What about Ukraine and Russia's other conflict – over gas? (+video)

Russia and Ukraine are at loggerheads over unpaid gas bills. If they can't come to terms, Europe could be left out in the cold this winter – literally.

By , Correspondent

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    An employee passes near valves and pipes at a boosting compressor station (BCS) on the East Poltava gas field near the village of Kovalivka, Ukraine.
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Although the military conflict in Ukraine between government forces and pro-Russia rebels is worsening, there's another battlefront in the conflict between Kiev and Moscow: the economic war over gas. And it could have a more profound impact on Europe than the fighting.

European officials are scrambling to bring Russia and Ukraine to the bargaining table to negotiate at least a temporary truce in their gas war – and avoid a complete shutdown of Russian gas deliveries to Europe this winter.

European Energy Commissioner Guenther Oettinger, in Moscow Friday for urgent talks with Russian Energy Minister Alexander Novak, said he hopes to bring the two sides together with European mediation by mid-September. In a clear concession to Moscow, Mr. Oettinger said that additional measures against Russia in the ongoing sanctions war between East and West, should not include curbs that would affect Russia's vital, cash-earning gas sector.

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At present gas and oil are being delivered through the Soviet-era Druzhba network, which carries almost half of Russian gas exports, and a good part of its oil exports, to Europe. But in June Russia's state gas monopoly Gazprom cut off supplies to Ukraine, citing an unpaid back bill of $4.5 billion, and apparently intractable disagreements over price. Before the shut-off, Ukraine managed to fill its vast Soviet-era underground storage tanks with gas, and now hopes that it can survive the coming winter with minimal new imports of Russian energy.

That means either Russia or Ukraine could use the gas flow to Europe as a political weapon in coming months, experts suggest.

"I'm sure the Europeans don't want to freeze this winter, and that's why they're taking action now," says Alexei Kokin, an oil and gas analyst with UralSib Capital, a leading Moscow investment firm. "Even if the most extreme contingencies are avoided, there are still several ways Europe could be left without enough gas in the depths of the coming winter."

A vital need – and heavy club

Ukraine has already warned that it might shut down transit of Russian gas and oil through Ukraine to punish Moscow for its continued support of east Ukrainian rebels. Energy exports account for over half of the Russian government's annual revenues.

And this week Ukrainian Prime Minister Arseniy Yatsenyuk said he believes that Moscow will shut down gas supplies as a means of pressuring Europe, a claim Russia denied.

Experts say that either scenario is possible, especially if the political and military struggle between Moscow and Kiev grows much worse. "Nobody can do without gas supplies, so it's an obvious weapon," says Mikhail Krutikhin, a partner at RusEnergy, a leading Moscow consultancy.

If the West keeps ratcheting up sanctions against Russia, it's possible Moscow could retaliate by switching off gas supplies to Europe.

"That's a very extreme scenario, and I'm sure no one wants it," says Mr. Kokin. "But if, say, the West cuts Russia entirely out of the financial system, so that there would be no way for Russia to receive and use payment for its gas, then Moscow could say, well, OK, then we won't send you any gas."

But even without a worst-case situation like that, a midwinter cut of gas supplies to Europe could occur without either side explicitly intending it, analysts say.

For one thing, Ukraine might siphon off some gas transiting through its pipelines to meet urgent local demand as it allegedly did during a previous Russia-Ukraine gas war in 2009, leaving downstream customers with critical shortfalls.

If Ukraine hoards all of the gas in its storage tanks to meet its own needs, as it has said it will do, Europe could accidentally be left in the cold, says Mr. Krutikhin.

"Those storage tanks were designed to have gas on hand to meet peak demand," he says. "Nobody can predict the weather. If there is a serious cold snap this winter, and Gazprom is unable to draw on those stocks to meet increased demand, the impact on Europe could be very serious."

'We need a solution'

Hence, the Europeans want Moscow and Kiev to come to at least an interim agreement, in which Ukraine could buy the gas it needs in the dead of winter from Russia, leaving the gas flow to Europe unthreatened, experts say.

In the longer term, the gas dispute between the two antagonists is being reviewed by the Stockholm-based International Arbitration Tribunal. But that could take over a year to settle, while the coming winter is already on the horizon.

"We need a solution that prevents an escalation between Ukraine and Russia," Oettinger said Thursday. "We need Ukraine as a transit country. Ukraine needs gas in winter. In a long and cold winter, Ukraine will not have enough stored gas of its own."

Russia has said it's willing to compromise a bit on price, but only if Ukraine pays its debt – which Gazprom now puts at over $5 billion – and agrees to short-term contracts of just three months at a time for future deliveries.

"Russia wants to keep Ukraine on a short leash, to be able to use this instrument to pressure them over and over again," says Krutikhin. "The Europeans are very nervous, because they don't know what [Russian President Vladimir] Putin is up to, or what he's going to do next. This gas situation is going to become critical pretty soon, and nobody knows how it can be solved."

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