Streetwise Professor

January 8, 2009

My Heart Bleeds

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 10:08 pm

One of the arguments commonly raised in Russia’s favor in the periodic gas wars with Ukraine is that Russia has every right to get the “market price” for its gas.  That is, it can charge what it wants, and can refuse to sell to anyone that won’t pay what Gazprom demands.

Fair enough.  But a couple of things to keep in mind.

First, as I wrote a couple of years ago in “Yes, But What Kind of Market“, the “market price” is not the same as an (even approximately) competitive price.  Gazprom exercises market power.  Moreover, Gazprom price discriminates.  For instance, it charges Belarus a lower price than Germany, or Ukraine, for that matter.  So, Gazprom/Russia is not really arguing that Ukraine is demanding to pay a subcompetitive price; it is asserting that it has a right to receive a supercompetitive price. . . because it can.   Hardly the moral high ground.

Second, this logic cuts both ways.  If Gazprom has the right to demand what it wants for gas, why doesn’t Ukraine have the right to demand what it wants for transporting gas?  And remember, although the differential has narrowed somewhat, Gazprom has historically exercised the power inherent in its control of the only route by which Turkmenistan can export gas by charging an extremely high transit fee, paying the Turkmen far less for gas than it receives when it sells it to the Europeans. (This was documented in Yes, But What Kind of Market.)  In essence, Ukraine is using the market power inherent in its control of the pipeline between Russia and Europe in exactly the same way Russia/Gazprom has used the market power inherent in its (government granted) monopoly over the pipeline between Turkmenistan and Europe.  And which it also uses, by the way, to stifle competition from other Russian producers of gas.  (As one prominent example, it used its ability to deprive BP-TNK access to a pipeline to force the consortium to sell the Kovykta field to Gazprom–a commitment the Russian giant is now trying to escape given its financial straits.  And even domestic Russian gas producers have been unable to get stranded gas to market.)  So, when Gazprom and Putin scream “No Fair!”, there’s more than a little hypocrisy involved.  My heart bleeds.

Bottom line–there are no saints involved in this episode.  There is a classic bilateral monopoly situation.  Each side is using its leverage to try to extract as much from the other as possible.  There is a substantial rent to be had, and Ukraine and Russia/Gazprom are using every lever they can to get the lion’s share of that rent.

Both sides play the victim, but there’s little to choose between them.  Well, there is.  Gazprom’s protestations of commercial morality ring very, very hollow given that it treats other sellers of gas in exactly the same way that it accuses Ukraine of treating it.

What do they say about payback?  Hmmm.  Trying to remember.  Starts with a “B”, I think.

This conflict is inherent in the dysfunctional market structure upstream and midstream.  State mandated monopolies over transportation in Russia and Ukraine, with no system of open access and common carriage, distort markets.  When these monopolies are back to back, rent seeking battles are inevitable.

Absent some regime of open access, or common carriage at regulated rates, the distortions in the Eurasian gas market will persist.  The second best alternative is to create additional pipeline routes connecting other sources of gas (Turkmenistan, Kazakhstan) with consumers downstream.  Importantly, these additional routes must not be in control of the incumbents–notably Gazprom–so Nord Stream and Blue Stream South Stream don’t help.  An additional, non-Gazprom pipeline would create additional competition (though far from anything resembling perfect competition) both for the gas, and for the transport of gas.

This is not likely to happen anytime soon, given the difficult economics of Nabucco, the dynamics of the new Great Game in Central Asia (and Russia’s strong strategic hand in that game, and its ruthlessness in playing it), and the pathetic dithering of the Europeans.  Which means that the gas wars will remain as regular a New Years event as the Rose Bowl and hangovers.

