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Direct deliveries in exchange for transit: Ukraine-Russia new gas contract

Author : Olena Holubeva

In order to maintain a long-term gas transit contract, which annually brings Ukraine up to $ 3 billion, our country might lose a political decision, adopted in 2015, and resume direct gas supplies from Russia
08:35, 24 September 2019

gas talks
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In order to maintain a long-term gas transit contract, which annually brings Ukraine up to $ 3 billion, our country might lose a political decision, adopted in 2015, and resume direct gas supplies from Russia. The idea was voiced at the trilateral talks in Brussels, Gazprom. The interest of Ukraine and the willingness to consider the resumption of direct gas supplies from Russia were recently confirmed by Oleksiy Orzhel, Ukraine’s Minister of Energy and Environmental Protection. However, the hottest discussions will deal with the issue of price – not in the plane of lowering prices but maintaining them at the current premium level.

Direct deliveries from Russia in exchange for transit

On the day of trilateral negotiations in Brussels on the transit of Russian gas in the Ukrainian pipes, it was said that the Russian delegation arrived with a proposal to resume direct gas supplies from Russia to Ukraine. As you know, they were suspended in November 2015 due to the annexation of Crimea and the active phase of Donbas war. The information that the Russian delegation raised the issue of supplies was also confirmed by statements of Maroš Šefčovič, the European Commission Vice President.

Minister Orzhel does not deny that the issues of concluding a transit contract after 2019 and the decision to resume direct deliveries are interconnected. At the same time, he emphasized that the conversation was “market and constructive” and that “did not look like pressure:” “They (representatives of Gazprom and the Russian Federation, - ed.) said that our logic was to deliver more, and ours (of the Ukrainian delegation, - ed.) was that if they deliver more, the market price should be set."

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It seems that the Russian side really has reason to seek certain concessions from Ukraine, including access to Ukrainian capacious market, but the Ukrainian side’s ambitions regarding the transit agreement are great too. Ukraine wants to conclude a new gas transit agreement for a period of at least ten years with guaranteed pumping volumes of 60 billion cubic meters per year.

Related: Gas squabbles: What to expect from Ukraine-Russia gas talks in Brussels?

Hennadiy Kobal, Director of ExPro Consulting, noted that, based on the current situation with the availability of gas pipelines to pump Russian gas bypassing Ukraine, the Russian side has an urgent need for the Ukrainian gas transportation system, but no more than for one year (it is obvious that Nord Stream-2 will not be launched this year). As one of the options, the Russian side proposed to extend the current contract for a year. European Commission does not agree to support this idea. Experts believe that the Ukrainian side will have to adjust the desired terms of the transit contract. “I don’t believe in the possibility of concluding a contract for ten years,” Kobal confessed. It seems that Naftogaz also allows for various timing options. The press service of the company published the calculation of the tariff for the transit of Russian natural gas to Europe through the Ukrainian gas transportation system only for the next five years (for the period 2020-2024), when booking 60 billion cubic meters transit capacity of the GTS tariff will be 3.21 dollars per 1 thousand cubic meters per 100 km, and when booking 90 billion cubic meters - $ 2.56 per 1 thousand cubic meters m per 100 km. This is higher than the tariff for the transit of Russian gas in 2019, which amounted to $ 2.61 per 1,000 cubic meters per 100 km.

Ukraine will not be able to agree on volumes of more than 50-60 billion cubic meters per year, says Leonid Unigovsky, the director of Naftogazbudinformatyka LLC. Note that this is significantly less than the volume of transit in 2018 - 86.779 billion cubic meters. In some years, transit volumes reached 112 billion cubic meters. Earlier, the figure was 50-60 billion cubic meters, it was enabled by the decision of the European Court on the OPAL gas pipeline (limited the possibilities of Gazprom to guarantee the use of the pipeline at a level of 40% of the throughput. A similar decision is expected for the Eugal gas pipeline (continuation of the Nord Stream-2 gas pipeline under construction).

Ukraine has still not imported gas from Russia. Why?

Gas supplies from Russia to Ukraine ceased at the end of November 2015. It was positioned as a political decision, reaction to the annexation of Crimea and the hot stage of the war in the east of Ukraine. Technically, the solution was based on the fact that Naftogaz was the only company that had a supply contract (it expires simultaneously with the transit contract at the end of 2019) with Gazprom. At the same time, the contract was concluded on enslaving conditions. Ukraine was obliged to buy a fixed amount of gas, regardless of its real needs. At the same time, it could not re-export Russian gas.

Related: Ukraine should continue preparation to stop of Russian gas transit from January 1

In addition, according to the pricing formula laid down in the contract, it was less than $ 200 per thousand cubic meters in 2009-2010, then it rose to $ 485 in 2014 (for comparison, the current market price of gas is $ 160-170 per thousand cubic meters). Ukraine stopped paying for contractual obligations, and then completely switched to gas purchases in Europe. In 2014, Gazprom turned to the arbitration institute of the Stockholm Chamber of Commerce and demanded that unpaid gas and interest arrears be collected from Naftogaz. The total amount of claims amounted to about 47 billion dollars.

