Victory: Ukraine doesn’t need Russian gas anymore – and puts transit at risk

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naftogaz gazprom-sliderUkraine has completely “eliminated” its dependence on Russian gas, Ukrainian national gas company Naftogaz has declared in an open letter. Last year it stopped importing Russian gas for its own consumption altogether. At the same time, according to a paper written by Thierry Bros, Senior Research Fellow from the Oxford Institute for Energy Studies (OIES), Naftogaz is putting the future of the transit of Russian gas at risk by demanding higher transit fees. “This is in effect providing the green light for Nord Stream 2.

In a remarkable “open letter” sent on 25 November, Naftogaz declared that “Today is the first anniversary since Naftogaz stopped importing gas from Russia.” According to the company, “the gas dependence on Russia is eliminated. Naftogaz and the rest of Ukrainian importers now have access to alternative gas sources and can choose among dozens of suppliers. Many parties joined their efforts to enable sufficient gas supplies from Europe to Ukraine.”

“With the intergovernmental agreement signed on 12 October 2016 between Russia and Turkey, the 17 bcm/y currently transiting Ukraine for Turkey could well disappear from 2020″

Naftogaz notes that “in less than two years of work and with the help of our Western partners, international financial institutions, coordinated efforts of the president, the government and the parliament, we have managed to achieve an important result: the attempts of the Russian leadership to use gas for political pressure on Ukraine are not efficient any more.”

“Without alternative gas supplies from Europe” says Naftogaz, “we would have had to buy gas from Russia at non-market prices, with billions of dollars additionally paid to Gazprom for the gas which had not been used in previous years (the take-or-pay principle), as well as to pay for supplies to the occupied Donbas that are beyond our control. Breaking the gas supply monopoly of Russia enables us to fight for Ukraine’s gas independence in arbitration now.”

EU policy

As Naftogaz suggests in its open letter – in which it thanks “the European Commission, the Energy Community Secretariat, the governments of Slovakia, Poland and Hungary, the World Bank, the EBRD, President of Ukraine Petro Poroshenko, Ukrainian PMs Arseniy Yatseniuk and Volodymyr Groysman, Ukrainian MPs, customs officers, expert community and civil society” – the elimination of Russian imports testifies to the success of EU gas market policy in recent years.

“Ukraine would be well advised to grasp the fact that economics matters in a level and competitive playing field in the energy sector”

EU policy is based on liberalisation and integration of markets, expansion of interconnections and “unbundling” of infrastructure and supply. This has made it possible to supply Ukraine from other sources – including Russian gas transported through the Nord Stream pipeline to Germany and then on to Ukraine. The new dynamics of the European gas market have been confirmed by several studies, including one we wrote about in October 2015 from consultancy IPA Advisory and another more recent study from the European Centre for Energy and Resource Security (EUCERS). 

Major route

Ukraine’s newly achieved “independence” from Russia refers only to Russian gas imported for domestic consumption, however. The transit of Russian gas to Europe is a different matter. As Naftogaz notes in its open letter, “Ukraine remains a major route for Russian gas to the EU and ensures secure transmission.”

The question is, though, for how long?

In a new paper from the Oxford Institute for Energy Studies (OIES), Has Ukraine scored an own goal with its transit fee proposal?, Senior Research Fellow Thierry Bros argues that the new transit free proposal made by Naftogaz in October, effective from 1 January 2016, is not designed to make the Russians want to continue to keep Ukraine a major route. According to Bros, by greatly increasing its transit prices, Naftogaz is effectively stimulating Gazprom and its western partners to go ahead with Nord Stream 2, the planned pipeline through the Baltic Sea from Russia to Germany that is strongly opposed by Ukraine and other Eastern European countries.

Describing recent developments in European pipeline politics, Bros notes that Ukraine is increasingly losing the battle for market share in gas transit. He writes that in October, “Naftogaz potentially lost $700m/year from the $1.7bn transit revenue it received in 2015 from Gazprom for transiting 64.1 bcm [billion cubic metres]. With the intergovernmental agreement signed on 12 October 2016 between Russia and Turkey, the 17 bcm/y currently transiting Ukraine for Turkey could well disappear from 2020. Furthermore, following the recent EU Commission deal on OPAL, an additional 10 bcm/y bound for Europe could disappear even sooner , giving rise to the possibility that transit volumes through Ukraine could be as low as 37 bcm/y post 2020.”

“As new pipelines are opened in a world where European gas demand is declining, the logic of natural infrastructure monopolies has changed to an era of competition between routes”

With regard to the OPAL pipeline – which takes gas from Nord Stream through Germany to the Czech Republic, and for which the European Commission has recently established new rules that allow Gazprom almost full use of it – Bros writes that “on 10 November Polish gas monopoly PGNiG asked that the European Commission publish the text of its decision on OPAL. However, until the European Commission has done so, the state-owned company cannot take any legal steps against it, and, as a result the rerouting of gas via Nord Stream 1 will increase its load factor and profitability, and could also improve the business case for Nord Stream 2.”

