By John Dizard
July 26 2006

(Published abridged)

The political crisis in Ukraine that broke up the pro-European and American Orange Coalition is having profound knock-on effects in energy and, ultimately, the securities markets. The most immediate effect is that Europe now has few attractive alternatives to ensure secure access to natural gas. On the present course, this is leading to an undeclared bidding war between European importers and their US rivals for relatively scarce supplies of liquefied natural gas…

Under the Western model for building and operating gas pipelines, you are paid a good, but not excessive, regulated return for acting as a common carrier. Russia explicitly rejects that model; it sees pipelines as an instrument of its political power. Russia and its allies in Ukraine resolved January's crisis over the cutbacks of gas at the Ukraine border by in effect giving the state-controlled Gazprom control over the Ukrainian pipelines and a huge storage system near the border with Europe.

The Russian company's control over Ukrainian pipelines also cuts off one of the alternative routes for new pipelines between the giant Central Asian gas reserves and Europe. January's dispute was less over the price of Russian gas imports, since these are largely paid for by transit fees, than over Ukraine's access to Russian pipelines to import Turkmen gas.

Under the European model, this access could not have been denied. Ukraine has signed the European protocol on energy transit, and the Orange prime ministerial candidate, Yulia Timoshenko, had said her government would follow its requirements. Ukraine's willingness to implement the transit protocol under a non-Orange government is questionable.

Furthermore, by leaving control over Ukraine's internal oil and gas production with the local oligarchic structure, the country's ability to reduce its dependence on Russian, and Russia-transited, gas imports, is negligible. That increases the risk to European supplies.

Western oil and gas people who have operated in Ukraine believe the dependence could be reduced under a different legal regime. As one says: "Ukraine has very significant reserves of gas. Timoshenko told us two months ago she would open up production sharing agreements and joint venture access to these fields. That would have brought in the western oil companies."