There are exactly five things Kiev must do to become energy independent and disentangle itself from the Russian-driven geopolitical gas war:

1. Sell its pipeline system (most importantly); 2. Sell the remaining state interest in oil and gas company Ukrnafta; 3. Aggressively farm out as brown-field developments areas licensed by state-owned Ukrgazproduction; 4. Develop additional import resources, either through Europe or liquefied natural gas (LNG) through the Black Sea; 5. Provide security in pricing and contracts.

Before we embark on the specifics of this roadmap, it’s important to look at exactly how we got where we are today.

Call it what you want — unrest, separatism, foreign invasion — but the fact is there are troops running around eastern Ukraine killing people. The current situation is dire from any standpoint; economically, it is disastrous, triggering high taxes and steadily increasing inflation.

In addition, Ukraine and Russia are once again fighting over gas supplies and the transport of Russian gas to Europe.

The primary reason we’re here, of course, is economics. We’re all familiar with the events of the Maidan protests, what led to this and what has happened since. However, one could argue — as I have chosen to do during the Fifth Annual Ukrainian Energy Forum that kicked off in Kiev June 24 — that the failure to secure and develop independent energy resources within Ukraine has allowed Russia to conductgeoeconomic warfare which has escalated to low-intensity conflict in eastern Ukraine.

Gas supply, and the threat to that supply for Europe, is what has forced Russia to move aggressively on multiple fronts to defeat Ukraine in its efforts to modernize and westernize its economy, its future, and its way of life.

So, how to start the liberalization process? Ukraine has argued that its gas transportation system is a strategic asset. Business-minded people take issue with this interpretation, which ignores the commercial potential of the pipeline system. Now that we have come full circle in a long-brewing Ukraine-Russia gas war, perhaps the pipeline should be considered “strategic” — if not in the way the Ukrainian authorities have long understood. The pipeline system, worth $20 to $30 billion, can indeed play a strategic and tactical role in resolving Ukraine’s crisis with Russia, but only if it’s sold off.

Ukraine should sell 50 to 75 percent of it for cash to a consortium involving the EU, U.S. and Russia and operated by a U.S. business enterprise, preferably based in Houston. This can only happen if Russia agrees to remove troops and other proxies in eastern Ukraine and then works with Ukraine to secure the border and cease all low-intensity conflict efforts, including on the ground, and in cyberspace and the trade arena.

Russia would pay cash for the gas transmission system and absolve Ukraine of the existing gas debt (given the Russian gas price of $395 per th.m3, Ukraine owes Russia $4.58 billion).

Doing so would allow Russia to continue to supply gas to Europe. The Ukraine crisis is as much about Ukraine not joining the EU and NATO as it is about Russia securing reliable and ongoing gas sales to Europe. A consortium-run pipeline system is the only neutral solution that allows Russia a face-saving way out.

The pipeline system, and the state-run company that manages it, should be turned into a transparent public company in London, for instance. The sale of 50 percent of the company could generate sizable profits, part of which could be invested in modernization.

All of this requires the recognition that Ukraine’s pipeline system is strategic only for Moscow — which needs it to control gas to Europe — while for Kiev, it should be a commercially viable asset. The crippling level of debt, the loss of Crimea, the continued destabilization of eastern Ukraine by Russia through the use of various proxies — including Chechen mercenaries — the suspension of gas supplies to Ukraine only last week, an apparent terrorist attack that resulted in an explosion on the gas pipelines in central Ukraine — all of this points to the necessity of an urgent rethink of strategic versus commercial philosophies. As a privatized commercial asset, the pipeline could raise $50 billion for Ukraine.

Related Article: Moscow and Kiev: A Dialogue Of The Deaf

Until now, the pipeline system has been nothing but a conduit for Russian gas into Europe. Russia already ships almost half of its gas to Europe via pipelines that bypass Ukraine, and in 2015, if Gazprom’s South Stream pipeline comes online as planned, it will be shipping a lot more gas to Europe without Ukraine. In this current dynamic, it could be even less than that. But it SHOULD be much more.

