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Russia-Ukraine gas dispute – endgame?

Andy
January 8, 2009
37 comments
2 min read

Russian invasion of Ukraine

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In the New Year’s spirit, I’m going to stick my neck out and predict that the current annual Russo-Ukrainian gas dispute will be resolved by the weekend.

Why? Because there’s nowhere else for either side to go. They’ve both pushed all of their bargaining chips into the middle of the table.

Depending on which way you look at this crisis, and who you believe, one of two things has happened in recent days. Either:

  • Russia cut off the gas to Ukraine, Ukraine retaliated by taking some of the gas intended for customers in Western Europe, and Russia re-retaliated by shutting off the gas supply to Europe.
  • Russia cut off the gas to Ukraine, then accused Ukraine of stealing gas intended for Europe to give it an excuse to cut off the gas supply to Europe.

Either way, the gas supply from Russia to Europe via Ukraine has been shut off. There’s nowhere else for either side to go in this dispute. There are no more gas supplies to cut, and no other sanctions either can apply will do the other side anywhere near as much damage as has already been done.

The heads of both the Ukrainian and Russian gas companies are in Moscow today, and they’ll both be meeting with grumpy EU officials. With nowhere else to go, expect a deal to be done within days, and for all three parties to go home claiming a modest ‘victory’.

PS – for a fascinating primer on the historical background to the Russia-Ukraine gas dispute, check out Jerome Guillet’s post in the European Tribune.

Andy

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37 comments

  • Why did Ukraine refuse the offer of $250 per 1000 m^3 from Gazprom? What happen to the Ukrainian hard currency reserves – there still must be around $31 billions??

    [Answer: Most of has been invested into Lehman Brothers, Fannie and Freddie and other “very reliable” investment funds – on advice from the American advisers of course. The Ukrainian government would never admit this – but they lost all of their money in American investment funds – now they are fighting Russia over gas. How pathetic.]

    Russian President´s last blog post..Russia-Ukraine gas war is evolving into a trade war

  • Great post Andy. It is a shame that this is how two super-powers need to conduct themselves. This is every year they have this pissing contest. Why not negotiate a 5 year or 10 year deal? Because it’s easier to go through this every winter.

    It is tough to take either side seriously, but one has to feel for the Ukraine, they are acting only to keep their people from freezing.

  • Its over I think – you might be right Andy – just saw on Irish tv news that Russia has agreed to switch on the gas as long as observers are present to ensure Ukraine doesnt steal any.

    http://www.rte.ie/news

    ”Why not negotiate a 5 year or 10 year deal? Because it’s easier to go through this every winter. ”

    I genuinely think that money is the issue for Russia, and kicking Yushenko is just an added bonus. A long term contract at a reduced rate from the market price is not in Gazprom’s interest, and its hard to blame them. Ukraine – in the shape of Yushenko -seem to have taken every opportunity possible fo annoy the Russians, including persevering with NATO application even though the majority of Ukrainians dont want it. Its hard to blame Russia for treating them like any other punter in the light of this behaviour. For once I think Russia is right.

  • Shouldn’t Gazprom get paid?

    Have the involved Ukrainian negotiators had the best interests of Ukrainian citizens at heart?

    I’d like to see a comparison poll on how Rusisans and Ukrainians each view the situation. A key question would pertain to how much which side should be blamed? It would be interesting to see how many in Ukraine show some sympathy for the Gazprom view when compared to Russians siding with the involved Ukrainian negotiators.

    Andy

    Before the full cut off, there was a decline in shipments to some countries. This was stated by the involved countries.

    Michael Averko´s last blog post..A Tale of Two Anne’s

  • ”Shouldn’t Gazprom get paid? ”

    Absolutely they should. But I’m reminded of a situation that happened when I was in Wellington. A woman living in a poor area hadnt paid the electricity bill and the power company switched off the power. She died as some medical device she had in the house (I think a defibrilator, or some such device) of course couldnt work without power. It caused a massive scandal in NZ. It worries me that people may be cold and the elderly dying cos of this. But Gazprom of course must be paid.

    ”Have the involved Ukrainian negotiators had the best interests of Ukrainian citizens at heart?”

    I dont know, but its seldom that politicians do have these interest at heart anyway. At any rate their orders are likely coming from Yushenko.

  • Remeber Belarus are facing similar price hikes yet there has been no problem there. The Nord and south streams are signed, partnership comapines with many european countries are already agreed and in some cases ratified in some paraliments.

