Business — by A law to punish Russia for its annexation of Crimea and military aggression in eastern Ukraine could force European gas consumers to conclude transit contracts with Ukrainian counter-parties to use the nation’s vast pipeline system of 38,600 kilometers.
When European Union member states, Turkey and Moldova buy natural gas from Russia, they contract with the Russia party at Ukraine’s western border, thereby obviating the need for a Ukrainian counterparty. But soon, Western gas consumers might have to deal with the Ukrainian side.
Changes to the rules of gas transit might enter through the backdoor should Ukraine’s parliament pass a law on sanctions against Russia on Aug. 12, which would oblige European buyers to deal with Ukrainian companies instead of Russia’s Gazprom.
Russia’s state-owned gas behemoth has a separate agreement with the Ukrainian gas transit company, the state-owned Ukrtransgaz. Kyiv receives around $3 per 1,000 cubic meters per 100 kilometers, depending on a formula that is based on the price of gas itself.
In 2013, Ukraine transited 86 billion cubic meters (bcm) of gas to Europe for almost $3 billion, according to Gazprom. Europe receives a third of its gas from Russia, half of which passed through Ukraine.
The measure is part of the proposed law on sanctions to be imposed on 72 individuals and 65 legal entities – mostly Russian – for supporting and financing terrorism in Ukraine. It forbids Russian gas transit services via Ukraine, according to an Aug. 11 statement by state gas giant Naftogaz Ukrainy. To compensate, the company is proposing that all European and Turkish counter-parties dealing with the Russian gas company Gazprom, which would be sanctioned, to sign transit deals with Ukrtransgaz in order to maintain a constant flow.
While Russia turned off the taps to Ukraine on June 16, it continued to supply gas to Europe via Ukraine’s vast pipeline system. “Naftogaz confirms its readiness to provide the same flawless transportation of natural gas to European consumers,” said Naftogaz Chairman Andriy Kobolyev.
The transfer of right to transit from Russia to Ukraine can be seen as a way of getting gas system reforms in through the backdoor. Since June, the government of Prime Minister Arseniy Yatseniuk has wanted to split up the gas system so that it would conform to the EU’s Third Energy Package, whereby the gas transit component would become “unbundled” and an independently-run entity. Then, the Europeans would have no reason not to use Ukraine’s system.
According to Andriy Chubyk, energy analyst for the Centre for Global Studies Strategy XXI, “Ukraine is obliged within Energy Community membership to enact full-scale reform of Ukrtransgaz, including real obligations and rights to operate under EU energy law.”
The law to sanction Russia might also be the push Ukraine and Europe need to get the reforms moving, former presidential advisor on energy issues Bohdan Sokolobsky told the Kyiv Post. “This would force discussion on rebuilding the gas transit system,” he said.
Ukraine’s strategic gas transit system is worth $25-$35 billion, Kobolyev told journalists on July 23 at the Ukraine Crisis Media Center.
Should European and Turkish counter-parties begin signing gas transit contracts with Ukraine, the country could reap other benefits. This first and most obvious is that Gazprom wouldn’t have to be dealt with on transit agreements, since the sale point would shift from Ukraine’s western to its eastern border. Naftogaz and Gazprom have been at loggerheads about debts and pricing for years, leading to periodic gas shut-offs.
A second benefit is higher transit fees. Ukraine has the lowest gas transit fees in Europe, argues Sokolovsky, so Ukraine should be able to eventually raise them.
Third, this proposal might create an opportunity for Ukraine to buy gas form EU operators at the Russian border instead of reverse gas from EU, which is limited, says investment company Eavex energy expert Dmytro Churin. Gazprom has argued that large volumes of reverse-flow gas would violate contracts signed with the Slovak operator Eustream, for example.
The Yatseniuk government has been trying and mostly succeeding in contracting gas supplies from Central Europe via the reverse flow method, whereby Russian gas that had been pumped through Ukraine is sold back to the transit country via European operators. So far, the government has convinced Poland, Hungary and especially Slovakia to sell gas to Ukraine by this scheme. On April 28, the Slovak government said that combined reverse flows from Slovakia, Hungary and Poland could reach up to around 16-17 bcm annually. However, for this year the total should be just 8-10 bcm, Energy Minister Yuri Prodan said at the time.
Last year, Ukraine consumed 50 bcm of gas, of which 28 bcm was bought from Russia, 2 bcm purchased from Europe, and 20 bcm extracted domestically. This year, consumption is expected to be in the mid-40s bcm range.
But things could get complicated on the legal side. On the one hand, Naftogaz says that this deal offers a legal mechanism for Ukraine to maintain Russian gas flow to Europe in light of sanctions. On the other hand,experts argue that European counter-parties have existing contracts with Gazprom, and by extension Ukraine, and so depending on the wording these contracts might not allow the counter-parties to sign transit deals with Ukraine. “An interesting thing here is whether EU companies will be able to renegotiate transfer of ownership for Russian gas on Russian border instead of EU-Ukraine border under current scheme,” explains Eavex’s Churin.
Investment boutique Dragon Capital agrees. “Such a scheme would require amending the existing gas supply contracts between Gazprom and European companies to change the transfer point and exclude costs attributable to transit via Ukraine. Gazprom will actively oppose any steps in this direction and EU counterparties are likely to react cautiously for fear of potential supply disruptions” the company wrote on Aug 11.
The European Commission said it was looking into the details of the proposal.
(Kyiv Post business journalist Evan Ostryzniuk can be reached at email@example.com).