By Luke Baker
BRUSSELS (Reuters) - European leaders hold critical talks on Thursday about how to tighten the screws on Russia following its seizure of Crimea, how to support Ukraine's stricken economy and how best to wean themselves off Russian oil and gas in years to come.
With President Vladimir Putin celebrating Crimea's addition to the Russian Federation, and his officials mocking the EU's response so far, leaders are expected add around a dozen names to the 21 Russians and Crimeans already placed on a travel-ban and asset-freeze list.
But while agreeing to expand the list to include figures closer to Putin will be one thing, it is a long way short of the financial and trade sanctions diplomats and analysts say are necessary to make Moscow pay attention.
Speaking ahead of the summit, German Chancellor Angela Merkel said a discussion of financial sanctions - what the EU is referring to as phase three of its response - would take place at the summit, but no agreement on it is expected.
"The (summit) will make clear that we are ready at any time to introduce phase-three measures if there is a worsening of the situation," Merkel said in a speech to parliament.
Russian forces took control of the Black Sea peninsula in late February following protests that toppled Moscow-backed Ukrainian President Viktor Yanukovich provoked by his decision to spurn a trade deal with the European Union last November and seek closer ties with Russia.
NO "PHASE-THREE" YET
When the EU's 28 leaders last met on March 6, they issued a statement saying they would consider financial restrictions - such as freezing trade finance and targeting specific companies - if there were "any further steps by the Russian Federation to destabilize the situation in Ukraine".
At the time, it was not clear whether the forces in Crimea were sent by Putin and if he planned to seize the peninsula.
Since, Russia has not only occupied the region, but a referendum has been held in which Crimeans voted 97 percent in favor of seceding from Ukraine, and Putin has incorporated Crimea and its 2 million people into Russia.
Rather than seeing those events as justification to move to the next stage of sanctions, most EU member states are inclined to hold off, keeping phase three for any further move by Russian forces into eastern parts of Ukraine.
"There's no appetite, no consensus to move to stage three at this point," said one European official preparing the summit.
The problem Europe faces is maintaining its unity. While Russia or the United States can largely act on the directions of one person, the European Union can only take action with the unanimous agreement of 28 prime ministers and presidents.
Germany, Britain, France, Poland and one or two other countries largely agree about the need to respond vigorously to Russia, potentially including financial sanctions, but most of the rest have severe reservations.
UKRAINE AND GAS
What they are likely to be able to agree on - beyond the adding of a few names to the asset-freeze and travel-ban list - is financial support to the rest of Ukraine to help prop up the economy and bring the country closer to Europe's heart.
Leaders will sign the political elements of an "association agreement" with Ukraine's interim prime minister on Friday, opening the way for around 11 billion euros ($15 billion) of financial assistance to flow to Kiev as soon as it strikes a deal with the International Monetary Fund.
The EU has also agreed to bring forward trade benefits for Ukraine, cutting customs duties on nearly all Ukrainian imports, a measure that will deliver savings of around 500 million euros a year for exporters.
Once the trade aspects of the association agreement are signed with Ukraine after it has held presidential elections on May 25, those trade benefits will come permanently into force.
The signing of the association agreement is a symbolically significant step for Ukraine's interim leadership as Yanukovich's rejection of the agreement in November lead to the protests and his eventual overthrow.
From Europe's perspective, if steps can be taken to bolster Ukraine's economy and integrate it more tightly with the EU, growth will pick up, raising per capita income and standards of living - creating a clear distinction with Russia.
At the same time, the EU faces a geopolitical challenge in trying to move away from its dependence on Russian energy.
While Moscow considers itself a reliable supplier of gas and oil to Europe, which takes about 30 percent of its energy from Russia, the relationship could easily come under strain if the Ukraine dispute worsens.
Leaders will discuss ways to diversify their supplies, potentially including more wind and solar power, domestic shale gas exploration and imports of liquefied natural gas from the United States and Middle East.
Britain circulated a paper to EU member states ahead of the summit suggesting that one solution in the long term could be taking more oil and gas from Iraq.
But while many ideas and proposals are circulating, the EU will struggle to reduce its reliance Moscow in the short-term and most alternatives will be more costly than the oil and gas that is currently pumped directly to the West from Russia.
Germany, Europe's largest economy, takes about 40 percent of its gas from Russia. It is in the midst of trying to shift away from nuclear power towards renewable energy, but may have to think about boosting use of heavily polluting coal if it cannot rely on Russia in the long run.
(Additional reporting by Noah Barkin in Berlin and Barbara Lewis and Robin Emmott in Brussels; Editing by Giles Elgood and Anna Willard)