Beyond Pipelines

In this time of chaos and uncertainty, there is one thing about which there can be no ambiguity: Ukraine must transform its energy sector.

The ambiguity is more European than it is Ukrainian. The current crisis promises to become further exacerbated with Ukraine’s planned signing of the Association Agreement with the European Union on June 27. Ukraine hopes this will put pressure on Europe to resolve the gas sales issue, but it is unlikely to have much immediate impact on gas supply to Europe, particularly in the summer season, when gas stocks are relatively high.

Kiev presumably thinks that gas supply disruptions might just refocus EU countries back on the crisis in Ukraine, as they care above all about their own economic interests. The message Kiev is hoping to send is that if Europe cares about energy security for the next winter, it should help resolve the crisis in Ukraine now rather than letting it fester into the autumn.

The transformation must be comprehensive and it must be done with a clear understanding of what strategic assets really are. It is a process that must be completed over the course of years, and which must start definitively with the sale of the pipeline system, which is at the heart of the crisis in Ukraine.

Beyond this, Kiev will have to start selling off other assets and making the industry much more transparent, which will bring Western investors in to take advantage of the favorable gas price environment. But that’s the end game. Right now it’s about starting off the big transformation.

While it starts with the sale of the pipeline system, there are also abundant natural resources waiting to be development, and they will continue to wait without greater transparency. There are some other hard decisions Kiev will have to make as well, including selling off the state-run gas companies, Ukrnafta and Ukrgasproduction.

Kiev must realize that its eastern areas of Donetsk and Luhansk account for around 15 percent of Ukrainian GDP and have very significant linkages back to the rest of the Ukrainian economy. The risk in accepting the status quo in these two oblasts is an economic weight that the post-Maidan administration will not be able to handle and that will in the end be its downfall.

Right now, the Maidan government is tenuous, and the West needs to do much more to give it a chance to succeed, either by getting more serious with sanctions or lending financial support to Ukraine, or both. Ukraine assumes that sanctions pressure is keeping the Russian tanks from rolling across the border en masse, but this is a gamble at best.

By Robert Bensh for Oilprice.com

 

KIEV– Steal less, invest more, run a fair game and, by all means, sell off the pipeline system that Moscow has been using to keep Ukraine in line — these were the overriding sentiments of the Ukrainian Energy Forum, which kicked off June 24 in Kiev just as rebels in the east shot down a military helicopter and a ceasefire between government and pro-Russian separatists appeared to be in danger.

As experts and officials from Ukraine, Europe and the United States gathered for the three-day conference to discuss Ukraine’s energy future in the context of the “gas war,” the messages were twofold: Russia’s geoeconomic warfare has to stop, and Ukraine can find opportunity in adversity.

“It’s not really coincidental that the pipelines going around Ukraine look as much like a World War II pincer movement as anything. It is. It is meant to bring Ukraine in line, if not to bring it down,” Paul Shapiro, a senior banker for natural resources at the European Bank for Reconstruction and Development (EBRD), told the forum.

“The Gazprom contract is the elephant in the room. Obviously when they’re being accused at the same time of supporting what is, essentially, a proxy war in a large part of the country, it’s a difficult situation in which to negotiate a commercial contract,” Shapiro said.

And that “pincer” pipeline was a key focal point of the energy forum, with calls mounting for its privatization and transformation into a valuable commercial asset that would help earn Ukraine its freedom from the Russian gas chokehold.

According to Robert Bensh, a Ukraine energy expert and partner with Pelicourt LLC private equity firm,selling off the pipeline system worth $20 to $30 billion is the most crucial step at this juncture for Ukraine’s energy independence.

