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COHEN: Russia's gas war

By Ariel Cohen | Tuesday, January 13, 2009

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Despite feverish negotiations with participation of the European Union, Russia and Ukraine failed to agree on resolution of the gas dispute between them. Mutual disdain escalated haggling and acrimony between leaders in Moscow and Kiev to hysterical pitch.

With 11 people frozen to death, and tens of thousands shivering, this is a humanitarian disaster caused by the worst energy crisis in Europe since the 1973 Arab oil embargo. Whole towns in Eastern Europe remain without heat. Not surprisingly, Russia is losing its reputation as a reliable supplier of gas, and Europeans are hopping mad.

The clash is over the price of natural gas as well as over geopolitics. Russia, a major exporter, wants top dollar. Ukraine, an importer - but also the site of a key pipeline delivering Russian gas to the rest of Europe - wants bargain prices and higher fees for transit.

On Jan. 1, 2009, things turned ugly. According to the Russian state-owned monopoly Gazprom, Ukraine owed more than $600 million in penalties for late payments. That's when Russia began reducing gas supplies to Ukraine amidst frigid temperatures: 10 degrees Celsius lower than average. The initial reduction affected six countries. Today, the crisis extends to 13 countries from the Balkans to the Baltics.

With temperatures as low as zero Fahrenheit, the demand for heating is growing, mitigated only by declining industrial production. Ukraine used to pay for gas way below Europe's market prices, while Kiev is trying to deny Russian accusations of siphoning off gas earmarked for the Europeans. But Moscow's demands go beyond greed.

The crisis is about more than gas, though. Ukraine is a key energy transit state. Moscow is also signaling the Ukrainians, Europe and the United States that Ukraine should remain within the Russian sphere of influence, and NATO is a no-no.

The crisis demonstrates Europe's strategic dependence on Russian gas. In the long term, the situation must change, to keep Europe from falling hostage to Russia.

Russia has long used energy as a geopolitical weapon. And Ukraine left itself vulnerable by failing to diversify its energy basket away from the cheap Russian gas, clean up corruption, and modernize its own energy sector. Today, Ukraine consumes as much energy as Germany, but produces only 10 percent of German GDP.

Worse, Kiev failed to develop a coherent policy toward its Russian supplier. This is because shady intermediaries, like Swiss-based RosUkrEnergo, in charge of sales of the Russian and Turkmen gas, allegedly greased palms of senior officials in both countries until October of 2008.