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Ukraine could fail to pay its gas bill on April 10, turning up the heat in a new gas row with Russia. Moscow is mad at the EU and Ukraine after they declared they would upgrade Ukraine's transit gas pipeline and Russia is determined it won't be excluded from the lucrative contracts.

Several senior members of the Ukrainian government, most notably Prime Minister Yulia Tymoshenko, have publicly said that Russia should be included in the work. The EU, terrified of causing another round of gas cuts, has also come out strongly in favour of including Russia in the job.

However, the Kremlin isn't convinced. Its line with Ukraine has been hardening rapidly since the announcement was made in Brussels on March 23. The CEO of state-owned gas monopolist Gazprom, Alexei Miller, reversed a promise this week not to fine Ukraine for taking less gas than it contractually agreed to in a deal that resolved the gas dispute in January. Ironically, Miller told the Belarusians the opposite on April 8. The Russian Finance Ministry has also held up approval of a $5bn short-term loan to Ukraine agreed in March to cover the expected budget shortfall this year.

Now, Gazprom says it will set up its own European alliance to carry out the work as a counterweight to the declaration signed in Brussels by Ukraine and the EU. The Russian company says it already has its main Western European partners on board - including Germany's E.On and Italy's Eni - in a classic bit of divide and rule.

Weak position

Western Europe is in a weak position. The EU has failed to developed a coordinated energy policy amongst member states and Gazprom has successfully appealed to individual governments that are more interested in securing their own energy supplies than towing the Brussels line. While Gazprom provides about a third of Western Europe's gas supplies, Italy, for example, gets over 80% of its gas from Russia and its partners as a function of its geography and the pipeline routes.

Russia is also taking advantage of Ukraine's financial problems. Ukraine's gas bill for March is due to be paid April 10. The Ukrainian national gas company Naftogaz Ukrainy only just managed to scrap together enough to pay the February bill. According to reports, Naftogaz doesn't have the money to meet the March gas bill and the chances are high it will miss either this payment or subsequent ones. In that event, Gazprom would be allowed to fine Ukraine and also demand pre-payment going forward.

Moreover, the bill is going to rise in the coming months, as Ukraine has been importing almost no Russian gas in the last month, drawing it down from its reserve tanks. However, these reserves will have to be replaced at some point, causing a spike in deliveries. VTB Capital in Russia issued a report on June 8 saying it couldn't account for a 9.1bn-cubic-meter fall in Gazprom's exports - at least part of this is due to Ukraine relying on reserves rather than deliveries. Naftogaz says it will cost UAH37bn ($4.8bn) to refill the storage tanks against the $700m-odd the company paid for its February gas. The whole issue testifies to just how poor Ukraine's financial position is.

Prime Minister Yulia Tymoshenko's government is clearly playing for time and hopes that it can raise fresh cash from an international donor. The World Bank has just promised to lend the country $500m to tide it over and the IMF mission arrives in Kyiv on Thursday, June 9 to discuss conditions that Kyiv will have to meet before the second $1.9bn tranche of a stabilisation loan agreed in November can be released.

Divide and rule

Gazprom's change of heart over the amount of gas it will charge Ukraine for March came on April 3 after Miller reported to Prime Minister Vladimir Putin about his April 2 meeting with executives from E.On, Eni and Gaz de France. Miller was quoted as saying: "This meeting was initiated by our partners. It touched upon the issue of the declaration signed in Brussels recently by the EU and Ukraine. We all take the view that this declaration was developed without involving Russia, Gazprom as the gas supplier, or Europe's leading gas consumers. Naturally, we also agree that such an approach is fundamentally flawed, making the declaration unviable. In other words, it is impossible to put into practice." Miller added that the meeting resolved to establish a working group, which will assemble "within four to six weeks for an equally high-level meeting."

Eni and E.On are not just major consumers of Russian gas; they are also Gazprom's partners in key Russian energy projects - the South Stream and Nord Stream gas pipelines (Gaz de France also wants to get involved in Nord Stream) - which will provide new gas routes to Europe that bypass Ukraine.

The Ukrainian government met on April 8 to discuss the March gas bill. A source told Russian daily Kommersant that Russia has offered a $5bn loan to cover the gas payments, but it is unclear if that offer still stands. Russian President Dmitry Medvedev said on March 24 that he was calling off inter-governmental talks until the questions raised by the Brussels's declaration were settled.

"Intergovernmental consultations were scheduled for April 8. In the expected scenario, Ukrainian Prime Minister Yulia Tymoshenko would announce that gas payments had been made on schedule, and Vladimir Putin would propose making arrangements for a $5bn loan to cover the cost of Russian gas for Ukraine's underground storage tanks. But the Brussels declaration has mixed up all the cards, disrupting these plans," a Ukrainian source told Kommersant.

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