Russia suspends gas flow to Ukraine as talks fail to yield compromise

As has long been feared, negotiations between Russia, Ukraine and the EU over Russian gas supplies to Ukraine have ground to a halt.

Despite last ditch negotiations over the weekend a deal did not materialise and the two sides remain some way from reaching a deal. Ukraine is willing to pay a price of $326 per 1,000 cubic metres, however Russia continues to demand $385. Russia also insists that Ukraine owes debts of $4.5bn, of which it wants $1.95bn paid immediately. Reports over the weekend suggested Ukraine (pushed by the EU) was willing to offer a $1bn payment immediately – an offer which was swiftly rejected.

What does this mean for Ukraine?

• Reports suggest that Ukraine has sensibly built up sizeable gas reserves – around 14 billion cubic metres, enough to last the country until December. This reduces the immediate pressure on the negotiations.
• However, both sides are now playing hardball and have filed lawsuits at the Stockholm international commercial arbitration court. Russia is also refusing to countenance any further talks until a sizeable chunk of the outstanding debt is paid. The hope of a quick solution then seems to be fading

What does this mean for the EU?

• So far, the direct impact will be limited. Russia has said it will continue to transit gas through Ukraine to the rest of Europe and Ukraine is obliged to ensure all gas is delivered. This is vital given that Europe receives just over 30% of its gas from Russia, 16% of which comes through Ukraine (according to the EIA).

• That said, this assumes Ukraine will not siphon off any gas for itself (although as pointed out above it does have sufficient reserves), as it did back in 2009 when a similar situation arose. That time Ukraine's decision was driven by mostly by simple economic necessity. Even though it has sufficient reserves this time around it does not guarantee it will not adopt a similar approach. Any disruption in supply to Europe would force the EU to become more involved, possibly to the benefit of Ukraine – clearly, if the situation continues to worsen there may be an incentive for such action (although of course the political fallout in Europe would not be positive).
• In the longer term the indirect impact could be that this because another area of Ukraine where the EU has to become more involved. At the very least, future bailout funds could be primarily earmarked to prepay for Russian gas, something Russia seems intent on enforcing. This could either increase the cost or reduce the impact of the bailout.

In the end, despite the current intransigence of both sides, it remains in their interests to strike a deal. Russia seems to have the upper hand at the moment but equally Ukraine remains an important market for it and pushing the country further away may only exacerbate the original issue it took exception to – Ukraine moving closer to the EU.

However, this state of affairs only holds as long as the gas continues to flow through Ukraine. If this stops, then the volatility of the situation would increase significantly and the incentives would shift radically (as we have said before, neither side would want a breakdown in energy relations between the EU and Russia). This is the key point to watch in coming days and months.

Does Russia’s gas deal with China change things for the EU?

News just out is that Russia and China have finally signed a gas deal, the negotiations of which have been going-on for a decade. (As the picture above, taken from a Gazprom investor presentation showed, this is something Gazprom has been targeting).

This is a pretty surprising turnaround given that every news outlet was reporting overnight that Russian President Vladimir Putin had failed in his attempts to finalise the deal in his current trip to China which ends tonight.

The key points of the deal are follows:

• The contract will be over 30 years and is unofficially estimated to be worth $400bn (19% of Russian GDP).

• It will see Gazprom supply up to 38 billion cubic meters (bcm) of gas to China per year from 2018. Once further pipelines are complete, this could be expanded to 61 bcm per year. As a comparison, over the past four years Gazprom has exported an average of 157 bcm per year to Europe (including Turkey).

• No official price has been revealed but the biggest sticking point has been that China believed Russia’s price demands were too high. It will be interesting to see if Russia gave in on this point.

• This deal has proved increasingly important for Russia as it looks to shift it’s away from relying on European demand for its energy exports.

What does this deal mean for the EU?

• In the short term, not too much. The economic links between Russia and Europe will continue to be significant and they will continue to be reliant on each other when it comes to energy (the former to sell the latter to buy).

• The deal will not be in place until 2018 and even then will only see Russia selling a fraction of its gas exports to China every year, exports to the EU could still well be two to four times the size.

• For these reasons, it is unlikely to change the potential impact which EU sanctions would have on Russia. Although of course Russia remains relatively unconcerned by such threats when it knows of the huge divides within the EU on the issue.

• All that said, it is symbolically important and could have longer term impacts. It highlights Russia’s desire to move away from links with Europe. Combine this with Europe’s desire to increase energy security and the relations between the two sides could become increasingly cold and distant. Although, some countries due to geographical proximity (Bulgaria/Hungary) or due to long standing economic links (Germany) will surely continue to have good relationships with Russia.

• It also raises questions over future tie ups between Russia and China. Areas such as payments systems, broader financial markets, transportation and machinery have all been touted as sectors for potential cooperation between the two countries. Again while a long term issue, such ties up may concern the West since Russia and China are currently reliant on their exports in many of these areas. Both the EU and US will need to figure a clearer policy for how to deal with such changes, with the EU in particular in need of updating its policy towards its eastern neighbourhood.