Another Winter of Discontent: Europe Fails to Wean Itself off Russian Gas

Apparently the Kremlin was initially unaware of how quickly the mood had shifted against Russia. It was not until Wednesday, just as the Russians were celebrating Orthodox Christmas in a frosty Moscow, that the government attempted to avert a new blow to its image. Prime Minister Vladimir Putin appeared on television to demonstrate that Russia's actions were legally irreproachable. Putin, with his back to a Christmas tree, met with the director of the Russian customs authority, who promptly told the prime minister that his agency had regrettably been forced to send a warning to Gazprom because it was sending a commodity -- Russian gas -- across the border into Ukraine. Under Russian law, the official said, this was tantamount to smuggling.

Then Gazprom CEO Alexei Miller appeared before the camera to assure Putin that yes, indeed, Kiev was no longer conveying the Russian gas to Europe, but instead was diverting it into its own network. To punish Kiev for what he called "theft," Miller suggested to Putin that Russia shut off Ukraine's gas supply. "Is this documented?" Putin asked Miller. "Yes," Miller replied. Putin, glancing at his wristwatch, said: "It is now 3:45 p.m., and Gazprom is still supplying gas. I agree that deliveries should be discontinued. We should do this in full view of the public."

This little production was aired exactly seven hours after Ukraine had officially reported the interruption of the gas supply.

Putin's instruction to Miller to interrupt the supply was an open "invitation to commit a breach of contract," says a senior energy executive from the western German city of Essen, noting that Russia's natural gas customers have valid contracts with Gazprom. Those agreements, says the executive, stipulate that those customers must be able to obtain a specific volume of gas at a specific transfer location and at a specific price. Wulf Bernotat, the CEO of German energy giant E.on, was also disillusioned, noting that Gazprom runs the risk of jeopardizing its reputation as a "reliable business partner."

While the Russians and the Ukrainians fought like cats and dogs last week, the West speculated over whether Russia's tough approach might not be economically motivated this time.

Moscow, spoiled by a decade of strong economic growth, but still highly dependent on oil and gas prices, is now suddenly not in such a great financial position. Russian currency reserves have shrunk by a quarter since August, while the ruble lost 15 percent of its value against the euro last year. Gazprom, which reported a record profit of €25 billion ($34 billion) in 2008, now owes twice that amount.

In other words, the company needs money. Although it sits on 17 percent of the world's known natural gas reserves, the energy giant has hardly managed to increase production volume within the last decade, even though domestic demand grew by 25 percent and Gazprom now sells its natural gas in 32 countries. Old fields are becoming depleted, but a lack of funding for investment means that new fields are not being developed quickly enough. Experts estimate that the Siberian Yamal peninsula, which has one of the world's largest gas reserves, alone requires €145 billion ($198 billion).

Kiev on the Brink of Bankruptcy

As a result, Gazprom has already been forced to buy an additional 50 billion cubic meters from Central Asia to meet its delivery obligations. And because the European Union and China are also competing for lucrative contracts, Turkmenistan, Kazakhstan and Uzbekistan have been able to significantly increase their prices for the gas they sell to Russia.

Nevertheless, Gazprom, which is essentially part of the Russian state, has sufficient backing. While Moscow still holds the world's third-largest currency reserves, Kiev has been teetering dangerously on the brink of national bankruptcy for weeks.

Every other blast furnace has already been shut down in Ukraine's steel mills, the pillar of the country's export industry, and tens of thousands of workers have been let go. One euro costs 11 grivna, or more than 50 percent more than recently. Besides, the government is dependent on aid from the International Monetary Fund (IMF). Under these circumstances, it was clear that every dollar counted for the Ukrainians.

It ought to have been possible to resolve this conflict, at least according to the laws of reason. Beginning in January, Moscow wanted to charge Ukraine $250 (€185) per 1,000 cubic meters of gas, but Kiev was only willing to pay $235 (€150), under the assumption that the difference would be Russia's contribution to maintaining the Ukrainian pipeline network -- in other words, an increase in transit fees to $2 (€1.45) per 1,000 cubic meters of gas for every 100 kilometers (62 miles). It was a reasonable price, by Western European standards, and it would have cost Gazprom just under $350 million (€255 million) in 2009.

It has been known for years that Ukraine is unable to maintain, much less modernize its 37,500-kilometer (23,400-mile) pipeline network. Nevertheless, nothing was done in recent years to address the problem. Last week Klaus Mangold, the chairman of the Committee on Eastern European Economic Relations at the Federation of German Industry (BDI), recommended reviving the idea of a gas transport consortium.

In 2002, Putin and then Ukrainian President Leonid Kuchma signed a treaty on just that very issue. The Germans were also involved and were expected to contribute capital and know-how. But the plans were postponed after Ukraine's Orange Revolution. Kiev was concerned that the Russians would use the agreement to take over its pipeline network.

