Some predictions on the forthcoming Russian-Ukrainian gas 'crisis'

We've recently heard more veiled threats from Putin about Ukraine being unable to pay for gas (thus presumably leading to new attempts at cutting them off), which suggests that Russia is getting itself ready to start a new crisis. That means two things:

  1. the internal infighting between groups of powerful Russian and Ukrainian oligarchs for the control of unofficial Russian gas deliveries to Ukraine (more on this below) is still not conclusively settled, and requires "action" using official levers of State and interference with Gazprom's export deliveries through Ukraine;
  2. Russia thinks it stands a better chance to focus European blame on Ukraine and, even more importantly, to get Europeans to buy off the Ukrainians (thereby increasing the available unofficial gas loot for the players involved).
While Russia's actions are not easily understandable when considered as those of a country, they are much easier to interpret rationally when you look at who the actual players behind the scenes are. Conversely, public European reactions which sound logical are, in fact, incredibly naive if you know the industry a bit and, given that the people involved are certainly not naive, they are other things at stake.

So let's try to make some predictions and unravel what's actually going on.

Originally posted on European Tribune. See also my full series of articles on earlier episodes of the Russian-Ukrainian crises here

First, as a reminder, since 1994, there have been two separate bits in the Russian-Ukrainian gas trade:

  • the official part, whereby Gazprom delivers gas to Naftogaz (roughly 20-25bcm/y), the Ukrainian national gas company, and uses Naftogaz's network of pipelines for its gas exports to Europe (including Turkey) - roughly 130-150bcm/y of transit; this trade roughly balances itself out, ie is settled without any ash payments. Given that gas prices are more volatile than transit prices, Gazprom regularly tries to get paid something more for the gas it delivers, arguing that it has become worth more than the transit services, and Ukraine refuses to (or can't) pay. This is the public dispute, and it is, in reality, a sideshow;
  • the unofficial part, whereby semi-mysterious traders like RosUkrEnergo and its predecessors deliver gas to Ukrainian clients using Gazprom's pipelines but gas formally sourced elsewhere. As I have explained in detail in this paper for the IFRI research institute, this business was created by Gazprom managers, jointly with large Ukrainian gas consumers, to get around the impossibility for Gazprom to get paid by Naftogaz under the official trade: Ukrainian gas users get gas cheaper than if they bought if from Naftogas, and the suppliers get some money from gas deliveries from Gazprom's network to Ukraine; the initial customers can then on-sell more gas to other Ukrainian users and make additional money for them and their Russian accomplices. This is fundamentally an unstable business because (i) it has to be done in the shadows, as it goes directly against the interests of Naftogas, the national company, and it uses Gazprom's network at no benefit for the company, (ii) all the major Ukrainian gas users (mainly the big steel-bashing companies in the East) want to be the privileged intermediary that gets first access to the gas and a cut on further sales, (iii) various clans within Gazprom (and their associates in the Kremlin) want their hands on that juicy business. Amongst unavoidable players in this game, you thus have the big customers in Ukraine, the people with formal authority over gas transit both in Ukraine and in Russia, the people with access to gas inside Russia or in Central Asia, and their counterparts within Gazprom...
Fights on the second front can spill on the first front, as the two businesses largely use the same pipelines and gas inside the system is fully fungible.

The West's error has been to try to interpret what's going on in light purely of the first, public, conflict. Of course, one reason this happened was that in 2006, some players in the West had very strong motivations to suddenly make a big deal of what had been a recurring, and mostly ignored, conflict. The UK government was facing the very real prospects of gas cuts as domestic production was shrinking and inadequate plans for import and gas storage were in place; the Russian-Ukrainian gas crisis offered a perfect opportunity to turn a domestic policy failure into an international conflict, with blame nicely thrown at a familiar enemy. In parallel, the US administration had cooled on Putin following the takeover of the Russian oil industry by oligarchs unfriendly to the Western majors which he oversaw; that crisis was a perfect opportunity to paint him as a dictator bent on oppressing his neighbors, especially in the wake of the "colour" revolutions in Ukraine or Georgia. Once that interpretation was pushed unto an unsuspecting public, it took hold - and the Russians, focused on the behind-the-scenes conflict, did little to behave in ways that could have changed that perceptions.