Bros also notes that Ukraine has been losing political support in the EU recently: “the OPAL decision also raises the question of continued EU support for Ukraine, even as the latter continues to fight both militarily and politically with Russia. On the political level, it would seem that Ukraine has lost some support in Europe. It must now at least be an open question as to whether the European Commission will feel able to continue its support of Ukraine, at a time when European citizens have other priorities (employment, migration) and European companies continue to prefer to deal with Russia, as it is the largest oil and gas resource holder in the world and the largest seller of hydrocarbons to Europe.”

He adds that “Brussels also has other priorities, not least of which is the need to solve the current Brexit issues. In addition, EU sanctions in response to Russia’s actions in the east of Ukraine and Crimea, introduced on 31 July 2014 and prolonged until 31 January 2017, could be more difficult to renew in future, as evidenced by the Italian prime minister preventing the European Council from publishing a call for sanctions against Russia on 20-21 October 2016. The recent election of Donald Trump in the US also gives rise to uncertainty for Ukraine going forward.”

Commercial reality

With Gazprom diversifying its routes, political support for anti-Russian policies crumbling and gas demand in Europe stagnating, Ukraine should make itself an attractive partner as transit country for Gazprom, Bros suggests: “Ukraine would be well advised to grasp the fact that economics matters in a level and competitive playing field in the energy sector. In order to maintain the remaining flow (of both revenues and profits) of Russian gas transiting to Europe, Ukraine should therefore shift its transit negotiation strategy away from policy and towards commercial reality. In other words it needs to adapt its negotiating strategy rather than labelling Nord Stream 2 as a Trojan horse for Europe.”

“Naftogaz could make Nord Stream 2 financially less attractive by reducing the price of its own transit”

“As new pipelines are opened in a world where European gas demand is declining”, writes Bros, “the logic of natural infrastructure monopolies has changed to an era of competition between routes. Naftogaz could make Nord Stream 2 financially less attractive by reducing the price of its own transit. By offering a cheaper Ukrainian transit agreement for the period 2020-2030, Gazprom’s European partners (Engie, OMV, Shell, Wintershall and Uniper) would have more difficulty justifying the €8bn investment in Nord Stream 2 to their shareholders and to the EU Commission. But Naftogaz is instead suggesting that it wants to greatly increase its transit prices from 1 January 2016, de facto making the position of Gazprom and its European partners stronger with respect to Nord Stream 2.”

In his paper, Bros discusses the arguments advanced by Naftogaz to justify its new transit free proposal, but finds them unconvincing. By “hiking the tariff”, Naftogaz “could be seen as providing the green light for the construction of Nord Stream 2”, he concludes.

Comments

  1. Andrii says

    The above arguments against Naftogaz are a kind of half truth, because it was several times very clearly said, that mentioned tariffs apply only for the period up to 2019 with respective decrease afterwards and are caused rather by Gazprom unwillingness to negotiate by commercial means current contract.
    European consumers should ask their suppliers right know, how they are going to ensure gas flows during regular maintenance works, Gazprom is making every year on Nord Stream I, if Ukraine will be completely switched off from the transit. This gap will be two weeks each year as the minimum. Ukraine will survive without one transit company and transit fees, but weather European companies will stay so brav in relations with Russians, as they are right know, it is rather rhetoric question…

    • Adrian says

      Dear Andrii, I understand your argument(s) but as far as I know, Ukraine is Contracting Party to the Energy Community Treaty. According to the Treaty and taking the thereto related decisions of the Ministerial Council of the Energy Community into account, Ukraine is obliged to transpose and implement the provisions of the Third Package, so including Regulation 715/2009 EC.
      According to article 13 of the mentioned Regulation, tariffs, or the methodologies used to calculate them, applied by the transmission system operators and approved by the regu­latory authorities pursuant to Article 41(6) of Directive
      2009/73/EC, as well as tariffs published pursuant to Article 32(1)
      of that Directive, shall be transparent, take into account the need
      for system integrity and its improvement and reflect the actual
      costs incurred, insofar as such costs correspond to those of an
      efficient and structurally comparable network operator and are
      transparent, whilst including an appropriate return on invest­
      ments, and, where appropriate, taking account of the benchmark­
      ing of tariffs by the regulatory authorities.
      In other words, it seems that the tariffs are not in line with the provisions of the Regulation, in particular taking into consideration that the gas transmission system in Ukraine is very old, hence written off. The tariffs should be much lower then nowadays. When increasing the tariffs, cost reflectivity will be given even to a lesser degree than currently. So either the announced progress in the implementation of the third package (see the thereto related reports of the Secretariat of the Energy Community) has not been achieved yet or the Secretariat of the Energy Community is not willing to assess the status quo in a correct manner (for whatsoever reasons) or they miss expertise on cost accounting and tariff deviation – which is the most likely assumption. Even if your argument is that the contracts are valid till the end of 2019, one could say that old contracts can’t be changed but if so then the transmission system operator can’t increase the tariffs as well. From the economic – not political – point of view I have never understood why Gazprom has not insisted on the implementation of Regulation 715/2009 EC, in particular article 13 thereof. I fully agree with the statements in the article of Mr. Bros, in particular when taking into account that the usage of Nord Stream I and II – once built – generates just SRMC for Gazprom whereas when using the transit route in Ukraine the full tariffs have to be paid for, which means that in a fierce competition situation Gazprom has an advantage, hence incentive to use their own infrastructure. Sorry for this very direct statements. Best regards Adrian

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