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Russia and Ukraine Feud Over Natural Gas Pipeline

January 2, 2006 at 12:00 AM EDT
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VICTORIA MacDONALD: The pipes supplying Russian gas to large swathes of Europe but not the Ukraine after Russia raised the price fourfold and today the Russian government accused the Ukraine of stealing gas overnight.

SPOKESMAN (Translated) The amount of gas stolen on Jan. 1 by Ukraine from the European pipeline is about 100 million cubic meters with a market price of over 25 million U.S. Dollars. If the theft will continue at such a tempo, than the value of the stolen goods will be extremely significant.

VICTORIA MacDONALD: Following a cabinet meeting, Kiev denied it had been stealing gas although it said it would siphon off supplies if temperatures dropped below freezing.

It was clear by this morning, however, that there has been a knock-on effect with many of Russia’s European clients noting noticeable drops in the gas pressure. Western Europe gets 25 percent of its gas from Russia with 80 percent of that coming via the pipeline through the Ukraine. France today reported a drop of around a quarter in Russian gas supplies overnight. Similar falls emerged in Italy, Austria and many East European states including Poland, Hungary, Slovakia, Romania and Croatia.

This afternoon, Russia acknowledged the supplies had been affected and that it would restore them by Tuesday evening. Like other European Union countries, the UK has so far taken a relatively neutral stance. It can afford to at the moment with domestic gas supplies coming from the North Sea and Norway. But there is growing concerns throughout the EU that the dispute cannot be allowed to drag on with winter demand and prices already high. Nor is it a good start to the beginning of Russia’s presidency of the G-8 and today EU officials said they would hold an emergency meeting on Wednesday to discuss Moscow’s reliability as an energy supplier.

JIM LEHRER: And to Margaret Warner.

MARGARET WARNER: Late today, the EU’s foreign minister contacted leaders in Kiev and Moscow to urge them to resume negotiations. And Ukrainian President Viktor Yushchenko told European ambassadors he was willing to refer the matter to international arbitration.

For more on the Russia-Ukraine gas dispute and its fallout, we are joined by Michael McFaul, a professor at Stanford University, a senior fellow at its Hoover Institution and a senior associate at the Carnegie Endowment for International Peace. And J. Robinson West, chairman of PFC Energy, a consulting firm that advises oil and gas companies and governments on energy issues. Welcome to you both.

Professor McFaul, first of all, just explain to us, why did Russia take this really draconian step to completely cut off its natural gas to Ukraine?

MICHAEL McFAUL: Well, formally it’s about the price of gas. They want to charge the Ukrainians the world market price, which means a four-fold increase in the price.

Informally, of course, it’s about politics. Ukraine for many years since its independence has been loyal to Moscow. After the orange revolution last year, President Yushchenko has said “we’re going to look to the West.” And so Moscow decided, “okay, you’re gonna pay a price for looking to the West.” So this is really about Ukraine not being loyal to the Kremlin.

MARGARET WARNER: And you think they’re trying to use — Russia’s trying to use the leverage of its oil and gas — or in this case just we’re talking about gas, politically, essentially?.

MICHAEL McFAUL: Yeah, absolutely. I mean, this is all about politics. Russia does not charge market prices to Belarus– which is loyal to the Kremlin. It even doesn’t charge market prices to the Baltic states. They want to charge the Ukrainians twice what the Baltic states are charged. This about politics. They want to bring down the Ukrainian economy and show that there’s a price for the orange revolution from last year.

MARGARET WARNER: Robin West, how do you see it and what is wrong though, just as a business matter, economic matter, with Russia saying if Yushchenko wants to look to the West, let him pay western prices?

J. ROBINSON WEST: Well, the gas business is a different kind of business than the oil business. And the Ukraine has said — President Yushchenko said that over time they would be prepared to increase prices. But the gas markets in the Ukraine are tied to supplies in Russia; they don’t have a choice.

And they have to be able to have a moderate change rather than a steep change. And as Professor McFaul sad, this is a political issue. They’re trying to reverse the orange revolution using their energy market power to do it.

MARGARET WARNER: Now explain what you meant when you said it’s not like the oil market and that Ukraine doesn’t have other options here. Why not?