That interpretation of the conflict also had the added benefit of make the US and UK look like the defenders of freedom and markets in Europe, against the weak and compromising French, German and Italians, too cowardly or corrupt to confront the Russians, and too busy coddling their national energy companies against from the "fair competition" of more nimble markets which would otherwise spontaneously create alternatives to Russian gas imports.

By 2009, it was obvious that things were not completely black and white, and the narrative of Russia imperialistically exercising the "energy weapon" against the plucky freedom-loving Ukrainians and other neighbors was not enough to explain things. Europeans, collectively, started taking a harder look at Ukraine's behavior - but they continued to focus almost exclusively on the first conflict, which was much easier to grasp. Russia decided to push its advantage, to push the blame on official Ukraine, and hopefully get Europe to finally pay them something for the gas delivered to Ukraine - thus the much longer cuts that took place in January, and what appeared to be a successful resolution through European loans to Ukraine. But of course, as I predicted then, Ukraine failed to meet the conditions to get that loan (which, contrary to the loans extracted from Russia, they'd actually have to repay), dumping the problem once again in Russia's lap.

Fundamentally, even with the new pipelines Russia is building, Ukraine has a stranglehold over Russia's exports, and can go on not paying for its official gas deliveries, effectively offsetting these with the transit service; and it should be noted that, even with variable prices for natural gas, this is not a bad deal for Gazprom (which know it). So while there is a lot of theater around the first conflict, and continued attempts to change the stable solution that has been reached, this is not an equilibrium likely to change, unless Russians and Ukrainians (which have a common interest there) somehow manage to make the European cough up some money along the way. Thus the continues crises, and the fearmongering about Russia's "energy weapon," which is basically encouraged by Russia to some extent as it seems to give them a bit more leverage and importance in the public eye.

The second conflict is much more intractable, much less subject to the restrictions of traditional diplomacy, and its players are likely to continue to use and abuse the instruments of State they control for their private purposes, thereby creating confusion for international onlookers.

So it is likely that further crises will erupt, and that gas deliveries to Europe will be temporarily shut down, typically in January.

Before going into predictions, an aside: gas consumption is very seasonal, with winter consumption typically double or triple summer levels, which means that quite a bit of storage capacity is needed to smooth out deliveries and ensure adequate supplies through the winter (deliveries in winter are often lower than demand). Most consumer countries - and in particular big importing countries - have significant buffers, and these are usually full at the beginning of the winter, ie when the crises happen. So, other than for a very small number of East European countries that have little storage and fully depend on Russian deliveries, Russian gas cuts have no impact whatsoever on actual gas availability for consumers in most countries, which can simply draw on their stored reserves a bit more than usual.

As a final point of background, and as I have argued many times before, electricity market deregulation in Europe has encouraged investment by players in gas-fired power plants, because they are the easiest and least risky to finance (given that electricity prices are largely driven by gas prices, as gas-fired plants are the marginal cost suppliers most of the time, gas-fired plants are almost always going to be in the market, or near enough, to be viable, as opposed to plants with high fixed costs like nuclear or wind which, unless they benefit from specific regulation, can find themselves making short term losses for longer than investors can afford, even if their long term average price is competitive). Over the past 10 years, Europe has built only two kinds of power plants: wind farms, thanks to the specific renewable energy rules, and gas-fired plants:

So, if one is worried about the gas supplies from Russia, there are two very simple steps fully under our control:

  • change power market regulation to eliminate its proven bias towards gas-fired power plants and limit the growth of European demand for gas, a large portion of which, in the long run, can only be supplied by Russia; pointing a finger at Russia's supposed "energy weapon" when one could very easily be less dependent on gas is a sign of incompetence or a distraction from the other priorities of such energy policies (which are, in fact, a jobs programme for City commodity traders, M&A advisors and associated parasites);
  • for countries that do not have sufficient gas storage capacity, urgently work on building these, or getting permanent access to friendly neighboring countries that may have more favorable locations available; lack of storage capacity may have been a valid excuse 15 years ago for many former Soviet Bloc countries which had built infrastructure predicated on Soviet deliveries, but today it should not wash - and blaming Russia for gas delivery cuts is, again, a distraction from incompetent domestic policies.
So, finally, my predictions:

