2019 Could Be a Very Bad Year for Ukraine

When Russia stops using Ukraine as a transit country for energy exports a major hole will open in the Ukrainian economy which the EU and the US are not prepared to fill

Tue, Oct 3, 2017
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For several years, Russia has been warning—consistently and clearly—that it intends to stop using Ukraine as a transit country for sending its energy to Western markets. If this happens, a major hole will open in the Ukrainian economy which Europe and the United States do not appear to be prepared to fill.

Consistently, I am amazed at analysts who produce pages of plans about how to reorient Ukraine's geopolitical focus Westward and embed Ukraine in the security architecture of the Euro-Atlantic world, yet assume that Ukraine's economic relationship with Russia will continue unabated. In the 1990s, this was not an unreasonable assumption, because Russia had no choice but to rely on existing Soviet-era infrastructure networks and had no wherewithal to construct alternatives.

Thus, the economic-security balance that had emerged after the fall of the USSR—where Russia needed to sustain Ukraine (notably with below-market price energy) in order to guarantee that it could sell the rest at much higher prices to paying European customers—made sense.

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It was not always going to be sustainable, and we saw how both Russia and the Baltic States, for their own security interests, moved to alter this implicit bargain: the Baltic States started by developing alternative sources of supply and taking the very painful short-term steps to reform their economies away from the narcotic of lower-cost Russian energy and raw materials. Russia, for its part, after it became clear that Latvia, Lithuania, and Estonia would enter both NATO and the EU, developing an entirely new northern export infrastructure based out of the St. Petersburg region that allowed Russia to stop its dependence on Baltic access.

Both Ukrainian prime minister Yuliya Timoshenko, heroine of the Orange Revolution, and President Viktor Yanukovych, the villain of both the Orange and Maidan revolutions, realized Ukraine's peril, and both attempted to negotiate long-term agreements with Moscow that would incentivize Russia to keep using Ukraine as a transit country and would make it cheaper for Russia than constructing new bypass lines to the north and south of Ukraine. Yanukovych threw in a long-term lease for the Russian Black Sea fleet in Crimea to sweeten the deal (and to derail efforts to shift the fleet to Novorossiisk in the Kuban).

After the Maidan revolution, however, Russia again began to accelerate its plans to end Ukrainian transit. Despite Western sanctions, European Union regulatory efforts, and a short-term spat with Turkey after a Russian fighter jet was shot down on the Turkish-Syrian border in late 2015, these efforts have not ceased. Russia has been steadily announcing that it plans to shift its export routes by 2019.

Ostensibly, this is not a problem for Ukraine, which has dramatically demonstrated its ability to buy gas, oil and coal from non-Russian sources—with gas being shipped in from European partners to the West and a shipment of U.S.-produced coal arriving in country. But these alternatives are more expensive for a struggling economy—and the real shock will come when Russian transit fees cease. The Ukrainian state energy company will be left with a network of lines, storage depots and pumping stations which will need to find new customers.

Perhaps some energy from the Caucasus could be sent via the Odessa-Brody route from the Caspian to Europe, but that will not produce enough replacement income. Ukraine may be able to increase its own domestic energy production, but foreign firms will not want to invest until there is a durable peace settlement in the east and the Crimea question is settled.

On top of that, the Ukrainian government cannot repeat some of its shenanigans of the last decade by imposing all sorts of unreasonable conditions on foreign energy firms (among them, to sell large amounts of energy at low prices to domestic interests). There is also the risk that once Russia stops using Ukraine as a transit country, the ongoing conflict could expand. It is remarkable that Eastern Ukrainian separatism somehow did not appear in those parts of the country where the gas pipelines run—but could that change after 2019?

The response of the European Union commissioner in charge of energy matters, Maros Sefcovic, is to try to continue to compel Russia to use Ukraine as a transit country. But this strategy appears to be doomed to failure.

Turkey no longer has any incentive to do the EU's work for it, and, after President Vladimir Putin's recent visit to Ankara, President Recep Tayyip Erdogan reaffirmed that the rapid completion of the Turkish Stream line is a priority for his country, both to guarantee his country's ability to receive Russian energy that does not have to transit Ukraine, and to be able to position Turkey as a replacement transit country for Russian energy to reach southern and central European markets.

No matter her personal dislike for Putin or her distrust of Kremlin motives, German chancellor Angela Merkel is also committed to protecting Germany's energy security—and Germany's investments in Russian energy projects—by seeing the doubling of the Nord Stream line fulfilled on schedule.

Although the new sanctions passed by the U.S. Congress contain provisions that would impact the ability of Western banks to finance these new lines, European firms may take a page out of French energy conglomerate Total's playbook when, after initial EU sanctions were imposed on Russia over its actions in Ukraine, it chose not to withdraw from its profitable Yamal gas project but instead turned to Chinese sources of finance.

As a further backup to plans to bypass Ukraine, Gazprom is also mulling increasing sales to Azerbaijan—which would reflect an indirect, backdoor way to reach Europe, because Russian gas sold to Azerbaijan could allow Azerbaijan to increase shipments to Europe (and be able to augment deliveries) through the Trans-Anatolian line.

(On a separate note, the need for that line to operate at full capacity will present an unpleasant geopolitical choice for the United States—not using Russian gas increases the likelihood Azerbaijan might want to open access to the line to Iran, giving Tehran new markets and an un-blockadable access to European markets, or the U.S. would have to be prepared to engage in a "Great Game" with China over whether Turkmenistan's gas keeps flowing east to Beijing or is redirected west).

All of this suggests that a "relax, don't worry" approach on the part of Western analysts who assert that Russia's plans can be blocked is not warranted.

We have a clear deadline: 2019, when the new lines are expected to be finished and the current Ukraine-Russia gas transit contract expires. Now is the time to consider the policies that would be needed to secure and promote Western interests—and not to assume that Russia will keep footing the bill.

Source: The National Interest

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