2006 Review:No more Mr Nice Guy - Russia played gas hardball in 2006

By Stefan Korshak Dec 28, 2006, 18:39 GMT

Kiev - It was supposed to have been just good business, a permanent energy supply immune to politics.

Moscow's invasion of Afghanistan, the reunification of Germany, and indeed the break-up of the Soviet Union never cut off the flow of Russian natural gas to Europe.

Last January did. Since then, an aggressive Kremlin has been

driving increasingly hard bargains with its customers, especially the ones unfortunate enough to live next door.

Ukraine was the initial target. By the end of 2005, talks on natural gas prices to Ukraine were deadlocked. The Russian position, enunciated by Russia's steely-eyed President Vladimir Putin, was blunt: 'Ukraine should pay market prices, just like everyone else.'

The Ukrainians demurred, pointing out that if Russia jacked up the price a good deal beyond what they were paying - 60 dollars per thousand cubic metres - the Ukrainians could always cut Gazprom off from its cash cow, Europe, in retaliation.

Russia provides the European Union 24 per cent of its gas, paying Gazprom, the Russian natural gas monopolist and Russia's largest company, more than 70 per cent of its earnings. Eighty per cent of Gazprom's gas travels to Europe via Ukrainian pipelines.

The clock ran out at midnight sharp on January 1, 2006. Gazprom reduced the gas volumes it was pumping into Ukrainian pipelines, declared it was no longer selling gas to Ukraine, and claimed it was continuing to supply gas only to its European customers.

The Ukrainians were ready. Declaring it had no intention of sending Russia's gas through its pipelines for free, Kiev siphoned a percentage of the gas destined for Europe as transport fees.

As a result, during the 48-hour crisis, Germany, Austria, Hungary, Poland, Serbia-Montenegro, Romania, Italy and France all reported decreases of up to 30 per cent in their flows due to Ukrainian siphoning (Russian position), or Russian failure to send enough gas (Ukrainian position.)

Ukraine - the country targeted by Russia for a gas embargo - experienced no fuel problems.

The Russians and Ukrainians eventually agreed on 130 dollars, roughly half what Europeans pay. The pro-Russian wing of Ukrainian politics won control of the next parliament in March, and by October had inked a deal with the Kremlin for a moderate price rise in 2007.

The gas story had a less happy ending in Georgia, where a pro-US government regularly criticized Russian foreign policy in general, and Russian gas pricing in particular. Unsurprisingly, as 2005 drew to an end, Russia said the price of gas to Georgia was to increase from 60 to 110 dollars.

The Georgians angrily refused to pay. For unknown reasons, but with extremely good timing for Gazprom negotiators, a pair of January bomb blasts broke the two trunk pipelines carrying Russian gas to Georgia.

Europe meanwhile, was again experiencing shortages of Russian gas, this time because record low temperatures in Siberia reduced gas volumes produced by Gazprom.

The Georgian capital Tbilisi froze, to say nothing of less-well- provided Georgian provinces. Eventually the pipeline was patched, and the Georgians agreed to 110 dollars. But that was just for 2006 - by the end of the year Gazprom had announced it intended again to double the price to Georgia to 230 dollars.

Even the Kremlin's best friends have not been immune from the Russian gas weapon. Aleksei Miller, Gazprom's CEO, in July announced Belarus would no longer enjoy its favourable 46-dollar gas price, and in 2007 pay at least 130 dollars.

The authoritarian Belarus government, one of Russia's few true allies, was livid, and charged Miller with 'betraying the trust between Slavic brothers.' Miller's subordinates, unintimidated, by October were saying 200 dollars was the right price for Russian gas sold to Belarus.

Belarusian president and undisputed leader, former collective farm boss Aleksander Lukashenko, in recent weeks has lashed out at the proposed hikes, creatively suggesting the creation of a 'pipeline OPEC' with Ukraine to dictate gas transportation prices to Gazprom.

Monopoly of course is not an idea lost on the Russians. Valery Yazev, head of the Russian Gas Society, called a Russian-led 'gas OPEC' able to dictate natural gas prices 'an absolutely sensible business idea.'

Nor are Russia's close neighbours necessarily the limit, for Gazprom's hardball tactics. Russian media in November reported Gazprom planned 14-per-cent price hikes to Europe for 2007. Gazprom executives so far have not commented on that particular report.

All over Europe, as 2006 counts down, 'energy diversification' is a hot topic. Nuclear power, from London to Warsaw, is suddenly quite a popular idea.