''Intelligence Brief: Russian Gas Dispute''

On January 1, 2006, Russia implemented a gas supply cut-off to Ukraine after the last days of negotiations failed to produce a compromise. Kiev's authorities dispatched a statement saying their country has enough gas to face the bitterly cold winter. As Ukraine's state-owned energy firm Naftogaz Ukrainy warned, European countries, such as Hungary, discovered on January 2 that the pressure of natural gas coming from Russia via-Ukraine had fallen 25 percent.

Gazprom and International Politics

Gazprom, the Russian oil and gas giant which owns 16 percent of the world's proven natural gas reserves and controls 20 percent of its global production, has become a decisive geoeconomic actor. Following the European Union's decision to give Ukraine the status of a "market economy" last month, the Russian corporation made a distinction between Ukraine and Belarus (with Belarus still being a state-administered economy), claiming that Ukraine must pay for gas supplies as much as international markets indicate. According to Moscow, politically-driven low prices are not relevant when conducting business with market democracies.

Austria, Germany, Hungary, Italy, and Romania already pay US$230 per 1,000 cubic meters of natural gas to Gazprom. During last year's Russian-Ukrainian talks, Kiev claimed it should pay a lower price due to its proximity to Russia and its special role of being a bridge between Russia and the West since the majority of Russia's natural gas pipelines pass through Ukrainian territory.

As the crisis became more acute, Kiev declared last week that it is ready to pay market prices for gas, but asked Gazprom to only progressively raise the price, which the Russian corporation refused to do, instead offering just a three-month delay to implement the price increase.

Obviously, the market economy argument, although formally correct, is a pretext to implement pressure on Kiev.

Gazprom is acting as an agent of Moscow to pursue Russia's political interests. Putin's international economic policy and Gazprom's policy are marching united. The Russian president is now in control of the energy giant, guaranteeing that he will remain a key player, at least indirectly, even if he fails to be re-elected in 2008. His main international strategy is to give Russia the status of a great power in a new, multipolar world order in which Russia, China and India will be the main Eurasian powers. [See: "The Coming World Realignment"]

In Putin's view, friendship with the U.S. and the West is possible if Russia's security and interests are respected in Eastern Europe, the Caucasus and Central Asia. But the E.U.'s and N.A.T.O.'s penetration in the former Soviet sphere of influence puts such friendship at risk.

As PINR noted in May 2004, N.A.T.O.'s expansion toward former Soviet republics is viewed in Moscow as an unacceptable strategic threat. The battle for Ukraine -- a country that is approaching general elections in March 2006 -- is heating up. The reason is eminently geopolitical: Russia cannot ensure its strategic security, nor project its power toward the Black Sea and Central European regions, if Ukraine is a hostile state. [See: "Russia Views N.A.T.O. Expansion as a Strategic Threat"]

Russia, via-Gazprom, is therefore using its gas supplies as a political weapon to enhance its influence in Ukraine and will continue to do so in the next months. Even though such blackmailing actions will not help Russia enhance its image internationally, Putin seems more interested in reassessing Russia's weight as a great power than in gaining Western sympathy and approval.

Since Central and Western European countries also largely depend on Russia for their natural gas supplies, Putin's stance against Ukraine could endanger European-Russian relations as well. It is also true that Russian credibility as a reliable world energy supplier could come under question if the Kremlin's anti-Kiev move causes serious regional problems. Apparently, though, the Russians seem to believe that they can force the situation precisely when Moscow takes the helm of the annual G8 presidency.

Moscow would like to avoid the deterioration of its relations with the E.U. members (and especially with France and Germany) and therefore also wants a solution to the crisis; however, at the same time it wants to signal to Ukraine the dangers of a pro-American and pro-N.A.T.O. policy. The Russian-Ukrainian dispute will be won by the player most capable of getting the support of Western countries, and, in the end, a compromise on the modalities of Kiev's payment to Moscow is the most probable outcome. In this respect, the option of a Western financial loan to Kiev, enabling Ukraine to cope with the raising price, is not to be ruled out.

However, the current Russian-Ukrainian issue highlights another crucial point: the rise of a new Russian capitalism having peculiar characteristics, and Moscow's geopolitical counter-offensive after years of setbacks.

Russian Capitalism and Moscow's Power Projection

Statistics recently made available in Russia show the rise of a new Russian capitalist model. According to the Italian financial daily Il Sole-24 Ore, such a system is first and foremost characterized by state ownership of no less than 40 percent of the G.D.P. One of the last liberal politicians in Moscow, Andrei Illarionov -- who left the Kremlin in December -- effectively defined the Russian system as a "corporatist model, marked by the dominance of big public [state] groups."

Gazprom's recent opening-up to foreign capitals also highlights a specific political strategy to keep the Kremlin's grip on large Russian corporations. The state maintains control over 51 percent of the oil giant's stakes, whereas the remaining 49 percent is split among foreign private business groups. In doing so, Putin and his fellow powerbrokers have managed to formally adhere to market principles while maintaining de facto control over their strategic assets.

Such a model is set to expand in Russia. The importance of its reinforcement is obvious and two-fold. On the one hand, it sets the rules for conducting business in Russia. On the other hand, it gives the Kremlin the needed leverage to project its power and influence abroad, with the fundamental aim to re-create a Russian sphere of influence from Belarus to Crimea, and from the Caucasus to Kyrgyzstan.

The Bottom Line

Politically, the Russian-Ukrainian dispute will remain central for the first quarter of the year, with Ukrainian President Viktor Yushchenko facing an electoral challenge by both his former ally Yulia Timoshenko and his pro-Russian adversaries.

As mentioned, it is likely that Putin will try to send a tough message to Kiev and, to a lesser extent, the West, without exacerbating its complex relations with Western European powers. The E.U., under Austrian presidency for the next six months, is eager to appease Putin and is unlikely to open a dramatic confrontation over Ukraine.

However, the effectiveness of Moscow's strategy in influencing Kiev's electoral outcome is unsure, and the political battle inside Ukraine will need to be carefully monitored in the coming months.

At the economic level, the gas crisis is set to increase the energy security concerns of the world powers after years of a dramatic increase in oil prices. Apart from ecological issues, fossil energy brings two fundamental problems: the prices are steadily on the rise, and the political dependence upon suppliers augments instability.

Therefore, prospects exist for new and enhanced plans for ending such dependence. Already in September 2005, a group of European deputies announced the creation of a broad platform designed to implement a European hydrogen-based economy in the coming decades. Additionally, nuclear energy is, once again, considered to be an economic priority by many players. [See: "Economic Brief: E.U. Plans for Alternative Energy"]

Report Drafted By:
Dr. Federico Bordonaro