Russia resumes gas exports to Ukraine
FROM THE ECONOMIST INTELLIGENCE UNIT
Russia has resumed full gas supplies to Ukraine and Western Europe, barely a day after it cut volumes in order to force a resolution of its pricing dispute with Kyiv. A negotiated solution is now in prospect, whereby Ukraine will pay a price 2-3 times higher than its present US$50 per 1,000 cubic metres tariff but well below that demanded by Russia and will levy a much higher transit fee on Russian gas exports to Western Europe. Assuming that this happens, without a deal giving Russia part-control over Ukraine’s gas pipelines, the costs of the dispute for Russia will outweigh the meagre benefits. Ukraine, conversely, could come out ahead—although short-term economic disruption could be severe and its government may yet face a backlash in the March parliamentary election.
On January 1st Russia’s gas monopoly Gazprom, having failed to reach an agreement with Ukraine on sharply higher gas prices, cut the volume of gas through the “Brotherhood” pipeline that supplies Ukraine and Western Europe. Gazprom customers Italy, Germany, Slovakia and Hungary reported 30-50% falls in the volume of delivered gas. Gazprom officials accused Ukraine of stealing gas destined for Western Europe; Ukrainians responded that under existing agreements they were entitled to take 15% of the gas volumes that transit their territory. Because Russia had also cut supplies of Turkmen gas, which account for half of Ukraine’s total demand and exceed supplies from Russia itself by 50%, Ukraine appears to have been forced to take gas from the pipeline—even though it has large quantities of gas in storage that are apparently sufficient to cover several weeks’ demand.
European complaints appear to have forced Gazprom to step back. On January 2nd the company announced that it would increase volumes through the pipeline in order to ensure that its export commitments to Western Europe were met in full. This was implemented within a matter of hours, with the result that Ukraine should once again be receiving sufficient supplies of Russian gas. Although the prospect of further supply disruption cannot be ruled out, it is likely that the gas crisis, from Europe’s perspective, is now over.
Compromise in the offing
The most likely scenario is that the two sides will soon agree to revise the terms of their gas trade. Currently, Russia supplies 24bn cu metres of gas at US$50 per 1,000 cu metres and Ukraine applies a transit tariff of US$1.09 per 1,000 cu metres per 100 km on the 120bn cu metres of Russian gas that crosses its territory each year. This arrangement is supposed to run to 2009.
With regard to the price, the US$230 per 1,000 cu metres that Russia has latterly demanded was way above the level applied to other former Soviet states. Under the new pricing structure, Georgia and Armenia are to pay US$110 per 1,000 cu metres and Estonia, Latvia and Lithuania are to pay US$120-125 per 1,000 cu metres. The highest tariff is to be applied to Moldova, which will pay US$160 per 1,000 cu metres. Now that Russia has blinked in the gas price dispute, having upset its principal West European customers in the process, it is most unlikely to insist on US$230 per 1,000 cu metres—mainly because Ukraine has more leverage over Gazprom than any other CIS state because of the vast transit volumes.
As a result, it is likely that the gas price will nearly triple, to US$140-160 per 1,000 cu metres—a level in line with the prices now applied to other CIS states, and close to the price that Gazprom was demanding before the stand-off became heated. This is, moreover, the price that Gazprom itself has been counting on in its financial planning. The other element of the gas trade, the transit tariff, will increase, probably by 70-100%—and because transit volumes are much larger than volumes delivered to Ukraine, this will significantly offset the financial shock of higher gas prices. Because of Ukraine’s leverage and the fact that Russia has blinked first, it seems improbable that the deal will involve any change in the ownership or control over Ukraine’s gas pipeline system, even though this is a major Gazprom interest. Rather, the major uncertainty over any compromise deal surrounds the timing of the move to higher prices and transit tariffs: will the transition happen almost immediately, or will it be phased over several months or years?
Russia’s slim pickings
Assuming that a compromise solution along the lines outlined above is reached, the outcome of the gas dispute will be more negative than positive for the Russian side. Gazprom will benefit financially from the new arrangement, for although its transit bill will rise substantially its revenue will increase to a much greater extent. Assuming a gas price of US$160 per 1,000 cu metres, its receipts would rise by US$2.6bn while an increase in transit tariffs to around US$2 per 1,000 cu metres per 100 km would increase its expenditure by approximately US$1bn. In addition, Gazprom could expect to make significant gains from levying higher transit fees on Turkmen gas going to Ukraine.
Set against this financial gain, however, Gazprom would have failed to force Ukraine into ceding joint control over the gas pipeline network. This has for years been a major Gazprom objective, as 80% of the company’s exports to Western Europe go via Ukraine but Gazprom has no control or equity stake in the pipeline. In Belarus, by contrast, Gazprom owns the Yamal-Europe gas export pipeline and has recently acquired full control over other gas export infrastructure. Viewed from this perspective, the lack of control over the Ukrainian pipeline network, which delivers the exports that account for 60% of Gazprom’s revenue, constitutes a major business risk—one that Gazprom has failed to reduce or manage by its strong-arm tactics.
