Russia cuts gas to Ukraine. But will Moscow take the bigger loss?

Kiev owes Gazprom billions in unpaid gas bills. But the Ukraine-Russia gas wars have taken a toll on Europe's confidence in Russia as an energy supplier.

And so begins the third major "gas war" between Russia and Ukraine in the past decade.

Russia shut off the gas tap to Ukraine today, exercising its nuclear option in its long-running row with Kiev over the price of energy. The Kremlin's state-owned monopoly Gazprom is seeking payment of nearly $2 billion in debt, as well as Ukraine's agreement on a new, higher unit price on gas shipments.

Unlike the first shutdown in 2006 and the much more bruising standoff in 2009, this gas fight comes amid circumstances that more closely resemble a real war. Russian-armed rebels in eastern Ukraine are still holding off Kiev's forces and threatening to break up the country, and Moscow is demanding tough political concessions from Kiev.

But Russian experts say that, like the previous gas wars, the current conflict – and its attendant threat of downstream cutoffs to Europe – is likely to damage Russian credibility as a reliable supplier and further spur Europeans to diversify away from Russian energy sources in the longer run.

'No trust on either side'

Concerns over alienating European customers are probably the main reason Moscow has twice extended its deadlines to shut off Ukraine's gas, and offered Kiev a series of discounts and concessions that would permit Ukraine to pay about the European average for its Russian gas.

Ukraine balked at those terms in last-ditch talks over the weekend, leading Gazprom to implement what it calls a "prepayment" scheme, in which Ukraine will receive only as much gas as it has paid for in advance. Since that is currently zero, Gazprom CEO Alexei Miller told journalists Monday, that's the amount of gas Ukraine is going to get.

Both sides say they are taking their cases to the arbitration court in Stockholm.

Moscow has always won its gas battles with Ukraine in the past, largely because Kiev is dependent on Gazprom for about three-quarters of the gas that powers the country 's notoriously inefficient heavy industries and heats its homes in winter. Despite financial backing and moral support from Europe and the US, Ukraine doesn't have a solution that would wean it from the Russian gas tap any time soon.

Gazprom claims that Ukraine owes $4.5 billion for supplies delivered over the past several months, and promises a discount of 20 percent if Kiev pays promptly. It says it has offered to sell gas to Ukraine for $385 per thousand cubic meters [tcm], or about the European average, but says Ukraine insists on paying the $268 per tcm that the pro-Moscow former President Viktor Yanukovych negotiated last December.

Experts say there is no way the new pro-Western government in Kiev will get the discounts granted to Mr. Yanukovych in return for pledges of political loyalty. They also say Russia is unlikely to come down much below the average European price, in part due to fears that Ukraine will sell the cheaper gas on to European consumers.

"This is a tough struggle, and there is no trust on either side," says Alexander Konovalov, director of the independent Institute of Strategic Assessments in Moscow. "Both sides are pushing to the limit, trying to use the gas row to maximize their advantages in a much wider conflict. For now there is no urgency in Ukraine, because all of the Soviet-era gas storage depots built in Ukraine are full, and the season is mild. So this tug-of-war could go on for quite awhile."

Europe in the middle

As usual, it's Europe that's likely to be caught in the middle. The European Union gets about 30 percent of its gas from Russia, but some countries in eastern and central Europe are completely dependent on Gazprom's supplies. Almost half of that gas is delivered in pipelines running through Ukraine, and could be vulnerable to being siphoned off – as Moscow accused Kiev of doing in the previous conflicts.

Interim Ukrainian Prime Minister Arseniy Yatsenyuk warned Ukrainians over the weekend to prepare for a Russian gas shutdown, saying that "this is not about gas" but rather "a general plan for the destruction of Ukraine." On Monday he tweeted defiantly that Ukraine "won't continue subsidizing Gazprom [to the tune of] $5 billion annually, so that Russia can arm itself against us [with this money]."

Mr. Yatsenyuk also urged European leaders to block Gazprom's SouthStream pipeline project, which would run under the Black Sea to southern Europe, bypassing Ukraine. Under US pressure, Bulgaria has already agreed to suspend construction on the pipeline, leaving Russia scrambling for alternative routes.

Gazprom has been working for some time to cut Ukraine out of its gas pipeline system. It partially succeeded with the opening of Nord Stream under the Baltic Sea three years ago, which now carries most of the gas exports to Russia's most important European customer, Germany.

The longer the dispute goes on, experts say, the more it's likely to radically change the world's energy markets. Russia's frustrations with Ukraine, in part, have already led it to pivot eastwards toward growing [and less politically charged] markets in Asia, particularly China. Europe, potentially burned by yet another Russia-Ukraine gas shutdown, will inevitably step up its search for alternative sources, perhaps even shale gas from the US.

"Everyone is retrenching, looking for different ways to meet their energy needs. In particular, Ukrainian leaders urgently need to focus their minds on how to get by with less Russian gas," says Mr. Konovalov. "At the end of the day, Russia will probably lose the most. But it's probably going to be a long, and very wrenching, gas war for everyone."