Kyiv to dictate terms: What does decision of Stockholm Arbitration mean to Ukraine?

Author : Olena Holubeva

Source : 112 Ukraine

The final decision in the dispute between the Ukrainian Naftogaz and the Russian Gazprom under the contract on the transit of Russian gas through the Ukrainian transportation system had to become a decisive point. However, it seems, it became only the starting point of a new round of confrontation.
11:30, 7 March 2018

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112 Agency

On February 28, the Stockholm Arbitration Court made a final decision in the 3.5 years dispute between the Naftogaz of Ukraine and the Russian Gazprom under the contract for the transit of gas to Europe signed on January 19, 2009 in Moscow after the negotiations of Prime Minister of Ukraine Yulia Tymoshenko and Russian President Vladimir Putin. The contract was signed by the deputy head of the Naftogaz Igor Didenko and the deputy head of Gazprom, Valery Golubev. The contract was concluded for a period until 2019 and provided for the pumping at least 110 billion cubic meters of Russian gas with a tariff of $ 1.7 per 100 km in the Ukrainian gas transportation system. The cost of Ukraine's gas transportation services in 2009 was $ 2.35 billion. In 2017, Ukraine earned $ 3 billion for the transit of Russian gas.

On October 13, 2014, Naftogaz of Ukraine applied to the Arbitration Institute of the Stockholm Chamber of Commerce with a claim that, according to the commercial director of Naftogaz, Yuri Vitrenko, was filed "in connection with the Gazprom’s non-compliance with minimum transit volumes (110 billion cubic meters per year), with the need to review the rate of transit, as well as the implementation of European legislation in relations between Naftogaz and Gazprom”.

Vitrenko recalled that Ukraine had become a member of the Energy Community, had undertaken the implementation of the European energy legislation, which it did by adopting the Law on the Natural Gas Market. "After that, the regulator set new tariffs, approved the GTS Code and said that since 2016 all relations in the field of gas transportation should be regulated in accordance with these regulatory documents. We asked Gazprom and said that we have changes in the legislation and so the contract should be aligned with them. Gazprom refused because it believes that the relationship should be regulated by the current contract. We disagreed and turned to arbitration. Prior to that, we held consultations with the European Commission, the Energy Community Secretariat, and it was decided that, in fact, applying to arbitration is the safest way, which should not lead to the cessation of gas supplies to Ukraine and Europe, "said the commercial director of the Ukrainian state-owned company.

Initially, the financial claims of Naftogaz in the dispute were $ 6.2 billion, but they increased to $ 15 billion - for shortage and underpayment under the transit contract plus interest, while Gazprom put forward counterclaims for 0.05 billion dollars, said the press service of the Naftogaz of Ukraine.

What did the court decide?

Ukraine was waiting for the decisions of arbitration with great excitement. It is not surprising because such decision was of key importance for the most sensitive issues of the Ukrainian economy. According to the director of ExPro Ukraine consulting company Gennady Kobal, the decision was important, since it could put Naftogaz in a difficult financial situation and severely unbalance the state-owned company. "It will mostly depend on the amount of money that Gazprom will have to pay by the decision of the arbitration court. On the first arbitration (which decision was announced in December 2017) Naftogaz should pay $ 2 billion plus interest. If the decision on the transit contract is envisaged a large number of Gazprom's liabilities or a much larger amount, Naftogaz will be in a better position ... But if it's less ... Do not forget that Naftogaz still needs funds to buy Russian gas by arbitration (the minimum annual volume of gas that Naftogaz should buy during 2018-2019 was reduced from 41.6 billion cubic meters to 4 billion cubic meters.) And international financial institutions will not lend money for purchasing gas from Gazprom," said the expert for several hours before the decision.

As a result, Naftogaz won, and Gazprom became a debtor. Stockholm arbitration ordered it to pay Naftogaz compensation in the amount of 4.63 billion dollars, taking into account the final calculation for gas delivered in 2014 and 2015. "If we take the sum from this amount for the supplied gas, which we did not pay in 2014, and there is an amount over $ 2 billion (confirmed by the final decision of the Stockholm Arbitration, which was adopted on December 22, 2017), $ 2.5 billion remains which our Russian counterparties, according to their statements, recognize as the amount they owe us," said  Andriy Kobolev. He clarified that "Gazprom's obligations" come into force on February 28, that is, from March 1, we could add interest. "Penalties for Gazprom will amount to 526 thousand dollars for each day of overdue payments," calculated CEO of Naftogazbudnformatyka company Leonid Unigovskiy.

