ETF Trends
ETF Trends

In an effort to explain the annexation of Crimea, there has been a great deal of coverage surrounding the region’s ethnic ties with Russia and the political motivations of the move. After all, it was only 60 years ago that Crimea was gifted to Ukraine by Russia and it’s fairly understandable that Russia is a little antsy at the idea of having NATO on its doorstep in the wake of the ousting of President Viktor Yanukovych in the Ukrainian uprising. However, less attention has been paid to the underlying energy-related economic motivations of the move and therein lies a clearer picture of why Crimea is so important.

A couple weeks ago Russia’s state owned Gazprom announced that it would be tightening the screws on Ukraine by withdrawing the natural gas discount they provide in the second quarter of this year. In the wake of this, the Ukraine will likely face a price increase in the neighborhood of 30%. Ukraine enjoyed the discount on Russian gas as part of a prior agreement between Vladimir Putin and the former Ukrainian president, whereby the Ukraine rejected a pact with the E.U. in favor of closer ties with Moscow, a move that led to three months of mass protests, violence and an eventual regime change.

The Ukraine is the primary means by which Russian gas reaches Europe: 50% of Europe’s natural gas imports from Russia travel across the Ukraine. The country annually consumes approximately 50 billion cubic meters (bcm) of natural gas and produces roughly 22bcm, leaving about 28bcm to be covered by way of imports.Russia is the source for the lion’s share of those imports, at nearly 26bcm.1 As such, Moscow has enjoyed considerable influence over its neighbor since the breakup of the former Soviet Union, having gone so far as to shut off the gas to the Ukraine twice since 2006 in order to steer Ukrainian politics the way it wanted.

Russia’s annexation of Crimea was swift, unapologetic and left most the world astounded at how quickly it all transpired. There was no immediate threat and the area accounted for a meager 4% or less of Ukraine’s GDP. 2So why so fast? The answer appears to lay offshore of the Crimean coast.

The waters offshore of Crimea are said hold between 4 trillion and 13 trillion cubic meters of natural gas according to the Ukrainian government, and with development capex in the range of $8-9 billion could produce 9.7 billion cubic meters (bcm) of gas by 2030. 3 However, any chance of getting out from under the thumb of Russia or realizing the future monetary value of those energy assets disappeared from Kiev’s balance sheet as soon as Crimea was annexed.  From the Kremlin’s perspective, who exported nearly 6,248bcm in 2012 according to the EIA, 4this isn’t a huge play but it’s a decent addition to their reserve base and it keeps the Ukraine in their place: a customer in need.

In the weeks before the uprising and overthrow of the government, it was reported that ExxonMobil and Royal Dutch Shell, acting as leads of a consortium, were in production sharing negotiations with the government concerning the Skifska offshore gas field. Interestingly there was only one other bid for the development of the Skifska field and that came from Moscow-based oil and gas company Lukoil. 5 In the wake of the hostilities, Exxon announced that negotiations would be put on hold. 6 Given that Russian legislation stipulates that any offshore production in Russian waters requires 51% of state ownership, post annexation this consortium has a new “opportunity set” to consider.  ExxonMobil and Shell may find that the new terms are not nearly as enticing as they once were. Not to worry though, Gazprom or Lukoil might be interested.

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