Gazprom not entirely unjustified

The dispute between Russia and Ukraine over gas supplies rumbles on. Despite some European regions declaring a state of emergency, Russia's state-controlled Gazprom have yet to reconnect the supply.

Gareth Morgan, manager of the F&C Russian Fund, comments: "It is easy to paint Gazprom as the villain in this debacle. However, whilst their actions have been aggressive, they were not entirely unjustified. This is a complex issue which first occurred in 2006 and has resurfaced again with collapsed negotiations over this year's contract price and the Ukraine's failure to pay November and December's supply to the tune of $1.7bn."

Morgan points out this the debt has now been paid, but the stumbling block remains the contract price. "Central Asian economies are now charging a price near to European netback prices, meaning that Russia are paying more for the gas they buy from Central Asia but losing out where the Ukraine are demanding a significant discount," he said.

The situation has been exacerbated by the fact that the gas price is linked to crude oil prices, but lags it by 6-9 months. "Whilst oil prices have fallen in the last 6 months, gas prices have some way to go and will not mirror the decline until at least the summer. Ukraine is delaying its price agreement in the hope that oil price declines will finally feed through into gas prices and they get a better deal - but in the meantime, Gazprom takes a financial hit."

Morgan states that while the Ukraine and Europe are suffering, the action also bears consequences for Gazprom, both operationally and politically. "Whilst the gas supply remains switched off, this has implications to both infrastructure and operational activities. Gazprom had been seeking to diversify their capabilities in Western Europe away from the Ukraine via construction of new pipelines. However this is still in the developmental stages and will take many years. In the meantime, Gazprom's actions will further sour relations with Western Europe who may now possibly step up attempts to diversify its fuel needs elsewhere.

Approaching Central Asian countries to agree a reduced price is not a likely option - with other Asian countries, such as China, looking to secure their supplies from the same source, Gazprom do not want a situation where they cannot guarantee this supply".