In addition, Gazprom has dented its strong reputation as a reliable supplier of gas to Western Europe. From the EU perspective, Gazprom is primarily to blame for the gas price dispute: it set the January 1st deadline, hiked its price demands to an unreasonable degree and initiated the cut in gas deliveries. Although Ukraine appears to have responded by taking gas that was destined for EU states, this course of action might have been legally justified by existing agreements; even if it was not, the country had little other option given the complete cessation of gas supplies in the middle of winter.
As a result, Gazprom’s behaviour appears reckless and this could spark consideration within the EU on the need for greater diversification of energy supplies. Gazprom is counting on the fact that EU demand for Russian gas will increase markedly in the next two decades, as North Sea gas production declines and Germany and the UK close their nuclear power stations. A greater reliance on indigenous energy sources, such as nuclear power, or a stronger focus on diversifying gas supplies—most likely by constructing more terminals to import liquefied natural gas (LNG)—would undercut the market share that Gazprom expects to hold in the EU.
Russia’s government is also a loser. It had sought to assert its dominance over Ukraine via the gas dispute but has been reminded of the fact that the two states are interdependent in the gas sphere—Ukraine relies on Russia for its gas, but Russia relies on Ukraine to deliver the gas exports that keep Gazprom solvent and so bolster the federal budget. As with its meddling in Ukraine’s 2004 presidential election—where Moscow openly backed the Ukrainian premier Viktor Yanukovych and recognised his victory before official results were announced—Russia has been embarrassed in a fight that it had no need to pick. The incident, moreover, is likely to have international ramifications: Russia has just become the chair of the G8 and intends to focus the G8’s agenda on energy security. Crude attempts to bully Ukraine merely underline Russia’s shaky political credentials as a G8 member and raise questions about its own reliability as an energy supplier to Western nations.
Good for Ukraine, but not for Yushchenko?
For Ukraine, the balance sheet is mixed. In the face of intense Russian pressure, the authorities held firm and Gazprom blinked first. In the gas sphere, it is clear that Russia is not the dominant party but rather that the two sides are interdependent. Just as importantly, there is no indication that Ukraine will now be forced to share or surrender ownership of the pipelines on its territory.
In the long term, a move to market prices for gas will be positive for Ukraine. Economically, it will eradicate the distortions in Ukraine’s economy and lead to sharply lower gas consumption. Russia aside, Ukraine is currently the fourth-largest gas consumer in Europe—a status in no way merited by the size of its economy or population. Politically, moreover, a move to market pricing for gas will reduce the scope for corruption and the leverage that Russia has over Ukraine.
Nevertheless, in the short term there could be considerable disruption if gas prices double or triple. The government could seek to cushion the impact by keeping household prices steady and ensuring that industrial prices only double, although this would increase budgetary spending by over US$1bn. Because privatisation receipts were swollen in 2005 by the Kryvorizhstal reprivatisation, such expenditure is within the government’s means. Yet it will only delay the gas-price shock for the economy, and economic growth is likely to be adversely affected in any case. Nor is it clear that the introduction of energy-saving technology at power plants and metallurgy and chemicals enterprises will be achieved in good time and with a minimum of disruption.
The greatest uncertainty for Ukraine centres on the impact that the gas dispute and the inevitable hike in gas prices will have on the March parliamentary election. This vote is especially important, because constitutional changes due to come into effect in 2006 give more power to parliament at the expense of the presidency. Opinion polls in late 2005 suggested that President Viktor Yushchenko’s bloc would not gain a clear majority in parliament and would need to form an alliance with either the nationalists of former premier Yulia Tymoshenko or the pro-Russian parties (including that of Mr Yanukovych). The impact of the gas dispute thus far is difficult to gauge: will voters turn away from Mr Yushchenko because Gazprom is seen to be punishing Ukraine for the “Orange Revolution”, or will they back him because he has stood firm in the face of Russian pressure?
It seems probable that the electoral impact of the gas dispute will depend mainly on the extent and timing of the gas price rise as well as the ability of Ukraine’s government to cushion the blow. A decision to protect households to the greatest possible extent is politically sensible, although it will further endanger Ukraine’s already strained budgetary situation. It may not be sufficient, moreover, to protect Mr Yushchenko from a backlash at the polls if a doubling of gas prices for industry leads to a sharper than expected industrial slowdown, the closure of some enterprises and job losses. So while Russia has fared poorly from the gas dispute, it is too early to say that Ukraine and Mr Yushchenko have fared well.