  • there will be another gas crisis this winter as Russia senses European worries and tries to get the EU to send some money in Ukraine's way, for Russia's benefit;
  • Europe will, once again, ignore the real issue (that Ukraine and Russia have willfully created a parallel gas market, and that their politicians are more busy trying to grab a slice of the loot than to enact sensible energy policies, and will repeat the same tired angry platitudes about the need for Russia (and possibly Ukraine) to behave, and for Europe to be "unified" against this threat (the separate negotiations run by GdF, E.On and Snam will be called inefficient, when they are nothing but; the fact that all of Russia's pipelines go to Europe and they have no choice where to sell their gas will be under-emphasised; the very real protection brought by long term take-or-pay will be ignored - or even undermined)
  • there will be yet more calls for a better European gas market, for further energy deregulation (ignoring that this encourages gas consumption), and for a joint purchasing authority (see here for a recent exemple from a French politician who should know better), without any discussion of how that gas should be split, who should get the presumed (but imaginary, given that current price formulas are already market based) cost savings wrung out of Russia, and who will decide on allocation of shortages, if any;
  • expect shortages to appear again in selected East European countries (ie , in some cases, to be manufactured by local authorities in order to blame Russia), without any discussion of the reality of storage and the lack thereof, and conversely, dark accusations (augmented by London and Washington) about the insufficient lack of solidarity of Western Europe and its cowardice towards Russia, with associated calls for further European subsidies to build new connecting infrastructure (a not completely unreasonable idea) or new nuclear or coal-fired power plants;
  • Russia will play its accustomed role with its usual rigidity, alternating dark threats, accusations of unfairness from Europe, and shameless calls for Europe to pony up money; it will certainly not offer to sell its gas at Ukraine's border, which would dump the transit problem in Europe's hands, but eliminate the possibility of the second market to exist (Europe will not try to offer the same, as nobody is keen to take over Ukraine's gas infrastructure and its associated problems (underinvestment, corrupt managers at all levels, and a legacy of complex contracts to untangle));
  • Ukraine will be, as usual, completely confused, given that the 3 political forces that are fighting it out in Kiev de facto represent 3 of the oligarchic clans that are fighting for the loot. They WILL cut off Europe if Russia reduces deliveries, but otherwise, beyond expecting to get money from the outside, will do nothing to solve the issue or clarify it;
  • in the end, the crisis will come and go with no actual impact on the ground (other than temporary or manufactured ones in select countries), politicians and pundits will huff and puff and pontificate importantly, and will provide no actual solution, because none is needed for the important things (Europe does get all the Russian gas it wants), and none is available for the real loot-capture underneath, which is only to the detriment of Russian and Ukrainian citizens, but who cares about them?

I live in Ukraine and completely agree with you. We, ordinary citizens are nobody needs.

May it be relevant that there is an epidemic of respiratory infections in Ukraine already, before any cuts?
In such circumstance it might be considered inhuman to cut gas supplies. Might that impact on what happens?
By the way, from the window here I can see five gasholders (I estimate capacity 1.5M m3), the total for Birmingham. But it seems these are only a trivial part of national storage. Nevertheless if they all empty could it be a warning of trouble (for others as we ourselves have no gas here)?

Each time this has happened, we've heard UK politicians claiming that we are "being held to ransom" by Russia over the gas. Each time I've thought it's equivalent to a cocaine addict crying when their supply is cut or the price rises or both and saying "my dealer is holding me to ransom". Err, kick the habit ...

In the UK (and the rest of the EU), that can mean wind and geothermal energy. Scotland especially is the EU's Saudi Arabia of wind.

Geothermal Resources

Wind Resources

HVDC links between Iceland, Scotland and Norway would be a good way of connecting the large wind and hydro resources in Northern Europe, eventually as part of a larger grid with the rest of the wind and some nuclear power across central Europe with CSP making a contribution from the south.

