Which Side Won in the Gas Dispute?

By Taras Ostapchuk

Now that the first round of the natural-gas price war between Ukraine and Russia is over, there are debates about which side has won. The Russian establishment and the Ukrainian opposition claim that Russia has profited at Ukraine’s expense. Ukraine’s government, on the other hand, has proclaimed its own victory.

Ukrainians are left confused and nervous. Although an agreement has been reached and the blue fuel continues to scorch in Ukraine’s stoves and furnaces, the public has recently witnessed how a coalition of opportunistic political forces has ganged-up and overthrown the government at the outset of the parliamentary elections. And, Yulia Tymoshenko, the ex-Premier, has been ranting and raving about a betrayal of national interests.

From the media we hear:

1.         The price for Russian natural gas has been set at $230 per 1,000 cubic metres.

2.         Ukraine will be importing gas at $95 per 1,000 cubic metres.

 In order to understand which of the two sides benefited most, we need to examine the agreement.

The first part deals with the transit of Russian gas through Ukraine’s territory:

1. In the field of providing the transportation of natural gas belonging to Gazprom (OOO Gazexport) and RosUkrEnergo through the territory of Ukraine and the Russian Federation, sides have agreed until 01.01.2011 to a rate of $1.60 dollars US for the transportation of 1,000 cubic metres for a distance of 100 km.

The rate for the transit of Russian gas is clearly fixed until 2011 at $1.60 and is not tied to the market price. Therefore, if the world price of gas increases, Ukraine might not be able to compensate its losses by increasing the price for the transit. Also, the rate is lower than the average European rate, which ranges between $2.30 to $2.40.  On the positive side for Ukraine, there is a nearly 70 per cent gain in profits; previously the rate was $1.09.  The new rate seems adequate considering that Ukraine’s costs of maintaining its pipelines are likely to be lower than those of European countries. However, given the current upward trend in natural-gas prices, fixing the rate for five years is questionable. Overall, this part of the contract is a point scored for Gazprom.

The second part states:

2. In the field of supplying natural gas to Ukraine, sides have agreed to appoint RusUkrEnergo as the supplying side. Beginning from 01 January 2006 Gazprom does not supply Russian gas to Ukraine and Naftogaz in turn does not export Russian gas from the territory of Ukraine.

This part interestingly indicates that Gazprom has supposedly left the Ukrainian market. From now on, the company responsible for supplying Ukraine with gas is RosUkrEnergo.

The Russian media interpreted this move in the following way: Even if a second round of the gas war were to arise, Gazprom’s name and reputation as a supplier will not be affected. This way of thinking is limited. In any event, Russia’s reputation as a supplier would be on the line and not Gazprom’s. European consumers view Russia as “the” supplier of natural gas. If another dispute were to arise, the West would once again aim its criticism at the Kremlin and at Putin, in particular, and not at Gazprom or RusUkrEnergo. These companies are viewed as merely tools used to exert political pressure.

Another point to consider is that Gazprom sells gas for $230 virtually to itself (since it is the parent of RosUkrEnergo) while Ukraine purchases it for only $95. But, why should the Ukrainian side concern itself about the transparency of RosUkrEnergo? And, why should it matter to Ukrainian consumers if the scheme benefits corrupt Russian officials? All that should matter to the Ukrainian public is transparency on the Ukrainian side.

But, what are the guarantees that RosUkrEnergo will be a reliable supplier since there are none stated in the agreement? It must be remembered that this document is merely an agreement that outlines the parties’ intentions.  In the actual contracts, real guarantees from the Russian side, assuring that RosUkrEnergo will fulfill its obligations, will undoubtedly appear, thereby eliminating most concerns.

In the second part of the agreement, it seems that Ukraine has potentially won.

The third part states:

3. To realize the sale of natural gas originating in Russia, on the territory of Ukraine, Naftohaz of Ukraine and RosUkrEnergo, in the shortest term, no later than 01.02.2006, will create a joint stock venture the asset-base of which will be formed by bringing in monetary funds and other assets.

This point does not state what “other assets” Naftohaz may have to chip in to create this joint enterprise with RusUkrEnergo, so we are left to speculate on their nature. If the implication is that in order to realize the sale of Russian gas in Ukraine Naftohaz will have to concede parts (or all) of Ukraine’s pipeline infrastructure, then such a move will result in a strategic loss for Ukraine. It would be more meaningful for Naftohaz to purchase shares of RosUkrEnergo but then one may question the entire purpose of the latter enterprise (which has neither gas nor pipelines).

Part four is the most interesting.