SOURCE: ViewsWire Eastern Europe
Russia has resumed full gas supplies to Ukraine and Western Europe, barely a day after it cut volumes in order to force a resolution of its pricing dispute with Kyiv. A negotiated solution is now in prospect, whereby Ukraine will pay a price 2-3 times higher than its present US$50 per 1,000 cubic metres tariff but well below that demanded by Russia and will levy a much higher transit fee on Russian gas exports to Western Europe. Assuming that this happens, without a deal giving Russia part-control over Ukraine’s gas pipelines, the costs of the dispute for Russia will outweigh the meagre benefits. Ukraine, conversely, could come out ahead—although short-term economic disruption could be severe and its government may yet face a backlash in the March parliamentary election.
On January 1st Russia’s gas monopoly Gazprom, having failed to reach an agreement with Ukraine on sharply higher gas prices, cut the volume of gas through the “Brotherhood” pipeline that supplies Ukraine and Western Europe. Gazprom customers Italy, Germany, Slovakia and Hungary reported 30-50% falls in the volume of delivered gas. Gazprom officials accused Ukraine of stealing gas destined for Western Europe; Ukrainians responded that under existing agreements they were entitled to take 15% of the gas volumes that transit their territory. Because Russia had also cut supplies of Turkmen gas, which account for half of Ukraine’s total demand and exceed supplies from Russia itself by 50%, Ukraine appears to have been forced to take gas from the pipeline—even though it has large quantities of gas in storage that are apparently sufficient to cover several weeks’ demand.
European complaints appear to have forced Gazprom to step back. On January 2nd the company announced that it would increase volumes through the pipeline in order to ensure that its export commitments to Western Europe were met in full. This was implemented within a matter of hours, with the result that Ukraine should once again be receiving sufficient supplies of Russian gas. Although the prospect of further supply disruption cannot be ruled out, it is likely that the gas crisis, from Europe’s perspective, is now over.
Compromise in the offing
The most likely scenario is that the two sides will soon agree to revise the terms of their gas trade. Currently, Russia supplies 24bn cu metres of gas at US$50 per 1,000 cu metres and Ukraine applies a transit tariff of US$1.09 per 1,000 cu metres per 100 km on the 120bn cu metres of Russian gas that crosses its territory each year. This arrangement is supposed to run to 2009.
With regard to the price, the US$230 per 1,000 cu metres that Russia has latterly demanded was way above the level applied to other former Soviet states. Under the new pricing structure, Georgia and Armenia are to pay US$110 per 1,000 cu metres and Estonia, Latvia and Lithuania are to pay US$120-125 per 1,000 cu metres. The highest tariff is to be applied to Moldova, which will pay US$160 per 1,000 cu metres. Now that Russia has blinked in the gas price dispute, having upset its principal West European customers in the process, it is most unlikely to insist on US$230 per 1,000 cu metres—mainly because Ukraine has more leverage over Gazprom than any other CIS state because of the vast transit volumes.
As a result, it is likely that the gas price will nearly triple, to US$140-160 per 1,000 cu metres—a level in line with the prices now applied to other CIS states, and close to the price that Gazprom was demanding before the stand-off became heated. This is, moreover, the price that Gazprom itself has been counting on in its financial planning. The other element of the gas trade, the transit tariff, will increase, probably by 70-100%—and because transit volumes are much larger than volumes delivered to Ukraine, this will significantly offset the financial shock of higher gas prices. Because of Ukraine’s leverage and the fact that Russia has blinked first, it seems improbable that the deal will involve any change in the ownership or control over Ukraine’s gas pipeline system, even though this is a major Gazprom interest. Rather, the major uncertainty over any compromise deal surrounds the timing of the move to higher prices and transit tariffs: will the transition happen almost immediately, or will it be phased over several months or years?
Russia’s slim pickings
Assuming that a compromise solution along the lines outlined above is reached, the outcome of the gas dispute will be more negative than positive for the Russian side. Gazprom will benefit financially from the new arrangement, for although its transit bill will rise substantially its revenue will increase to a much greater extent. Assuming a gas price of US$160 per 1,000 cu metres, its receipts would rise by US$2.6bn while an increase in transit tariffs to around US$2 per 1,000 cu metres per 100 km would increase its expenditure by approximately US$1bn. In addition, Gazprom could expect to make significant gains from levying higher transit fees on Turkmen gas going to Ukraine.
Set against this financial gain, however, Gazprom would have failed to force Ukraine into ceding joint control over the gas pipeline network. This has for years been a major Gazprom objective, as 80% of the company’s exports to Western Europe go via Ukraine but Gazprom has no control or equity stake in the pipeline. In Belarus, by contrast, Gazprom owns the Yamal-Europe gas export pipeline and has recently acquired full control over other gas export infrastructure. Viewed from this perspective, the lack of control over the Ukrainian pipeline network, which delivers the exports that account for 60% of Gazprom’s revenue, constitutes a major business risk—one that Gazprom has failed to reduce or manage by its strong-arm tactics.