A better near term plan is a crash course in insulating (especially externally) and making air tight the UK housing stock. A slightly more expensive longer term plan would be installing solar water heaters and heat pumps on areas outside of the gas network with co-generation installed on suitable sites.

I have three basic points to make on this issue:
1.Europe’s gas crisis is at an end, there is plenty of surplus gas available on the European gas markets, due to the opening of new LNG gas import terminals and the massive drop in demand for gas.
2.Europe’s Energy Security situation has improved as it is now well able to withstand supply disruptions.
3.It is time for Gazprom to stop wasting billions on political pipedreams.'sgascrisis.htm

= Lots of our employers have gone bust and lots of their customers can no longer afford to heat their homes, so....Hooray!, the crisis is over. RIP.?

The rating agency Fitch cut Ukraine's credit rating last Thursday and said a delay in IMF funding coupled with a huge budget gap would lead to more instability, a warning underscored by another state firm seeking to restructure its debts.

Prime Minister Yulia Tymoshenko has already warned a delay in the IMF's release of $3.8 billion this month would make life "extremely difficult" for Ukraine and other ministers have said Kiev's ability to make timely payments for Russian gas could be affected.

GDP contracted more than 18 percent in the second quarter compared with a year ago; and bad loans amount to 30 percent of all lending.

Ukrainian President Viktor Yushchenko today urged Russia to change an agreement on supplies of natural gas whose terms he said were too onerous for the Ukrainian economy.

Reuters quoted Yushchenko as saying: "Keeping the contracts unchanged ... will create potential threats specifically to the reliability of supplies of gas to Ukraine and its transit to other European states"

Yesterday his rival Prime Minister Yulia Tymoshenko said that fees for transit needed to double.

So, plenty of politicing between the two main presidential candidates and two months to go.

I think that these will become yearly events. The north stream will be completed. The gas storage facilities in the Ukraine are the key components to the distribution system. Do you think that the Ukraine, today, represents a "failed state"?

It's party failing - but then it's been partly failing for a long time...
North Stream will be built indeed, but will not change the dynamic that much, as UKrainian infrastructure is still needed.

The latest "Corruption perceptions Index" shows Ukraine as the 146th most corrupt state out of 180 shared with Zimbabwe & Russia, chart and full table at:

Disappointingly for me Britain has slipped to a 11-year low, equal to Japan and just ahead of the US.

Gullibility Index more like. Capitalist countries have long had the benefit of MUCH more sophisticated propaganda because their free market in corruption and PR enables the successful deceivers to become ever more wealthy mega-corporations while the unsuccessful deceivers went bust decades ago.

Thank you for these insights in the dark shadows.

So no one seems to think this is partly a smoke screen for declining Russian natural gas production and that in the words of Matt Simons “Europe is toast, cold toast”?

Well if not, it's good practise..

I don't think it is a smokescreen. While Russian gas production will decline at some point, I think this is still reasonably far away. The capacity to increase exports for a couple decades is there - although maybe not to expand it to the extent some in Europe seem to expect.

How could possibly Ukraine not paying is a smoke screen for Russian production? Two completely different events with no correlation at all.

You underestimate our level of idiocy over here. Few have time or curiosity to question the myths they are peddled by the sources of "information". Blair did after all get voted into office three times.

At the end of the day, in spite of all the chatter about bad Russian behaviour, Russia is subsidizing both Ukraine and Europe. Ukraine gets a much more massive subsidy but Europe still pays less than half the price of oil for gas on a btu for btu basis. Considering that natural gas does not need to be refined even the comparison with oil prices is not fair.

The picture of a naive Europe unaware of Russian-Ukrainian intrigues is utter BS. NATO helped install Yushenko in power (remember the phony exit polls staged by the US, British and Canadian embassies -- they should have done more exit polls in Ohio in 2004) and the loyal stooge Yushenko wants to force Ukraine into NATO even though over 60% of Ukrainians do not want to join. Last year he was busy sending weapons to his NATO wannabe pal Sakashvili to assist in the repression of South Ossetians. The EU report on the August 2008 attack on South Ossetia proves that the EU is playing Washington's game (if it wasn't it would not be spouting off about excessive force when it can't even supply a list of 100 Georgian civilians killed by the Russians when in 1999 NATO killed 3000 Serbs and Albanians in its drive to take over Kosovo).

