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14 March, 2011  ▪  Іrina Khodorova

The Three-Martini Launch

Building an NLG terminal in Ukraine could be a move to diversifying gas suppliers—or just a waste of taxpayer money

This year, Ukraine’s delegation was proactive as never before at the World Economic Forum in Davos. The President amused investors, while his officials hustled earnestly to diversify energy supplies. Watched by their Presidents, Viktor Yanukovych and Ilkham Aliyev, Ukrainian and Azerbaijan fuel and energy ministers signed two critical deals about transiting Caspian oil through Ukraine and supplying liquid gas from Azerbaijan. Ukraine’s Minister Yuriy Boyko stated that Ukraine would get 2bn cu m of gas in 2014 and 5bn cu m in 2015, saying, “Ukraine will build a terminal and Azerbaijan will fill it with gas.”

An appetizing idea

The idea of building a natural liquid gas (NLG) terminal in Ukraine can only be welcomed, as it will allow the country to diversify energy sources. A resolution to build a terminal on the Black Sea coast was approved back in March 2010 and the Government expects the facility to go on line by 2014 with a capacity of 10bn cu m. It has also been announced that a state-owned enterprise called The National NLG Terminal Project, set up at the end of December, will be responsible for it. They are to prepare a feasibility study by September 2011 and construction will be tendered out by January 2012.

In their efforts to avoid energy dependence on Russia, most Old World countries built their own NLG terminals several years ago. Bulgaria and Romania both launched similar projects in 2010. The key advantage of natural liquid gas is that it is relatively cheaper than the gas piped by Russia. First, transporting NLG to the EU is easier from the Middle East and Africa than from Russia. Second, the cost of shipping and converting NLG, that is, turning gas to liquid and then liquid back into gas, is lower than the cost of pumping and servicing pipeline systems and so on.

In 2008-2009, the price of Russian gas went up steeply while NGL spot prices plummeted and EU countries switched to this alternative fuel. Liquid gas put considerable pressure on Gazprom, whose export of fuel to the EU fell 11.4% in 2009, causing its market share to slip from 25% to 22%. Meanwhile, total imports of NLG to European countries grew by 25%. Qatar alone doubled its supply, although earlier it had been selling gas mostly to the US. In 2009, its NLG was selling for US $80–90 per 1,000 cu m, while Russian gas ranged from US $260 to US $300 for 1,000 cu m, even for long-term contracts.

Pick your price range

This year, however, buying from Qatar looks less attractive: after the country gained a foothold in the EU gas market, it stopped output at eight production facilities in 2010 and cut exports by 66%. Needless to say, this caused a spike in NLG prices on world stock exchanges: in August, NLG was US $150 per 1,000 cu m. Still, even this is better than the US $275 that the Russians charge for 1,000 cu m of natural gas at the German border.

British Petroleum projects that demand for NLG will remain stable in the EU in 2011, while supplies grow 32%. Moscow-based Prime Mark Asset Ma­­na­­gement,1 estimates that, by 2020, North Africa and the Middle East will be able to double liquid gas output to 476bn cu m, while the share of NLG on European gas markets could go up from 11% in 2008 to 36% by 2035.

Yet, most experts surveyed say that the rising price of liquid gas should not hamper the building of a terminal in Uk­­raine, since diversifying fuel sources is a strategic objective. “As long as Naftogaz buys gas only from the Russians, no one will be able to prevent Gazprom from dictating prices and, hence, politics,” says Mykhailo Honchar, Director of Energy Programs at the Nomos Center.

The pricing policies of the Russian monopolist confirm this assumption—and those countries that have dared to start diversifying their sources have felt a definite easing. “As soon as European countries started to increase their NLG purchases, Russia loosened its price policy,” says Oleksandr Todiychuk, ex-CEO of Ukrtrans­­nafta. Latvia is a typical example. It could not negotiate a discount from the Russians until it joined forces with Poland to build a common terminal.

Theoretically at least, Ukraine does need an NLG terminal. But this raises a slew of practical issues. What guarantees are there that huge amounts of public money will not be wasted, as with Odesa-Brody pipeline, which stood empty for several years after construction was completed? How much has official Kyiv considered the risks that relations with the Kremlin will grow tense, possibly leading to a steep rise in the price of Russian fuel while the terminal is being completed? How will these challenges be handled? At the moment, only experts are prepared to offer answers to these questions, whether directly or by pointing to trends. Meanwhile, the Government is counting money: the cost of construction is expected to reach €1bn and Ukraine will be able to buy NLG for $190 per 1,000 cu m, including transport and re-gasification costs.