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  1. You do great stuff! May I add – as you have previously noted, there is not much economic literacy in Ukraine or Russia, or the post-sovok states, for that matter. But they do know corruption. So here’s a little nitty gritty – on the Ukrainian side, there is a guy named Firtash who owns 45% of the Ukrainian 50%; Fursin owns the other 5%, but all of this is murky, because there are other entities behind that. Firtash funds the Party of Regions in Ukraine, which is said to be pro-Moscow. President Yushchenko, who is trying to hand on for dear life, and whose “ratings” are at about 5%, is looking to hook up with anyone he can to remain President. So, while he’s engaged in severe and hystrionic battles with Prime Minister Tymoshenko, he is looking to make alliances with – the Party of Regions. Towards that end, he supported Firtash and RosUkrEnergo previously, against Tymoshenko’s attempt to cut them out, and has previously entered into political alliances with the Party of Regions. Plus, as reported in Ukrainian Pravda, Firtash gave some rides on his jet to Yushchenko’s wife and kids on trips to Brussels.

    If RosUkrEnergo gets cut out, that cuts out Firtash, which cuts out a lot of funding for the Party of Regions.

    Ukraine doesn’t really have political parties – it has amalgamations of political “forces.” Ukraine does not have individual candidate elections for Parliament, either. Rather, people vote for a “party list”, by “party.” Each party list contains a list of the 450 that would fill all the seats in the Ukrainian Parliament, should that “party” get all the votes. Of course, noone knows everyone on the 450-person list, only the “top 5.”

    So – one buys one way onto the party list, or one buys a proxy or a shill. And, of course, the higher up one is on the party list, the more likelihood that one will actually make it into the Parliament (obviously, no party has yet received 100% of the vote.)

    And – each “party” needs funding for its assorted activities, like buying expensive yachts, jets, mansions, etc. That is funded by oligarchs, many of whom are actually in the Parliament. But, the oligarchs are also tied in with government, which they abuse to the hilt.

    Soo- Firtash funds the Party of Regions. In return, people inside the government – require – the use of RosUkrEnergo in gas dealings.

    The Key (sorry to be so long-winded) —

    If Tymoshenko eliminates RosUkrEnergo, she eliminates Firtash, and a huge source of funding for the Party of Regions, her political opponents, and erstwhile chums of President Yushchenko.

    Yanukovych, from the Party of Regions, is good buds with Medvedev, and Putin – after all, all the sovoks knew each other from way back when (just like all the people at AT&T knew each other before its breakup in 1984).

    President Yushchenko has repeatedly stated that “corruption is killing Ukraine.”

    But, as they used to say about the sovoks: “they think one thing, say a second, and do a third.”

    Comment by elmer — January 9, 2009 @ 2:43 pm

  2. Thanks for the kind words, Elmer, and the very informative comment. And welcome as a commenter–please make it a habit;-)

    And no need to apologize for being long winded (as if I should talk;-)

    Yes, not very pretty things come crawling out when you turn over rocks in that part of the world. Your analysis of the The Good-The Bad-The Ugly standoff, and its intersection with RosUrkEnergo is interesting and persuasive. Methinks that Tymoshenko’s opposition to RosUkrEnergo does not imply a principled stand against intermediaries in general, just that intermediary in particular, for the reasons you set out. No doubt if the dough being siphoned off by an intermediary was flowing her way, she’d see things differently.

    The dynamics you describe are so embedded in the socio-economic-politico culture of the region that it is doubtful that any election outcome will lead to meaningful change in this modus operendi. Thus, this soap opera will probably have as long a run as General Hospital or the Young and the Restless.

    Re your saying about the sovoks–indeed. I am reading Custine’s travelogue of imperial Russia (detailed post to follow), and what most disturbed (or should I say disgusted) him during his visit was the pervasive dishonesty he encountered. Similarly, Richard Pipes thinks that dishonesty was the most salient, and most dispiriting, characteristic of the USSR. This legacy lives throughout the ex-USSR/ex-Russian Empire.

