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Analysis: Kiev-Moscow pipeline impasse

By PETER LAVELLE

MOSCOW, Nov. 22 (UPI) -- Russian and Ukrainian negotiators again failed to reach an agreement on natural gas supply contracts for 2006 in the latest round of talks in Kiev this week.

Russia's energy giant Gazprom wanted a three-fold price increase and payment for gas deliveries in cash. Because almost all of Gazprom's exports transit though Ukraine, Gazprom's Ukrainian counterpart, Naftogaz, has considerable leverage over any agreement. In the end, there will be a compromise due to interdependence.

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Gazprom's agenda for a new natural gas contract with Ukraine includes abandoning the current barter system of payments for gas transportation services, as well as demanding Russia's western neighbor pay the same price for natural gas as its European customers -- $150 tcm versus the current $50 tcm of natural gas sold to Naftogaz. Needless to say, Ukraine is balking at the terms.

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In 2004 Ukraine's natural gas consumption exceeded 70 bcm while domestic production was only 20 bmc. Gazprom covered part of this deficiency by providing Ukraine 29.2 bcm as payment to Naftogaz for transportation services.

Ukraine's natural gas consumption is anything but ordinary. In absolute terms, it is the fifth-largest consumer of natural gas after the United States, Japan, Russia and Germany. However, given the size of these economies by gross domestic product are at least 10 ten times larger than Ukraine, the country's natural gas consumption is nothing less than tremendous. In real terms (in a calculation of 1000 m3 for $1000), Ukraine is the largest consumer of natural gas in the world.

Ukraine's addiction to cheap natural gas is a Soviet legacy and a policy area neglected by the country's political elite since it gained independence in 1991. Prior to independence, oil and natural gas imports were cheap, usually wasted and stimulated energy-wasting industries, such as heavy machinery, steel production and chemicals. The state's continued energy subsidies also damage Ukraine's external trade; exports are often under investigation for violating anti-dumping laws.

Until the authorities address this issue, Ukraine has no choice but to push for cheap energy from Russia and, to some extent, Turkmenistan. Ukraine has shown interest in increasing gas imports from Turkmenistan, but the latter's gas must use Gazprom's pipelines to get its product to market. Gazprom has no incentive to promote this relationship.

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Ukraine's competitive advantage in dealing with Gazprom is its geographic location. The firm transits its natural gas through Ukraine to sell in other foreign markets. Naftogaz is key to Gazprom's international operations and this is the leverage Ukraine has in any agreement over the price it pays for Russia's natural gas, as well as transit fees.

Gazprom's dependence on Ukraine is almost absolute. It earn most of its income from exports, and its main export route runs directly across Ukraine. Naftogaz has an extensive network of pipeline corridors that come to an end in Europe. Gazprom shipped 138 bcm of its total European exports of 153.2 bcm through Naftogaz pipeline system in 2004.

In an effort to go around Ukraine, Gazprom plans to build a pipeline that will link the Russian port of Wyborg and the town of Greifswald in northeastern Germany, running underwater for almost 744 miles. It will initially provide gas to Germany, and offshoots may subsequently be built to link it with several other countries, including Britain. The pipeline is forecast to deliver 20 bcm of natural gas a year, a trifle compared with its present total export regime.

However, with Europe's growing gas consumption continuing to increase it is extremely unlikely Gazprom will be in a position to bypass Ukraine as a transit point for decades to come and the Ukrainians know this.

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In the end, neither Ukraine nor Russia has much room for maneuver. In the end, Ukraine will have to pay a higher price for gas imports and Gazprom will pay higher transit tariffs. Neither can afford to be a net loser in these negotiations.

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Peter Lavelle is a Moscow-based analyst and writes political commentary for RIA Novosti.

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