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Russian-Ukrainian Conflict Spilling Beyond Borders And Into Natural Gas Markets

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The Russian and Ukrainian conflict is about freedom -- not just to political expression but also to explore new economic ties with the western world, which includes finding additional access to lucrative natural gas supplies.

It’s a battle that extends well beyond the walls of the former Soviet Bloc and into the heart of Europe that has long relied on Russian natural gas to provide about a quarter of its needs -- a third of which flows through Ukraine’s pipelines. Now that Russia has taken military control of the Crimean section of Ukraine, those conduits are in peril.

Russia, meantime, provides anywhere from one-third to one-half of Ukraine’s natural gas. And, since 2006, the two nations have had legitimate battles over how to value that vital product. During the early years of that dispute, Russia had wanted to quadruple the cut-rate prices to Ukraine. Recently, though, those natural gas prices are tied to global oil prices and have sold at much greater rates, which has cut Ukraine’s consumption of Russian natural gas.

Ukraine still subsidizes the gas that it does buy for its own citizens, noting that without such help, its already recession-ridden country would go into an economic tailspin. The International Monetary Fund is reporting that energy subsidies made up 7.5 percent of Ukraine’s 2012 gross domestic product.

“The Ukrainian economy has been in recession since mid-2012, and the outlook remains challenging. In January–September 2013 GDP contracted by 1.25 percent year-over-year, reflecting lower demand for Ukrainian exports and falling investments,” says the IMF’s December 2013 analysis.

For the moment, Ukraine -- and Europe as well -- have gotten a minor reprieve because each has had a mild winter. Europe is also warming to U.S. natural gas imports in the form of liquefied natural gas, which can sell for a premium there. Its also been shying away, lately, from Russian gas and using more coal.

Europe, too, has also won access to a number of new pipeline routes, or ones that are able to bypass Ukraine and enter the continent other ways. Among them: Pipelines are linking the Caspian Sea, Middle East and North Africa with Continental Europe. Algeria, for example, is increasing the capacity of its export routes that carry gas into Italy and efforts are also underway to do the same for routes into France and Germany.

Ukraine could ultimately break loose of the natural gas shackles from which Russia has help it captive. A Washington Post story says that Ukraine has signed deals with Chevron Corp and Royal Dutch Shell to invest as much as $10 billion into shale gas development in the western part of the country. ExxonMobil, meantime, wants to drill for oil and gas in the deep water of the Black Sea there -- something that the paper says will have to wait given the uncertainties.

It’s accurate to say that the distrust that permeated during Cold War era still exists. But Russia can still be counted on -- to act in its self interest. And in this case, the need to grow its own economy and to continue to market its natural gas to both Eastern and Western Europe could help soothe things.

Many Europeans say that Russia needs the revenues from selling its natural gas as much as the West needs those supplies. They maintain that the former Communist state is as reliable of a partner as the nations of the Middle East or Northern Africa. Other nations made up of mostly the former Soviet Bloc argue that Russia leverages its natural gas domination as a way to earn economic clout.

There's no disagreement that Russia holds vast natural gas reserves. According to the U.S. Energy Information Administration, it possesses 27.5 percent of the world's gas supply. About half of its own needs are met with natural gas while it provides about 23 percent of Europe's demand.

Russia’s prized national asset is the natural gas company Gazprom, which is an outgrowth of the old Soviet empire. Today, though, Gazprom suffers from aging fields, state regulation and monopolistic control.

While Russia has been investing in its natural gas sector, it lacks the know-how or the capital to vastly increase its production. For that, it has been in talks with some western enterprises that consist of ConocoPhilips and Norsk Hydro of Norway to develop the gas-rich Shtokman fields in the Barents Sea. To become an energy leader, the U.S. Energy Information Administration says that between $173 billion and $203 billion must be invested in Russia's gas sector by 2020.

Therein is the western world’s leverage with Russia, which needs the capital and technology to increase its international status. The crisis in Ukraine, however, is challenging the whole geo-political-economic paradigm. Russia needs Ukraine both culturally and economically. But it also needs to refurbish its image and to ingratiate itself with the world community.