By Christian Lowe Jan. 6, 2009

MOSCOW (Reuters) - Russia sharply cut gas flows to Europe via Ukraine on Tuesday in a dramatic worsening of a pricing dispute with Kiev that threatened to disrupt supplies as far west as Italy and Germany.

The escalation in the price dispute and severe cold weather drove the British gas market, Europe's biggest and most liquid, to its highest level since October.

Officials from the Eruropean Union, which is dependent on Russia for a quarter of its gas, met both sides in the dispute on Tuesday and the bloc urges them to find a solution this week.

The Czech Republic, which holds the EU's rotating presidency, said it was considering the "extreme option" of a three-way EU-Russia-Ukraine summit.

"The only solution is to get straight to the negotiating table," Czech Industry Minister Martin Riman said after talks with Alexander Medvedev, the deputy CEO of Russian gas export monopoly Gazprom.

"The Russian side... is ready for this step. We are too and I expect the Ukranian side, after the talks in Kiev, is also ready," said Riman after meeting Medvedev in Berlin. Earlier in the day he met Ukrainian officials in Kiev.

The head of Ukraine's state energy firm said he would fly to Moscow on Thursday.

Russia and Ukraine blame each other for the crises, which has struck at the height of the European winter and spread alarm across the continent.

EU members Austria and Romania said deliveries were down 90 percent and 75 percent respectively, and German energy firms said there could be gas shortages in Europe's biggest economy if the dispute dragged on and sub-zero temperatures persisted.

"Even our possibilities will reach their limits if these drastic cuts in shipments last and if temperatures continue to stay at very low levels," E.ON Ruhrgas Chief Executive Bernhard Reutersberg said.

Hungary, Bulgaria, Turkey, Macedonia, Greece and Croatia said Russian gas flows via Ukraine had halted, creating what Bulgaria called a "crisis situation" in the middle of winter.

An Italian source close to the matter said Gazprom would only be able to guarantee less than 20 percent of the expected gas supplies to Italy on Tuesday, and the industry ministry said Rome planned to increase gas imports from alternative suppliers.

France said supplies had plunged 70 percent although its economy is less vulnerable than Germany and Italy as 80 percent of its electricity is produced by nuclear energy.

BLAME GAME

Day-ahead baseload gas touched a session high of 73 pence on the dispute and by late trade was 7.75 pence, or 12.76 percent higher, on the day at 68.50 pence per therm.

Gazprom said it supplied 65 million cubic meters (mcm) to Europe on Tuesday through ex-Soviet neighbor Ukraine, a fall of 78 percent from the 300 mcm it had been shipping since the dispute erupted on January 1.

"According to the latest information, Ukraine is stealing about 15 percent of the gas that moves to the Russian-Ukraine border," Gazprom Chief Executive Alexei Miller told Russian Prime Minister Vladmir Putin.

Gazprom had previously accused Ukraine of shutting down three Russian export pipelines early on Tuesday and said it was a hostage of Kiev's "irresponsible behavior." It said it would try to use alterntive delivery routes to avoid a crisis.

Ukrainian President Viktor Yushchenko said Moscow would continue cutting gas supplies to Europe or stop them altogether and the government ordered regional utilities to start using fuel oil instead of gas.

Neighboring Slovakia will declare a state of emergency, Czech news agency CTK reported. Poland cut gas supplies to industrial clients, while Serbia and Bosnia said Russian supplies had completely stopped.

JAN. 1 CUT

The dispute threatens to worsen Russia's ties with the West, already fraught after its war with Georgia last year.

Europe's heavy dependence on Russian energy - and vulnerability to supply disruption - was highlighted when Moscow reduced volumes to Ukraine on New Year's Day after failing to reach agreement with Kiev over gas prices.

But most bigger EU countries say they have large amounts of gas stockpiled after several mild winters and have access to supplies from sources such as Norway and Algeria.

"If there are significant drops in supplies to the European Union, the key question is whether it goes on for a very long time. But it would have to go on for weeks or months for serious problems to arise for Western European customers," said Simon Blakey, director of European research at Cambridge Energy Research Associates.

Russia and Ukraine have clashed repeatedly on a range of other issues, particularly the ambition of Ukraine's pro-Western leaders to join NATO.

The disruption comes at a bad time for Europe, which is experiencing a cold snap likely to drive up gas demand.

"We are in a crisis situation," Bulgaria's Economy Ministry said in a statement. State firm Bulgargaz told industrial users it was suspending or cutting supplies to a minimum and urged them to switch to alterntive fuels like oil. Two fertilizer companies had to halt production.

Worries about European gas supplies, coupled with Israel's military operation in Gaza, have pushed oil prices up to a three-week high close to $50 a barrel. Russia, whose main export is oil, stands to benefit from a recovery in prices.