Russia has every right to cut Ukraine and Europe off from gas supplies for non payment. The sanctimonious European hypocrites should put their money where their collective mouth is and pay for Yushenko's blackmail attempts since they are his backers.

I hope Jerome will address this criticism directly.

It is impossible for me to believe that "Europeans" are "naive" about power plays or corruption (having continuously refined that sort of activity for at least the last 1000 years). Likewise, it beggars belief that the "corrupt clans" of Ukraine stop at the western Ukranian border, or that some Americans (even further west, who learned their trades at the Europeans' knees) know nothing of and do not stand to profit from the disharmony.

Also, most "Americans" (the average citizen, that is) would likely not be anxious to remain in NATO if they had a choice in the matter.

The pawns are not consulted about how they are moved on the Grand Chessboard (The Grand Chessboard: American Primacy And Its Geostrategic Imperatives).

The US and UK had an interest in providing a wrong interpretation of the conflict in 2006 (to distract from domestic problems, and maintain the atmosphere of fear that fans the MIC), and it has stuck, however wrong it may be, because it fits with our past mindsets (the Evil Empire, remember) and is convenient to push further deregulation and Old-Europe-bashing.

Nobody in the public sphere really cares about explaining such a complex topic; it's just spun for domestic or international political advantage.

Hah! I was waiting to see if Z’s work would be referenced in this thread – nice work LNG.

In my library, Chessboard stands right beside Conquest’s, The Harvest of Sorrow:

Alas poor Ukraine. Witness to a legion of horrors, her beautiful people are caught –yet again– in the clutches of a nightmare...

Pawns indeed.

Don't forget that discourse from "Europe" on Russian gas is overwhelmingly driven by the UK and the Eastern countries, which both have a vested interest in fanning the flames of conflict with Russia. France, Germany and Italy have a more reasonable position, but it's portrayed in the dominant media as weak, sold out or self-interested.

But don't forget either that these crises do little for Russia or Russian interests: money is stolen from Gazprom and the Russian State more than from anyone else in the process.


I'm sure that you, as a banker, have a much better understanding of the admonition to "follow the money" than I do. But I think I know a little about this --

If the goal (of European governments) were really to get the most gas to the most people, the arrangements would be very different.

Conflict sells papers and TV viewer time; conflict makes weapons systems and NATO necessary; conflict, or the potential for conflict justifies government surveillance and repression. Conflict is the motive force that generates money. So, follow the money.

And of course, it isn't just gas. Pepper and cloves and silk seemed adequate to "fan the flames of conflict" in times past. Always, of course, with the additional worthy goal of ridding the world of heathen Musselmen.

I notice this comment about Gazprom's ability to obtain sufficient investment funds in the Moscow Times:

Rising Demand to Spur Investment

State gas monopoly Gazprom, which supplies a quarter of the European Union’s natural gas, is unlikely to be able to secure the necessary financing for expansion of its production facilities without reconsidering its investment priorities, said Alexander Nazarov, an energy analyst with Metropol.

“Gazprom will not be able to invest enough. It is too keen on economically inefficient, political projects,” he said.

The IEA report predicts that “increased cooperation between state multinational energy firms” will be necessary to obtain financing and improve extraction technologies.

But Nazarov said the rush to expand supply over the next 20 years could act as a force to depoliticize the energy industry. “Independent producers in Russia may replace Gazprom’s falling production,” he said.

Bah. "Analysts" have been saying for the past 15 years that Gazprom was not investing enough, or investing in the wrong places, and predicting shortages. They have been wrong every single time. Maybe they will be right at some point, but the onus to prove it is on their shoulders rather than the other way round. Gazprom has a pretty striking track record of successfully producing enough gas for all its "ral" need (vital domestic consumption, cash-generating exports) while looking like it doesn't have enough to deliver more gas (because it would have to deliver it for almost free to the wasteful domestic non-vital users)

This is another recent article I found:

Gazprom woes hit Britain

But analysis to be presented this week by energy watchdog Ofgem spells out a far more worrying picture.

