Natural gas negotiations between Russia and Ukraine collapsed Wednesday, with Russia preparing to cut gas deliveries tomorrow. This would be the second time in 3 years that Gazprom has cut deliveries to Ukraine over a price dispute, in turn threatening supplies to the EU. Ukraine is the EU's major transit route for gas deliveries, with over 80% of the bloc's external gas supply traveling over its territory.
The latest Russo-Ukrainian gas row is a reminder that despite the current (low) price levels, energy security remains a major issue, particularly to countries with heavy reliance on external supplies. It may also presage a more aggressive Kremlin in 2009, one that seeks to renegotiate gas contracts (particularly with former Soviet republics paying below market prices) with more frequency and adopts a less compromising position.
As Russia's budget comes under greater pressure, the rouble is devalued further (by as much as 10%, as many economists believe is necessary to account for the loss of petro/gas revenues, a cut the Kremlin has resisted with all of its will) and political unrest rises, the Kremlin will struggle to prop up the Russian economy. It will almost certainly turn to its energy leverage to plug the shortfall and boost spending.
Putin's authoritarian consolidation and economic nationalism have relied on a middle class complacency derived from petro/gas riches. The boom years were financed by the commodity bubble. Over this period the Russian government failed to adequately diversify, liberalize and modernize its economy. This made the Kremlin overly reliant on companies like Gazprom for tax revenues (and spending). Due to excessive state intervention and legal uncertainty, particularly when dealing with foreign investors, Russian industry became overly reliant on the Kremlin for finance and favor. What developed was an economy fundamentally underpined by high commodity prices. This house of cards was always vulnerable to a price collapse. Now that its here, the tight societal weave of Putin's Russia is starting to fray. It is unclear whether Putin/Medvedev are prepared to mend it.
Russia's resurgence has as much to do with oil and gas as it does with Putin. The major question for Russia in 2009 is: how does Putin respond?
