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Russia Gas Threat Shows Putin Using Pipes to Press Ukraine

By Elena Mazneva and Stephen Bierman
March 03, 2014 9:38 AM EST 137 Comments
A section of the Urengoy-Pomary-Uzhgorod pipeline, also known as the West-Siberian Pipeline, or the Trans-Siberian Pipeline - Russia's main natural gas export pipeline - moves underground near Ivano-Frankvisk, Ukraine, on Thursday, Feb. 6, 2014. Ukraine.
Photographer: Vincent Mundy/Bloomberg
A section of the Urengoy-Pomary-Uzhgorod pipeline, also known as the West-Siberian Pipeline, or the Trans-Siberian Pipeline - Russia's main natural gas export pipeline - moves underground near Ivano-Frankvisk, Ukraine, on Thursday, Feb. 6, 2014. Ukraine.

OAO Gazprom (OGZD)’s threat to end natural gas discounts for Ukraine adds to the financial burden on the near-bankrupt government in Kiev and makes Europe’s energy supply part of the escalating crisis.

Russia’s gas-export monopoly said on March 1 it may end last year’s agreement to supply Ukraine at a cheaper rate unless it’s paid $1.55 billion owed for fuel. It’s the first time since the overthrow of pro-Moscow president Viktor Yanukovych last month that Russia has directly used its position as Ukraine’s dominant energy supplier to pressure the new regime.

Vladimir Putin, who has permission from Russian lawmakers to deploy troops to Ukraine, has repeatedly used gas to strong-arm his western neighbor, cutting off supplies twice since 2006 over payment disputes. Because Ukraine hosts a network of Soviet-era pipelines that carry more than half of Russia’s gas exports to the European Union, any disruption of supply puts the region’s energy security at risk.

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Gas debt “is a traditional Russian move to pressure Ukraine,” said Mikhail Korchemkin, head of Malvern, Pennsylvania-based East European Gas Analysis. “In the past decade the Kremlin used the gas tap as a tool of political pressure on the former Soviet republics.”

Gazprom shares fell as much as 17 percent to 116.79 rubles in Moscow, the most since 2008, as investors sold Russian stocks and currency in response to Putin’s actions in Ukraine. The stock traded at 119.13 rubles at 5:40 p.m. local time.

Interim Government

Ukraine’s interim government led by Arseniy Yatsenyuk can little afford to meet Gazprom’s demand for back payment as it tries to negotiate a $15 billion bailout with the International Monetary Fund. Ukraine, which uses more gas than France, gets more than half its supply from Russia.

The IMF will assess the situation in Ukraine in a visit to begin tomorrow, Managing Director Christine Lagarde told reporters in Bilbao, Spain today.

A Snapshot of Ukraine's Past and Future

Ukraine has an agreement, negotiated last year by Yanukovych’s government, to buy gas at a discounted rate until the end of March. In the days after the government fell, Russia’s prime minister said the deal could be honored under a new regime. That’s now changed.

Ukrainian Energy Minister Yuriy Prodan told reporters in Kiev on March 1 that he’s unsure when payments to Moscow-based Gazprom can be made.

“It seems without payments for gas and fulfillment of commitments, Ukraine may not keep its current gas price discount,” Gazprom spokesman Sergei Kurpriyanov said by phone.

Russia’s Energy Ministry sees no reason to renew the agreement to reduce gas prices in the second quarter, Interfax reported, citing an official it didn’t name.

Gas Shipments

So far, Russian gas shipments to Ukraine and the rest of Europe haven’t been disrupted during the crisis. Supplies are passing through the network as normal, national pipeline manager Ukrtransgaz and Gazprom said today.

“We hope that there will be no disruptions to transit,” Alexander Medvedev, Gazprom deputy chief executive officer, told analysts and investors at an investor day in London. “At least what’s happening so far gives us such a hope.”

If Russia ends contracts to supply Ukraine, it may have a knock-on impact on European supplies, said Dennis Sakva, an energy analyst at Dragon Capital in Kiev.

Gazprom supplied about 30 percent of Europe’s gas last year, according to data from a bond presentation last month. Although a mild winter, which meant European stockpiles are higher than average, had kept gas-market reaction to the crisis subdued, prices surged today.

German Contract

U.K. gas for next-month delivery climbed as much as 10 percent, the biggest gain since September 2011, on the ICE Futures Europe exchange in London. Dutch gas for April increased as much as 10 percent while the German NetConnect contract rose 8.1 percent, according to broker data compiled by Bloomberg.

Germany’s EON SE (EOAN), one of Gazprom’s largest customers, said while it’s getting supplies as normal, the company always kept gas stored to cope with unexpected disruptions.

In a prolonged outage, gas buyers could turn to other pipeline suppliers such as Algeria and Norway or increase imports of liquefied natural gas on tankers.

“Thank God it’s spring now and our underground storages are full,” said Bohdan Sokolovskyi, who was an energy adviser to Yanukovych’s predecessor. That will enable Ukraine to maintain supplies to Europe in the short term even if Russia cuts shipments to the former Soviet republic, he said.

Ukraine probably has enough gas stored to last four to five months, according to Alexander Paraschiy, an analyst at Concorde Capital in Kiev.

South Stream

Longer term, the crisis will add impetus to Gazprom’s South Stream project, a Black Sea pipeline from Russia to Europe that bypasses Ukraine.

“It is impossible to avoid transit risks without South Stream,” Gazprom’s Medvedev said.

The Nord Stream link that runs from Russia to Germany has already cut the proportion of EU-bound gas shipped through Ukraine to about 50 percent from 80 percent since it opened in 2011.

“The key ramification is speeding up South Stream construction with more support now for this project from previously skeptical European customers,” said Lev Snykov, a partner at Greenwich Capital in Moscow.

To contact the reporters on this story: Elena Mazneva in Moscow at emazneva@bloomberg.net; Stephen Bierman in Moscow at sbierman1@bloomberg.net

To contact the editor responsible for this story: Will Kennedy at wkennedy3@bloomberg.net

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