Others agree. In fact, last week, Ukrainian Prime Minister Arseniy Yatsenyuk told parliament that Ukraine was planning to set up a company to manage the pipeline and suggested bringing on European and American companies to help operate it in order to ensure that Ukraine remains a key transit country for gas to Europe.

“One of the reasons that you’re having such problems with Russia right now is that they’re doing everything they can to secure energy supply to Europe,” Bensh told the conference. “When you threaten that market, they act the way that they have — creating unrest from a trade standpoint in eastern Ukraine. They’ve launched a low-intensity conflict. They’ve taken Crimea.”

U.S. Ambassador to Ukraine H.E. Geoffrey Pyatt told the conference “a great deal about Ukraine has changed over the past year, but the strategic importance of energy issues has not.”

read more on Oilprice.com

 

by Kevin Chupka for Yahoo Finance

While Iraq has dominated the geopolitical stage this week (and with good reason), there’s still some crazy stuff going on in Ukraine. Earlier this week Russian natural gas giant Gazprom shut off the flow of its product to Ukraine. Then last night a portion of a pipeline in Ukraine “mysteriously” exploded. Can anything be done to calm the tensions?

In short, yes says energy expert and former advisor to the Ukrainian government Robert Bensh. For starters Bensh notes that 60% of Europe’s gas flows through Ukraine. When Gazprom shut down the flow it impacted more than just Ukraine and that alone could prompt action if the rest of the EU begins to feel the pinch. “What this really is more than anything else is Russia exerting control and influence both over Ukriane and the European Union with regard to its gas supply,” he says.

Then comes the exploding pipeline. Bensh admits this has Russia’s fingerprints all over it and says it will allow them to “argue to the European Union and the United States that Ukraine cannot secure the transportation system and something must be done.”

So what then can the U.S. actually do? Not much Bensh says. “The U.S. has significant influence, it has a very good relationship with the Ukrainian government. At this point they are letting the new president Poroshenko deal with and negotiate with Russia. He’s actually a very good president for the country at this point in time. If anyone can find a solution it will be him.”

That solution may actually surprise you. While it would be a tough pill to swallow Bensh says Ukraine must sell some of its pipeline system…to Russia!

Poroshenko “must sell at least a third of it to Russia,” he says, “and that ultimately is a good thing not only for Ukraine and Russia but also for Europe.” Such a sale would make the pipeline secure, would get the gas flowing, and would probably even result in some improvements to the system. What happens after that is anyone’s guess.

 

 

Liquefied natural gas (LNG) to Europe isn’t a get-rich-quick scenario for the impatient investor: It’s a long, strategic play for the sophisticated investor who can handle no small amount of politics and geopolitics along the way. When it comes to Europe, Russia’s strategy to divide and conquer has worked so far, but Gazprom is a fragile giant that will eventually feel the pressure of LNG.

Robert Bensh is an LNG and energy security expert who has over 13 years of experience with leading oil and gas companies in Ukraine. He has been involved in various roles in finance, capital markets, mergers and acquisitions and government for the past 25 years. Mr. Bensh is the Managing Director and partner with Pelicourt LLC, a private equity firm focused on energy and natural resources in Ukraine.

In an exclusive interview with Oilprice.com, Bensh tells us:  

•    Why the smart LNG play is a long-term one
•    How LNG fits into the European energy picture
•    Why LNG will eventually pressure Russia in Europe
•    Why Gazprom is but a fragile giant
•    How Russia combines gas and political influence in Eastern Europe
•    How the European Union is easy to divide and conquer
•    Why the Ukraine crisis has brought attention to the South Stream pipeline
•    Why Bulgaria is the new front line
•    How Lithuania succeeded in negotiating down Gazprom
•    What Moscow’s Crimea annexation really achieved
•    Why it’s game over for Gazprom prices when Turkey steps in

James Stafford: Where does LNG fit into the overall European energy picture?