Western politicians used to fret that Gazprom could restrict supplies as part of the Kremlin's strategic manouvering.

The concern at Ofgem, expressed in an interview with chief Alistair Buchanan, is far more practical.

Will the Russians actually have the capacity to meet increasing demand for gas in Europe over the next decade? If not, the outcome will be higher prices for us all. 'This is not a comment on Gazprom's management. Or a criticism of Gazprom. It is just a fact. Production investment is down, revenues from Russia are down,' Buchanan said, sitting at a conference table in his Millbank offices.

'I am not questioning that the gas is there or that the gas will come. My question on behalf of British consumersis, when will it come?'

I wonder if Gazprom doesn't run into the same issues that Devon and Cheasapeake Energy run into. It is very expensive to do new investment. Unless prices are quite high, it doesn't make sense to invest in additional natural gas production.

But contributing to this issue is a price issue. I think that the same thing happens with natural gas as with oil above $80 or $85 barrel. At some point the price of natural gas becomes too expensive for society to afford, especially with factory outputs are down and many have been laid off from work. I am not sure where that price for natural gas is--but I suspect it is lower than the price to produce natural gas from some of the more difficult Russian locations.

Nope. The marginal cost of production of gas from Gazprom is still incredibly low, because such a large part of the cost of the transport infrastructure to bring the gas to market and that already exists (new fields are not that far from existing trunk pipelines), and Gazprom has such massive economies of scale.

That Gazprom "wastes" some its surplus rent in inflated costs, political investments or outright corruption does not change the underlying fact.

Gazprom is managing its investment programme to provide for its vital needs: domestic consumption (heat, power) and hard currency exports. If strong arming Central Asian autocrats makes more sense than investing in new fields, that's what they do too.

Excellent article. Very acurate I'd guess. I particularly appreciated your analysis of "free market electricity".

such energy policies (which are, in fact, a jobs programme for City commodity traders, M&A advisors and associated parasites)

You've hit that nail right on the head.

I think this is a short term issue. The fact is the Russians ARE building their new line to Germany. This can't be dismissed out of hand. Secondly, scads of LNG facilities are being built world wide, which will tend to homogenize both prices and availability. Right now it doesn't matter at all about supplies to Europe...prices are very, very low and there exists a huge glut world wide in NG resources, keeping the price low.

If Russia in 5 years brings on even 1 nuclear reactor per year, that's 300 million cu meters a day MORE gas available. Russia is screwed with lower prices and Jeromes predictions only come true if the price is jacked up. Which doesn't appear to be happening.

I agree--price is the issue. If the price is high enough, things tend to work. If price is high enough, there will be shale gas built in Europe, and pipelines for the shale gas. If price is too low, nothing seems to work.

We don't really know what the maximum affordable price for gas is, before recession sets in (or gets worse). It may vary by country. If maximum affordable price is too low relative to production costs, problem can be expected to occur.

I don't think Europe will be free from its dependence on Russian natural gas any time soon. There may be "scads of LNG facilities being built world wide", but there is also rapidly increasing demand in the developing world. I expect there will be very little excess capacity in the next decade as developing nations' appetite for natural gas kicks into even higher gear.

Just look at what the Energy Export Databrowser shows has happened recently in the following regions:

  • Persian Gulf -- Massive growth in production and consumption. Still exporting (for now).
  • Subcontinent -- Self reliant in natural gas until recently. When production peaks they'll be importing a lot more.
  • China -- Just switched from excess production to imports. Insane growth in consumption.
  • Japan -- Always an importer. No decrease in demand during their decade long economic slump.

Except for Japan, these regions are just beginning to build out their infrastructure for consuming natural gas and I wouldn't bet on lower prices for LNG in five years time or in any time frame.

-- Jon

1) Nors Stream doesn't really change the dependence of Russia on Ukrainian transit and storage; again, the underlying issue of the crisis is not the dependency on Ukrainian transit, but the oligarch's games on the rest of the Ukrainian gas business
2) LNG import facilities are being built, but very few new LNG export installations are being built. Once all the Qatari projects come onstream, there will be very few capacity additions in the following 5 years. Most LNG is sold, like pipeline gas, under rigid long term contracts, and spot sales are not, and will not be a liquid market - each one is a complex deal which requires parties with access to the relevant infrastructure: those that do will make super-profits on each such transaction, but these will not be enough to arbitrage away the price differentials
3) European domestic supplies are declining, and Russia's exports have always been constrained by wilful policies of the big Western countries rather than by physical availability. The long term contracts use price formulas indexed to oil prices and this is unlikely to change.


