Article / 14 July 2015 at 9:00 GMT

It's a gas for Russia and Ukraine

Russia oil and gas expert
United Kingdom
  • Ukraine suspends Russian gas purchases
  • On-off affair suits both sides – for now
  • Ukraine can store gas; Russia can look to Europe
  • Kiev government will need new price deal by winter

By Nadia Kazakova 

On July 1 Ukraine decided to halt gas supplies from Russia in a dispute over gas pricing. The reaction all around was rather subdued. European spot gas prices moved up, but have since adjusted on a surge in transit flows via Ukraine.  

Gazprom is unlikely to be too upset either. It would rather export more to Europe now, as contract gas prices are set to fall further in the fourth quarter of 2015. It might want to thank Ukraine for nudging European customers into buying now, wary of potential disruption risks further down the line.

The concerns might be misplaced. Ukraine still needs the Russian gas, and is likely to resume purchases. It might be taking a (not unreasonable) gamble on lower gas prices in Q4. Even without the Russian imports, Ukraine would continue to pump gas into storages, only at a reduced rate.  

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 Average temperatures in Kiev drop below 0C (32F) for four months of every year. Photo: iStock.

The latest gas stand-off between Russia and Ukraine might make perfect sense, on both sides.

Russia revised its gas price to Ukraine, offering to sell gas at $247/1,000 cubic meters in Q3. It is around a $40 discount to the price, which is calculated under the formula set in the long-term contract (which is the subject of ongoing international arbitration). The new price seems to be relatively close to what Ukraine is paying for reverse gas supplies from Europe. 

So far, so fair. 

Ukraine saw the price level as too high (or rather the discount too low) and stopped buying Russian gas from July 1. Unlikely as it is, both Gazprom and Naftogaz might gain rather than lose as a consequence.

There was a surge of transit volumes of Russian gas to Europe via Ukraine. It might have been a combination of lower contract prices from July 1 and 'just-in-case' buying from European importers, in case the gas dispute drags or leads to disruptions. 

Any loss of sales to Ukraine (estimated at 1.5 billion cubic meters for Q3, worth $370 million), would be compensated by higher exports in Q3 to Europe. It would be a net gain to Gazprom if it sells more volumes in Q3 rather than in Q4, as its European export gas prices are likely to fall in Q4.

Russian gas exports to Ukraine and Russian gas transit via Ukraine
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Source: www.utg.ua 

Ukraine, on the other hand, might have decided that it could save some money by postponing purchases of Russian gas until Q4, when contract gas prices might fall by 10% quarter-on-quarter (assuming the Brent oil price stays at around $60/barrel). It could mean Ukraine paying around $230/1,000 cubic meters rather than $247 currently on offer. 

Meanwhile, Ukraine can continue increasing its gas storage, even in the absence of Russian imports. Ukraine produces around 1.5 Bcm of gas a month and the domestic consumption is likely to stay just over 1 Bcm a month throughout most of Q3. 

It means that Ukraine can pump its European gas imports into storage, taking it from 12.3 Bcm as of July 11 over 15 Bcm by end September. 

Ukraine gas storage injections and gas storage level
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Source: www.utg.ua

Ukraine would still need to go back to Russia for the gas before the start of the heating season (early-mid October). At that point, it might have to accept the price on offer.

There is also an issue of finding finance to fund the gas purchases. The Ukrainian government has set up the Energy Reserve Fund (with the target size of $1bn), specifically for assuring adequate storage levels (and, by extension, transit of gas via Ukraine). However, it would require foreign funding in addition to the Ukrainian government guarantees. 

With the money in place and some helping hand from Europe in negotiations, a deal with Gazprom should be within reach, without giving the markets another scare at the onset of winter. 

– Edited by Oliver Morrison

Nadia Kazakova is a Russian oil and gas specialist 

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