Article / 09 June 2014 at 11:47 GMT

Russia, Ukraine and Europe − the D-Day party is over

Russia oil and gas expert
United Kingdom
  • Russian equities up nearly 2% after Putin's "positive" D-Day meetings
  • Respite in hostilities set to cement "unacceptable" status quo in Crimea, east Ukraine
  • Putin makes oblique threat to Europe if Ukraine receives reverse gas supplies
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"If we see that someone's breaking our gas contracts, we will cut deliveries and there will be simply not enough physical gas in the European market." − President Vladimir Putin

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You really wouldn't want to be the party-pooper, would you? They invite you over, sit you at a nice table, and get you mixed in with a thoroughly respectable, albeit, unavoidable crowd. Of course, you play along, all smiles and trot out your nice-to-see-you-toos at the correct moment, never missing a cue. 

You make a prerequisite promise or two to catch up with him or her next week, without really meaning it. Then you go home, relax and return to your usual self. Oh, and then you remember that they did tell you something about not getting invited again if you keep moving the fence posts into your neighbour's garden.

The Russian equity markets cheered (RTS Index was up 1.89 percent) on the news that President Vladimir Putin had a “positive” encounter with US President Barack Obama  and had a 15-minute face-to-face with the newly elected Ukrainian President Petro Poroshenko at the top level gathering to mark the 70th anniversary of the D-Day landing in France on June 6. The hope is that the dialogue will bring to a close military hostilities in east Ukraine and resolve bi-lateral economic issues, such as the gas dispute. There are signs, however, that the optimism might be misguided, and we might soon be back into a prolonged and a difficult stand off.

The pure politics

According to The Times, President Obama made it clear to President Putin that de-escalation depends on Russia recognising President Poroshenko as the legitimate leader of Ukraine, ceasing support for separatists in eastern Ukraine, and stopping the provision of arms. President Obama said to the Ukrainian President that an immediate ceasefire in the Ukrainian southeast was a condition for further talks.

At his inauguration on June 7 in Kiev, Petro Poroshenko, in turn, offered an amnesty to separatists who did not commit serious crimes, and promised local elections in east Ukraine. He, however, ruled out talking to “terrorists” (i.e. armed separatists), spoke out against federalisation and insisted that Ukrainian would remain the only official language of the country.

For his part, President Putin continued to insists that the new Ukrainian authorities should talk directly to the separatists in east Ukraine. It is doubtful that the Russian administration will ever admit direct involvement in the unrest in east Ukraine and call the fighters off. It would claim no authority over various paramilitary groups and no control over their arms supply chain.

The ceasefire in east Ukraine would be welcome as it would stop bloodshed. It might also allow separatist forces to reaffirm their grip over the controlled territory in east Ukraine. It would effectively cement the current status quo which appears unacceptable to Ukraine and the Western leaders. It would most likely lead to a third wave of sanctions against Russia.

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Western leaders urged Vladimir Putin at this weekend's D-Day remembrance meetings to help end the violence in eastern Ukraine by trying to rein in the activities of pro-Russian separatists. Photo: jon11 \ Thinkstock

The gas politics

The Russian and the Ukrainian Presidents did not discuss the gas dispute in France. The good news is that President Putin reassured Europe that “Gazprom and our Ukrainian partners are close to the final agreement. We do not rule out that [we] can meet the Ukrainian side halfway, support them if, of course, they pay off the accumulated debt.”

In the same breath, however, Putin continued: “Non-payment risks remain very high and if someone wants to resolve the Ukrainian [gas] problem by reverse gas deliveries, they are deeply mistaken for two reasons. If we see that someone's breaking our gas contracts, we will cut deliveries and there will be simply not enough physical gas in the European market. Secondly, there is high risk of non-payment, the Ukrainian economy is in a difficult situation and the [Ukrainian] non-payment burden will be put on the shoulders of our [European] partners.'