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Kobolev stressed that the arbitration decision says that the interest will be only on the amount of the delta - the difference between the sum of Naftogaz (given for non-payment for gas delivered in 2014) by the December decision, and the amount confirmed by the arbitration on February 28, on the obligations of Gazprom. "The Tribunal ordered an offset, that is, we do not owe Gazprom anything, but it owes us $ 2.56 billion," emphasized Kobolev.

The Arbitration said on compensation for the shortage of transit volumes but did not confirm the principle of ship or pay. If this principle was confirmed, then Gazprom would have to automatically pay for pumping volumes, if they were less than the minimum volume of 110 billion cubic meters per year. "What we got is not a classic ship or pay, we did not have it in the contract, we have a certain hybrid," Kobolev added.

He noted that if in 2018-2019, Gazprom will not pump the minimum volume, Naftogaz will again be able to easily obtain compensation in arbitration.

"In the case of transit volumes, both legal and economic factors played a role, and we explained the direct relationship between justified transit tariffs and the volumes that are being supplied for transit, and the corresponding revenues of Naftogaz. That is why the tribunal agreed with our logic. Although our Russian contractors say that the contract is now unbalanced and they do not understand how the tribunal on one hand did not satisfy their demands on the "take or pay" principle and at the same time fully meet the demands of Naftogaz for a similar fact, while the" take or pay "principle is written right in the contract, and it says directly that if we do not choose the minimum contract volumes for the year, we must pay for them. At the same time, it is not written directly about minimum transit volumes. We have found an opportunity to explain to the tribunal why Gazprom should pay us exactly for 110 billion cubic meters, and not for the volume that it wants to send for transit, "Yuriy Vitrenko explained.

Will the Gas Transport System be a part of a foreign company?

The decision of the Stockholm arbitration should also be a start for the process of unbundling - the separation of the gas transportation system from the Naftogaz of Ukraine. According to Resolution of the Cabinet of Ministers No. 496, the assets used for the transportation of natural gas in the framework of unbundling should be transferred to an independent company within 30 days of the final decisions in two cases that are considered in the Stockholm Arbitration. At the same time, the transit contract itself remained with Naftogaz. On the eve of the decision, Andriy Kobolev said that Naftogaz asked the tribunal to transfer the contract to another legal entity. After unbundling, authorities want to attract a foreign company to the management of the GTS, which will invest in its development. "The management company, which will get to the management of the GTS, should receive revenue from transit," said Gennady Kobal.

However, for actually attracting a foreign investor to the GTS management, it is necessary not only to solve the issue of transferring the contract but also to change the legislation. "The parliament should vote on a law that will give the company involved in the management of the GTS (foreign partner) the right for ownership, which should be privatization or partial privatization - for example, the transfer of 51% of the GTS into ownership, and this is a prerequisite for attracting a foreign partner. To attract a company as a consultant is not an option. It needs an investor who will come and invest his own money in the reconstruction of pipelines, gas pumping stations. The investor will do so only if his rights and investments will be protected, in particular, property rights, "Kobal said.

Among the requirements of Naftogaz, which the arbitration did not support, was an increase in the tariff for transit in the Ukrainian GTS. In Stockholm, it was decided that this issue lies in the implementation of Ukrainian legislation and that the Ukrainian independent regulator should seek to revise rates for transit. "The transit rate has not been revised yet, I emphasize - for now, this issue is not closed, we expect that the Ukrainian regulator will take the necessary steps to apply new tariffs for Gazprom's gas transit," Yuri Vitrenko said. He did not rule out that in the near future on this issue, Gazprom could expect "pleasant surprises", and said that the Naftogaz team is now looking for possible solutions to raise rates. "We will be engaged in the revision of tariffs. This also concerns the issue of virtual reverse as part of the implementation of Ukraine's energy legislation in the contract. We hope to begin the negotiation process, if it fails, then there are other tools. In order to hedge the regulator, we work with a team of lawyers, we try to find an option," said Andriy Kobolev.