    The ProfessorComment by The Professor — January 10, 2009 @ 9:33 am

  3. May I submit that in the sovok union, dishonesty was a way of life, and a means of survival. Everyone stole, there was a huge underground economy, almost everyone had little plots of garden somewhere to make sure they had food. To my great amazement and shock, I ran into this personally, to my great surprise, when I was over there – and had a person simply state that everyone stole from the factory where he worked in order to survive. People who were not insiders wanted to get out of there so badly that I saw them cry. Even Way back then, I got quite a few flowers from girls (I’m not a Pierce Brosnan or a Clark Gable). Poor things, they wore the same clothes every day. There weren’t many cars, but whoever had them sure knew how to fix them and keep them running. And that included making sure to take the windshield wipers with you when you parked the car, so they wouldn’t get stolen.

    But that’s how I knew that the sovok union was going to fall apart – the underground economy. It makes sense, because the people in charge were themselves dishonest. People had the saying “we pretend to work, and they pretend to pay us” – for a reason. One had to find a way to cleverly get around the government and the system – or risk getting killed. The biggest crime was – political.

    There are other personal examples, but suffice it to say – the sovoks really did a number on the people, to the point that today, they literally don’t know how to be human beings.

    I will never forget the scene from the movie “Archangel”, with Daniel Craig, when he says to the old lady holding an icon of Stalin (to this effect) – “but he killed your daughter, he was a murderer” – the old lady just smiles, because Stalin was “an important man.”

    Even after the fall of the sovok union, as we all know, people were desparate to get out – so the girls “married” their way out, and others claimed “religious discrimination.”

    Fortunately, the younger ones have not been so heavily influenced, but it will take a while for all of that to wear off – unfortunatley.

    Except in Russia – where it continues.

    Comment by elmer — January 11, 2009 @ 10:41 am

  4. “For instance, it charges Belarus a lower price than Germany, or Ukraine, for that matter.”

    One cant argue with facts, but one can argue that facts exist for a reason, which you, apparently, know nothing about, and just nonchalantly assume that it is by Gazprom’s good will alone Belarus recieves gas for a slashed price ?
    For the likes of you Putin personally explained things in his latest press-conference, which basically can be summed up in two points :
    1) While moving gas to Belarus itself – Russia doesnt add export tax, which goes both ways for some other commodities as well.
    2) Gazprom gradually gets some of the Belarus pipe infrastructure as part of the gas payments.

    Love the blindly hating community you have here, ta-ta.

    Comment by Telia — January 11, 2009 @ 10:49 am

  5. Telia–

    When I approved your comment for moderation, it disappeared. Please resubmit if you’d like. I apologize, but apparently there was a WordPress glitch.

    The ProfessorComment by The Professor — January 11, 2009 @ 11:11 am

  6. Belay my last–was able to recover it from the spam queue–dunno why it went there.

    Re your specific comments.

    1. No hate here. Just nobody drinking the Putin KoolAid. Whom do you think I hate, anyways?
    2. Re export tax–i.e., Russia exercises its discretion, charging a tax to some, and not to others. That’s exactly what I meant by price discrimination–charging different prices for the same commodity to different customers. This also begs the question of why Belarus receives such favored treatment, but others do not. I think this reinforces my point, rather than rebuts it.
    3. And just how did Gazprom get the Belarussian pipe infrastructure, hmmm? Let me think. I remember now! It was another case of Gazprom strongarm robbery. It/Russia threatened Belarus with a ruinous price increase, which it stayed in exchange for getting control of the Belarussian gas pipeline system. Again–reinforcing my point, not rebutting it.
    4. Do you seriously believe that the factors that you mention–even overlooking points #2 and #3–explain a nearly $300/mmcm price difference between the Europeans and Belarus?
    5. The Belarussian point is of secondary, no tertiary, importance in what I say above. The key point is that Gazprom howls about the Ukrainians standing between it and its customers by withholding pipeline capacity, when that’s exactly what Gazprom does with Central Asian gas–and even Russian gas produced by firms other than Gazprom. In other words, Gazprom is trying to convince the world that it is making a principled argument, when in fact it violates that principle daily–and has done so for years. Indeed, a good fraction of Gazprom’s market capitalization is attributable to its implementation of the exact same methods for which it excoriates the Ukrainians.
    6. Lay off the KoolAid.

    The ProfessorComment by The Professor — January 11, 2009 @ 11:26 am

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