealings with Ukraine. Questions were raised about Russia's reliability as an energy supplier and the desirability of remaining so heavily dependent on Russian gas.
As a result of these pressures, the crisis was speedily resolved. On January 4, Russia and Ukraine reached a complex 5-year agreement under which RoskUkrEnergo, a rather mysterious company owned jointly by Gazprom and an Austria-based shell company with unknown beneficiaries, will buy natural gas from Russia at a price of $230 and from Turkmenistan at a price of $60-65 per 1,000 cubic metres. It will then mix this gas and supply it to Ukraine at a price of $95 per 1,000 cubic metres. With the conclusion of this agreement, the threat of an energy crisis in Europe was averted.
Do these developments offer any lessons for us, in the context of the Iran-Pakistan-India gas pipeline proposal and our own energy security concerns' The political background is very different in the two cases and it would be wrong to seek exact parallels. However, the European case does offer a vivid illustration of two important characteristics of gas pipelines that bear on energy security.
First, trading in natural gas creates an even greater degree of interdependence between buyers and sellers than in the case of oil. Oil can be transported by pipeline, road or sea and can, therefore, be sold in any market. Natural gas, on the other hand, can move only through pipelines, unless it is first converted into liquid form. Pipelines require long-term agreements between buyers, sellers and transit countries. Alternative markets or sources cannot be found overnight. Construction of new pipelines, or CNG infrastructure, is both expensive and time-consuming. Mutual interdependence between buyers and sellers is thus very high.
Second, though this interdependence cannot totally eliminate the risks of politically caused disruption of supplies, it does very significantly reduce these risks. Russian gas supplies to western Europe commenced in the Eighties and they were never interrupted on account of Cold War tensions. Indeed, they have never suffered disruption, with the single exception of the recent blip, which was quickly corrected.