Vladimir Putin has seized the Crimean peninsula on the Black Sea from Ukraine as this issue of Oil & Gas Financial Journal goes to press. Russian armed forces have taken control of government buildings in Simferopol, the regional capital, and Russian jets are routinely violating Ukrainian air space. The crisis is serious and could escalate into a full-scale war between Russia and its former USSR republic, which became independent in 1993. Theoretically, Russia could easily overwhelm its smaller neighbor, but a guerilla-style conflict could ensue for many years if Putin decides to occupy Ukraine, a Texas-sized nation with about 44 million people.
Why is this relevant to the energy community? Because Ukraine and a large part of Europe are heavily dependent on natural gas supplies from Russia, and most of the gas transits Ukraine bound for utilities and end-users in Eastern, Southern, Central, and even Western Europe. Some Russian gas goes through Belarus to the north, but 80% of Russian gas exports to the European Union move through the Ukrainian steppes, or plains, and a protracted conflict could disrupt gas supplies. It isn't likely that other sources of gas could be found to meet Europe's energy requirements in the short term.
Reliance on Russian gas imports has long been a concern for the European Union, but no action has been taken to find other sources, including domestic production from shale deposits in France, Poland, and elsewhere. To the contrary, France, for example, has banned hydraulic fracturing within its borders. This essentially put an end to shale development in the Paris Basin and elsewhere within that country because operators rely on horizontal drilling and fracking to make production economical. For the most part, the EU has sided with environmentalists rather than pro-business interests even knowing that Russia is holding an ax over its head with respect to gas availability and pricing. In fact, Russia has signed agreements with China in recent years to send gas supplies east to that energy-hungry nation.
The Ukrainian economy is especially vulnerable because of its heavy dependence on Russia for energy supplies. Ukraine depends on imports from Russia to meet about 70% of its annual oil and natural gas requirements and 100% of its nuclear fuel needs. The country is heavily dependent on nuclear energy, and its 15 nuclear power plants generate about half of its electricity needs.
Ukraine consumed about 2.3 trillion cubic feet of natural gas in 2011, with domestic production accounting for around 30% of the total at 700 billion cubic feet. The remainder of the supply is made up by Russian natural gas imported through the Bratstvo and Soyuz pipelines. Two-thirds of Gazprom's revenues come from the sale of gas that crosses Ukraine.
In January 2009, after a two-week dispute that saw gas supplies cut off to Europe in mid-winter, Ukraine agreed to 10-year gas supply and transit contracts with Russia in that brought gas prices in line with world levels. The strict terms of the contracts have further hobbled Ukraine's cash-strapped state gas company, Naftohaz. In April 2010, Ukraine negotiated a price discount on Russian gas imports in exchange for extending Russia's lease on its naval base in Crimea by 25 years, to 2042, with an additional five-year option to 2047.
Putin apparently feels justified in intervening in Ukraine because of the base, one of Russia's largest, and the presence of many Russian-speaking residents in Crimea. He believes the overthrow of his ally, former Prime Minister Viktor Yanukovych, by nationalist and pro-Western Ukrainians, is a threat to Russian hierarchy in the region.
Ukraine's geographic position and proximity to Russia explain Ukraine's importance as a natural gas transit country, through which volumes flow to Austria, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Germany, Greece, Hungary, Moldova, Poland, Romania, Slovakia, and Turkey. As mentioned earlier, disputes between Russia and Ukraine have resulted in interruptions to Russia's natural gas exports through Ukraine.
Recent discoveries of shale gas deposits in Ukraine provide the country with a possible means to diversify its gas supplies away from Russia. In January 2013, Shell agreed to explore an area that the government estimates holds about 4 trillion cubic feet of shale gas reserves. Current plans include development of shale gas resources for domestic consumption and exports to Western Europe by 2020.
For its size, Ukraine consumes relatively little in the way of liquid hydrocarbons. In 2011, the country consumed 300,000 barrels per day of liquid fuels, but produced only 82,000 barrels per day. The remainder was imported, mostly from Russia, but with smaller volumes originating in Kazakhstan and Azerbaijan.
Putin has tried to keep Ukraine in Russia's sphere of influence and has opposed the country's attempts to gain membership in the European Union. This is part of what the recent protests have been about. The Ukrainian-speaking western portions of the country, including the capital Kiev, identify more closely with Europe while the Russian-speaking eastern part of the nation and the Crimean peninsula, where nearly 60% of the population identify themselves as Russians, prefer closer ties to Moscow.
It's likely not a situation that will be resolved soon, and it's one that threatens to disrupt European energy supplies. It has the potential for upsetting natural gas prices in countries far removed from the conflict.