J. ROBINSON WEST: Well, the way natural gas works is that its physical –its commodity that — its physical nature is different than oil. Oil you can — it’s a fungible commodity; you can move it around.

MARGARET WARNER: So there’s a world oil price and everybody’s paying the same thing?

J. ROBINSON WEST: And if the Ukrainians couldn’t get Russian oil, they could get Iraqi oil or they could get Kazakh oil. But the way natural gas works, it moves by pipeline; and natural gas is different than oil and these big pipelines tend to hard wire relationships. It’s different than oil.

And this is a hard-wired relationship and the Russians are going to try and squeeze the Ukrainians because they didn’t have a choice.

MARGARET WARNER: What other options does Ukraine have? Professor, McFaul, in terms of — what’s the impact going to be? If Russia holds firm here can it either A, afford to cave into Russia and immediately start paying four times as much or, B, do without?

MICHAEL McFAUL: Well, you know, they could do both. But both would be bad outcomes for Ukraine. I mean, I think if they pay the four-fold increase, estimates are that it would be a 5 percent decline in GDP. And that’s after a year where Ukraine really hasn’t grown. So it would be very hard economically. But they could do it.

Secondly, of course, they get most of their gas not from Russia but from Turkmenistan and they could try to increase the supply from Turkmenistan. The problem there, of course, is that the Turkmen gas comes through Russia and Russia basically yesterday cut that off.

Now it’s flowing again and I don’t know, Turkmen gas versus Russian gas, it seems that Russia has backed away, that they don’t want to play this hard ball game but it would have dire economic consequences for Ukraine in the short term.

MARGARET WARNER: Let me turn to our energy expert. How much of a stranglehold does Russia really have on the supply of natural gas into Ukraine?

J. ROBINSON WEST: Well, Russia supplies about 25 billion cubic meters a year.

MARGARET WARNER: Which is roughly a third?

J. ROBINSON WEST: About a third. Turkmenistan in Central Asia is about a third. And then they’ve got some local indigenous production as well. But the key thing is –

MARGARET WARNER: But just to understand this, the gas from Turkmenistan goes right through Russia –

J. ROBINSON WEST: To get to –

MARGARET WARNER: To get to Ukraine so Russia could totally put the squeeze on it.

J. ROBINSON WEST: They could squeeze it but, by the same token, as your report pointed out, about 85 percent of Russia’s natural gas flows through the Ukraine pipelines to Europe. Natural gas is one of the largest hard currency generators for Russia and for the Russian government. This is a big deal. And it’s a big deal which goes way, way beyond the Ukraine and Russia.

MARGARET WARNER: Well, let’s move beyond the Ukraine and Russia and explain– as an energy expert– the following: Russia said yesterday when they turned off these taps that they would just turn off the gas for Ukraine but the stuff for Western Europe was going to keep on flowing. Obviously it did not keep on flowing and there are huge decreases.

First Russia said today — we heard the gentleman say it’s because Ukraine is siphoning off the gas illegally. But then late today they said well, we’re going to turn on the taps. I mean, what is the situation here? Is the gas — can they — could Russia completely sidetrack Ukraine’s gas and still sell in Western Europe?

J. ROBINSON WEST: Well, theoretically yes, because there are allocations, there are contracted allocations that move through the pipeline. But if the Russians are going to try and squeeze the Ukrainians, the Ukrainians can squeeze the Russians and I think that’s what happened overnight.

MARGARET WARNER: You do, you do think that they were siphoning?

J. ROBINSON WEST: Yes.

J. ROBINSON WEST: What’s your view of that, if that’s sort of how Ukraine is handling this? Do you think that’s what they were doing?

MICHAEL McFAUL: Well, it’s a mutual dependency and the Ukrainians were trying to signal that they have some leverage here, too. And let’s not forget that the transit fees that Ukraine — that Russia has been paying Ukraine are also below market prices.

So part of the Ukrainian beef is, well, if you’re going to raise the prices on that, then we’re going to take 15 percent of everything that goes through. And they determine, again, arbitrarily, that that’s what they have a legitimate right to.

