IEEJ： March 2014

○ｃ IEEJ 2014

Special Bulletin
A Japanese Perspective on the International Energy Landscape (163)

March 4, 2014

Tense Ukraine Situation and Its Impacts on Energy Market
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan

Rapidly growing tensions in Ukraine have attracted global attention. The Ukrainian
government collapsed in late February as President Viktor Yanukovych left the country amid his
government's escalating dispute with rebels. An interim government came into being in the capital
city of Kiev, relieving pro-Russia Yanukovych of the presidency. While the pro-Western interim
government is based in western Ukraine, people sympathetic to Russia are abundant and influential
in the eastern and southern (Crimean peninsula) parts of the country. In this way, Ukraine is notunited. Various destabilizing factors are mixed at political, economic and social levels.

Russia, which has positioned Ukraine as a cornerstone of its security, could not ignore thegovernment change. Geographically, Ukraine borders Western Europe, sandwiched between theEuropean Union and Russia. The Russian Black Sea Fleet is based in Sevastopol on the Crimean
peninsula. Russia has thus had significant, special relations with Ukraine. In such a key country, thepro-Western government has replaced the pro-Russian president. Russia might have concluded that
this development represented a grave threat to its security. As a result, Russian forces stationed on
the Crimean peninsula have put local government, airport and other key facilities under control
despite strong opposition and checks from the United States and Europe as well as the interim
government, taking effective control of the peninsula by March 3, as has been reported.

The interim Ukraine government and Western countries raised strong opposition to theRussian military intervention. U.S. State Secretary John Kerry called Russia's troop movements into
Ukraine an "incredible act of aggression." Russia for its part has described its action as required forprotecting Russian residents, and, as requested by the (legitimate) Ukrainian (Yanukovych)
government, maintaining a confrontational attitude against Western countries.

To counter the Russian action, Western countries have threatened to boycott a preparatory
meeting for Group of Eight summit that Russia will host in Sochi in June and to impose economic
sanctions on Russia. They have even indicated excluding Russia from the G8. The Ukraine situation
has rapidly grown tense on Russia's military intervention, Western countries' opposition and anescalating exchange of accusations between them. Some observers now see U.S.-Russia relations as1

IEEJ： March 2014

○ｃ IEEJ 2014

the worst since the end of the Cold War and fear that the United States and Russia could revive theCold War. Given that future Russian actions are very uncertain, the world is breathlessly watching
the Ukrainian situation.

The Ukrainian crisis has shaken the international energy situation. As a revival of the Cold
War is feared, the market has begun to respond to geopolitical risks. The Brent crude oil futures pricerose from $109.02 on February 28 to $111.20 on March 3. While international oil market supply andRussian crude oil supply to East European countries via Ukraine have remained unaffected, agrowing sense of risk has apparently exerted an impact on the market.

A problem that is likely to grow more significant in the energy market is related to Russian
natural gas supply. Europe is the largest natural export market for Russia and depends on Russia for
about a quarter of its natural gas imports. Some pipelines for Russian natural gas exports to Europe
avoid Ukraine, including the Nord Stream pipeline opened in 2011. But most Russian natural exports
to Europe go through Ukraine.

In January 2009, Russia actually suspended pipeline gas supply for a short period of timeamid a gas dispute with Ukraine. As the Ukrainian situation has grown tense, energy market players
have begun to pay attention again to how Russian gas exports via Ukraine will be affected. Since thiswinter has been rather warmer than in past years, no special problems have so far emerged with
European gas supply and demand, with inventories remaining at high levels. As noted above, gas
supply routes to Europe avoiding Ukraine have been developed. Given economic rationale andreputation risks, Russia is rather unlikely to suspend gas supply again. Nevertheless, concerns overRussian gas supply risks have attracted attention in the market due to the rapid developments in
Ukraine and future uncertainties. In this respect, Russia has indicated a plan to cancel a discount forgas sales to Ukraine that had been agreed under the previous Ukrainian government, attracting
attention from energy market players.

Another point to which we should pay attention is the impacts of the Ukrainian crisis on
Russian energy trade and investment. Future developments are very uncertain with no optimism
justified. If Western countries actually impose economic sanctions on Russia, various impacts mayemerge on Russian energy trade and investment. Russia has exported energy resources primarily toEurope. Over recent years, however, it has expanded oil and LNG exports to the Asian market
including Japan. As Russia is considering investment in various strategic energy projects for the
Asian market, Japan will have to closely watch future developments regarding Ukraine and theirimpacts on the energy market.
Contact: report@tky.ieej.or.jp
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