4. Sub-section 1:

Sides will sign subsequent contracts/agreements with the aim to create, beginning from  01 January 2006, an annual commodity balance for RusUkrEnergo in the following volume:

Purchases:

• 41 billion cubic metres of Turkmen gas is to be purchased from Gazprom (OOO        Gazoexport) and Naftohaz of Ukraine from volumes that are already available.

• Up to 7 billion cubic metres of gas originating from Uzbekistan is to be purchased from OOO Gazoexport with the purpose of partly swapping it with the supplies going to the trans-Caucasian region.

• Up to 8 billion cubic metres of gas originating from Kazakhstan is to be purchased from OOO Gazoexport with the purpose of partly swapping it with the supplies going to the trans-Caucasian region.

• Up to 17 billion cubic metres of Russian gas is to be purchased from OAO Gazprom at a price, calculated from the basis price of gas ($230 for 1,000 cubic metres).

The Russian public is interested only in the price of their gas. It is clearly stated that the price is $230, which is what Gazprom asked for in the first place. Also mentioned are precise volumes of Turkmen, Uzbek, and Kazakh gas; however, nothing is said about their price. This may seem alarming, but let’s remember that Ukraine had already contracted to receive 39 billion cubic metres from Turkmenistan at $44. This contract could never have been realized without Gazprom agreeing to transport this gas through its pipelines.  Through this new agreement, Ukraine will receive its previously contracted gas, at the right price (on the Russian-Ukrainian border, Turkmen gas costs around $80-$90 per 1,000 cubic metres). Frankly, it seems that the price of $230 was hammered in only to show that Russia had won the negotiations. The total volume of Russian gas is small and can be decreased through energy conservation – a step which Ukraine must undertake regardless.

4. Sub-section 2:

In 2006 – 34 billion cubic metres of gas is subject to be sold at the price of $95 for 1000 cubic metres, which holds in the first half of the year 2006, to the created joint-stock venture that is consistent with the third point of this agreement. Before such venture is created, until 01.02.2006 this gas will be sold directly to Naftohaz with the purpose to be realized in the domestic Ukrainian market, without the right to be re-exported.

This part is the most thought-provoking. Gazprom is obligated to supply 34 billion cubic metres at $95. Given the prices that other European countries pay, this should be acceptable for Ukraine. 34 billion cubic metres accounts for nearly half of Ukraine’s consumption, and leaves the 22 billion cubic metres needed to completely fulfill Ukraine’s needs [34 billion-20 billion (own supplies) = 22 billion].

The problem here is that the $95-price is only valid for the “first half of 2006” and only for 34 billion cubic metres. Where will Ukraine get the 22 billion cubic metres and at what price in the second half of the year? Answers are not found in the agreement.

There likely will be pressure to increase the set price, and a second round of intense negotiations will follow shortly. Additionally, this part of the agreement forbids Ukraine to re-export Russian gas into Europe. Therefore, gas received at $95 will not be sold in other markets at higher prices; Ukraine has no room to speculate.

A price of $95 is not sustainable. Why would any supplier agree to fix their price for five years, when the world price is constantly rising? President Yushchenko himself declared that Ukraine’s position is to gradually move towards world-market prices. Beyond any doubt, Ukraine has to eventually pay a market price in order to be truly independent from Russia.

Finally, the last part states:

5. The rate for the transportation of natural gas and the price of gas written in this agreement can only be changed through a bilateral acceptance on both sides.

This statement helps to guarantee that Russia will not threaten Ukraine with multiple “overnight” price-hikes. If Russia proposes a price increase, Ukraine can insist on increasing the transit rate, especially if it is far off from the market rate. A unilateral increase in sale price would result in yet another large-scale scandal, which the Kremlin will not likely want to repeat.

To conclude, this new agreement represents a compromise, with worse terms for Ukraine than the previous one. Yet, the additional costs for Ukraine are by far less than the potential losses which would have been incurred as a result of a long-term conflict with Russia if Ukraine had insisted on adherence to the former contracts.

A legal challenge in Stockholm, as had been proposed, would have lasted realistically for more than a year, with an uncertain outcome. Also, even if the ruling would have been in Ukraine’s favour, mechanisms to force Russia to compensate Ukraine are nonexistent.

The current agreement saved the reputation of both sides and prevented a further escalation of the conflict. It also ensures a continuous supply of natural gas to Ukraine for the time being, thus preventing prolonged uncertainty for the economy and giving the Ukrainian government time to regroup. Important is also the fact that if Russia declares that it sells its natural gas to Ukraine at $230, then Ukraine no longer owes anything to Russia politically.