Don’t sweeten the pot

The campaign to discredit the idea of building an NLG terminal in Ukraine started long before the deal in Davos. Last year, right after First Vice Premier Andriy Kliuyev announced that construction would start in 2010, a roundtable was held in Kyiv, called “Who will solve the problems of Ukraine’s gas industry?” at which leading Russian oil and gas experts ostensibly searched for an answer to this question—and found one. “Europe’s getting liquid gas at cost. That’s not right… Nobody knows how much NLG will cost in four years’ time,” was the conclusion of Leonid Grigoriev, President of the Russian Institute of Power, a foundation. This kind of concern is understandable.

In 2010, NAK Naftogaz Ukrainy imported 36.47bn cu m of gas from Russia. Domestic consumption was an estimated 57.64bn cu m. For the Ukrainian market to shrink by 10bn cu m of gas would be a painful loss for Gazprom if the NLG terminal is eventually completed and filled as planned—especially against the background of plummeting gas consumption in the EU. Mikhail Korchemkin, managing director and advisor at East European Gas Analysis, converted this loss into cash equivalent and estimated “up to $12bn in annual income.” “The NLG market is developing too rapidly for Gazprom,” says this analyst. Indeed, it was for this reason that the Kremlin tried pushing for a merger of Gazprom and Naftogas and to get a chance to influence the choice of gas suppliers for Ukraine. Yet all it got from Kyiv were vague promises. The real maneuvers are yet to come.

“The refusal to use Odesa-Brody pipeline in reverse in 2004 was a purely political decision that had nothing to do with economics,” says Oleksandr Todiychuk about the prospects of an NLG terminal in Ukraine and that it will be used as intended. According to this industry expert, interested global players have powerful leverage to “freeze” any national project, although that power is not unlimited. For instance, the Pivdenniy oil terminal near Odesa was completed despite the clamor raised by a number of Russian companies, who claimed that it would pose an environmental hazard for the entire marine zone.

Nomos Director Mykhailo Honchar concurs: “It’s inevitable that there will be obstacles facing the construction of an NLG terminal in Ukraine. Poland, for instance, had problems transferring the ownership of land when it wanted to undertake a similar project.” Moreover, the bureaucratized permits system in place in Ukraine today means that any project can be postponed indefinitely. In short, the Government needs to concentrate political will in order to make the NLG terminal a reality. “The biggest risk is that there won’t be available liquid gas on the market—a fairly realistic possibility, given the current NLG boom…” says Honchar. In this same context, Todiychuk notes that any deals with Azerbaijan could go sour if Turkey’s position and interests are ignored, as that country can and does restrict the shipment of hazardous cargo across the Bosphorus.

In any case, the deal with Azerbaijan will not be enough for Ukraine to maintain NLG supply levels. Kazakhstan, Belarus—which is currently choosing between Ukrainian and Latvian projects—and even China, whose China Machine-Building Intеr­­national Сorporation is interested in building a terminal near Mykolayiv as part of an already-launched project to build a new seaport, could potentially participate in the construction of this terminal. Stirol Concern, recently purchased by Dmytro Firtash’s Group DF, too, has expressed interest in investing in the construction of an NLG terminal in Ukraine.

“From the economic perspective, there are no problems with building and using an NLG terminal,” says Todiychuk. “The facility can easily be hooked up to Ukraine’s existing gas transit system. Nor is there any need to connect the terminal to the main pipeline separately, since the purpose of supplying liquid gas to this country is certainly not to interfere in the transit of fuel from Russia to the EU.” Others, including Vadym Kopylov, former COB of Naftogas Ukrainy and now Ukraine’s Deputy Finance Minister, agree with Todiychuk, although Mr. Kopylov points out that only 2/3 of the capacity of Ukraine’s gas transit system is used currently.

Indeed, it’s not entirely clear why Ukraine has already turned down the option of transiting or even selling liquid gas to Europe, even as it plans to construct a terminal in its territory.  Perhaps announcing the construction of a liquid gas terminal is Kyiv’s feeble attempt to talk Russia into a more reasonable price for the natural kind. And if Moscow suddenly concedes, the megaproject could be history.

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