Strain in the EU-Ukraine-Russia Energy Triangle

Ukraine’s current tug-of-war with Russia over the pricing of its Russian gas imports should be watched closely by the EU, which receives 20% of its gas supply via Ukraine and which suffered record supply disruptions in 2009, the last time a similar price dispute escalated. After having accepted Ukraine into its Energy Community in 2011, the EU is rightly making further financial and diplomatic support conditional on Ukraine liberalising its domestic gas market. Those reforms, however, run counter the interests of well-connected local business magnates. Coupled, with EU concerns over the jailing of Ukrainian opposition leader Yuliya Timoshenko, Ukraine’s resistance to reforms is cornering it into a difficult negotiating position with Russian Gazprom, which may well gain a stake in Ukraine’s gas transportation system (GTS) in exchange for a discount. Alternatively, Timoshenko’s release towards the end of 2012 may lead the EU to counterbalance Russia’s growing leverage. In any case, however, vested interests are likely to continue hinder the liberalisation of Ukraine’s domestic gas market, the only credible way to reduce energy security threats to the EU stemming from periodic Ukraine-Russia tussles.

Policy Implications

• Economic and political integration with the EU remain widely popular, long-term goals for Ukrainians. The local business elite also needs better access to European export markets. The EU needs to leverage its appeal to spur Ukraine towards making its gas sector more efficient and transparent. Such reforms would reduce energy security threats for the EU by reducing the likelihood of future Russia-Ukraine tussles.

• Ukraine’s well-connected business interests will likely continue to resist the liberalisation of the domestic gas market, and any progress in that direction will be tentative and half-backed. If reform progress will be insufficient to allow for European involvement in upgrading Ukraine’s GTS, the country will face even greater financial dependency on its Slavic big brother.

• Given uncertainty over Ukraine’s ability to liberalise its gas sector based on European principles, the EU needs to prepare for Russia’s expanding control over that sector, as well as over gas transit routes more generally. In this context, it is prudent for the EU to continue promoting alterative sources, such as LNG imports and, in the longer term, European shale gas.