    The real losers in this whole situation are the Ukrainians not just now but in the future. The Ukraines 2 largest sources of income are west bound energy transit/storage and arms. Russia and the rest of Europe are already planning to bypass them in regards to energy in both transit and storage. With the recent revelations in Ukraine’s parlimentary investigations into illegal arms dealing, revealing not only Ukraine selling arms to Georgia at cut prices, but during the actual conflict then even shipping it to Georgia in the guise of humanitarian aid after the conflict finished. According to EU legisation any nation shipping arms to a war zone should encur an arms embargo. This combined with the price of minerals etc produced by Ukraine plummeting could leave this country in economic meltdown.

    As for the gas heres an interesting post from Misha today over at la russophobe. My similar post was censored though this response was better anyway.


    Russia sells gas to Europe under long term contracts that stipulate the price of gas based on the price of oil (for equivalent BTU energy content). The price price of gas is re-adjusted twice per year (every 6 months) to reflect changes in oil prices. Russia supplies about 25% of Europe’s total gas supply and about 80% of that Russian gas passes through Ukraine’s Soviet-era pipelines. Russia has long sought to diversify the transit routes in order to ensure both security of supply (for Europe) and security of demand (for Russia). The two largest projects are the Nord-Stream (”North Stream”) and South Stream pipeline projects. These projects will bypass unstable transit states such as Ukraine and pipe Russian gas directly to Russia’s best customers in Western Europe. Russia is also participating in joint ventures to construct massive gas storage facilities in Europe, which would improve the continent’s ability to weather temporary disruptions to supply such as we are now seeing. The largest gas storage facility in the world is under construction in Belgium and Russia’s Gazprom is a partner in this joint venture.

    But until these projects come online Europe will continue to remain overly dependent on the Ukrainian transit routes and thus vulnerable to periodic supply disruptions such as we are now seeing.

    Since the fall of the USSR in 1991, Ukraine has continued to receive Russian gas at a fraction of the price Europe pays. Even at these below-market rates Ukraine frequently fails to pay. For 2008 Ukraine’s price was $179.50 per thousand cubic meters (tcm). This was less than half the average European price of $418 per tcm. The cumulative economic subsidy which Russia has provided to the Ukrainian economy (in the form of subsidized gas) since Ukrainian independence in 1991 amounts to some $150 billion, measured in constant 2009 dollars.

    Since 2008 Russia has been paying the full “netback” price to Central Asian gas producers. (The “netback” price is the full European market price, minus only an allowance for transportation costs.) This absurd and unsustainable situation now sees Russia buying gas in Turkmenistan for $350 per tcm and selling it to Ukraine for $179.50 (a loss of $170.50 per tcm right off the top, not even counting transportation costs).

    The bulk of Russian gas does not come from Central Asia, but rather from Central Siberia, as this pipeline map illustrates. In addition China is now investing in large scale energy projects in Central Asia which will move the bulk of available Central Asian reserves east (not west).

    As most of Russia’s older oil and gas fields are now facing declining productivity, Russia faces the necessity of making massive investments in energy projects in its far east and arctic regions in order to continue to meet its energy export obligations. This has dramatically raised the marginal cost per unit of energy extracted. Russia is no longer willing (or even able) to continue to deliver energy to customers who refuse to pay market rates (let alone those customers who frequently refuse to pay at all).

    That Ukraine is a relatively poor country and that it has been adversely impacted by the US-induced global financial crisis is doubtless true, but frankly this is not Russia’s problem. Russia is also a relatively poor country and Russia has its own problems to worry about.

    If Europe or the U.S. truly believe that Ukraine “deserves” to have its energy-inefficient economy and its culture of political and business corruption subsidized to the tune of billions of dollars annually, for the foreseeable future, then some formula will have to be arrived at whereby Europe and the US can pay those subsidies. Russia is no longer willing or able to carry Ukraine’s weight.

    Russia has long indicated that former Soviet Republics must expect a transition to market prices for gas (as already happened with oil long ago, more or less immediately after the fall of the USSR). Russia has demonstrated remarkable patience and a willingness to phase in market prices over a number of years, to help former Soviet economies make the transition. But far from making efforts for such a transition, Ukraine’s economy remains the most energy-inefficient economy in the world. Ukraine continues to use more natural gas per unit of GDP than any other country on earth, including gas-rich Russia itself. Ukraine has not invested in any meaningful way in energy-saving technologies nor has it created a climate favorable to investments in the development of its own domestic energy resources, which by some estimates are not insubstantial.

