June 19, 2014

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TSG IntelBrief: A Contract Hit: Russian Actions in Ukraine

Taken as a whole, the recent Russian actions in Ukraine are tactics more commonly seen in criminal rackets moving into new territory and convincing businesses of the need for their protection: agitation, invasion, annexation, and contractual extortion, followed by armed insurrection. Moscow is determined to maintain control, by proxy, of the important regions in eastern Ukraine, and will continue to use strong-arm tactics to keep Kiev under growing pressure.

After invading and annexing Crimea, Russia considered its existing natural gas contract with Ukraine to be null and void because part of the agreed-upon price stemmed from Ukraine granting Russia access to its important Sevastopol naval base in Crimea. Russia then politely offered to sell the gas at double the price, and then demanded pre-payment from Kiev before shipment. And to help Ukraine accept the offer, Russia has now halted all supplies of natural gas to its neighbor while at the same time continuing to provide insurgents fighting in eastern Ukraine with tanks and heavy weapons. On the positive side, at least it’s not winter.

It is not surprising that the insurgents fighting in eastern Ukraine promptly refused the latest offer of a temporary cease-fire from the government in Kiev: After shooting down a Ukrainian transport plane—killing 49 people—with anti-aircraft weaponry, and amid reports that rebels now have tanks supplied by Russia, they likely see themselves in a relatively strong position. On the other hand, the government in Kiev likely sees itself in an extremely precarious position. The situation now is as tense as it has been since the beginning of the conflict.

The insurgents have serious military hardware obtained from Russia that can help them hold areas currently under their control. By shooting down the Ukrainian Ilyushin-76 and killing 40 paratroopers and nine other people, the insurgents were making a statement of capability. And by providing the insurgents with such capabilities, Russia was making a statement of warning to Ukraine: Do not try to militarily defeat their proxies. Kiev’s offer of a unilateral cease fire is an indication that they heard the warning.

All the while, Russia is conducting a contractual insurgency through its natural gas weapon. This weekend, after Ukraine didn’t accept the offer, Russia stopped delivering natural gas to them. Russia is still sending natural gas to Europe through the Ukraine pipelines but only the exact amount to meet needs in Europe.

European supplies will only be affected if Ukraine starts diverting some of the gas for its own needs. Russia is in effect daring Ukraine to annoy its only supporters in the West, in Europe, by stealing their gas in order to meet critical domestic demands. For Moscow, it’s a win-win situation. If Ukraine doesn’t divert gas, its economy free falls with the government not far behind, giving Russia a chance at a more Moscow-friendly regime. If Kiev does divert gas, it negatively impacts its Western allies who it needs to help pay off its massive $2 billion natural gas bill to Russia.

Kiev has sufficient gas reserves to hold out until Autumn, assuming there is no resolution to the contract dispute. Moscow has intensified its demands and will take extra pleasure knowing that whatever increased income it gets will likely come from the treasuries of the rival West.

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