The other thing, you mentioned the word “contract,” and I think it’s important to realize, at least from the Ukrainian perspective, this is a breach of a contract. In August of 2004, an agreement was signed to fix the price. And I went back and read it. It says the word “fix the price” through to 2009.

And arbitrarily, according to Ukrainians, the Russians have raised the price four times. So they think that they have a legal argument as well as an economic argument for why this is illegitimate.

MARGARET WARNER: Now explain, Professor McFaul why throughout Western Europe today there was just outrage. I mean, from political officials senior government officials, editorial pages of newspapers; it was huge.

MICHAEL McFAUL: Well, I think you have to go back 20 years to understand that and remember that when they first — the Soviets, that is the Soviet Union first started to export gas to Western Europe, our government, the Carter and Reagan, Democrat and Republican, were resistant to this. They said “look out, we cannot be dependent on the Soviets, on the Communists for our supply.” And that turned out to not be a real threat.

And we’ve had peaceful stable energy security, as Mr. Putin likes to say. We are a reliable supplier of energy to the West until yesterday, or until today. And that, then, said, hey, wait a minute, what is going on? You have been selling — President Putin has been preaching for the last several years since Sept. 11, unlike these other suppliers of oil and gas, we’re reliable.

MARGARET WARNER: Unlike the Middle East.

MICHAEL McFAUL: Unlike the Middle East. And now suddenly overnight they were playing politics with their supply of oil and gas. And that, rightly, I think, sent concerns around Europe and I hope here in Washington as well.

MARGARET WARNER: Pick up on that, because you said earlier this is even bigger than — probably even than Western Europe. What does this say or do to Putin’s global ambitions in terms of being an energy supplier?

J. ROBINSON WEST: Well, this is important for a number of reasons. First is the politics between Russia and Ukraine but beyond this Russia assumed yesterday the head of the G-8 and one of the keystones of the presidency of the G-8 on Russia’s behalf will be energy security.

MARGARET WARNER: And that’s Putin himself has said that.

J. ROBINSON WEST: That’s Putin; he said that. This is an important plank in their program. And we define energy security as reliable supply at reasonable cost. As Professor McFaul pointed out, the Russians have been very reliable suppliers up until now. Now, this may just be a hiccup, can be dismissed as a local spat. But if Russia is in the position that it is not a reliable supplier or is perceived as not a reliable supplier, that’s very serious for Russia’s relations with Europe.

It’s also important for Russia’s relations in the international community because Russia has been using energy in the last few years as its calling card. It wants to use energy to restore its great power status since it really doesn’t have a military anymore. If it’s not a reliable energy supplier, it’s not going to be an important player in world energy markets.

MARGARET WARNER: Do you think Moscow miscalculated here? I mean, the fact that they suddenly changed their tune by late afternoon, what’s your — I know I’m asking you to read tea leaves but you’re our Russia expert here.

MICHAEL McFAUL: Yes, they miscalculated in several respects. First of all, they didn’t think that the dispute with Ukraine would have the negative reverberations it had in Western Europe. I think they grossly miscalculated in that, and that’s why they turned the pumps on today.

Second of all, they lied or they didn’t lie or whatever but they said that Ukraine was responsible for it and then later in the day they increased the supply. That makes them look bad.

And third, it’s just the public relations, it’s the timing of it is that is so poor. As you said, they took over the G-8. There are lots of people that don’t think Russia should be the chair of the G-8 well before this dispute because of what’s happening internally in Russia.

And so Putin has for the last six months and his advisors and his public relations people have been saying “our summit is going to be about energy security. We don’t want to talk about human rights and democracy and all that stuff; we want to talk about energy security,” thinking that would be the issue they could have a nice, clean, friendly summit.

And with one day in a 24-hour news cycle they undermined the one positive card that they could have played at the G-8 summit.

MARGARET WARNER: And, very briefly, do U.S. energy consumers have reason to be concerned by this story?

J. ROBINSON WEST: Short term no; long term, yes. Russia is a very important supplier of energy and potentially to the United States in terms of liquefied natural gas where you put it on ships and bring it to North America.

The Americans insist on reliable suppliers and everywhere else in the world has been reliable for us, and if they want big contracts from America, the Russians must be reliable.

MARGARET WARNER: Robinson West, Michael McFaul, thank you both.