Robert Bensh: A better question might be, “When does LNG fit into the European energy picture?” When the price is right, it fits into the picture across the European Union, with new import terminals under construction, plenty of transmission lines to deliver it to land-locked countries and the prospect of deliveries from rising energy hub Turkey. And while it may not be a reality at this very moment, it is the prospect of cheaper LNG and the pace of LNG infrastructure development that has Gazprom worried about maintaining its monopoly.

James Stafford: So from an investor’s perspective, what do we need to know here?

Robert Bensh: Listen, the LNG economics are marginal. LNG is about long-term, steady supply. It’s a low-margin, long-term supply of gas to Europe. This is not a play for impatient investors who are looking to get rich quickly. This is a play for investors with longer-term vision, patience and strategic capabilities on a regional level. Those are the people who are going to make money off of this and, along the way, help reshape the balance in Europe away from Russia.

James Stafford: Who are the buyers in this scenario?

Robert Bensh: The countries that primarily take LNG are the Eastern European countries that are paying the highest gas prices and feeling the most significant strategic energy crunch from Russia. They can purchase large amounts of LNG on five 10-year contracts.

James Stafford: And what will Gazprom’s response to more LNG for Europe be? What are its options?

Robert Bensh: Gazprom will either see its supply reduced, or it will be forced to reduce prices to limit economic impact. But once we can start getting LNG through the Turkish-controlled Bosphorus Strait, it is game over for Gazprom in terms of pricing. You’ll still have LNG coming into Europe simply because demand will always exceed supply with long-term contracts in place. That’s when you’ll start to see significant amounts of Canadian and American LNG entering the European and Asian markets, which will affect gas prices in Europe.

James Stafford: Has Russia’s, or Gazprom’s, energy strategy in Europe really been as sinisterly brilliant as is often suggested?

Robert Bensh: In many ways, yes; but it has its limitations. Financially, Russian gas monopoly Gazprom is a fragile giant.

Russia’s European energy policy is to approach different EU states on an individual basis in order to discriminate with price and get the maximum price possible from each. Beyond that, Russia also attempts to lock in supply by consolidating control over strategic energy infrastructure throughout Europe, as well as Eurasia.

In 2002, for example, Russia attempted to buy major energy infrastructure holdings in the Baltic states of Lithuania and Latvia. When both countries refused to cede control, Moscow sharply cut oil deliveries to both states. The final piece of Moscow’s strategy is to maintain control of energy corridors, thus denying Europe any alternative energy routes.

Russia gets away with this because its divide-and-conquer energy strategy is made easy by the fact that the European Union is anything but unified.

James Stafford: How does Gazprom’s controversial South Stream pipeline play into the crisis in Ukraine?

Robert Bensh: The South Stream pipeline is now coming into much clearer focus against the backdrop of the Ukraine crisis. This pipeline, which would run from the Black Sea to Austria and bypass Ukraine, is both a frightening and exciting proposition for Central and Eastern Europe. The specter of this pipeline makes the fractures in Europe highly visible.

The annexation of Crimea was significant on numerous fronts. The Ukraine crisis provided Russia with the opportunity to achieve important the economic and geopolitical goals of promoting alternative energy supplies that bypass Ukraine. And the results have been quick: Already, some EU countries have indicated that they are willing to drop their objections to the South Stream pipeline in order to increase the percentage of gas shipped directly from Russia.

James Stafford: What about Bulgaria’s recent back-and-forth over South Stream? What can we read into this?

Robert Bensh: For the South Stream pipeline, which is largely a macrocosm of the Ukraine crisis, the front line is Bulgaria, where Russian influence is now at its strongest, and where there is already talk of the country becoming the next Ukraine. The wider EU is trying to block the South Stream project, while Central and Eastern Europe are very torn. Bulgaria is where this pipeline will enter the EU, and accusations persist that Gazprom has had a hand in framing Bulgarian legislation that would circumvent EU competition directives. All of Europe wants this pipeline, but Brussels doesn’t want it to be majority-Russian owned — they want to enable other suppliers to bring gas through it.

