Russia-Ukraine: A Market Dispute

Are the Russians and Ukrainians simply fated to go to the mat every year about this time, causing grief to their neighbors? Or is something else at work in their antagonism?

The philosophical answer is that, while it's hard to imagine these two former Soviet states living as friendly neighbors any time soon, the current dispute is a separate matter.

It can be reduced to a difference of outlook: Do you expect oil prices to rise to $60 a barrel this year, or to drop back down to between $30 and $40 a barrel? (Oil has surged in the last two trading days to about $46 a barrel because of the fighting in Gaza.)

In Europe, natural gas prices follow oil, and Russia is clearly of the consensus view that oil will average somewhere in the neighborhood of $60 a barrel this year. That corresponds to a natural gas price of about $350 per 1,000 cubic meters. (Here's the loose formula to get the natural gas price: divide the oil price by six, then multiply the result by 35.3).

Hence the claim by Russian Prime Minister Vladimir Putin that the demand by Gazprom, Russia's natural gas behemoth, for $250 per 1,000 cubic meters from Ukraine this year amounts to a "humanitarian gesture."

Ukraine, however, has embraced oil's most recent price band. It's arguing that oil will average $40 a barrel this year, or $235 per 1,000 cubic meters of natural gas. That's precisely what Ukraine has counter-offered to Gazprom.

(As a separate matter, if Europe truly is paying $500 per 1,000 cubic meters, as Gazprom has claimed, it is seriously overpaying. That corresponds to $84-a-barrel oil.)

(Another baffling issue is Russia's claim that it's owed a $600 million late fee on top of the $1.5 billion natural gas bill that Ukraine already has paid. That's a 40% penalty, and Ukraine is only a month late.)

The subtext is the nature of the two countries' contract, which is based not on the spot price of natural gas, or a forecast, but a formula that lags current prices by eight months. In other words, when Gazprom is retorting that it in fact could charge Ukraine $418 per 1,000 cubic meters if it so wishes, that's Russia's estimate of the price of natural gas last May.

In the end, look for the two countries to settle some place in the middle, say at $50 a barrel oil, which would entitle Gazprom to charge $294 per 1,000 cubic meters. But don't be surprised if Ukraine bends a bit more toward Russia's demand than a down-the-middle compromise; indeed, I wouldn't be surprised if Ukraine agrees to Gazprom's offer of $250 per 1,000 cubic meters.

The dispute has more bite than previous rows because of the economic times. Ukraine is in an economic fix, as is Gazprom.

Regarding the latter, Gazprom's troubles go far. It doesn't produce much of the gas it ships to Europe, but markets gas it buys mostly from the Central Asian state of Turkmenistan. In order to obtain long-term rights to that gas, and not have it siphoned off by a covetous West, Gazprom has agreed to pay the Turkmen about $340 per 1,000 cubic meters.

Given market prices, that means that Gazprom might be forced to sell to Europe this year at a loss, unless it unilaterally cuts the price it pays to the Turkmen, who in that case could respond by withholding supplies.

"Gazprom is in a tough spot," says Kenneth Medlock, a natural gas expert at Rice University's James A Baker Institute for Public Policy, who helped me with the calculations for this article. If Gazprom loses the Turkmen supplies, Medlock said, "they are going to have trouble meeting their contractual commitments" to Europe.

Finally, Some Sanity on Missiles

The U.S. proposal to install an anti-ballistic missile shield in eastern Europe appears unlikely to advance under the watch of its conceiver, President Bush. The new Polish government says it won't permit the shield right now because it's not clear that the next U.S. president will want it, and meanwhile it's not worth aggravating Russia.

Bush wants to place components of the shield in Poland and the Czech Republic. Russia's Vladimir Putin has opposed it, and Polish Foreign Minister Radek Sikorski has provided his government's position in an interview with the Polish newspaper Gazeta Wyborcza. They were kindly passed on in an article yesterday by Judy Dempsey at The New York Times.

Poland's shift is gratifying news for those like myself who think that there are so many divisive issues on the table with Russia that there's no reason to add another, especially when the shield is unreliable at best when decoys are used. When the shield definitely works, let's talk deployment.

The Polish position is built on multiple levels. It's tied up with Moscow's plans to build the Nord Stream natural gas pipeline from Russia to Germany, crossing the Baltic Sea and averting nations with which Russia has tense relations, like Poland.

Polish Prime Minister Donald Tusk wants Russia to reconsider Nord Stream. If the gas continues to cross Poland, Russia would find it harder to cut off the country during predictable periods of strained relations. Poland has also raised environmental concerns about installing a pipeline in the Baltic.

Moscow's Red Lines: Kosovo, Missiles and Berezovsky

Russian Foreign Minister Sergei Lavrov has used the occasion of a university speech to lay down an implacable position on some of the most divisive issues between Moscow and the West. It was another indication that Moscow is engaged as much in policy as in image-building as someone no longer to be trifled with.

Here is the first paragraph of the Agence France Press story: Russia will not back down on "red line" issues including the future of Kosovo and opposition to US plans for an anti-missile defence system in central Europe, Foreign Minister Sergei Lavrov said Monday. Read story

And an important quote from the piece: Lavrov said that some were worried by "the rapid rebirth of our country as one of the leading countries of the world. However, this does not mean that it's necessary to think up yet another myth about the Russian threat."

Steve's comment: Lavrov made the remarks today at Moscow State Institute of International Affairs. For those accustomed to negotiating with Moscow, whether during the Soviet or post-Soviet period, it is nothing new for it to "stick to our position until the end," as Lavrov put it.

Its immovable positions, he said, include a refusal to hand over Andrei Lugovoi to Britain in the case of the Alexander Litvinenko murder, rejecting Kosovo independence unless Belgrade itself agrees, and opposing Washington's plans to install an anti-missile shield in Poland and the Czech Republic (on the last item, one wonders about the hulabaloo on either side over an as-yet unproven system).

Lavrov also resurrected Moscow's chagrin over Britain's sheltering of oligarch Boris Berezovsky, whom he called one of several "odious characters" from Russia living there.

As a whole, these do not differ fundamentally from postures Russia has taken previously during the post-Soviet period. What is different is that it appears unlikely this time to shift position. And that appears to be as much show as principle.