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How Russia and Ukraine Affect UK Gas Prices

What Russia’s latest excursion into the Ukraine means for the gas prices for UK businesses.

The backdrop may be different, with a greater intensity and a potential war footing seemingly inevitable but the energy politics remain the same.

Back in 2005 as Ukraine’s pro-western government continued to gain momentum, was the subject of a nigh on five fold increase in the cost of natural gas it was sourcing from near neighbours and former rulers Russia. Most observers saw this as a form of punishment for Ukraine having the temerity to look west rather than east for their inspiration.

In 2005 though it wasn’t the KGB but another former ministry who administered the painful treatment, Gazprom. Where Ukraine had been used to paying $50 for 1000 cubic meters of natural gas, Gazprom signaled this had to rise to $230. Ukraine however wouldn’t pay, and by the new year of 2006, Russia carried through their threat and simply cut Ukraine’s supply.

But crucially this localized affair had a continent wide impact. Quite simply Ukraine was and still is a major transit route for gas from the rich fields of Russia, through the former Soviet states and into the energy hungry west.

By cutting supplies, Russia not only deprived Ukraine but also the west. None of this was an accident, Russia, again flexing its diplomatic, commercial and political muscles saw this as an excellent opportunity to reinforce their strategic import to the West.

With in excess of 25% of the total volume of gas consumed in the European Union being sourced from Russia and the vast majority being routed via the Ukrainian pipelines, a shortage of supply was quickly felt. Mainland Europe reported a drop in volumes supplied of 30%.

Of course demand remained high given the time of year and supply being artificially corrupted meant only one thing: price rises.

Suddenly a regional disagreement had become a major economic issue for pretty much the entire EU.

Resolution was eventually achieved but by 2009 most observers could be forgiven for thinking they were suffering from a particularly acute case of déjà vu.

Gazprom, having apparently been not been satiated by Ukraine’s capitulation and willingness to meet their previous demand now informed the embattled state that they would need to find $400 per 1000 cubic meters or face national disconnection.

Cue refusal and another new year’s day shut off.

This time however things got nasty, the cold snap exacerbated the impact down the pipeline and Ukraine and Russia pointed the finger of blame at one another for the suffering caused. Not just economic either, this time there were very real human casualties. Europe soon realized there could never be a state of ‘business as usual’ whilst Russia was a major provider of gas with a fundamentally ideological difference. The cold war may have been over, but the dogmatism of the era clearly wasn’t.

Which makes it all the more depressing that five years on, almost to the day, we have another Russia-Ukraine stand-off, but one that could very realistically escalate into real conflict.

As Viktor Yanukovych’s pro Russia regime superseded leaning democratic Ukraine of the mid 2000’s there had been a period of cordiality between the nations and indeed even led to a Russian about turn delivering a significant discount on the cost of Russian gas. However with the toppling of Yanukovych’s regime came a reversion to the norm.

Gazprom suddenly became concerned about Ukraine’s credit worthiness and the cut-price deal for the Yanukovych administration was quickly scuppered with 2009-esque talk of a need to charge upwards of $400 for 1000 cubic meters once again.

So what have western European nations done to diminish the impact of this seemingly never ending spat? And what is the short-term prognosis for gas prices given this latest turn of events?

In truth, quite a lot has happened.

Firstly, America’s shale revolution has provided a fresh, alternate source of gas, creating a new dynamic in the market, and reducing Europe’s exposure to Russian gas. That said, Europe still import around 30% of their gas needs from Russia and any softening of impact would require negotiations with American sources and the inevitable time of transportation to offset the immediate shortfall.

Secondly, new gas storage facilities have been developed whilst pre-existing ones have been renewed and enlarged. One of gas’s positive attributes as an energy and generation source is its ability to be stored, stockpiled and released on demand. Europe soon learnt the need for reserves not only form cold snaps and high demand but from fundamental interruptions to the system.

And that brings us to the third point, the cold snap, or lack of it. After an arctic 2013 we have just arrived out the back of an exceptionally wet but mild winter. As a result winter demand has been dampened, keeping reserves high and enabling greater resilience from exceptional events. As we move into early spring there is no sign of a belated cold snap and so the supply, demand balance does not appear to be about to be upset any time soon.

These insurances, storage, shale and sunshine, put Europe in a far better position to ride out the Russo-Ukrainian interruption.

However, the optimism of a negligible price impact is probably overstated. Traders are notoriously jumpy about change or even perceived change. As a result this risk, albeit running at a reduced level compared to the recent past, will be priced into future contracts until such point that Russian, Ukrainian relations are normalized. Until the next time.

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