The LNG announcement and subsequent denial is the latest development in an energy dispute between Ukraine and Russia that began more than a year ago. The crux of the disagreement between the two countries is the price that Russia charges Ukraine for natural gas (currently $432 per thousand cubic meters), which Kiev wants lowered. Russia has said it would only reduce the price if Ukraine merged its state energy firm, Naftogaz, with Russia's Gazprom or joined the Moscow-dominated Customs Union. However, this would undermine Ukraine's sovereignty, particularly because Russia's Nord Stream and the soon-to-be opened South Stream pipelines will cut into Ukraine's transit volumes.

Yanukovich's government has resisted giving into Moscow's demands. Instead, Kiev has pursued a two-pronged strategy to diversify away from Russia — cutting overall consumption of natural gas and ramping up its procurement of alternative sources of energy.

Cutting Consumption

So far, the first part of Ukraine's strategy has proved relatively successful. The country has cut its imports from Russia from 40 billion cubic meters in 2010 and 2011 to a projected 26 billion cubic meters in 2012. Kiev has said it plans to import less than 20 billion cubic meters in 2013, and Ukrainian Energy Minister Yuri Boyko announced that the country will soon submit a formal request for 18 billion cubic meters for the year. However, Ukraine's ability to maintain these lower levels of imports is questionable. The country was able to make the cuts in 2012 largely because its natural gas storage was full, the winter was relatively warm and adjustments were made to increase the efficiency of domestic energy production (Ukraine has one of the most energy-intensive production systems in the world). It is unclear whether these conditions will exist in upcoming years, particularly since Ukraine's stored natural gas comes from Russian imports.

Importing lower volumes in the next year or so based on lower consumption could also prove problematic from a legal standpoint. Ukraine's contract with Russia has a "take or pay" provision for 80 percent of the contracted volumes. The contracted volume for 2012 and 2013 is 52 billion cubic meters, meaning that Ukraine must pay for at least 41.6 billion cubic meters regardless of its consumption rates. This could cause Russia to take Ukraine to court over the issue, though Boyko has said that Ukraine is prepared to defend its position in case of legal action. Gazprom has been on the losing end of several legal cases during the past year, though European companies initiated these cases and it is unclear if Naftogaz would have such a favorable result.

Seeking Other Energy Sources

The real question concerns the second part of Ukraine's strategy: procuring non-Russian energy. One hundred percent of the natural gas Ukraine imports now, and 75 percent of the country's total consumption, comes from Russia (the rest of the natural gas consumed is produced domestically). Ukraine has been exploring a number of alternatives to Russian natural gas, striking deals with other energy producers and working with partners to increase its indigenous energy production.

Ukraine intends to build an LNG import terminal on its Black Sea coast in the southern region of Odessa. This is the project for which Kiev said a consortium was being created with Gas Natural. However, the denial by the Spanish firm indicates this project is not as far along as the Ukrainian government suggests. Moreover, moving LNG tankers into the Black Sea through the Bosporus would require approval from Turkey, since the route runs through Turkish territorial waters. Although the LNG terminal would allow Ukraine to cut imports from Russia significantly, it is one of the least feasible projects Ukraine is considering at this point.

Ukraine has also been in talks to secure natural gas supplies from Azerbaijan once the country's Shah Deniz II field comes online. However, this natural gas will not become available until 2017 at the earliest, and Azerbaijan's ambassador in Kiev has said Ukraine would receive only 2 billion cubic meters per year. This would have little effect on Ukraine's overall energy imports from Russia, and supplies from Shah Deniz have been of interest to other potential buyers — including Turkey, various European countries and Russia — who could edge Kiev out as a natural gas customer for Azerbaijan.

Kiev also has plans to construct coal gasification plants. In August, Ukraine signed a $3.6 billion agreement with China for the construction of three plants, and two more were added to the agreement in September. The project is currently in the design phase, with hopes of beginning construction in 2013. This project would take advantage of Ukraine's sizeable coal resources and be financially beneficial, given that China is providing a line of credit. Moreover, the production costs of coal-to-substitute or synthetic natural gas are about $113 per million cubic meters — significantly lower than the price Russia charges Ukraine for natural gas imports. However, the five coal gasification plants would produce only an estimated 3 billion cubic meters, and construction likely would be completed in 2015 at the earliest.

Overall Assessment

Taken together, these projects eventually could wean Ukraine from Russian natural gas supplies to a significant degree. However, each is in a very different stage of development, and each has its own obstacles and variables. Some, like the LNG terminal, could cut Russian imports substantially if realized but likely would not be operational until the end of the decade. Others, such as developing Ukraine's shale gas potential or building a nuclear plant, would take even longer. The projects that have the shortest turnaround would still take a minimum of two to three years and would have only a limited effect on cutting imports.

Technical details aside, the common factor in each of these projects is the goal of giving Ukraine leverage over Russia in the countries' ongoing pricing negotiations. Ukraine's ability to hold out on Russia will depend on whether it can see these projects through in the medium term and maintain low consumption rates in the short term, which requires increased efficiency of Ukraine's indigenous energy production and comes with political costs. This two-pronged strategy presents Kiev with significant obstacles, but not following through would risk strengthening Moscow's influence.