The Bulgarian story is getting very interesting. Last week, the Bulgarian government said it was suspending working on South Stream, under pressure from the EU over the project and U.S. sanctions against Russian firms working on the project. Bulgaria is caught in a very bad place here—between Russia and the EU. On the one hand it is suspending work—for now, as it consults with the EU. On the other hand, it is making sure everyone knows it still intends to go ahead with South Stream.

James Stafford: How much of a threat to Russia is the European Commission’s pending investigation into Gazprom’s monopolistic activities?

Robert Bensh: Europe has argued that Gazprom manipulates prices for political gain and the European Commission is set to release the results of a two-year investigation this month, which is expected to demonstrate substantial evidence that Gazprom is breaking European laws. After that report is released, the EC could take action relatively quickly with up to10 billion euros in fines, which Gazprom cannot afford. Again, the Bulgaria question will figure prominently in his debate.

James Stafford: How does Russia take advantage of the divisions within the EU?

Robert Bensh: The problem within the EU is that Western European countries have more supply opportunities, while Central and Eastern Europe are stuck with Russia. There is no common policy among the EU countries, so there can be no unified front to take on Russia in the energy sphere. Russia takes full advantage of this bifurcation. While talking of interdependence and dialogue, Russia has insisted on providing demand guarantees for the producers and sharing responsibilities and risks among energy supplier’s consumers and transit states. Russia’s actions have not backed up its visions for a new global energy security due to the state policy of not budging from monopolizing gas production or oil and gas pipeline transportation. Europeans are wholly energy dependent on Russia.

Russia conducts geo-economic warfare on Europe. Russia’s vast oil and gas resources and strategic geographic positioning has translated into increased influence in global energy markets and political clout in its relations with the numerous states that remain more or less dependent on Russian energy. Lawsuits and rulings from the European Commission will prove to be well intended, yet ultimately failed efforts to control Russia’s policy aims driven by control of energy supply and transportation. Here is where efforts to reduce dependence by one client state will have a concomitant benefit for other client state consumers. The European Union lacks a coherent, unified energy strategy and policy towards Russia. Russia thus wisely triangulates client states and the EU to achieve their policy goals either through cheaper supply or infrastructural development.

James Stafford: Will other countries in the region follow the example of Lithuania and Poland—both of which are aggressively pursuing alternatives to Russian piped gas?

Robert Bensh: Some, yes, out of necessity. The wisest ones, of course, will develop what they can internally of their own resources in an effort to reduce or possibly even remove the need for Russian oil and gas.

James Stafford: Where in Europe is there the potential to actually develop domestic resources to reduce Russian dependence?

Robert Bensh: Ukraine has the potential to do so. Poland, potentially, as well. Other countries, the Baltics in particular, will have a much harder time reducing dependence through internal resource development. For this reason, the development of LNG and additional transportation routes to the region are vital strategically to reduce the dependence on Russian energy.

James Stafford: How should we perceive Lithuania’s recent success in negotiating down gas prices with Gazprom?

Robert Bensh: The country has very earnestly pursued LNG and is close to signing a supply deal with Norway’s Statoil. This, in turn, has forced Russia into price concessions for fear of losing market share. But for now, it’s a luxury that the poorer members of the EU in Central and Eastern Europe cannot afford, economically or politically.

Unfortunately, most countries will not play ball. Either they have enough of an internally generated resource base to help reduce dependence on Russian energy, or they have multi-integrated economic ties to Russia. Or both.

The crisis in Ukraine has taught us a devastating lesson: The failure to reduce dependence on Russia, in combination with a multi-integrated economic union with Russia, exposes a client state to geo-economic warfare. In Ukraine, this situation eventually led to President Viktor Yanukovych refusing to sign an Association Agreement with the European Union, which in ignited the Maidan protests that led to the president’s overthrow and Russia’s annexation of Crimea.