North and south streams are build to avoid Ukraine. After they are build there will be far less dependence on Ukraine to the point where even a complete shutdown of transit through Ukraine would not be as critical.

And storage can be build comparatively easily (no political issues to deal with).

P.S. I liked (sarcasm) that phrase "We've recently heard more veiled threats from Putin about Ukraine...". Threat? :-) How can Putin threaten that Ukraine would not pay? He does not get to decide when or who Ukraine pays or not - all he can do is to analyze situation and at most react to such event. He warned that Ukraine might not be able to pay and that was after conversation with Ukraine government officials. Warning and threatening are semantics of course, but meaning is quite different.

North stream is actually more about avoiding Poland, which has been much more unreliable and painful to deal with than Ukraine. Poland actually uses the pipelines on its territory as weapons (and then goes to cry in the arms of the USA). Ukrainian gas, again, is not about geopolitics, but about large scale money-skimming scams.

In any case, North Stream will be 55bcm/y after phase 2 (28bcm/y) to start with, which is not enough to eliminate the need to use Ukrainian pipelines, given that more than 120bcm/y transit there. As long as more than 20bcm/y need to go through Ukraine on take-or-pay long term contracts, Ukraine will have the possibility to siphon off the gas.

And gas storage in the required volumes (Ukraine can store more than 35bcm of gas) is NOT easy at all to replace. You need to have depleted fields near existing transit infrastructure, and ideally as close as possible to the end market as possible (given the seasonality of consumption).

Hi Jerome,

you wrote:

North stream is actually more about avoiding Poland, which has been much more unreliable and painful to deal with than Ukraine. Poland actually uses the pipelines on its territory as weapons

Could you give some concrete examples for such a situation? Although I agree that Poland has rarely acted cooperative in the Russian gas deals, there has not been even a single case when Poland stopped or restricted gas transit through its territory.

How has Poland been unreliable? How did it use the pipelines as weapons? I think most people in Poland would instantaneously associate the phrases "unreliable" and "pipelines as weapons" with Russia...


First off, thanks for the excellent review of the behind-the-scenes action.

I just came back from Europe, having visited Copenhagen, Budapest and Vienna and I would like give a small review of what I gleaned of the German-Scandinavian view of the situation. It's a little different from the Anglo-American view.

The Scandinavians aren't that dependent upon Russian natural gas supplies and the Swedes spent a lot of time arguing about the potential environmental impact of the North Stream pipeline. Some left wing groups commented that not building it would be a good thing as it would force Germans to come to grips with energy issues. Calmer heads with some international experience prevailed and the Swedes eventually gave the project the thumbs up. (You don't want to make enemies with Germany and Russia at the same time!)

The Germans, of course, are pleased that Sweden and Finland finally signed on to the North Stream project and are looking forward to its completion. This, they imagine, will finally free them from the Ukraine-Gazprom chicanery you have so clearly described.

In Vienna, I asked folks directly what they thought about a potential replay of the gas crisis. To my surprise they were mostly uninterested except for it's impact on economic refugees arriving in Vienna. (Vienna is a major point of entry for Eastern Europeans moving to the West.) The Austrians have a four month supply of gas in storage and, like the Scandinavians, derive a surprising amount of their household heating from either district heating (Fernwärme ~ %16) or biomass (~ %25). Process heating and drying is the other major use for natural gas in Austria for which they use ~ %50 natural gas and ~ %40 biomass.

Also, the Ukranian Swine Flu epidemic broke out while I was there and the German language newspapers made it look like mass hysteria in the Ukraine over this flu and implied that this would have a distinct economic impact. One article, I think in FAZ, even connected the dots arguing that the Ukraine would use this as an excuse to not pay Gazprom this winter.

