The Russia-Ukraine Gas Dispute: Not Over Yet

The news today out of Russia was that a solution to the problem has been reached. There's an argument to be made, however, that this is just a superficial and/or temporary fix.

This is a good explanation of the root of the problem:

Ukraine used to get its gas allocation from Soviet planners and continued to expect the same after independence. When Russia first tried to get payment for its deliveries in the early 1990s, it failed. When it first cut off gas to Ukraine to enforce payments, Ukraine simply tapped the gas sent for export purposes; when European buyers howled, Russia relented and restored gas supplies without having managed to get paid by Ukraine. This has gone on. Yet somehow the gas continues to flow every year.

This problem is now repeating itself. Despite the apparent solution, the conflict may not be over yet. Here's why.

Russia has financed its recent success with the profits from selling off oil and gas reserves at the high prices of 2008. The recent drop, however, is severe:

The long-term picture is even more interesting:

Clearly, gas prices are heading toward a price valley. If the drop is sustained, Russia could be heading back to the bad old days of 2000-1. Compare the chart below, of the performance of the Russian economy since the fall of the Soviet Union, to the gas price chart above. The periods which saw the lowest gas prices - 1999 and 2001 - corresponded with times of low growth, if not outright crisis.

What else is going on? Well, Russia is looking at a huge budget deficit next year because the assumed oil price was $95 a barrel. (To give an idea of the relative size of the fluctuation, consider that the Russian federal budget could go from a surplus of 5% of GDP to a deficit of 5% of GDP in 2 years!) So it's going to be tough for the government to enact a Keynesian stimulus package - investors aren't as willing to buy the Russian bonds that would be used to pay for economic stimulus as they are to buy American bonds. (For proof of this, check out the spread between the interest rate on US treasuries and Russian government bonds - a measure of the perceived risk of these investments. Before a speculative frenzy in December, the latter had yields of between 7.6 and 11.3 percent. T-bills are at 3 percent or less.

Meanwhile, Ukraine is experiencing a prolonged political crisis. Its government is basically surviving on the strength of a loan from the IMF. Much like Russia, its former solvency was based on high commodity prices which have since taken a nosedive.

So here's the punch line: Russia actually needs the money from Ukraine, but the latter can't afford to pay! As things stand now, Ukraine pays less than half of what Europe pays per cubic meter of gas. Russia wants to raise the price, but both are in some pretty serious financial trouble. Thus, the dispute seems to be more a function of economics than of Russian belligerence, despite the serial occurrence of this dispute. It's also partly about downward pressure on supply caused by Russia's chronic underinvestment in its infrastructure, as an op-ed in the Washington Post on the 2006 version of this dispute points out (h/t CFR).

As the link at the top indicates, a tentative deal appears to be in place. This appears to be a rough compromise at best. While it might deal with Ukraine's alleged diversion of gas intended for consumption in Europe, disagreements about both the cost of the gas paid to Russia and the transit fee paid to Ukraine remain essentially unresolved. While it's hard to say how financially significant any gas diversion might be, ultimately the durability of the settlement will rest upon this unknown figure.

This is a revised and expanded version of a post that first appeared on Black's Bailiwick.

Comments

[Sam Black - Huffpost Blogger]

tammylynch,

I agree that the planning has been quite poor. However, this does make sense from Russia's perspective if it can (or thinks it can) outlast Ukraine in the dispute. In that case, the increased price that Ukraine would be forced to pay would eventually make up for the lost sales during the crisis. And as oxi suggests, there could be some geopolitical considerations at play as well.

SB

[oxi]

Two things Russia could do. One is further destabalize Ukraine to where they could sever Ukraine in half and take control of the Russian speaking part and back it up with military ground units and their navy in the Black Sea. NATO would do nothing in response as they were silent when Georgia started that war back in August.

Second and more dangerous Russia is in the process of delivering the S-300 PMU-2 missile system to Iran. Such a system Israel has warned would prompt them to attack Iran before they become operational. This would start a wider Middle East war that Russia would only gain from with higher oil prices and drag the U.S. into another costly war.

Both would benefit Russia at the expense of the West!

[tammylynch]

This is an interesting explanation of the economic issues involved in the dispute.

I would note, however, that no one, including Russia, has said that the Russia-Ukraine gas dispute is almost over. The issue that appears to have been resolved (at least very temporarily) is the transit of gas from Russia through Ukraine to Central and Western Europe. Russia and Ukraine are probably farther from a deal to restart gas to Ukraine than ever. This means that the gas being transited is far from stable.

I agree that there are economic reasons for Russia wanted to push the price up as high as possible and Ukraine to keep it down. However, the logic of Russia losing $200 million per week from Ukrainian business escapes me. The country is causing Gazprom serious economic stress, when it could have continued the gas, continued to negotiate and continued to receive $200 million per week.

The argument that Ukraine wouldn't pay is undermined by the fact that they did. The late fees in dispute could have been dealt with in arbitration, as requested by Ukraine, and more than likely, Ukraine would have been ordered to pay at least a good chunk of the $600 million Gazprom is demanding.

Now, where does Russia find itself? Gazprom is up to $40 billion in debt, Ukraine is saving $200 million per week and has an excuse not to follow through on the $600 million arbitration.

This is some of the worst economic planning I've seen.