Ukraine will pay its $2 billion Russian gas bill

In what is becoming an unpleasant New Year tradition, Russia again threatened to cut off Ukraine's gas supplies if the struggling post-Soviet state failed to pay off at least $2 billion in arrears by Dec. 31.

By Tuesday evening, Ukraine appeared to have averted a cutoff by borrowing money from the country's two biggest state banks. A spokesman from Russia's state gas monopoly, Gazprom, said that no money has been received yet.

Even if the immediate crisis is resolved, the underlying tensions between Russia and Ukraine remain – and could result in another standoff later.

Ukraine is floundering amid financial paralysis and is racked by political conflict between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko. Europeans are watching developments closely, worried that any extended cutoff of the main energy artery between Russia and the West could leave them facing serious disruptions this winter.

Europe depends on Russia for some 40 percent of its natural-gas consumption, and most of that arrives via a Soviet-era pipeline through Ukraine.

Gazprom, itself requesting a government bailout, insists that the Ukraine dispute is purely commercial, and has appealed to Europeans for "understanding." Some Ukrainians, however, claim there is a political subtext to Russia's demands and warn that the Kremlin's real target is their government's aspirations to join NATO and draw Ukraine closer to the European Union.

"The Kremlin is showing that we can be rewarded for good geopolitical choices, and punished for bad ones," says Alexei Kolomiyets, president of the independent Institute of Euro-Atlantic Integration in Ukraine's capital, Kiev. "Energy supplies are the main instrument of pressure upon us, and we are left with very few options. It's quite possible that there can be interruptions in the gas supply to Europe in coming weeks."

Mr. Kolomiyets points to Belarus, a Russian ally granted a significant price cut this week on its already subsidized rates for Russian gas, as an example of how some are rewarded for making the "right" choices. "We hear that the Belarussian Parliament will recognize the [Russian-sponsored] republics of South Ossetia and Abkhazia in Georgia," in return for being given a favorable gas deal, he says. "This is an obvious object lesson for others."

But Russian experts allege it's Ukraine that's complicating the issue, by pursuing anti-Moscow policies while enjoying subsidized Russian gas. "Russia doesn't want to influence Ukrainian politics," Kremlin-connected analyst Gleb Pavlovsky told the independent Interfax news agency Monday. "The Russian position is simple: Get the money, step back, and leave Ukraine to its own devices."

Prices for Russian gas spiked this year to some $500 per thousand cubic meters, although Ukraine, which depends on Russia for 75 percent of its gas, has until now paid less than half the European price. Russia's point of view is that Ukraine needs to clear its arrears and begin paying market rates. The Kremlin says Ukraine, which received an emergency $16.5 billion loan from the International Monetary Fund this fall, ought to be able to cover its debt to Moscow.

"The problem is aggravated this year by several factors," says Konstantin Zatullin, deputy chair of the State Duma's commission on the Commonwealth of Independent States. "First, Ukraine really lacks the means to pay. Second, the Ukrainian political system is on the verge of collapse. And the Ukrainians seem to be in no mood to hold constructive talks on ways to resolve the problem."

In the short term, Russia has few alternatives. If Gazprom attempts to halt Ukraine's gas supplies, it faces the likelihood that Ukraine's state energy firm Naftogaz will start siphoning gas from the pipeline as soon as its stored [and unpaid-for] reserves of Russian gas run out, which could happen as early as mid-January. When this occurred in previous years, the shortfall was passed on to downstream European customers. Another option being discussed in Moscow is a total halt in gas supplies through the line, which would punish Ukraine but face Europe with crippling shortages.

"Gazprom has attempted to explain things to the Europeans, and to seek their understanding, but these efforts haven't been very successful so far," says Valery Nesterov, an energy expert with Troika Dialog, a Moscow investment bank. "Europe is egoistic. They're interested in receiving stable deliveries of gas, and if they don't they'll blame the supplier. This is Russia's dilemma."

In the longer perspective, Russia is sponsoring two new pipelines to Europe that will bypass potential problem countries such as Ukraine, Poland, and the ex-Soviet Baltic states. Nord Stream, an undersea Baltic route promoted by both Russia and Germany, is due to open in 2011. South Stream, under the Black Sea, will eventually deliver Russian gas directly to southern Europe.

Moscow may also hope that a new OPEC-style natural gas cartel, launched at a forum of gas-exporting countries in Moscow last week, will be able to decouple the price of gas from that of crude oil, which has plunged by two-thirds in recent months.

Since most gas supplies are delivered via expensive dedicated infrastructure and under long-term contracts, it's uncertain how effective the group, which includes Iran, Qatar, Libya, and Venezuela, might be in any short-term efforts to control the market.

But Russian Prime Minister Vladimir Putin made Russia's intentions clear.

"The expenses necessary for developing fields are rising sharply," he told the forum. "This means that despite the current problems in finances, the era of cheap energy resources, of cheap gas, is of course coming to an end."