It seems that the Russian President was suggesting that if Ukraine stops buying gas directly from Gazprom, the company might be unwilling to increase supplies to other European customers above the contracted volumes, if those volumes are then delivered to Ukraine. The statement might raise some eyebrows, as it suggests that it is not just a matter of debt settlement or the level of the gas price for Ukraine that bothers the Russian side. It appears it is difficult for Moscow to let go of the idea of retaining control over gas flows in and out of Ukraine.

The problem of non-payment, on the other side, might not be as bad as it looks. Naftogaz did not pay its debt to Gazprom because it was re-selling Russian gas at a loss at regulated tariffs, then waiting for reimbursement from the Ukrainian government. Solvent industrial customers were buying gas at market prices, but not from Naftogaz. They would go to intermediaries, such as OstChem Gas Trading AG, owned by Dmyrto Firtash.
In 2013, Naftogaz imported 12.9 billion cubic meters from Russia, while Firtash's companies bought 12.92 Bcm from Gazprom (including 5 Bcm at a discounted price of USD 268 per 1,000 cubic meters, partially financed by GazpromBank).

In 2014, the new Ukrainian government has already hiked domestic gas tariffs to remove some of the subsidies. Gazprom also said earlier in the year, that it would stop trading with Firtash. It should help liquidity at Naftogaz and make it easier to pay to Gazprom.

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Vladimir Putin flexed his muscles during the D-Day celebration with a warning to Europe over Ukraine. Photo: Thinkstock

The gas without politics 

The trilateral gas talks between Ukraine, Russia and European Commission resume today in Brussels. Over the last seven days, the discussions between Gazprom and Naftogaz switched to a bilateral – and, one assumes – more commercial format at the insistence of the Russian side.

The compromise deal seems within reach. It would involve Naftogaz paying off USD1.45 billion in debts for November-December 2013 (at an estimated price of USD 395 per 1,000 cu m). Gazprom then agrees to give Ukraine a discount of USD 100 (to USD 385) per 1,000 cu m for deliveries from April 1,2014. The discount would be valid for a year. Ukraine might need to drop her aspirations to re-write the 10-year contract signed with Gazprom in 2009 (removing ban to re-export Russian gas and re-setting export delivery point to Ukraine/Russia border). At least for now.

If it does go wrong, Naftogaz will go to arbitration. Gazprom might insist on pre-payment if all outstanding debts are not paid in full. Or we might see another stop-gap solution, when Ukraine pays some debt, and Gazprom gives everyone another week to fill up the gas storages. The good news is that they are getting fuller, but the bad news is that even full storage will offer little comfort if the gas dispute drags into the winter.

Table. EU-28 gas storages, billion cubic meters

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Source: http://transparency.gie.eu/

And finally...

If it does go wrong, at least we know – theoretically – what to expect. The European commission published a very useful document on May 28, the so-called 'In-depth study of European Energy Security'. Among other useful information, it explains the consequences of disruption in Russian gas deliveries via Ukraine (and Belarus) in the peak season for 14 days (unpleasant, but bearable. p.119).

There is also analysis of how to replace the Ukrainian gas transit more or less permanently (p.115)
Europe would need to shut down some chemical industry, import more via the Nord Stream, bid up for LNG supplies and switch to diesel for electricity production. Tough, but survivable. There are also pages and pages for individual EU countries and their situation in regards to their gas supplies.

For the most patient, the real discovery is found on page 197, in a section on Russian neighbour Latvia: “Because of the specific operating regime in Russia, Gazprom in winter time is not able to supply the St. Petersburg area from its own network. Hence, it uses the storage facility in Incukalns (in Latvia) to send the gas towards Russia, Estonia and – to a smaller extent – Lithuania in the winter...”. It effectively means that Russia's second largest city is supplied in winter from an EU country. No wonder European gas traders are so incredibly relaxed.

So if there is a bit of muscle flexing from the Russian side, at least we know that the gas will continue flowing in winter. There is, however, no guarantee on a low price.

-- Edited by Martin O'Rourke

Nadia Kazakova is an expert on Russia with a particular emphasis on the oil and gas sector.
1y
Jim Earls Jim Earls
Good article-thanks.

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