After this visit, I seem to get the impression that the Russian-Ukranian gas crisis is perceived quite differently and as much less of an acute crisis in the German/Scandinavian language zone than the very simplified Anglo-American version we get in the English language media.


-- Jon

My view on the gas dispute is as follows:

1)Ukraine is going bankrupt and cannot pay its gas bill without external support.
2)Russia needs Ukraine to export its gas, but does not want to bear the full cost of preventing a Ukrainian meltdown.
3)Ukraine uses its position to blackmail Russia and Europe into keeping the cash flowing, getting loans from the IMF without complying with IMF terms, for money which will never be paid back.
4)When Nord Stream is completed Russia will keep the gas flowing to Ukraine, but only in return for full political control behind the scenes.
5)Although the corruption is there, the real issue is what happens when the IMF stops paying.

Good post. Can't say I disagree. Trying to figure what's the final outcome.

From rational choice theory point of view, Bruce Bueno de Mesquita (ppt warning) argues that the following things matter:

1) Who have a stake in the decision and can influence it? As you outline:
1.1 Russian Oligarchs
1.2 Russian officials
1.3 Ukrainian oligarchs
1.4 Ukrainian officials
1.5 European officials

2) What do they publicly argue they want (concrete outcome, not some hopeful dream)?
2.1 Higher prices for gas from Ukraina (how much)?
2.2 Europe to pony up at least 1bn USD to Ukraine
2.3 ?
2.4 No-price hikes from Russia to Ukraine (or that somebody takes on the costs)?
2.5 Secure delivery of gas to Europe at roughly the current price levels?

3) How focused are they on this issue. How salient it is to them? Scale 1 (least) to 10 (most):
3.1 ?
3.2 8
3.3 ?
3.4 6
3.5 4

4) How much persuasive influence (e.g. clout) they can exert (maximally)? 1-10
4.1 ?
4.2 9
4.3 ?
4.4 7
4.5 2

5) Are they resolved towards maximum utility or towards agreement? Agreement~1, Max Util~10
5.1 ?
5.2 7
5.3 ?
5.4 5
5.5 2

Of course, one would have to ask a real expert on Euro-Russo-Ukrainian gas relationships about these.

Then just run a game-theory rational utility maximization monte carlo run on that. Incidentally, Bueno de Mesquita's models are proprietary, not available for scrutiny, but available via paid consulting. Maybe Europe should pony up the $50k minimum and have him model this case. Considering EU probably wastes that much money on MEPs biscuits in a year, I think it would be money well spent :)

I wonder what the outcome would be?

Individual experts are not usually more right on this than chimps throwing darts (ref: Tetlock)

My completely non-expert wild guess is that this will end in brief tears for the Europe. Europe will pony up a 'loan' to Ukraine. My timeline is shorter than getting off gas (infrastructure & policy changes needed 10-25 yrs).

Where else are we going to go with our gas demand? Nabucco is not here, neither is the gas for that (for sure).

Nordstream permits can/could be used for a bit as a bargaining chip, but they are limited due to their non-necessity for Russia and tendency of Nordic politicians towards agreement rather than utility maximization by default.

I'm not an expert on these matters, far from it.

It'd be interesting to hear Jerome's opinion on who has the most clout, focus and willingness to play to the ultimate end game with gloves off? That is, looking beyond this winter and maybe even next.

And yes, Ukrainian/Russian/European citizens do not matter. They have no clout, they don't have a voice, can't exert claims and are not stakeholders. They get what's given to them.

"Nordstream permits can/could be used for a bit as a bargaining chip, but they are limited due to their non-necessity for Russia and tendency of Nordic politicians towards agreement rather than utility maximization by default."

Finland has certainly got utility out of Russia, with timber export tariffs being frozen (and possibly even reduced) and with the eastern end of the pipeline being built in Finland, not in Russia. I do not know what Sweden got, but I am sure there was something for them too.


Thanks again for detailing the many forces at play in this market and the nuances of their positions. The more light we can have on this subject, the better. One question: would more hydropower development allow even higher levels of projected wind buildout? I realize the number of feasible locations is modest, but does the wind industry see this as an overall complementary boon to their long term benefit?