    Ukraine’s gas strategy has been to exploit its monopoly over Soviet-era European gas transit routes in order to extract “rent” from Russia. This “rent” basically takes three forms: (1) Cash transit fees which Russia pays to Ukraine for the transport of Russian gas across Ukrainian territory. These transit fees are a normal and customary part of the gas business everywhere in the world. Of course Russia understands that it costs money to build and maintain transportation infrastructure. Russia is certainly willing to pay reasonable, customary (and competitive) transit fees, which cover the cost of constructing and maintaining gas transit facilities as well as a reasonable rate of return on the capital invested in such projects. (2) Ukraine has also insisted on receiving Russian gas at below market prices. This of course is not a “normal” aspect of the gas business, or any other business, in a market-based economy. This would be as if I contracted with a trucking firm to transport a thousand chickens, at a mutually agreed transport price, and then the trucking firm came back to me and insisted that I also sell them as many chickens and they cared to purchase, for half price. (3) Ukraine has also periodically engaged in the outright pilferage and theft of Russian gas supplies in transit to European markets, paying nothing at all for this gas. This would be as if I contracted with a trucking firm for the delivery of chickens, but half the chickens were simply missing when the truck was opened at its destination. How much do you want to be I will not be doing much business with that firm in the future?

    To say that Ukraine is not a reliable and profitable partner for the transportation of Russian energy is the understatement of the century. Perhaps this will change in the future and Ukraine might become a more reliable and normal partner. But frankly I don’t see this happening at least until alternative transport routes are opened. Ukraine continues to believe that it can get whatever it wants from Russia by holding Europe’s gas supply hostage. If the current crisis does not make this abundantly clear then I don’t know what would. Perhaps Ukraine can maintain the status quo for some years, and continue to extract monopolist rent from European gas supplies, but if so Europe is going to have to pay. Russia is finished paying for this nonsense.

    The era of cheap (and sometimes free) Russian gas in Ukraine is fast coming to an end. The sooner Europe and the world (and especially Ukraine) come to grips with this reality the better off everyone will be.

    I would challenge anyone to name one Western energy company or utility that would continue to provide products and services to a non-paying “deadbeat” customer, year after year and decade after decade. As the chairman of Gazprom said recently, “when you receive a product you have to pay for it. If you don’t pay then you are not going to continue to receive it.”

  • FW

    I saw a piece in the media today where a Ukrainian official said that Belarus pays a lower rate than Ukraine. Without checking, I suspect he’s right.

    If true, since when do countries offer a comparatively better break to those who haven’t been particularly agreeable?

    Michael Averko´s last blog post..Congress Should Bail Out Porn Industry

  • There are two things here. Firstly, Ukraine is entitled to charge a transit fee for the gas that Russia sells to Europe and pipes through its territory. Ukraine is entitled to charge as much as it likes for this, and Russia in turn is entitled to find alternative transit routes. Given there are currently few alternatives, Ukraine can probably get away with increasing transit charges every time Russia increases the gas price. I am guessing that the net cost to Ukraine of the gas once transit fees have been deducted is what is the issue here.

    Secondly, Russia is supplying gas to Europe. Russia is the supplier, Europe is the customer. Ukraine is simply a provider of transport services, and the onus is therefore on Russia to ensure that its own disagreements with its (in effect) subcontractor are sorted out and do not interrupt the supply. It is very rare in the energy provision industry that a supplier can get away with blaming third-parties for not fulfilling obligations. When Shell are contracted to provide LNG to Korea, Shell would never be able to cite a dispute with the shipping company as a reason for non-delivery. That Russia has shut down the supply and is asking the customer to intervene in the dispute is demonstrating that Russia is not following the normal behaviour which can be expected of most, if not all, international energy suppliers.

    Tim Newman´s last blog post..Buncefield Incident Revisited

  • “Remember Belarus are facing similar price hikes yet there has been no problem there.”

    @ Free World – There hasn’t been a problem this winter, but last winter’s dispute between Belarus and Russia led to Russia taking the a similar approach of shutting off the oil supply to Belarus because Belarus was siphoning off oil in transit.

    I saw a piece in the media today where a Ukrainian official said that Belarus pays a lower rate than Ukraine. Without checking, I suspect he’s right.

    @ Mike Averko – You have to wonder at the wisdom of the variable pricing approach sometimes. There are political benefits, but also huge risks too.

    If Country A sees that Country B is getting a better price for it’s gas, it’s only going to encourage Country A to try to get that price too from their supplier. After all, if the gas can be supplied to Country B at such a low price, why can’t Country A get the gas for that price too?

    Ukraine is simply a provider of transport services, and the onus is therefore on Russia to ensure that its own disagreements with its (in effect) subcontractor are sorted out and do not interrupt the supply.

    @ Tim Newman – couldn’t agree more. Whatever the motivations, and money at stake, it’s all short term compared to the battering that Russia’s reputation as a reliable energy supplier has been taking over the past few years.

