Russia – Ukraine

Business or Political?

At a time when gas supply is tight and cold weather had been forecast for this winter period some would say that Gazprom’s timing to have a dispute with Ukraine, the main highway for transporting gas into Europe, was not looking to anyone’s best interests except their own. Whilst it is true that the message from Russia to its former states is a very clear one, the damage done to their credibility is also very clear.  

In an attempt to move away from old trading agreements and treat Ukraine as a European customer rather than an ex-soviet state and friend, Gazprom started negotiations with Ukraine to increase the price that it sells gas to Ukraine by up to 400%. Up until this point Ukraine had been used to receiving gas at well below the European market price, so understandably they resisted this. What should have been a straight-forward business negotiation turned into a political situation as both governments - still smarting from an oil dispute back in May 2005 - went head to head, and neither were able to reach a satisfactory agreement. This resulted in Russia halting gas supplies to Ukraine on 1^st January 2006 with damaging results to both their reputation as a gas supplier and to other countries who rely on gas supplies from Russia via the Ukraine pipelines. Gazprom insisted that they maintained enough gas flow to supply their European customers, but after complaints from many countries, supplies were resumed on 3^rd January with a temporary agreement in place.  

Approximately 145 bcm of gas was supplied through the Ukrainian pipeline network in 2005, 25 bcm of which was for Ukraine and the remainder, which accounts for about 85% of gas supplied to Europe from Russia , was bound for other European states. The agreement then was that Naftogaz Ukrayiny paid $50/1,000 cm for gas at the Russian border, less than a quarter of the price paid by most states in Western Europe for Russian gas, and charged Gazprom $1.09/1,000cm/100km for transportation costs, which was paid for with gas rather than cash. As Ukraine has started to drift towards closer ties with the EU, Gazprom decided the time had come to charge Ukraine on a similar basis to other EU countries for their gas. To this end, Gazprom demanded Ukraine pay $230/1,000cm for their gas from 1^st January onwards. Whilst Ukraine agreed that prices would rise, they asked for stepped increases and offered a starting price of $80/1,000 cm for 2006. December arrived with still no agreement on the price rise, so the Russian government stepped in and suggested that Ukraine ’s gas supplies be cut off until they agree to Gazprom’s terms.  

On 4^th January Russia and Ukraine agreed a new deal. The border price for Russian gas would still be the suggested $230/1,000 cm. But in reality Ukraine will only actually pay $95/1,000 cm, slightly higher than their original offer, but fairly close. This is how it apparently works.  

RosUkrEnergo, a company owned 50% by Gazprom and 50% by Austria ’s Raffeisen Bank, will buy gas from Gazprom. The Russian gas will then be mixed with cheaper gas bought from Central Asia (at $80/1,000 cm) and sold to Ukraine for a composite price of $95. This keeps the Ukrainian government happy as price of gas bought at the Russian border remains comparatively low. It also keeps the Russians happy as they will be supplying less gas to Ukraine , and receiving a higher price for what they do sell. Both countries should therefore meet their stated aims of reducing Ukrainian imports of Russian gas.  

This new agreement is supposed to last five years, but all ready there are murmurs of gas price increases from Central Asia, so how long this agreement will last, or whether it was only ever a temporary face-saving measure, time will tell. Allegations from opposition figures within Ukraine suggest that the price has only actually been agreed for six months, with further price rise demands likely in the summer, which has started a political storm within Ukraine in the run up to elections in March. The flip side of this new arrangement is that Russia has to pay more for gas transportation, now $1.60/1,000cm/100km in cash instead of in gas as before.  

So the dispute is over for the moment, maybe. Ukraine has two options for securing its gas in the long-term, either return to dependence on Russian gas, which would mean taking huge steps to restore relations with Russia , or find creative ways to import gas from elsewhere that stays clear of Russian soil. One possible plan might be to buy from Iraq and ship it via a pipeline through Turkey and under the Black Sea . Whilst there can be no timescale for this due to the ongoing conflict in Iraq, other Western Europe countries may have an interest in this scheme. The way Russia dealt with Ukraine has left, for many, doubts as to the reliability of Russia as a gas supplier.  Since the cut of supplies many countries have reported a drop in gas from Russia . Among them are; Austria, France, Germany, Hungary, Poland and Italy, which is now close to utilising its strategic storage stocks due to reduced supplies and high demand. After Gazprom’s insistence that Ukraine stole the gas, that was intended for its European customers, Ukraine finally owned up to taking extra gas during the very cold weather in January. This now causes another problem as Ukraine will have to pay for the extra gas probably at the higher price that they wanted to avoid in the first place. And so it goes on.  

The Russian president Vladimir Putin has expressed a hope that an acceptable agreement will be reached between Russia and Ukraine to secure stable gas deliveries to Europe . It appears that Ukraine started taking 35mcm/day that was intended for European customers out of the pipeline and when Gazprom shipped a further 35mcm/day to compensate for it Ukraine took that also. There seem to be two possible reasons why they would do this. The weather was cold. In the past, under the old agreement, it would not have been a problem, and Russia kept Ukraine warm. But things have moved on now and gas, whether from Russia or elsewhere, needs to be paid for. The other reason that Ukraine might take this gas could be to further discredit Russia as a gas supplier in the eyes of Europe . Again, time will tell. Both countries are in a position where they need each other. Ukraine needs Russian gas and Russia needs Ukraine ’s pipes.  

One thing for sure is that gas security has managed to remain on the top of government agendas all across Europe . This is somewhat ironic as President Putin intended to make energy security a key part of his Presidency of the G8 this year, but undoubtedly not on the basis that Russia may no longer be a reliable energy partner. The other thing to note is that, unless Ukraine and Russia make it up, when Ukraine needs more gas it will be unlikely to come from Russia unless the price is right. There remain questions about where else it could come from in the short-term.

Researched and written by Paul Cassar and Nick White