The two positions were not deeply irreconcilable, but then, on New Year's Eve, the Russians decided to shut off the gas supply to Ukraine. Russia, angered by Kiev's stubbornness on the issue of transit fees, suddenly demanded a gas price of $450 (€328), knowing full well that it would plunge Ukraine into an abyss. Kiev perceived this as a provocation.

Could it be that Moscow was in fact not interested in achieving progress in the negotiations, but rather in undermining Ukrainian President Viktor Yushchenko during the course of the gas conflict, just as it did to Georgian President Mikhail Saakashvili, a man equally hated in the Kremlin, in the August Caucasus campaign?

Russian-Ukrainian relations are poisoned, now that the pro-Western Yushchenko is in power and is pushing for NATO membership, which has earned him the reputation of an American puppet in Moscow. "Ukraine is not even a country," Putin barked at US President George W. Bush at the NATO summit in Bucharest last April after Bush had advocated prompt accession for Ukraine and Georgia.

Yushchenko's renunciation of Moscow is especially distressing to the Kremlin because the Russian empire was originally established in Kiev. Indeed, many Russians still refer to Ukraine as "Little Russia." After rhapsodizing over a "common history cemented with blood," Russian Foreign Minister Sergei Lavrov must have been all the more outraged when Yushchenko came to his friend Saakashvili's aid in August when, according to Moscow, he supplied Georgia with military equipment.

Ukraine's Political Chaos

Since the Caucasus war, for which the West initially blamed Russia, a dangerous conviction has spread within the Moscow elite: That Russia is now strong enough, once again, to be able to ignore foreign opinion in conflict situations. At a New Year's celebration near Gazprom headquarters, to which American, European and Russian guests had been invited, a Russian oil executive said angrily: "We don't give a damn about everyone else, because others will always blame us, anyway."

Does this mean that the Kremlin was also determined to have its way in the case of Kiev?

It would be a favorable opportunity, especially in light of the current political chaos in Kiev. Yushchenko, who is fond of anti-Russian rhetoric, has lost most of his political supporters and is at odds with Prime Minister Yulia Tymoshenko. Nowadays, the two leaders of the 2004 Orange Revolution have taken to deriding each other as thieves and criminals.

In other words, the Russians have good reason to be secretly pleased. President Dmitry Medvedev recently spoke openly about the "weakness of the Ukrainian leadership," while Putin characterized it last week as "highly criminal." Both men know that Ukraine's upcoming early parliamentary election, as well as the presidential election, offer an opportunity for a change of government. Not Yushchenko, but his attractive opponent, is now considered the front-runner.

This is the only way to explain the impressions conveyed by political Kiev last week. The subject of gas was only mentioned on the television news after the conflict in Gaza, and the Ukrainians have shown relatively little interest in the dispute. After all, the gas -- supposedly Ukrainian -- was burning in their homes.

Despite the turmoil in the rest of Europe, the president apparently felt that it was unnecessary to return from his vacation in the Carpathian Mountains. Prime Minister Tymoshenko had also disappeared.

Neither of the country's two leading politicians, especially not Tymoshenko, wanted to be associated with a possible worsening of relations with Western Europe. To pursue her political ambitions, Tymoshenko also needs the goodwill of pro-Russian groups in Ukraine, which explains why she has been reluctant to attack Russia. Yushchenko has even engaged the government intelligence service to prove that Tymoshenko, still known as the "Gas Princess" since her days as the head of a company that has intermittently been the country's largest energy group, is in league with Moscow. Did she remain silent over the gas conflict last week, hoping that it would damage Yushchenko?

Wishful Thinking in Germany

Of course, Western Europeans are uninterested in the nuances of Russian-Ukrainian tensions. Their key concern is to achieve a reliable energy supply. The German government and energy industry unanimously assured the public last week that the kind of rationing that was occurring in Bulgaria and Slovakia would be unnecessary in Germany, even in a crisis. They insisted that other gas suppliers, such as the Netherlands and Norway, were available. Besides, they added, Germany's natural gas storage tanks are filled to brimming with enough gas to satisfy demand for up to 40 days.

But there is probably more wishful thinking than reality to these assurances. Faced with Arctic temperatures, Germans massively increased their gas consumption during the days of the crisis. Last Tuesday, gas consumption was about 25 percent more than on normal January days. According to officials at the Essen-based electric utility RWE, the unusually cold winter has also led to skyrocketing demand for natural gas in the rest of Europe.

Thus, obtaining additional quantities from the Netherlands or Norway would be practically impossible. Gas giants like the state-owned Norwegian StatoilHydro company, are already producing at their full capacity.

