What's cooking?

Thaddeus Best describes how the gas battle between Russia and Ukraine is hotting up

This year is expected to be a tough year economically, as countries across the globe struggle to keep their domestic markets stoked against a backdrop of deteriorating global growth. But it looks like Russia will have more than its fair share of problems over the coming twelve months. Recent elections led to riots in Moscow as protesters railed against suspected ballot stuffing and falsifications, among other voting irregularities, which cast doubt over whether Putin can expect to return to power this year following the presidential elections in March.

Russia's problems aren't just domestic ones. Tensions between Russia and neighbour Ukraine over Ukrainian imports of Russian gas are rising. Disagreements between Ukraine's state-owned Naftogaz and Russia's Gazprom have been flaring since 2005, when Russia claimed Ukraine was diverting gas intended for European markets to service its domestic needs. The spat culminated in Russia temporarily cutting off all gas supplies heading through Ukraine, which represent around 80 per cent of Europe's Russian gas imports, leading to severe energy shortages across the continent.

In for the kill

Russia has long been reliant on Ukraine's pipeline through to the western European market, a fact which Ukraine has deployed to considerable advantage in recent years. However, 2012 could be the year when the tables turn to Russia's advantage.

Ukraine has been struggling to restore its economic stability since the 2008 financial crisis, which saw its GDP contract violently by 15 per cent the following year as steel prices collapsed, forcing a devaluation of the currency in the process and wreaking destruction on the domestic banking system. Meanwhile the country's political scene has begun to look increasingly unstable following the sentencing of "gas queen" and former prime minister Yulia Tymoshenko to seven years in jail on abuse of office charges relating to gas deals brokered during her time as a politician. The conviction is widely regarded as being politically motivated, attracting condemnation from the EU, and other international observers.

Russia appears to have smelt blood. After it snapped up neighbouring Belarus' gas infrastructure towards the end of last year, offering the country cheaper gas in exchange for Russian ownership of Belarus gas pipeline firm Beltransgaz, the Russian need for Ukrainian infrastructure is no longer so acute.

Meanwhile, with gas prices ratcheting up, economically-unstable Ukraine has been forced to enter negotiations with Russia to discuss the possibility of a discount on its gas. And with Ukraine's economy rapidly deteriorating, reducing its bargaining power in the process, there has been precious little incentive for the Kremlin to push for swift progress in the talks.

Rising temperatures

The situation is heating up, with both sides engaging in their usual brinkmanship style of negotiation. Ukraine announced it would slash gas imports in order to keep its expenditure under control, despite its contractual obligation to purchase at least 33 billion cubic metres a year from Russia. Ukraine has also started to look at alternative sources of gas, and even alternative energy sources such as coal although observers are rightly sceptical that Ukraine will be able to reduce its demand for gas significantly in the short term.

Putin responded by pushing forward the construction of the South Stream pipeline to start this year instead of in 2013. The South Stream pipeline project will run through the Black Sea, bypassing Ukrainian waters in favour of Turkey's and carrying 63 billion cubic metres of natural gas a year, significantly reducing the importance of Ukraine's own pipeline network - and Ukraine's leverage over Russia. The Nord Stream pipeline through the Baltic Sea, which became operational last November, provides another way for Russia to sidestep Ukraine. This pipeline is expected to have a capacity of 55 billion cubic metres of gas a year by the end of 2012, although current capacity is about half that.

Thanks to the alternatives Russia now has to sending its gas through Ukraine, the risk of European homes experiencing a chilly few days is decidedly less pronounced than it was at the beginning of 2009. However, with Ukraine coming under increasing pressure as its own domestic economy edges towards crisis point, this fight is far from over.

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