Ukraine and Russia: The Role of a Middleman

Russia has prickly relations with several of its neighbors, but all pale in comparison with its friction with Georgia and Ukraine. Last August, the former resulted in a full-fledged war, and pessimism about the security of the U.S.-backed oil and natural gas corridor connecting the Caspian Sea with the West. Now, the latter -- Russia's long antagonism with Ukraine -- is provoking a similar recalibration of energy security, this time about natural gas supplies to Europe.

I have pointed out the pricing dispute that's raised the temperature between Russia and Ukraine. But Ed Chow, whose activities in Russia on behalf of Chevron in the 1990s I recounted in The Oil and the Glory, thinks something more is afoot. Namely, Chow thinks the issue separating the sides is at least partly who personally stands to gain from a new deal.

Chow and Jon Elkind, another veteran of the 1990s diplomatic conflict with Russia over the Caspian as a member of Bill Clinton's National Security Council, detail the underside of the Russia-Ukraine natural gas game in the latest issue of the Washington Quarterly.

The article notes the role of an opaque middleman company called RosUkrEnergo in the deal. We have discussed RosUkrEnergo at O&G; The Wall Street Journal's Glenn Simpson has done the best ground-breaking work on the company. Half-owned by Gazprom and two Ukrainian businessmen, RosUkrEnergo is the equivalent of a maitre d' who performs no principal role but controls access to the best tables. RosUkrEnergo owns no gas, or pipelines, yet earns a flat 20% take off the top of all the gas sold by Russia to Ukraine.

RosUkrEnergo takes that gas, and sells it. That amounted to a staggering $4.3 billion in proceeds to RosUkrEnergo in 2007, according to Chow and Elkind. How that money is divided has never been explained.

In a phone conversation, Chow notes that Gazprom and Ukraine at one point were just $15 apart in their negotiations -- Russia was demanding $250 per 1,000 cubic meters of natural gas this year, while Ukraine was offering $235. "If that was the only difference, why couldn't they make a deal?" Chow asks. "I suspect the difference was the role that RosUkrEnergo would play."

Chow and Elkind call RosUkrEnergo "shady." "The company’s role is a political bone of contention in that an entity with no assets, no track record, and no transparency was placed at the very center of the Ukrainian gas economy," they write.

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.

The Shadowy Game of Natural Gas

Russia is again threatening to cut off natural gas supplies to Ukraine. It says the reason is accumulated debt on the part of its neighbor. Gazprom, the Kremlin’s stalking horse, says Tuesday morning is the deadline – pay $1.5 billion, or lose a quarter of your supply. Talks are supposed to be going on in Moscow.

No one is opening up his accounting books, so we don’t know the true state of affairs on the two countries’ balance sheet. But there are enough dribs and drabs to get a picture of what’s at least partly going on.

This partial answer is Rosurkenergo. An entirely opaque go-between company – half-owned by Gazprom, and the other half by Ukrainian businessmen – Rosurkenergo buys natural gas from Turkmenistan sells it on to Ukraine.

Ukraine says it will pay off whatever debt it owes if the deal with Rosurkenergo is severed. But last week, a Gazprom official named Ilya Kochevrin told the Financial Times that, if that happens, Ukraine should expect a steep hike in its bill.

That line is probably not straight out of Mario Puzo, but it could be. One might rationally ask why a joint Gazprom-Ukrainian company is more capable of negotiating cheap gas than Gazprom and Ukraine directly.

One thing to note is that it has seemed that the Kremlin is attempting to get a lot of its financial house in order before the ascension of Dmitri Medvedev to the Russian presidency in next month’s elections.

Vladimir Putin, for example, has been peripatetic in his efforts to get Gazprom's pipeline deals with Central Asia and Europe sealed fast.

It’s also been a principal suspicion in the recent arrest of Russian mobster Semyon Mogilevich, an internationally hunted fugitive who lived for years in plain sight in Moscow before Russian authorities miraculously charged him last month with tax evasion. Mogilevich has been linked as a possible shareholder in Rosurkenergo, which if true could mean that his arrest was related to the company, and how and with whom the proceeds are shared.

This is all Kreminology. At the intersection of commerce, crime and geopolitics, such questions in the end get resolved. But what of the collateral victims, such as Europe? Gazprom claims this is just between Russia and Ukraine, and has assured Europe – which receives 80% of its Russian gas through Ukraine – that its supply won’t be affected.

Does anyone really believe that Ukraine won’t pass on the crunch to Europe in order to build up leverage?

Photo: dbking
Rights: Creative Commons

The Trouble With Being a Mobster

The Semyon Mogilevich story is becoming more intriguing. Over the weekend, Cathy Scott-Clark and Adrian Levy at the Guardian in London weighed in with a long piece linking the notorious alleged mobster to the assassination of former Russian intelligence officer Alexander Litvinenko.

Mogilevich, who has been on the FBI most-wanted list for years, was arrested last Thursday on tax charges in Moscow. Russian authorities said they had long been looking for Mogilevich, who has lived for years in plain sight in the Russian capital. There is much conjecture on why he was arrested just now. Some of it involves supposed efforts to unwind the shadowy natural gas trade between Russia and Ukraine, in which Mogilevich appeared to have a role.

The Guardian story is quite an involved piece of journalism. The top half is background, but it then picks up with a tale of Litvinenko investigating Mogilevich, who according to the piece griped about it to his FSB pals, who got angry at Litvinenko … well, you get the picture. It all ends with Litvinenko having polonium 210 dropped into his tea in November 2006.

I have to note the remarkable coincidence of two huge Mogilevich stories breaking at precisely the same time. First his arrest, and now the accusation of involvement in one of the biggest murder cases of recent years.

One can be certain that the FSB is scouring its voluminous unsolved case file for items to hang on the unsympathetic Mogilevich.