In addition, Gazprom has dented its strong reputation as a reliable supplier of gas to Western Europe. From the EU perspective, Gazprom is primarily to blame for the gas price dispute: it set the January 1st deadline, hiked its price demands to an unreasonable degree and initiated the cut in gas deliveries. Although Ukraine appears to have responded by taking gas that was destined for EU states, this course of action might have been legally justified by existing agreements; even if it was not, the country had little other option given the complete cessation of gas supplies in the middle of winter.
As a result, Gazprom’s behaviour appears reckless and this could spark consideration within the EU on the need for greater diversification of energy supplies. Gazprom is counting on the fact that EU demand for Russian gas will increase markedly in the next two decades, as North Sea gas production declines and Germany and the UK close their nuclear power stations. A greater reliance on indigenous energy sources, such as nuclear power, or a stronger focus on diversifying gas supplies—most likely by constructing more terminals to import liquefied natural gas (LNG)—would undercut the market share that Gazprom expects to hold in the EU.
Russia’s government is also a loser. It had sought to assert its dominance over Ukraine via the gas dispute but has been reminded of the fact that the two states are interdependent in the gas sphere—Ukraine relies on Russia for its gas, but Russia relies on Ukraine to deliver the gas exports that keep Gazprom solvent and so bolster the federal budget. As with its meddling in Ukraine’s 2004 presidential election—where Moscow openly backed the Ukrainian premier Viktor Yanukovych and recognised his victory before official results were announced—Russia has been embarrassed in a fight that it had no need to pick. The incident, moreover, is likely to have international ramifications: Russia has just become the chair of the G8 and intends to focus the G8’s agenda on energy security. Crude attempts to bully Ukraine merely underline Russia’s shaky political credentials as a G8 member and raise questions about its own reliability as an energy supplier to Western nations.
Good for Ukraine, but not for Yushchenko?
For Ukraine, the balance sheet is mixed. In the face of intense Russian pressure, the authorities held firm and Gazprom blinked first. In the gas sphere, it is clear that Russia is not the dominant party but rather that the two sides are interdependent. Just as importantly, there is no indication that Ukraine will now be forced to share or surrender ownership of the pipelines on its territory.
In the long term, a move to market prices for gas will be positive for Ukraine. Economically, it will eradicate the distortions in Ukraine’s economy and lead to sharply lower gas consumption. Russia aside, Ukraine is currently the fourth-largest gas consumer in Europe—a status in no way merited by the size of its economy or population. Politically, moreover, a move to market pricing for gas will reduce the scope for corruption and the leverage that Russia has over Ukraine.
Nevertheless, in the short term there could be considerable disruption if gas prices double or triple. The government could seek to cushion the impact by keeping household prices steady and ensuring that industrial prices only double, although this would increase budgetary spending by over US$1bn. Because privatisation receipts were swollen in 2005 by the Kryvorizhstal reprivatisation, such expenditure is within the government’s means. Yet it will only delay the gas-price shock for the economy, and economic growth is likely to be adversely affected in any case. Nor is it clear that the introduction of energy-saving technology at power plants and metallurgy and chemicals enterprises will be achieved in good time and with a minimum of disruption.
The greatest uncertainty for Ukraine centres on the impact that the gas dispute and the inevitable hike in gas prices will have on the March parliamentary election. This vote is especially important, because constitutional changes due to come into effect in 2006 give more power to parliament at the expense of the presidency. Opinion polls in late 2005 suggested that President Viktor Yushchenko’s bloc would not gain a clear majority in parliament and would need to form an alliance with either the nationalists of former premier Yulia Tymoshenko or the pro-Russian parties (including that of Mr Yanukovych). The impact of the gas dispute thus far is difficult to gauge: will voters turn away from Mr Yushchenko because Gazprom is seen to be punishing Ukraine for the “Orange Revolution”, or will they back him because he has stood firm in the face of Russian pressure?
It seems probable that the electoral impact of the gas dispute will depend mainly on the extent and timing of the gas price rise as well as the ability of Ukraine’s government to cushion the blow. A decision to protect households to the greatest possible extent is politically sensible, although it will further endanger Ukraine’s already strained budgetary situation. It may not be sufficient, moreover, to protect Mr Yushchenko from a backlash at the polls if a doubling of gas prices for industry leads to a sharper than expected industrial slowdown, the closure of some enterprises and job losses. So while Russia has fared poorly from the gas dispute, it is too early to say that Ukraine and Mr Yushchenko have fared well.
SOURCE: ViewsWire Eastern Europe
posted by Marko at 1/03/2006 07:26:00 PM
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