The arbitration decision, issued at the end of 2017, was in favor of the Ukrainian side. Although arbitration did not abolish the “take or pay” principle, it reduced the annual volume of the contract to 5 billion cubic meters per year. Taking into account the second decision of the Stockholm arbitration (under a transit contract), the difference in payments was beneficial Ukraine: the Russian gas monopoly owed about $ 3 billion. As security measures, Naftogaz secured the seizure of Gazprom’s assets in the UK and the Netherlands, as well as restrictive measures in Luxembourg and Switzerland. It was reported that the full amount from Gazprom will be recovered by the end of 2020.

Until this debt issue is fully resolved, it’s obvious that Naftogaz is unlikely to become Gazprom’s counterparty to direct gas supplies from Russia.  Experts believe that the reason why not a single company, including international traders, entered into a direct gas supply agreement with Gazprom to Ukraine over the past three years is the reluctance of Gazprom itself and those who have direct the influence of the Russian authorities. If the gas flow were stable, not only Russian but also Central Asian gas could come into Ukraine (which is even cheaper than Russian). This is partly confirmed by the fact that Gazprom in early 2018 refused to sell gas to Ukraine, which was ready to buy 4 billion cubic meters thus executing the decision of the Stockholm arbitration. As you know, then the missing volumes of gas were urgently purchased from Europe.

Related: Russia and Ukraine signal progress on natural gas transit deal

Achieve high prices

Mainly, the situation with direct deliveries of Russian gas to Ukraine now rests on the issue of the price of Russian gas. It is well known that Gazprom is a completely controlled by the Russian authorities and for this reason, it can afford to set not economically reasonable gas prices as leverage for the realization of Russia's political interests. In addition, the obvious advantage of the Russian gas monopolist is that it produces huge volumes of gas under favorable conditions. In addition, geographically, Russia has a direct entrance to the Ukrainian gas transportation system on the eastern border, which allows it to minimize $ 15-20 per cubic meter in transportation costs, compared with the price of traders importing gas by reverse from European directions.

Due to the fact that the main volume of gas on the Ukrainian market is supplied by reverse (domestic gas produced by the largest state producer Ukrgazvydobuvannia is mainly sold to the population as part of fulfilling sale obligations at a price lower than gas producers buy), the gas market in Ukraine now premium.

Related: Gas transit, direct supplies of gas to be discussed at next trilateral talks

The Ukrainian authorities are not ready to allow Russian gas to enter the market with such a difference in price and to collapse the market. The price "should be directly related to indicators on European markets," Oleksiy Orzhel said at a briefing. "The price (of Russian gas for direct deliveries to Ukraine, - ed.) will be determined in cooperation with the Russian side but should be tied to the European price. We should put a market signal in this system to avoid paying the political price," Orzhel outlined. At the same time, the authorities have not yet specified what price should be considered political.

The Minister also confirmed that the Ukrainian market is premium in price since it is focused on the import supplies.

Apparently, the issue of the price of Russian gas for Ukraine will cause a lot of discussions and even, perhaps, split the Ukrainian society into two camps. Many would insist that it is impossible to open the doors wide for Gazprom’s gas, as this would lead to a situation where Ukraine would be dependent on gas for Russia (no less than in the supply of diesel fuel and gas).

Virtual reversal could equalize the conditions

If the authorities fail to agree on maintaining premium prices and linking them to the price of the European hub, and direct gas supplies from the Russian Federation resume, some equalizing conditions for foreign traders with Gazprom may be signed by an agreement (Ukraine brought some variant of this contract in Brussels). It would allow establishing a virtual reverse (exchange of gas volumes between operators without physical pumping through the pipe, which would reduce the cost of the resource). In addition, after making appropriate changes to gas sales contracts with Gazprom, if there is an agreement, European traders will be able to buy gas from Gazprom on the eastern border. Moreover, in case of signing an agreement, the Russian company will have to open its shipper codes to Naftogaz (they allow each batch of gas and its addressee to be identified) – until now, Gazprom has categorically refused to do it.

Related: U.S. ambassador to Germany Grenell: Washington is against Nord stream 2 gas project

Russia is likely to make an agreement, Oleksiy Orzhel says. He stresses that this is a requirement of European law, therefore, the words of Oleksandr Novak, the Minister of Energy of the Russian Federation, after trilateral gas negotiations in Brussels that Russia is ready to conclude a transit contract with Ukraine under EU standards, can be regarded as consent to the signing of an agreement on interaction between operators. So far, Naftogaz has similar agreements with only two European operators: with the Hungarian FGSZ and with the Romanian Transgaz.

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