Russia-Ukraine Gas Negotiations: (Energy) Politics Is the Art of the Possible

By the end of this year, Russia’s Gazprom and Ukraine’s Naftogaz are expected to sign a new gas transit agreement which will put an end to 18 months of negotiations. After reaching a preliminary agreement in Minsk last week, Russia and Ukraine signed a Protocol on gas cooperation on December 20. Both sides agreed that Russia would continue to run natural gas through Ukraine after the current transit contract expires on January 1, 2020. The Normandy Format talks, held in Paris on December 9, provided a new impetus to negotiations and set the stage for the issue of gas transit to be addressed.

After reaching this deal, the signature of the new arrangement seems to be imminent; Gazprom’s CEO Alexey Miller has already disclosed the general elements of the compromise:

Gazprom agreed to reimburse Naftogaz $2.9 billion “under the final ruling of the Stockholm Arbitration Court”, while the Ukrainian gas company agreed to withdraw pending arbitration and legal claims (including a $12 billion claim filed with the Stockholm court of arbitration) and not to file any new claims. At the same time, Gazprom and the Ukrainian government will sign an amicable agreement on cancelling the $6 billion claim filed by the Antimonopoly Committee of Ukraine.

Naftogaz will agree to take the role of the transit organiser and, according to Gazprom’s statement, will assume “the risks that will arise in the transition period”. Both sides decided that Naftogaz, as the company responsible for the transit, will book 225 billion cubic meters (bcm) transport capacity for 2020-2024 (including 65 bcm for 2020 and subsequently 40 bcm/year) with Ukraine’s transmission system operator (TSO).

Gazprom and Naftogaz did not disclose transit fees, as negotiations are still ongoing, and this information may continue to remain confidential in the future. However, they will doubtlessly be aligned with the entry/exit transportation fees set according to the EU’ tariff methodology.

Gazprom and Naftogaz agreed to consider the possibility of direct gas sales to Ukraine, in line with Germany’s NCG pricing benchmark.

The Normandy Format and the Story of the Hamster Wheel
Hans-Joachim Spanger
If there is more to the ongoing efforts than managing a frozen conflict and if the Minsk path to conflict resolution is clearly blocked, a new approach must be found. The classic alternative is the internationalization of the conflict through the creation of a UN protectorate.


“The Minsk Compromise”: key reasons

A long-term supply cut would have been harmful both for Gazprom and Naftogaz, let alone downstream European gas consumers. In general, the EU is well-prepared for a breakdown of the trilateral gas talks, at least in the short-term, since gas storage facilities in Europe remain full. However, replacing the gas flows in Europe with stored supplies and extra LNG would come at a price. The Institute of Energy Economics at the University of Cologne (Germany) has estimated that European consumers would lose 4.1 billion euros as a result of a three-month supply curtailment, while Gazprom and Naftogaz would suffer revenue losses amounting to 500 million euros and 400 million euros, respectively. In the event that Russia didn’t send gas to Ukraine, there would be problem supplying customers inside Ukraine and in a number of EU/FSU countries, particularly Moldova.

The deal also resolves the issue of potential delays in the launching of the Nord Stream–2 pipeline following the imposition of US sanctions against the pipe-laying vessels engaged in this infrastructure project. The ability to access 65 bcm of transit capacity in 2020 would resolve all of Gazprom’s probable and improbable supply bottlenecks and complete its infrastructure projects in Europe on budget.

The capacity to be booked for Gazprom (225 bcm over the next 5 years) is also significantly smaller than what was originally requested by Nafogaz (600 bcm of ship-or-pay capacity for 10 years). Naftogaz’s realistic approach to its transit volume request might be explained by the ageing infrastructure (more than 60 % of Ukraine’s pipeline infrastructure is more than 33 years old) and modest investment plans: in 2019-28 Ukrtransgaz, a transport subsidiary of Naftogaz, plans to invest around $1.25 billion in pipelines and compressor stations. Currently, around 30-40 bcm/year of Ukraine’s gas transit capacity is being refurbished and/or is “fit” for long-term transit. Therefore, it is not surprising to see these numbers in the Protocol. Gazprom’s critics might claim that with the Nord Stream-2 and the Turk Stream fully operational, the company would not need that much of Ukraine’s transit capacity as of 2021/22. However, an expected increase in demand for gas in Central and Eastern Europe as well as rapidly decreasing domestic gas production in the EU might increase demand for Russia’s pipeline gas and consequently, the usage of the Ukraine route.

The settlement of legal disputes will also allow Gazprom to “defreeze” its assets in Europe and freely conduct any financial operations abroad. While the transit fees to be paid by Gazprom might indeed be occasionally higher than under the expiring transit contract, they are still significantly lower than the numbers originally proposed by Naftogaz (US$3.21 per 1,000 cubic meters per 100 km with 60 bcm/year of transit capacity booked).

The compromise reflects the objective facts (and is not therefore a consequence of an arbitrary political decision) at hand, such as the state of Ukraine’s gas transportation system, sanctions, gas demand in Europe, delivery logistics, etc.

Lock, Stock, and Two Smoking Pipes
Alexei Grivach
The transit of gas through Ukraine is too sensitive for Russia and Europe, at least ahead of the launch of Nord Stream 2. Until it is completed, the United States will continue to have the opportunity to discredit Russian gas supplies to Europe in order to promote its own LNG on the market.
Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.