Russia sends a chill down Europe’s spine

Russia's confrontation with Ukraine over the price of gas struck the first in a string of serious blows to Gazprom's reputation as a reliable supplier.

These include the deliberate use of monopoly power in stopping supplies to Ukraine and Moldova, collateral losses of delivery to the EU, further losses of delivery to the EU because of extremely cold weather in Russia, stoppage of gas supplies to Georgia and Armenia and of electricity to Georgia because someone in Russian Northern Ossetia blew up the infrastructure connections. The incidents raise many issues, some unconnected, yet all too simultaneous.

For gas-guzzling Ukraine, this is a huge wake-up call to adjust to the discipline incumbent upon an energy-importing economy.

But for Europe as a whole, the primary issue is about the regulation of monopoly power and illustrates a confrontation between EU and Russian ways of conducting the continent's most important affairs. The EU is all about supranational rules of economic and political conduct and dispute settlement by ordered legal procedures, whereas Russia is showing itself to be all about raw power, with little or no regard for any overarching international legal framework.

First, Gazprom's demand for price increases and the halt to supplies to Ukraine on 1 January was in breach of Protocol 4 of a 9 August 2004 deal between Gazprom and Naftohaz, which stipulated the price of $50 per 1,000 cubic meters for 2005-09, adding: "The rate shall not be revised by the parties." Ukraine did not, however, seek recourse to international arbitration. The Energy Charter offers multilateral dispute settlement procedures, but Russia has so far refused to ratify it.

Second, Gazprom blocked Ukraine's attempt to negotiate directly with Turkmenistan, by refusing to grant Turkmenistan the right of way for its gas through the Gazprom pipeline network, unless it was sold first to Gazprom (or the RosUkrEnergo consortium). Russia/Gazprom is not only playing the monopoly seller to Ukraine, but also the monopoly buyer - or monopsonist - for Turkmenistan. Russia's gas is being sold to Ukraine at $230 per 1,000 cubic meters, whereas Turkmen gas is being bought by Russia at an unspecified price, but which must be $95 or less at the Ukrainian border ($95 is the average price for Ukraine's purchases from RosUkrEnergo). At $230, Russia may in practice have priced itself out of the market, since Ukraine may, for the time being, rely wholly on Central Asian gas. In this case, what sense can be made of Gazprom's claim that it is applying market prices?

Third, this refusal of access to the pipelines is contrary to the EU's competition and internal market policy principles for such networks and it is a matter for the European Commission to consider whether this is illegal. In principle, the EU's jurisdiction extends beyond its frontier where trade with the Union is affected.

Fourth, the refusal of pipeline access to Turkmen gas is also contrary to the provisions of the Energy Charter's draft Transit Protocol, which Russia has refused to agree under pressure from Gazprom. This includes the "obligation to negotiate in good faith access to available pipeline capacity". Russia is therefore not here in breach, since the draft has not been agreed. But the affair illustrates the consequences of Russia's refusal at the policy level to subscribe to basic rules for regulating monopolistic markets, thus leaving room for unconstrained monopolistic behaviour by Gazprom.

Fifth, the RosUkrEnergo intermediary between Ukraine and the suppliers is a monument of non-transparency for a matter of such strategic economic importance. Who are the other 50% shareholders beyond Gazprom? Why are they hiding? Transparency and accountability are prime principles of economic governance in the EU and in G7 countries. This makes Russia's chairmanship of the G8 seem ridiculous, placing energy security at the top of the agenda when it is inventing such non-transparent schemes at the same time.

Since Russia seeks to exercise unconstrained monopolistic power where it can, the EU as a powerful buyer in the market has to combine two policies: try to bring Russia to agree and respect rules for competitive market behaviour and maximise its economic diversification of supplies.

The issue of diversification is already alive. Liquefied Natural Gas (LNG) investments are becoming increasingly economically viable and can ease the pipeline stranglehold. Coal and nuclear power are up for reconsideration. Oil and gas pipeline diversification possibilities also exist. For gas, the planned Nabucco project that would pipe Caspian and Middle East gas from Turkey to South-East Europe could be extended from Romania and Hungary into Ukraine and Moldova. Turkmenistan and Azerbaijan should return to the negotiating table with EU oil/gas majors to unfreeze the trans-Caspian pipeline project. The European Investment Bank and European Bank for Reconstruction and Development should bring serious funding to such projects, with equity as well as loans, if need be, in the name of strategic security, if, in the short-run, the commercial risks hinder investment decisions.

But the EU and Russia have an energy dialogue that is supposed to manage the relationship at a higher, strategic level. If Russia wants to have a common economic space with the EU and a real energy dialogue within it, if it wants to accede to the World Trade Organization and be a respected member of the G8, it has to play by the rules of civilised market regulation. Concluding a serious transit protocol would be the right step to demonstrate this.

• Michael Emerson is senior research fellow at the Centre for European Policy Studies (CEPS).

Commentary feature in which the author suggests that if Russia wanted to be part of the new world order - from the G8 to the WTO - it had to play by the rules of civilised market regulation. Author refers to recent disputes between Russia and Eastern European countries on the price for Russian gas.