Article / 04 September 2014 at 15:23 GMT

Ukraine can't refuse Russia's gas deal

Russia oil and gas expert
United Kingdom
  • Russia holds all the cards in gas deal with Ukraine 
  • Fears gas flows to Europe will be disrupted 
  • Could mark further Russia/Europe split, with Moscow looking to China

By Nadia Kazakova

The gas deal that Russia is offering Ukraine is quite generous, having only two conditions compared to the seven required by the ceasefire agreement. But both offers are the kind that might be difficult to refuse. Ukraine cannot afford to head into the winter months fighting, nor can it proceed without enough gas to take it through the six-month period when heating is needed.

Russia is in a much stronger negotiating position on both fronts. This could explains why its position is essentially “take or leave it”, or, perhaps more precisely, “it's my way or the highway”. 

If Ukraine does not accept Russia's offer before October 1 (repay some debt and buy the gas at $385 per 1,000 cubic meters and, possibly, drop the arbitration), it would face gas shortages domestically and risk disruption of transit gas flows to Europe.

The flip side of Russia's uncompromising position is the deterioration of its relationship with Europe. Any settlement in Ukraine made on Russian terms (as defined, of course, by President Putin) would see Europe upholding sanctions against Moscow. Ultimately, Europe would continue to seek ways to reduce its dependence on Russian gas, possibly putting an end to the South Stream pipeline project.

Moscow, of course, has anticipated this, and the result is the revival of China-oriented gas plans. One proposal that is currently being pushed would see West Siberian gas pipelined through Kazakhstan and Mongolia en route to China, and the necessary corridors have already been discussed at summits. For Gazprom, this would mean selling more gas to a single customer (and at lower prices and with tighter margins).

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Ukraine simply cannot afford a winter without a gas deal with
Russia – however chastening – in place. Photo: Thinkstock.com 
 
An offer Ukraine can't refuse

The Russian gas offer has been on the table – in essentially unchanged form – for a while, while Kiev's position has been shifting, gradually and with EU encouragement, towards its acceptance. Ultimately, Ukraine cannot afford to refuse the offer, even if it's not what it has been insisting on.

On September 2, Ukrainian national gas concern Naftogaz Ukrainy published on its corporate site an outline of the deal that it would prefer to sign. According to this release, the company's ideal agreement has four main criteria:

  • The company seeks a provisional (until the arbitration decision) price for Russian gas. This would be based on European hub prices, reduced by transportation costs (from the Russian border to the hub). 

  • Any outstanding debt to Gazprom would be calculated based on the provisional price. 

  • The gas transit agreement should align with EU legislation.

  • Gazprom would sign new transit contracts directly with the gas transit operator (Ukrtrnansgaz). Clearly, this is a tall order, especially if the Russian gas is needed within a month or so. 

A more precise position was expressed by Ukraine's prime minister, Arseniy Yatsenyuk, who explained Ukraine needs around 25 billion cubic metres of Russian gas per year, and it is prepared to pay US$385 per 1,000 cu m during the winter and US$300 per 1,000 cu mfor the rest of the year. This would result in an average price of around US$340.

The Russian response came in the form of a statement from Russia's prime minister, Dmitry Medvedev, and its phrasing sounded somewhat patronising. You can have the gas, he essentially said, on two conditions. First, you repay your outstanding debt, or at least some of it. Second, you agree to a price of US$385 per 1,000 cu m for Russian gas. Otherwise, Medvedev added, Ukraine is free to pay the contract price of US$485 per 1,000 cu m.

End of discussion. 

The best-case scenario

Theoretically, it is possible to square both positions. If Ukraine pays $1.45 billion for gas delivered in 2013 (this amount is not disputed), it can start buying Russian gas from October 1 at $385 per 1,000 cu m. This is exactly what Ukraine is prepared to pay, but Naftogaz would need to agree that Gazprom is offering a discount rather than re-setting the contract price. 

Even if this deal only covers the next six months, though, it would guarantee Russian gas for Ukraine and Europe. Ukraine is insisting on a fair deal from Russia, but the best it can get at the moment is a fair deal for its people.

The signs for an agreement are there. Reports indicate that the EU has put forward an interim agreement for Russia and Ukraine, but it may need adjustments to bring it closer to the Russian position. There are talks today in Brussels between Russia and the European Commission. The next round of the trilateral gas talks between Russia, Ukraine and the EU might take place next week, possibly in Brussels. If Ukraine fails to make a deal before October 1, there is a very high chance of transit gas flows to Europe being disrupted. 

On a side note, officials from the self-proclaimed Donetsk and Lugansk Republics claim that they have already agreed on a gas supply deal with Russia (rbc.ua). The supply could be organised via gas pipelines which loop across the territories from Russia and could work autonomously from the rest of the Ukrainian gas network.

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Russia may sign a deal with China in November which would see West Siberian gas redirected from Europe to its eastern trading partner. Photo Tomasz Wyszoamirski \ Thinkstock.com

Europe and Russia: the conscious uncoupling

There is no let up to the political tensions between Europe and Russia. Even if there is a ceasefire in Ukraine that holds, it has been done under duress and on Russian terms. It means that the sanctions will stay in place, and probably get tighter. It also means that both Russian and Europe would be looking at an 'conscious uncoupling' of their long-term gas affairs. Europe might be looking at using more of its LNG regasification capacity, and paying higher prices (read the FT's piece on how to live without any Russian gas for a year here). 

Russia would have to concede that the South Stream project is not going to happen, and it might sell less gas to Europe. 

Russia might therefore be urgently looking to send more gas to China. The Altay pipeline project has been revived (despite its cost and the technical issues of traversing high mountains in a seismic region) and might be signed as soon as November. 

The deal would redirect West Siberian gas from Europe to China. It might cost Gazprom and the Russian state margins and tax revenues respectively, though it would help China with the pollution and its economic development. 

– Edited by Michael McKenna and Oliver Morrison

Nadia Kazakova is a specialist on Russia, particularly the oil and gas sector
5y
fxtime fxtime
The search for alternative energy now speeds up imho whether it is wind turbines appearing everywhere or solar, or wave or even nuclear plants in Germany increasing their output Russia has made this one area of research into a crux issue imho.
5y
Nadia Kazakova Nadia Kazakova
I think there will be also more LNG, especially short-term
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Mickette Mickette
The Ukraine government should respect their own Russian speaking citizen and respect the memory of all the Russians who died for fixing Tschernobyl
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rajan vairawanathan rajan vairawanathan
This comment has been redacted
5y
danevagirl danevagirl
This comment has been redacted

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