According to Unigovsky, at least the process of attracting a foreign investor to the GTS will not affect this point. For a foreign investor, who is going to be involved in the management of the GTS, the issue of increasing tariffs is not fundamental, and with the current ones, it would be also beneficial for them to work.

Among the points on which Naftogaz failed to reach a decision in its favor in arbitration, the general director of Neftegazbudinformatyka LLC also noted that the point of transmission and reception of gas will not be transferred from the western to the eastern border of Ukraine and there will not be a virtual reverse.

What to expect next?

One of the main questions now is whether Gazprom will pay the compensation. And it is this issue that can become the starting point for even more severe battles of companies in the courts. Kobolev assured that Naftogaz, in case of the refusal of the Russian gas monopolist to fulfill financial obligations, uses the instrument of a compulsory collection. "We have instruments of struggle, in particular, forcible collection. Gazprom has many assets in Europe and around the world, "Kobolev assured.

It should be noted that President Petro Poroshenko also demanded from the leadership of the Ukrainian monopoly to seek the arrest of Gazprom's assets in case of non-payment under the decision of the Stockholm Arbitration.

Kobolev also did not rule out that Gazprom would challenge the decision of the tribunal, as it also disputes the previous decision on gas supplies. "Theoretically, there is such a possibility (to challenge the decision) for this, Gazprom will have to prove the violation of the procedure by the Stockholm Arbitration, which is very difficult," Kobolev said, stressing that "the beginning of the protest procedure does not stop the entry into force of the decision."

"Next, I think we should expect the continuation of the positional struggle between Gazprom and Naftogaz, and most likely, while Gazprom will not pay the amount decided by the arbitration, they will wait," said Unigovsky.

According to the expert, "it is obvious that Gazprom will fight": "They said that in the Swedish court they appeal on the first suit, and, apparently, they will appeal the current lawsuit."

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Another sign of how the relations between Ukrainian and Russian gas companies have become aggravated is the fact that Gazprom has returned an advance payment for the supply of Russian gas to Ukraine. Deliveries were to begin on March 1. Naftogaz sharply criticized this step, saying that "they regard Gazprom's refusal to supply as a violation of the contract and failure to comply with the arbitration decision." Gazprom answered that "for today, an additional agreement has not been agreed to the current contract with Naftogaz of Ukraine for the supply of gas necessary to start deliveries," Deputy Chairman of the Board of the company Alexander Medvedev told reporters.

Unigovsky believes that despite the possible intensification of the confrontation between Gazprom and Naftogaz, the issue of Russian gas supplies to Ukraine can just be settled. "From my point of view, this does not mean the end of the negotiation process on deliveries. It is possible that the problems arose due to the fact that according to the current agreements, which have not changed, daily gas supplies to Ukraine are regulated. In winter, this is a larger volume, in summer it is smaller. It is divided by the number of days in a month and thus the volume of daily supplies is deduced. As Kommersant estimates, for the volume of purchases of 4 billion cubic meters per year, the maximum daily allowable volumes for Naftogaz will be 17.3 million cubic meters in the first quarter, 11.4 million cubic meters in the second quarter, 10.45 million in the third quarter, and 15.7 million cubic meters in the fourth quarter. The fluctuations are allowed within 6%. If this principle is not changed and besides the supply will not begin on March 1 and later, we will not be able to have 4 billion cubic meters of gas, so the question is that the parties should start negotiations and settle these issues as soon as possible, "said CEO of Naftogazbudinformatyka LLC.

He also noted that "if the parties agreed and Gazprom agreed to this loss, Ukraine could get 8 billion cubic meters (which should be bought back from Russia in 2018-2019, according to the decision of the Stockholm Arbitration Court) practically for free": the amount that Ukraine should pay to Gazprom, would be more than enough to pay for the average price indicators of deliveries of 4 billion cubic meters of Russian gas both in 2018 and in 2019".

In Naftogaz, details of the talks on the supply of Russian gas and its possible price (there are rumors about 190 dollars per 1,000 cubic meters at the cost of gas for reverse supplies of $ 220 per 1,000 cubic meters) are not yet commented on. At the same time, Yuri Vitrenko said that the negotiations of Naftogaz and Gazprom on the implementation of arbitration decisions will soon begin.

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