James Stafford: Where will politics and geopolitics head this off? What is Russia’s weak point, it’s Achilles’ heel?

Robert Bensh: Russia has done a good job of tactically focusing on each client state, recognizing their weaknesses and exacerbating them to suit their needs. The only countries that can head this off are those with independent economies and diversified energy supplies. Russia can only provide oil and gas supplies and energy infrastructure development. It cannot provide expertise in oil and gas drilling or service, which really comes from the United States.

And Gazprom’s Achilles’ heel—that which makes it a fragile giant—is the prospect of losing the European market to LNG. And it eventually will, at least in part, though it won’t be tomorrow.

James Stafford: What does the LNG pricing look like right now?

Robert Bensh: LNG is always about $1 less than Gazprom. The U.S. wants to sell their LNG, period. Asian prices are higher, anywhere from $3-$4 higher. But long, steady supply will always get sold. Unless Gazprom comes down in its prices, to make LNG uneconomic, there will always be an LNG marketplace in Europe. There will always be enough supply to meet demand in Europe. All Gazprom has to do is drop its prices down $1 and LNG will be uneconomic. But you have some countries in Europe who are willing to pay a premium to reduce their dependence on Russian gas. LNG supply and the development of internal resources is a strategic decision being made by each country.

There won’t really be U.S. LNG hitting Europe until 2017-2018. There isn’t enough LNG coming from the U.S. to supply both Asia and Europe. Until there are more export terminals built in the U.S., there will always be significantly more demand than supply, from a U.S. standpoint. For now, U.S. LNG does not impact Europe—we’re not transporting enough in the next five years.

James Stafford: Last month, amid the crisis in Ukraine, Russia and China inked what is viewed as a highly significant gas deal. What are the implications of this deal for Europe?

Robert Bensh: Let’s put this into perspective a bit: This Russia-China deal might not be squeezing out potential supply to Europe, but making up for the likely disappearance of the market for gas from Ukraine. A decade ago, Ukraine was buying 52 billion cubic meters of gas annually from Russia, and last year, this was down to 28bcm. The take-or-pay agreement signed in 2009 was for 42 bcm, which is more than the annual supply as per the China deal. It is not unreasonable to think of Ukraine being totally self-sufficient in gas over the next decade as rational energy pricing reduces very inefficient consumption, while Ukraine has lot of opportunities to hike production — assuming it remains unified.

This is part one of a three-part series of interviews examining the prospects for Black Sea LNG.

By James Stafford of Oilprice.com

 

Kiev is feeling emboldened by the successful election of a new Ukrainian president and a bloody surge against separatists in the east, but in just a few days, Russia says it will twist the gas spigot, and there’s very little Kiev can do to stop that.

On June 3, Russia plans to reduce the gas supply to Ukraine — and hence, to Europe — if Kiev has failed to pay in advance for next month’s gas deliveries, the price for which has been doubled as a result of the political crisis.

Interim Ukrainian Prime Minister Arseniy Yatsenyuk is trying to play hardball with Moscow, suggesting that gas talks cannot move forward until Russia addresses the issue of $1 billion ingas it stole when it annexed Crimea.

Yatsenyuk may be riding high on the sense of stability the recent presidential election has brought, not to mention the unleashing of the Ukrainian military on pro-Russian separatists in Donetsk, but the “stolen gas” gambit is a losing one—a bunch of bluster that certainly won’t make Moscow go away.

Ukraine owes $500 million just for May gas deliveries, on top of a whopping $3.5 billion in outstanding gas debt (according to Moscow). If at least part of this debt is not paid, there won’t be any negotiating over price. Gazprom says Ukraine had agreed to pay $2 billion of its debt this week, but Kiev is instead talking about stolen Crimea gas.

