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2014 | www.selectasset.com
Violence in Ukrain and Russian gas: should investors be worried?

When Malaysia Airlines flight MH17 crashed in the Ukraine on July 17, most likely due to an errant rebel forces fighting in Ukraine, the situation on the ground suddenly took urgent on global impact. After all, 283 people died, and most of them were Dutch tourists while Australians, Britons, Indonesians and Malaysians, including children, were also among the dead.

This ugly turn of events, happened at time when internationals tensions had been easing regarding situation—the overthrow of pro-Russian President Viktor Yanukovych and the Russian annexation of Crimea—with Russia and the United States both making moves to avoid fanning the flames of conflict. However, today, with Western economic sanctions (including Japan), in full force—the most extensive imposed on Russia since the fall on the Soviet Union—the questions is how will the conflict affect Russo-European gas politics.

For it party, Russia has also imposed sanctions against the West, specifically an embargo on the import of agricultural products, including fruit, vegetables, meat, fish, milk and dairy. One would wonder if this moves hurts Russia more than it hurts the west, yet the biggest questions remains. What about the Russia’s gas?

While violence in Ukraine continues to make the news, international political tension—following the overthrow of pro-Russian President Viktor Yanukovych and the Russian annexation of Crimea—has eased, with Russia and the United States both making moves to avoid fanning the flames of conflict. However, questions remain about what effect the Ukrainian upheaval will have on Russo-European gas politics.

When discussing Russia’s natural gas industry, most experts agree that the Kremlin sees its role as much geopolitical as it is economic. One of the primary fears, according to Western pundits, to arise from the conflict is that Russia, using predominantly state-owned energy giant Gazprom as its proxy, will seek to throttle gas supplies to Ukraine. That could have serious implications for the EU, which receives 15% of its natural gas (half of the total it receives from Russia) from pipelines that run through Ukraine.

Another hot dispute concerns the status of Ukrainian gas debts, which The Washington Post  reports could reach $5.2 billion. In March, Gazprom raised prices from $269 to $485 per unit citing unpaid debts as the reason, and threatened to cut off all supplies. Similar disputes in 2006 and 2009 have led to large drops in gas pressure in European pipelines as well as reductions in supply. There are reasons, however, to expect that any impact on Europe of such a dispute would be limited for the time being.

  • Europe is far less dependent on gas supplied through Ukrainian pipelines than in the past. While the Ukrainian Brotherhood pipeline remains the largest, the Yamal pipeline through Poland and the new Nord Stream pipeline through the Baltic Sea both have spare capacity that could limit the effect of any new Russia-Ukraine dispute on Europe.

  • Europe is also far less dependent on gas from Russia as a whole than it used to be. Since 1995, European reliance on Russian gas has dropped from 60% to 30%.

  • Thanks to a mild winter over much of Europe and the timing of the current dispute in the spring and early summer, gas reserves remain high, which has thus far ensured that gas prices continue to decline in the face of the crisis.

Nevertheless, 30% remains a huge amount of supply for Europe to rely on if the dispute drags on into the long term. In addition, Europe and the United States have clearly backed Ukraine's new pro-European President Petro Poroshenko, a position that’s obviously unpopular in the Kremlin. So what effects can we expect from a Russia-Ukraine gas dispute?

  • If the dispute drags on into winter, a shutdown of the Brotherhood pipeline could have an impact on European gas prices. The Economist believes the biggest effect of this would be on Europe's demand for coal, which has tended to rise in response to increases in gas prices.

  • Attempts are also already underway in the West to blunt the influence of Russian and Gazprom in Ukraine by enabling reverse-flow gas deliveries, with pipelines from Poland and Hungary already employed to deliver small amounts. The New York Times reports that the current stumbling block is Slovakia, which has the largest pipeline capacity, and negotiations to secure use of Slovak pipelines are ongoing.

  • In the long term, increasing imports of liquefied natural gas (LNG) into Europe seem likely. The Independent reports that proposals to build a number of new LNG terminals across Europe are currently being discussed by the G7 in Brussels, while the U.S.A. would lift restrictions on shale gas exports.

With these points in mind, a key area when considering the long-term impact of a Russia-Ukraine gas dispute would most likely be the state of LNG prices. With strong demand for LNG in Asian markets such as Japan and South Korea, growing demand from Europe could put pressure on shipping capacity and drive up prices. However, the gradual restart of South Korea and Japan's nuclear power development programs, combined with new LNG supplies from ExxonMobil's Papua New Guinea plant and a current shipping surplus  have left LNG prices at uncharacteristically low levels.

That is of course no predictor of future price changes, and a cold winter in Europe could see a new gas supply issues emerging at the beginning of 2015. As it stands now, however, what’s most striking about how the turmoil in Ukraine has affected the gas market is just how little an effect it has had. Prices currently sit at surprisingly low levels and appear toe be ready to drop still further as European gas reserves approach full capacity over the summer. With Europe looking to diversify its gas supply over the longer term and global transportation becoming more efficient, the power of regional disputes such as that in Ukraine to destabilise global prices could be diminishing.

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