The latest escalation of tensions between Russia and Ukraine occurred earlier this year, resulting in disruptions in gas flows out of Russia to Kiev. However, this time, there are a number of clear differences which have potentially altered how Russia has approached the situation, as well as how Europe has reacted. As a result, for a large part of 2014 UK and European gas prices were in decline, despite the threat to supplies. Now, winter is coming, and debts have to be paid.
Relations between Ukraine and Russia have been in flux since the dissolution of the Soviet Republic which created the two states. Issues over land ownership were a major point of contention, as it has been in the latest dispute, with the unrest in Crimea being a focus. However, there were also issues over international allegiances; the relations worsening the closer Kiev has come to Europe and other western nations. Throughout this, there have been a series of disputes between Russia and Ukraine over gas supplies. On the surface these have been focused around payment, with Russian energy giant, Gazprom, often claiming Ukraine is in arrears. Though given the timing of the disagreements they almost certainly have a political dimension as well. Disputes and disruptions in supply were almost annual between 2006 and 2010, but there had been virtually no issues over supply during the tenure of pro-Russian Viktor Yanukovych as President of Ukraine between 2010 and 2014. These disagreements have garnered increased international focus, as any disruption in flows to Ukraine threatens European supplies. An estimated 50 per cent of the gas Europe receives from Russia flows through Ukraine (see Fig. 1). Previously, when Russian exports to Ukraine have been cut, even though Moscow has indicated that it is willing to meet contractual obligations to Europe, gas has still been ‘lost’ in transit.
The two main disruptions in European supplies through Ukraine occurred in 2006 and 2009. In both cases this resulted in a price reaction. In 2006, when the price swings were perhaps at their most evident, the importance of Russian exports to Europe at the time was highlighted twice. The first when Russian flows through Ukraine were reduced, and later in the month when cold weather forced Russia to cut exports to protect domestic supplies (see Fig. 2).
The twin price spikes in 2006 highlight one of the most evident differences between the 2014 dispute and earlier disagreements, that of heating demand. All other notable events have been at the height of winter, or close to it. This being the peak gas demand period, any cut in supplies will have a larger impact than other times of the year. In 2014, flows to Ukraine were not cut until mid-June, when demand across Europe was at a seasonal low.
Storage is another strong difference. Across Europe, storage stock levels ebb and flow with the seasons, filling over the summer to be used as backup during the higher demand periods of the winter. A cut in Russian supplies would put a greater reliance on storage reserves and, as the disputes occurred in the peak of winter, there were subsequent concerns over the ability for storage to cover the remainder of the season. However, in 2014, during the height of summer, there was minimal need for storage to backup supply, limiting the impact of any disruptions. Furthermore, the dispute had come after a mild winter, meaning stocks were still high at the time of the dispute and there was subsequently less pressure to secure gas for injection into storage over the summer.
While there was no pressure to fill storage quickly this year, injections have still risen sharply. Some of this was due to market players being concerned over the prospect of future disruptions. Mostly though, traders were taking advantage of the low price of prompt gas. This activity has been helped by an excess of supply this year, partly a result of warm weather keeping demand low, along with strong LNG supplies. While summer maintenance cut Norwegian imports and Russia increased its threats over supplies, Qatar’s seasonal maintenance has been light and it has kept its fleet of LNG ships heading towards Europe. The UK has been a particularly strong beneficiary of these cargoes, and overall deliveries have been at their strongest in years.
There are a number of reasons for these strong deliveries, the most obvious being price. Historically, April to June is the shoulder season for Asian LNG demand. Between the winter, when gas is needed for heating, and summer, when it is used by Asian electricity generators to help cover cooling requirements, the demand for LNG drops, cutting Asian prices and making Europe more attractive for spot cargoes (explaining why LNG deliveries for the UK have tended to rise during the spring). This year, Japan has come out of the winter with good LNG stocks, meaning less need for new cargoes to cover expected summer usage beyond that already contracted for, whichhas contributed to Asian LNG prices falling sharply.
Price may not be the only factor though. The timing would suggest a potential political dimension. Strong LNG flows have reduced the impact of any potential disruption in Russian supplies. This has weakened Russia’s bargaining position. The high rate of LNG cargo arrivals also come soon after a record gas deal being completed between Russia and China. This agreement would undercut the strong position of LNG in the Asian market, impacting on Qatar’s potential Asian profits. The deliveries also serve to highlight that Qatar is a reliable supplier and less reliant on transit nations to meet its obligations. Finally, there is Qatar and Russia’s differing position over Syria, which has strained already tense relations between the nations. Taken together, there is an argument to Qatar allowing gas to flow in high volumes to Europe, in order to limit the impact of Russia cutting supplies.
Routes to market
Regardless of Qatar’s motives, the ships are still delivering to Europe and have highlighted another important difference in the 2014 dispute – the diversification of supply. The last decade has seen work to reduce Europe’s exposure to Ukrainian flow disruptions. LNG has been one of the main tools to improve security of supply. Meanwhile, there are now other routes for Russia itself to get gas to Europe, rather than just through Ukraine. Nord Stream – via the Baltic Sea to Germany – became fully active in 2012. South Stream is also in development to bypass Ukraine and deliver gas to Austria, with an expected start date of 2018. This will further erode the importance of Ukraine in the supply infrastructure. Europe’s support for a pipeline – Nabucco – to secure Turkish gas, bypassing Russia totally, has been facing difficulties, particularly as it is in direct competition with the more developed South Stream. However, some form of link is still expected to be in place before the end of the decade. Kiev itself has also taken steps to reduce its dependence on Russia. Even as its supplies from Moscow dropped in the latest dispute, a deal with Slovakia was being finalised to allow gas in Europe to flow back into Ukraine.
All of the factors mentioned have underlined that the 2014 gas dispute is different to all of the others. However, this does not preclude the growing possibility that the situation could evolve into something similar to the disputes of the past. The downing of Malaysian flight MH17 may be the catalyst for more significant supply disruptions for Europe. Prior to the July 2014 round of sanctions triggered by the incident, it was not in Russia’s economic interests to take the supply disruptions further than it already had. As highlighted, reduced supplies would have a muted impact on the market over the summer. However, it would have a greater impact on Moscow’s gas supply revenues, at a point when its economy is in a precarious position. The new sanctions may push Russia to the point that it needs to react, or the sanctions themselves may reduce its ability to trade its gas, oil and coal. Either way, President Putin now has to decide if taking a stand against the sanctions, leading to a worsening of the Russian economy, will unite Russia behind him against a common enemy, or lead to dissent.
Putin’s position in the latest situation has been strengthened by Iran and talks between Iran and the west continue over Tehran’s nuclear programme. While under sanctions of its own, Iran has become bolder against the western powers, particularly following the rise of ISIS in Iraq. The US has already sought to improve relations with Tehran in the hopes that the two countries could work together to deal with extremists. Meanwhile, Russia has been a strong supporter of Iran’s position in the talks. This could help Russia’s position through association, as well as provide both parties with trading partners to help bypass their respective sanctions.
The situation with Russia is constantly evolving and there is more potential for tensions to rise than ease. The timing of the recent dispute may have, so far, worked to mitigate the price impacts, but now time is working against it. A continuation of the current stalemate, with no flows to Ukraine while the bill remains unpaid, will become more of an issue as demand rises into the winter. The 2014 Russia-Ukraine dispute has so far been unique in its lack of impact on energy prices, but the potential remains for it to turn into a full energy crisis.