The Real Way the West Can Impact Ukraine

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The weather is taking a decidedly better turn here in London these past few days.

It's a good thing, because all of the talk currently in British circles is about the deteriorating situation in Ukraine.

These concerns involve the all-too-obvious geopolitical impacts of a Russian takeover of Crimea and perhaps a broader swath of Eastern Ukraine.

However, there is another matter that has a more immediate impact on Europe, especially if the temperatures start falling again.

You see, despite the Russian-controlled natural gas pipelines under the Baltic Sea to northern Germany (Nord Stream) and across Belarus to Poland, most of the Russian natural gas coming to the continent still passes across Ukraine - about 80% in fact.

And Europe is still reliant upon this energy flow despite attempts to diversify.

That means the longer the crisis between Russia and Ukraine remains unresolved, the higher the tension level among Europeans will be.

Here's what that means...

Confronting a Critical Moment

The good news is that the situation is stabilizing. Not improving, mind you, but at least not becoming any worse. Stock markets in both London and in Europe are beginning to recover from recent massive declines.

But every economy needs to guarantee reliable sources of energy. Europe is hardly different in this regard. The massive hit in the investment markets from a possible interruption of the gas flow is hardly going to be a reassuring one.

The connection here is rather immediate and comes at a critical time. Despite a few improvements, both European economic prospects and credit markets are showing signs of another slide. Unemployment remains high, financial indicators are moving south, and the likelihood of another interruption in Russian natural gas is hardly encouraging for either the residential or industrial end user.

This is anything but an abstract concern. Everybody here remembers all too vividly the last Russian-Ukrainian spat. Back in January 2009, during one of the continent's coldest snaps in recent history, a disagreement broke out between Gazprom and the Ukrainian national gas company Naftogaz Ukrainy.

That resulted in a complete halt of the Russian gas pass-through across Ukraine, and some very cold folks further west. Now these concerns are already surfacing again.

Take earlier this week, for example.

Having just left our annual energy consultations at Windsor Castle, I found myself a guest in Bloomberg TV's London studio. The discussion quickly centered on the impact of what was transpiring in Crimea for gas prices in the European Union (EU) and the UK.

Even as crude oil prices spiked yesterday in both London (where the Brent benchmark price is set) and New York (West Texas Intermediate, or WTI), the attention was more directed at the level for natural gas.

In the United States, we usually view natural gas prices as essentially a function of the weather. In the winter, as has certainly been the case this year, waves of "polar vortex" temperatures from the north prompt additional drawdowns from gas stockpiles and an increase in futures contract pricing.

A similar connection exists during the summer. Then, however, a rise in temperatures results in additional gas consumption as more electricity generation moves from coal to gas as a primary fueling source. In addition, with gas-based propane being the primary energy source in rural America, the price of that gas has a rather direct effect on a whole range of agricultural products.

A Growing Dependence on Natural Gas

Nonetheless, as I have remarked in Oil & Energy Investor on several occasions, there are additional demands kicking in for gas - from an additional rise in power generation, through feeder stock for petrochemicals, vehicle fuel, added industrial use, to the advent of a significant rise in global liquefied natural gas (LNG) trade.

As a result, an appreciable rise in gas prices or an interruption in its supply will have significant and broader economic consequences. Given the recent policy moves in Europe, some of these are rather unanticipated.

One of these has already been underway because of other EU energy decisions. A concerted effort to move an increasing amount of energy usage from traditional sources to renewables has been underway for some time. This has been led by a German decision to close nuclear power plants in favor of solar and wind energy.

But the short-term consequences of this move are different than what was originally thought. Germany is now importing an increasing amount of electricity from France generated by nuclear power plants, while also increasing its dependence on imported coal from the United States.

Meanwhile, coal is also becoming a more relied upon "solution" for British energy needs in the face of increasing questions about the availability of affordable gas. This is an especially sore spot for British consumers, since all five of its main gas providers have recently increased their prices well beyond the actual rise in the cost of the gas itself.

Therefore, the positive environmental spin coming from EU headquarters in Brussels and the German government in Berlin over clean energy has suddenly taken a backseat to the more pressing reality of keeping folks warm.

And nobody I have spoken to believes the energy mix will improve now that a prolonged Russian-Ukrainian impasse is unfolding.

Where We Go from Here

The new government in Kiev will not cave to Moscow, and the Russian decision to take over Crimean military bases will not be reversed regardless of what communiques are issued from Western capitals.

Uncertainty over the gas flows will begin having a negative impact on European market recovery prospects. One result will be increasing attention given to LNG imports and added gas supplies from North Africa and an increasing reliance on Russia's Nord Stream connection via Germany.

But the bulk of gas moving into the continent from Russia is still dependent upon Ukrainian pipelines.

And that brings up yet another example of how global politics sometimes results in the strangest of maneuvers.

While condemning the Russian moves in Crimea, Brussels and London will need to provide financial assistance to the Ukrainian makeshift government in Kiev.

One of the demands that will be insisted upon in return for aid is a guarantee that Kiev will keep the pipelines open - and continue to deliver Russian gas to a concerned Europe.

About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle

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