What is promising in all of this is the election of Petro Poroshenko as Ukraine’s new president, by a wide margin and with more than 60 percent voter turnout. Ukraine has new, legitimate leadership that Russia, the United States and the European Union have all agreed to recognize.

The new president immediately pledged to deal with the separatists in Donetsk and Lugansk, establish a working relationship with Russia and hold early parliamentary elections, which undoubtedly is an attempt to capitalize on the current political good will and further weaken a parliament dominated by former Regions politicians, Fatherland and business interests.

What the presidential elections give Kiev is a bit more strength and a more united force to deal with its energy crisis, as well as with Moscow.

In the coming days, Russia will recognise Poroshenko’s legitimacy and remind him that June 3 is right around the corner. By next week, we could see the disruption of gas supplies to Europe, Russia’s largest and most profitable market.

If this happens, an acute energy crisis in Ukraine is all but certain. Ukraine stockpiles its gas supply for the winter heating months during the summer. With current low supplies and higher prices expected for this summer, Russia will walk all over Kiev.

Short of handing Gazprom a cashier’s check, there is no way to avoid the present crisis.

In the medium-to-long term, however, some hard decisions are going to have to be made—decisions that former Ukrainain vice prime minister and energy minister Yuri Boyko would have liked to make some time ago. These include selling off the state-run gas companies, Ukrnafta and Ukrgasproduction.

So we find ourselves reliving 2006 and 2009, when Russia cut off gas supplies to Ukraine and Europe.  And if Ukraine hopes to stop reliving these desperate years over and over again, it’s going to have to start selling off assets and rolling out the transparency.

The trick will be for Poroshenko and a newly appointed energy minister to work with both Russia and Europe to secure new pricing and to foster energy independence while at the same time being mindful of one very important fact: Ukraine’s westward drift toward the EU is what led Russia to annex Crimea in the first place.

Russia will continue to use Russian nationalist movements in eastern Ukraine to stir discontent and to sow chaos, striving to keep Kiev off balance as Moscow works to use gas as a weapon to ensure a compliant Europe. It’s a hard balance to maintain, especially as some Central European countries are seeing the light at the end of the independence tunnel.

Poroshenko is a highly pragmatic businessman, which is what Ukraine needs. But neither he nor those around him know energy, or Russia. From the energy crisis standpoint, it is the appointment of a new energy minister that will change the real balance of power.

There are very few figures in Ukraine who know the West, Russia and enough about energy to do what needs to be done. Because of that, Poroshenko’s pick for energy minister should be the smartest choice, not the most popular one.

Commentary by Robert Bensh, special to Oilprice.com

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By Robert Bensh

As protests in Ukraine’s eastern region turned violent on Sunday leading to the death of a Ukrainian security officer in a shootout with pro-Russian militia, Kiev threatens military action while Moscow flexes its geo-economic warfare muscles.

Pro-Russian militia groups have seized government buildings and police headquarters in Ukraine’s eastern city of Donetsk and Slovyanks–where the shoot-out took place–and despite a Monday morning ultimatum by the Ukrainian government, these groups have shown no sign of giving in.

There has been no movement by the Ukrainian military to make good on its ultimatum; indeed, the messages have been unclear and contradictory.

Acting president Oleksander Turchinov has dangled the idea of a referendum that would seek to address the demands of the region’s Russian-speaking population for more autonomy. In the same breath, Turchinov on Sunday promised a “large-scale anti-terrorist operation” to prevent another incident such as Crimea, which was annexed by Russia last month.

On Sunday, Moscow requested an emergency meeting of the United Nations Security Council (UNSC), while NATO came out with estimations that Russia had amassed up to 40,000 troops in more than 100 locations along its border with Ukraine.

This is the atmosphere that leads us up to 25 May presidential elections in Ukraine, which will be shaped by metamorphosing relations with Russia—and by energy.

Over the past few years, Ukraine’s relationship with Russia has become increasingly adversarial, in tandem with Russian President Vladimir Putin’s desire to increase his status and dominion. (Related Article: Ukraine Standoff Escalates, Could South Stream be in Doubt?)

