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.