Wall Street Journal
Jan 4 2009

Ukraine Natural-Gas Dispute Intensifies

By ANDREW OSBORN

MOSCOW — Russia’s dispute with Ukraine over natural gas prices
descended into counter claims and legal threats over the weekend, as
six European countries downstream said they had begun to record slight
supply disruptions.

Russia’s OAO Gazprom halted deliveries to Ukraine, a key transit
country, on Jan.1 after talks to negotiate a new supply contract for
this year broke down amid a price dispute.

Since then, Poland, Hungary, Romania, Turkey, Bulgaria and the Czech
Republic have reported slightly reduced supply. Gazprom says it is
pumping extra gas via Belarus and Turkey to ensure supply, while
Ukraine says it is using its reserves to maintain transit volumes. The
EU gets 80% of its Russian gas imports via Ukraine.

The dispute has forced both countries to defend their reputations as
reliable energy suppliers and evoked memories of 2006, when a similar
dispute led to more serious supply disruptions in Europe.

Russia and Ukraine spent the weekend trading recriminations and
lobbying to persuade the international community. Each said the other
was to blame for a shortfall of about 50 million cubic meters that has
apparently failed to reach European consumers over the weekend. That’s
about a sixth of what Russia pumps to Europe every day.

Gazprom said it had got President Dmitry Medvedev’s approval to bring
a case at the International Arbitration Court in Stockholm against
Ukrainian state gas company Naftogaz Ukrainy to ensure unimpeded
transit. In a statement, it said it would file the case "in the near
future." Naftogaz said in a statement it would counter file at the
same court if Gazprom went ahead.

Bohdan Sokolovsky, an economic aide to Ukrainian President Viktor
Yushchenko warned the dispute could trigger more serious supply
shortfalls in Europe in 10 to 15 days if a deal is not struck.

Lobbying efforts centered on Prague and the Czech government, current
holder of the European Union’s rotating presidency. The EU has so far
refused to arbitrate, calling on Russia and Ukraine to settle their
differences bilaterally. An extraordinary meeting of EU envoys is
scheduled for Monday to exchange information on the situation. Russia
says it sees no need for EU arbitration. Gazprom has, however, written
to the European Commission to ask it to monitor the gas supply
situation.

For his part, Ukraine’s President Yushchenko wrote to eight world
leaders on Friday, including President George W. Bush, putting forth
Kiev’s side of the story, according to Ukrainian diplomats.

Ukraine paid $1.5 billion in unpaid bills for 2008 to an intermediary
company that is 50%-owned by Gazprom, by Dec. 31. But Sergey
Kupriyanov, a Gazprom spokesman, told a news conference Friday the
Russian gas monopoly didn’t expect to get the funds until Jan. 11. He
said Ukraine owed a further $614 million in late-payment fines;
Ukraine says it owes no late fees.

In 2006, a similar dispute caused shortfalls in Russian supplies of as
much as 50% across Europe, although a deal was struck quickly under
heavy pressure from EU governments. Russia on that occasion was widely
accused of using gas as a political weapon to punish Ukraine’s
pro-Western government, a charge Moscow denied and has made efforts to
avoid this time.

Late Sunday, face-to-face talks between the two sides had yet to
resume. Talks broke down on New Year’s Eve after Ukraine rejected a
Russian proposal that Ukraine should pay $250 per thousand cubic
meters in 2009, up from $179.50 last year, but around half the price
paid by EU countries. Ukraine was proposing a smaller increase to
$201, but has since said it is ready to pay $235.

After saying on Thursday that it now wanted Ukraine to pay $418 per
1000 cubic centimeters of gas, Gazprom upped the ante again on
Sunday. Chief Executive Alexei Miller said the company now wants
Ukraine to pay $450, equivalent to what its closest EU neighbors pay,
less transit across Ukraine. He said he hoped that price would bring
the Ukrainians back to the negotiating table.

In a statement Saturday, Oleg Dubyna, Nafotgaz Chairman, said
accepting an earlier Gazprom offer of $418 would spark a "humanitarian
catastrophe" in Ukraine. The country’s inefficient Soviet-era domestic
heating systems and industries are heavily reliant on Russian gas
imports.

Ukraine says, however, that its large gas storage capacity is full,
allowing it to weather a cutoff longer than in 2006, when the Russian
cut-off was felt almost instantaneously downstream in parts of the EU.

In recent years Gazprom has raised gas prices towards world levels for
all of its ex-Soviet neighbors, who continued to enjoy heavy discounts
after the break-up of the Soviet Union. Less compliant neighbors, such
as Georgia, now have to pay full price, while allies such as Armenia
pay lower rates. The annual negotiations with Ukraine have been
particularly difficult, however. Moscow has pressed Mr. Yuschenko’s
pro-Western government to pay world prices since it came to power in
the 2004 Orange revolution, while Ukraine has used its leverage as a
critical transit country for Gazprom to reach the rich EU market to
push for more gradual increases.