Storage capacities in Germany are only a temporary fix. It is true that, at 20 billion cubic meters, they are in fact significantly larger than in other neighboring countries. But it would be difficult -- more likely impossible -- to replace all the Russian gas missing from the storage tanks.

But strategies for crisis situations are not the issue. Indeed, citizens and experts alike are increasingly questioning whether Germany is even on the right course anymore when it comes to energy policy. With little consideration for its growing dependency on its main supplier Russia, Germany has consistently increased its gas consumption in recent years.

Baltic Sea Pipeline Gets a Boost

More and more private households have already scrapped their oil tanks and installed gas tanks in their basements. Municipalities and industrial operations heeded calls from the federal government to build gas-fired cogeneration plants, and more and more coal-fired power plants were replaced by gas plants.

But while supply capacities from gas fields in the Ural Mountains and Siberia have been constantly expanded, European efforts to obtain alternative supply sources and routes have only progressed at a slow rate.

The planned Baltic Sea pipeline, which is to supply Germany and Europe with Russian gas by 2011, is likely to get a boost from the current conflict. It is possible, say some energy executives off the record, that this was even a reason for Russia to allow the dispute with Ukraine to escalate. Moscow had experienced considerable problems with the massive project in recent months. Scandinavian countries like Sweden have delayed construction for environmental reasons while there have been protests by environmental groups in Germany.

There is also disagreement over whether the pipeline through the Baltic Sea will truly make Germany's gas supply more secure or only heighten its dependency on Russia. Critics fear that the gas behemoth could develop a monopoly extending from production in Siberia all the way to distribution in Europe.

No less controversial is the plan to establish a new connection -- the Nabucco Pipeline -- through Southeastern Europe and Turkey to Azerbaijan, a gas producer. But that project will only be worthwhile if Iran is permitted to use the pipeline, say experts at the EU Commission in Brussels. But that, in light of the unresolved nuclear conflict with Tehran, is something European officials cannot even consider at the moment. Years ago the Bundesnachrichtendienst (BND), Germany's foreign intelligence agency, argued that when Europe is working out its energy strategies it should take more account of Iran as a supplier.

To reduce dependence on Moscow, the Europeans could also build additional gas terminals in ports, allowing the commodity to be shipped there in tankers from faraway production countries like Qatar or Libya. But the plan to build such facilities in the North Sea port of Wilhelmshaven failed due to a lack of LNG contracts.

Now European efforts to become more independent of Moscow could gain new momentum. On Monday European energy ministers attended a crisis meeting in Brussels to discuss ways out of the current predicament. It was the EU that brokered the deal that Gazprom and Naftogaz finally signed on Monday and teams of EU monitors have now been deployed along the pipeline in both Russia and Ukraine.

Old Conflicts Persist

Experts also expect consequences for the domestic energy debate in Germany. But as much as images of freezing children in Bulgarian kindergartens horrified Germans, when it comes to energy policy the country seems to prefer keeping its old fundamental conflicts alive. The first news of the new supply interruptions had hardly been reported before protagonists in Berlin were issuing the usual position statements. In light of the current gas conflict, said Economics Minister Michael Glos, a member of the conservative Christian Democrats, the country ought to revisit its decision to phase out nuclear energy. Environment Minister Sigmar Gabriel of the Social Democrats disagreed, calling that conclusion totally incorrect, and insisted that now is the time to ramp up the development of wind and solar power as sources of energy.

If Germany and Europe remain so divided over this issue, the West will not be immune to similar crises. The next gas war between Moscow and Kiev is a certainty, as long as both sides continue to negotiate prices in back rooms and shady middlemen become involved in the delivery. "For our customers, the often-criticized oil price connection in this crisis has proved to be quite helpful," E.on CEO Bernotat said triumphantly last week. "Despite the scarce supply, they should not expect higher prices." On the contrary, Bernotat said, the company plans to honor its promise to lower gas prices in February.

On Friday of last week, Putin called his German counterpart Angela Merkel to notify her of the resumption of gas deliveries. Nevertheless, Putin continued to deny any responsibility. "Energy as a weapon?" That meant nothing to him, Putin told the press, adding that only those countries on the verge of economic failure would mix up politics with economics.

At almost the same time, an expert in the field said precisely the opposite on the Russia radio station Echo Moskvy. Vladimir Milov, who was deputy energy minister under Putin for a period of time, said: "The Russian government has turned Gazprom into an instrument of foreign policy. Russia has cultivated the image of a gas dictator or, even worse, that of a gas hoodlum."

RALF BESTE, FRANK DOHMEN, CHRISTIAN NEEF, MICHAEL SAUGA, MATTHIAS SCHEPP, HANS-JÜRGEN SCHLAMP

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• Part 1: Europe Fails to Wean Itself off Russian Gas
• Part 2: Political or Economic Motives in Moscow?