But it is through the spectrum of energy that we have seen the more poignant phases of this change. The current controversial gas supply agreement Ukraine has with Russia was put in place less because of Putin’s negotiating skills and more because of a concerted effort by former prime minister and current presidential candidate Yulia Tymoshenko to destroy the Ukrainian gas lobby run by oligarch Dmitry Firtash.

While Ukraine has always struggled with gas supply issues, this really changed the dynamic. Yuri Boyko—former energy minister and another current presidential candidate–has gone from a close working relationship to a very strained one with Russia as he sought to both keep the population supplied with cheap gas and to increase the country’s independent energy supply.

Boyko’s plans to further diversify the industry were halted when he was promoted to the position of vice-prime minister and Eduard Stavitsky, a member of ousted president Viktor Yanukovych’s inner circle, was given the energy portfolio. At that point, all efforts towards energy independence abruptly ceased.

What’s going on now is geopolitical and geoeconomic battle for the region, driven by loss of Russian credibility and Moscow’s control of the Ukrainian presidency when Yanukovych was ousted in February.

But it’s important in all of this to pay close attention to what Russia is airing as its grievances, which included: an illegitimate Ukrainian government led by radicals; unprotected Russian speakers in the eastern regions; and $11 billion in unpaid Ukrainian gas debt.

What Moscow is saying, then, is that the current administration has zero representation from the eastern portion of the country. It is important to remember that over 40% of the Ukrainian population—all from the east—was against signing the economic cooperation agreement with the European Union, which was carried out immediately after the annexation of the Crimea in late March.

Russia can realistically argue that the Maidan protest movement drove the political section process, and that the current government is not representative of the country as a whole. The current administration was interested in placating the Maidan and moving towards Europe, not necessarily in united the country.

And what have they accomplished? Nothing. There are still people protesting in the Maidan; Crimea is gone; and eastern Ukraine is under threat of attack from Russia. (Related Article: Ukraine or Russia? How Would Economic Factors Influence a Vote?)

The current leadership should also take responsibility for its role in provoking the current situation. They refused to speak with Russia once they assumed leadership, stating they had support from Europe and the United States. At the same time, some politicians and ministers are busy conducting their own brand of justice, accusing anyone that is of the former government of crimes with little to no justification and trying to take advantage of their few remaining weeks in office to position themselves for future power.

What Russia wants is an integrated representative government. If this is realized, Moscow will no longer be able to play the legitimacy card. If Petro Poroshenko, who is leading in the polls right now, wins the presidency, then Ukraine will need a prime minister that is accepted in the east in order to have an integrated government.

This new government will also need to find an effective way to pay the country’s gas debt to Russia, because that will not disappear. The only way to do that is to start selling off energy assets and privatizing the energy infrastructure.

Russia has been able to manipulate Ukraine’s energy dependency to the benefit and pursuit of its foreign policy goals. We’re seeing this very clearly today as Putin has called for the payment of $38 billion from Ukraine, the result of unpaid gas sales and the removal of the discount for the Black Sea port in Crimea.

Ukraine’s economic crisis had been transformed into geoeconomic warfare caused by Russia’s control of supply to Europe and Ukraine’s failure to develop its own internal energy resources. And it cannot be coincidental that Russian troops are building up close to Ukraine’s gas pipelines.

Ukraine presents the most powerful example of Russia’s use of the energy weapon as a means to influence the foreign policy orientation of a post-Soviet state, and as “testing ground” for Russia’s possible use of energy as a foreign policy weapon elsewhere in the former USSR and beyond.

However, Ukraine’s new leadership has to take responsibility here as well. The current situation is not as black and white as our Cold War mentalities tempt us to believe. The onus is now on Kiev, and there are diplomatic and economic ways to halt the violent progression and render Moscow’s arguments moot.