    Every time energy supplies to Europe are disrupted because of a contractual dispute back down the pipeline, it becomes that little bit easier for Europe to justify looking for alternative fuel sources.

    Andy´s last blog post..Russia-Ukraine gas dispute – endgame?

  • Andy

    With all due respect, major powers are known to give breaks to those more in line with their views.

    In 2006, there seems to be a good deal of agreement that Russia stopped delivery of the Ukrainian portion of supplies while continuing the flow intended for other parts of Europe. In that instance, the result was shipments to Europe being curtailed, as many blamed Russia.

    As of right now and without checking the latest news, a major issue vis-a-vis restarting the regular flow from Ukraine is who does the monitoring of the supply route from Ukraine. At last notice, Russia isn’t opposed to EU observers, while seeking for Russian observers as well. At last notice, Ukraine opposes the latter. On this particular, I don’t think that the Russian position is so unreasonable.

    Michael Averko´s last blog post..Mentoring Women and Women Mentoring

  • Keeping in mind that Ukraine has been getting a good deal.

    Yesterday, Putin was quoted as saying that Ukraine will pay the global rate, with Russia having to pay an increased transit fee. This was probably stated with the long term in mind.

    This matter will probably be a fairly major issue in the next Ukrainian presidential election in 2010. In the short term, Ukraine isn’t feeling the pinch. The key is short term.

    Michael Averko´s last blog post..Mentoring Women and Women Mentoring

  • To be more specific, here’re the mentioned comments of Putin:

    http://en.rian.ru/world/20090108/119398542.html

    Who comes out ahead in that scenario? Practically speaking, is Ukraine in a good position to be able to honor such an agreement?

    Andy mentioned western Europe looking for other gas supply options. This has already been delved into. There’s insecurity and difficulties in pursuing such a route. As I think FW mentioned (pardon if wrong), Russia can pursue other transit options. This can be difficult as well.

    There will of course be an agreement. I question how well Ukraine comes out of this in the long run.

    Michael Averko´s last blog post..Mentoring Women and Women Mentoring


  • “Firstly, Ukraine is entitled to charge a transit fee for the gas that Russia sells to Europe and pipes through its territory. Ukraine is entitled to charge as much as it likes for this, and Russia in turn is entitled to find alternative transit routes. ”

    This is all true to a degree. Though the reality is Gazprom are not going to sell or transit gas at a loss. No company can do that. Remember what kicked this problem off was the failure of Ukraine to pay $1.5 billion dollars for gas received. Then a further $600 000 for late payment charges a penalty which was in the contract. Money that Gazprom are even today yet to receive. Clearly Gazprom are finding and building alternative routes to avoid Ukraine.

    What Ukraine claims it does not have a transit contract with Gazprom but how could this be true. They surely must have agreed a price at some stage for transit. though what is certain is Gazprom does pay above market prices for gas transit, in-fact the highest of all its transit countries.

    Europe needs Russian gas as its own limited gas fields are low and demand is growing. If anything gas supplies from Russia and many other sources are likely to increase. The nord and south streams clearly show that Gazprom and european gas companies are committed to increasing supply from Russian fields and bypassing Ukraine.


    I saw a piece in the media today where a Ukrainian official said that Belarus pays a lower rate than Ukraine. Without checking, I suspect he’s right.

    The Belorussian contract is different to Ukraine’s. With Ukraine and Russia there are two contracts, one is about gas supply and one for transit. As far as I know this is the only deal of this type due to previous problems. Most however including with Belarus have a netback price of gas. This is the cost of gas supply minus transit fees. What the Ukrainians do not tell you is they are comparing a netback price to there gas price. What they also don’t tell you is that Ukraine was a lower gas price in 2009 than the Belorussian netback price. They also don’t tell you that Belarus are facing the same price hikes.


    Ukraine is simply a provider of transport services, and the onus is therefore on Russia to ensure that its own disagreements with its (in effect) subcontractor are sorted out and do not interrupt the supply.

    If only it was this simple and surely totally depends on contracts signed.

