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How Will Russia’s Annexation of Crimea Affect Energy Markets?

By John Daly | Mon, 17 March 2014 19:37 | 1

Russia purportedly intervened in Crimea to protect ethnic Russians from neo-Nazi extremists that Moscow claims have infiltrated the transitional government in Kiev.  The results of the 16 March Crimean referendum are already assumed to be a foregone conclusion, with early figures indicating that the peninsula’s Russian majority voted 93% in favor of unification with Russia.

But the reality probably lies in the two seemingly intractable subjects that unite and divide Russia and Ukraine – energy and military issues.

The former – Russia’s need of Ukraine’s Soviet-era skein of natural gas pipelines that supply Moscow’s most lucrative European markets. Russia provides approximately a quarter of the natural gas consumed in the European Union; approximately 80% of those exports travel through pipelines across Ukrainian soil prior to arriving in the EU.

Beginning in the 1970s, Ukraine began to be crisscrossed by a skein of natural gas and oil pipelines – while many were designed to fulfill the requirements of both the USSR and its Eastern Europe allies, but ultimately European Gazprom clients as well. The energy-poor Ukrainian Soviet Socialist Republic’s role then was as a transit country, after its energy needs were met.

After the 1991 implosion of the USSR Moscow wanted two things – continued access to Ukraine’s pipelines to continue providing its affluent European clientele and for Kiev to pay ever higher natural gas prices. And so things trundled along for several years, until Ukraine’s mounting gas debts caused Moscow to propose a swap – Ukraine’s multi-billion dollar gas debt for the Ukrainian pipeline network.

Ukraine refused.

Disagreements first arose in March 2005 over the price Ukraine paid for Russian natural gas supplied and the transit costs Ukraine charged Gazprom, along with Russian allegations that Ukraine’s Naftohaz siphoned off a portion of the exports. Irritated by Ukraine’s footdragging over resolving the issues, on 1 January 2006 Russia turned off the taps. Bowing to the cold, three days later Kiev reached a preliminary agreement and supplies were restored. Beginning in October 2007 more disagreements over Ukrainian gas debts, which led to the reduction of gas supplies in March 2008, unsettling Gazprom’s European Union customers. As a state company Gazprom has unique leverage as a foreign policy quasi-state entity, which was deployed yet again in January 2009 when Gazprom cut the gas supply to Ukraine over non-payment issues and quantities to be supplied. The blowback further west was immediate, as the shutoff impacted 18 European countries in the midst of a cold winter. The political hardball severely damaged the image of Russia as a reliable partner.

Now, some analysts believe that the motivation for Putin’s campaign could be to ensure that Gazprom will control Crimean offshore energy assets.

Foreign oil majors believe that Crimea’s onshore and offshore fields will live up to expectation, with expanded exploration of the Black Sea off Crimea gone into overdrive.  ExxonMobil, Chevron, Shell, Repsol and even Petrochina have begun to show genuine interest in developing Ukraine’s energy assets.

During a meeting last November with foreign oil executives that resulted in an agreement being signed with Chevron then Ukrainian President Viktor Yanukovich remarked, "Today Ukraine is already successfully cooperating with global companies in the field of hydrocarbon production... Implementation of large-scale projects with Shell and Chevron will allow Ukraine by 2020 to meet all domestic demands for natural gas, and in an optimistic scenario - even export energy resources."

No doubt a scenario most distasteful to Gazprom.

And a booming offshore Crimean hydrocarbon industry could be sustained from the port of Sevastopol, the Black Sea’s finest natural harbor, which could service the Black Sea offshore oil fields and their massive advanced drilling technology, as it’s less than 60 nautical miles from the exploration zones.

All that remains for the Kremlin is to mollify the EU into accepting the Crimean referendum as a fait accompli.

By. John C.K. Daly of Oilprice.com

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  • Rudy Haugeneder on March 18 2014 said:
    There are worse problems that will impact on oil prices.
    A realistically pending Iran-Israel war might soon be about to make the Crimea problem look mild. Here's why:
    HAARETZ --" Israeli Defense minister says the United States has projected weakness the world over, from China through the Mideast to Ukraine. "Based on his evaluation that the United States isn’t going to do anything to frustrate the Iranian nuclear program, Defense Minister Moshe Ya’alon said Monday he’s changed his mind and now leans toward supporting unilateral Israeli action against Iran" according to the Israeli newspaper.

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