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The Other Gas Crisis

December 29, 2005

M. Ron Wahid

Driving to New York City this holiday season? What if you couldn’t drive through New Jersey because that state and New York had been unable to agree on the tolls at the Lincoln Tunnel? That’s not a bad analogy for what is happening right now, as winter sets in, between Russia and Ukraine in their dispute over the pipeline bringing Russian gas to Europe and to Ukraine itself.

The pipeline passes through Ukraine, but Ukraine has refused to agree to a 2006 rates schedule, even with the New Year fast approaching. This commercial brinksmanship helps no one and has already hurt Ukraine.

It doesn’t make sense as a negotiating tactic on a Manhattan transit strike; it makes even less sense for two developing nations struggling to achieve economic growth and attract Western investment after 70 years of Soviet Communism.

Russia holds the world’s largest gas reserves and is the second-largest oil exporter. Up to 80 percent of Russia’s gas exports to Western Europe pass through Ukraine, and this accounts for about 25 percent of Western Europe’s supply of natural gas.

The two sides had originally agreed to sign an agreement by July 1 on gas rates for 2006. But Ukraine’s strategy was evidently to delay. Aleksey Ivchenko, head of the Ukrainian gas company Naftogaz, was reported by Kommersant Ukraina in October to have said, “We shall wait until the end of the year and then if Gazprom will not sign with us the agreement on the transit of gas, we shall begin technical seizure [of the pipeline].”

The Russian company Gazprom’s original proposal was for a gradual gas price increase, leading to eventual full market rates for its Western European customers. With soaring world prices, however, that rate is no longer economical. Ukraine’s delays, therefore, did nothing but raise the cost of gas to Ukrainian customers. Ukraine’s refusal to negotiate a fair agreement in the summer has seriously hurt its economy and now raises the specter of an energy crisis in Europe this winter if the parties cannot agree on a rate for transit of gas.

More generally, this kind of attitude hurts Ukraine’s reputation in its efforts to attract Western investment. No foreign investor wants to worry about whether it can protect its investment in the event of adverse commercial conditions.

Consider the issue also from the perspective of international politics. If Ukraine continues to balk at reasonable terms for passage of gas, the logical alternative is a pipeline through Belarus, Europe’s last dictatorship. Is this truly in Western interests? Further east, recently, Kazakhstan inaugurated a new oil pipeline to China, a rapidly expanding market. So it is in the interests of all countries in Europe, as well as the United States, to keep oil and gas flowing smoothly on commercial terms to the West.

Commerce in hydrocarbons cannot easily continue if one country uses the simple fact of geography to exact exorbitant fees from users of the pipeline in other countries. The United States solved this problem in 1787 through the Commerce Clause, prohibiting any one state from interfering with commerce between the states. Ukraine has a clear right to a toll for the passage of gas across its territory; in recent years, Ukraine has essentially agreed to barter access to its territory for below-market prices for gas. That’s a logical outcome. But gaming the system will tempt other countries to do the same, leading to higher oil and gas prices for all consumers.