  • (Ugh … I hate it when people cut and paste seven paragraphs into the comments section…)

    There are a lot of funny conclusions to draw from this year’s gas war. One is that Kiev and Moscow seem to vigorously agree that their problems must be solved by European intervention, and both of them were eager to give everybody a taste of a cold winter house to push their point. Ukraine looks like they are going to suffer from Georgia exhaustion, as they have vastly over-estimated European goodwill. The Russians clearly don’t really give a damn about Gazprom’s reputation as a reliable supplier. Andy’s absolutely right that there will be a resolution by the weekend because Gazprom desperately needs the money. The Kremlin, I believe, has enjoyed this dispute – it has provided a necessary distraction from those auto tariff protesters and job cuts, showed a little muscle flexing to the West during a moment of vulnerability, and bumped up the price of oil (which was already enjoying a bounce thanks to the Gaza violence). Surely they will be disappointed when it is over, but for some reason, many in Europe are eager to give Russia the benefit of the doubt and pretend like politics had absolutely nothing to do with the singling out of the Ukraine.

    James´s last blog post..Redefining Sovereign Democracy

  • James considering Gazprom are hiking the prices for Belarus (a Kremlin ally) as well as the Ukraine how can you claim they are singling out Ukraine?

    I think Europeans are of the viewpoint why should Ukraine get gas cheaper than us and why did they just not pay their bill. Its looks like Ukraine wants one foot in the Russian Federation and one foot in the EU with all the benefits from both.

    You mention the auto tariffs, job cuts and Gazproms need for cash so why should they make an exception for Ukraine when it comes to gas prices.

  • Excerpt:

    “Surely they will be disappointed when it is over, but for some reason, many in Europe are eager to give Russia the benefit of the doubt and pretend like politics had absolutely nothing to do with the singling out of the Ukraine.”

    ****

    The “they” being Russia.

    This latest dispute doesn’t help Gazprom’s image. Given what’s being said, I don’t see how that comkpany so pleased with what happened. They were caught between wanting to get paid and how some would perceive them.

    ——————————————————————————————-

    Excerpt:

    “The Kremlin, I believe, has enjoyed this dispute – it has provided a necessary distraction from those auto tariff protesters and job cuts, showed a little muscle flexing to the West during a moment of vulnerability, and bumped up the price of oil (which was already enjoying a bounce thanks to the Gaza violence).”

    ****
    The involved Ukrainian side hasn’t “enjoyed” leading some to question Russia as a reliable source for gas?

    Michael Averko´s last blog post..Mentoring Women and Women Mentoring

  • What Ukraine claims it does not have a transit contract with Gazprom but how could this be true.

    That a contract exists would ordinarily be spectacularly easy for Gazprom to prove, but I suspect that the agreement involves several murky “middleman” companies tucked away in Switzerland from which nobody is quite sure where the monies go.

    Tim Newman´s last blog post..Buncefield Incident Revisited

  • Yushchenko’s displayed geopolitical leanings are clear. Tonight’s DW TV (aired in the US) had a feature which confirmed how some influential elements in the West have openly sought for central and western Europe to be less dependant on Russian gas – by seeking new options and improving upon existing non-Russian ones. This desire has been advocated before the recent row.

    FW

    I thought of your recent post when the mentioned DW feature said that Ukraine pays a higher gas fee than Ukraine.

    From early Friday NY time, here’re some recent pieces I came across:

    Gas for Europe is Contingent on Monitoring, Putin Says
    http://www.washingtonpost.com/wp-dyn/content/article/2009/01/08/AR2009010802920_pf.html

    ****

    Medvedev Says No Gas to Ukraine Until Documents Signed
    http://en.rian.ru/russia/20090109/119402826.html

    ****

    Ukraine to Allow Russian Observers In or Not?
    http://www.russiatoday.com/news/news/35693

    ****

    Hungary Delivers Gas to Serbia
    http://bbjonline.hu/index.php?col=1004&id=46239

    Michael Averko´s last blog post..Hugo Chavez To Keep Sending Free Oil To US Poor

  • Interesting read Lubos.

    Some recently released articles on the subject:

    Ukraine and Russia Sign Deal Over Gas http://www.nytimes.com/2009/01/11/world/europe/11russia.html?hp

    Ukraine PM: There Will Be No More Gas Middlemen http://www.rferl.org/content/Ukraine_PM_There_Will_Be_No_More_Gas_Middlemen/1368429.html

    Iran to Discuss Russia Swaps at Gas Forum http://online.wsj.com/article/SB123162971999271197.html

    Gas Crisis Focuses Minds on New Routes http://www.russiatoday.com/business/news/35713

    Michael Averko´s last blog post..UFO over UK wind farm sparks theories

  • By stealing (highjacking) gas that is being transported through its territory Ukraine behaves just like the Somalian pirates, who highjack ships. Why doesn’t the “international community” send an Army to Ukraine to protect the European gas that is being stolen by the Ukrainian government? In the case of the Somalian pirates an Armada of military ships has been deployed off the Somalian coast.

    Russian President´s last blog post..Beautiful Russian woman of the day: January 15, 2009

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