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5 August, 2019  ▪  Oleksandr Kramar

Defeating ourselves

How Ukraine has played soft with Russia in preparing for a gas clash next year

The response of the previous government to Russia’s open and long preparation for the gas war and the likely energy blockade of Ukraine starting from 2020, was shockingly passive. While Russia was finalizing Nord Stream 2 and building TurkStream in the south, Ukraine wasted at least four years it could have used effectively to prepare for the inevitable clash in the energy front. Ukraine expected someone far beyond the country to solve the problem. But counting on the talks, involving the EU, to extend gas transit or to impose sanctions on the companies involved in Nord Stream 2 was a sign of complacency from Ukraine’s leadership. The potential price will be a forced capitulation to the enemy on the gas front this winter. Sabotage by Ukrainian officials, inactiveness and the lack of a strategic approach amongst the top officials and the key institutions responsible for Ukraine’s preparation for the potential challenge in the gas and energy sector contributed to its shrinking chances to avoid that scenario much more than the perfectly expected treachery from Russia did.

What we see is that the new team in power led by Volodymyr Zelenskiy, too, lacks a well-planned strategy to strengthen Ukraine’s position in the potential clash with Russia. Moreover, one risk is that it may take populistic steps that will help the Kremlin accomplish its goals in forcing Ukraine to accept unequal, de facto post-colonial conditions of cooperation in the gas sector even in the aspects where it has been undermined with much effort in recent years. Moscow’s goal remains unchanged: to prevent Ukraine’s independence, to restore its total dependence on Russian fuels, and to impose the conditions of cooperation that would cement such dependence for the long-term prospect, thus helping Russia to eventually take full control over Ukraine’s energy infrastructure and its domestic gas market. All this would lead to its political control over Ukraine and further swallowing of it, or to a Belarusian scenario for Ukraine. 

Force posture

Gazprom has long and consistently prepared for 2020. It finished laying the sea section of the TurkStream pipeline on November 19, 2018. 57% of Nord Stream 2 was completed by early June 2019. Russia is waiting for the decision of Denmark that will define whether the pipeline is launched on January 1, 2020, when the contract for the Russian gas transit through Ukraine expires. Finally, a recent decision by Gazprom will have it pump the record 11.4bn cu m of gas into the European storage facilities it controls, compared to just 5.8bn cu m in the 2018-2019 heating season. 

Meanwhile, Gazprom has increased its presence on the EU market and its influence in the key decision-making states in the EU. This is supposed to ensure their loyalty in case of another war with Ukraine. 

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The share of gas the EU consumed from Gazprom was under 30% in 2013. It went up to 36.6% in 2018. The amount of gas shipments increased from 161.5bn cu m to 200.8bn cu m over this time in absolute numbers. Germany’s share of Russian gas consumption has exceeded 60%. The sales of Russian gas to Germany and Austria, the locations for the key gas hubs, grow at a shocking pace. By contrast, deliveries to most other EU member-states have shrunk in recent years.

The amount of gas sold to Germany in 2018 grew to 58.5bn cu m from 53.4bn cu m in 2017, while Austria purchased 12.3bn cu m in 2018 compared to 9.1bn cu m in 2017. Turkey bought only 24bn cu m in 2018, down from 29bn cu m in 2017, while Italy purchased 22.7bn cu m in 2018 compared to 23.8bn cu m in 2017. If Russia’s plans are to be implemented, it will be the hubs in Germany and Austria where extra gas will go through Nord Stream 2. Coupled with Nord Stream, its total capacity will amount to 110bn cu m. All this makes it highly likely that the Russian gas will no longer flow to Ukraine’s gas transit system for further transportation, unless Ukraine accepts Russia’s ultimatum expressed by Gazprom’s leadership: to extend the current transit contract that benefits Russia and was forced upon Yulia Tymoshenko by Vladimir Putin during the previous gas blockade in 2009. 

According to Moscow’s plans, the European side will be perfectly willing to pressure Ukraine into accepting that proposal (at least as a way to postpone the problem) if it faces a risk of not having the amount of gas critical for the heating season. That will give Russia an extra tool of pressure in favor of the construction and the distribution infrastructure to deliver Nord Stream 2 gas to the European countries, and gas from TurkStream to south-eastern Europe. Once it does, the EU’s need for gas will no longer be affected by the termination of transit through the Ukrainian system. For Ukraine, however, the inactivity of the responsible top officials in the past and continued inactivity of the new team in these issues, if it is the case, will only aggravate the problem of critical gas deficit. Ukraine will then be forced to speak to Gazprom and even accept a contract to buy gas under the terms dictated by Moscow.

Ukraine has so far been purchasing gas from the EU under reverse contracts. This gas was de facto coming from Russia. If Russia stops all transit through Ukraine (or if Ukraine faces a deficit of gas as a result of this termination), it will be difficult to physically import the amount necessary for Ukraine from the hubs in Germany and Austria, and this will be done at inflated prices.  

Wasted time

The 20/20 program, a trump card in the possible gas war with Russia in 2020, envisaged an increase in domestic extraction of hydrocarbons to 20bn cu m, and to 27bn cu m with other state and private companies. The program was never implemented. If it had been, it could have brought to a minimum Ukraine’s need for gas from Russia, layered over the saving of gas for households. Ukraine would then only lose transit revenues if Russia stopped the transit, but it would have no problem meeting its domestic demand. 

In reality, UkrGazVydobuvannia (Ukrainian Gas Extraction company) increased its gas extraction by less than 1bn cu m over recent years to a mere 15.5bn cu m in 2018. The growth in 2018 was 0.25bn cu m. As a result, Ukrainian companies will be lucky to extract 16bn cu m in 2020 by contrast to the 20bn cu m as planned under the 20/20 program. The protracted blockade of gas extraction concentration by oblast councils (especially in Poltava Oblast) and delays in authorizing extraction have contributed to the non-implementation of the program. UkrGazVydobuvannia received 13 authorizations in 2016, 4 in 2017 and 1 in 2018. The key components to this situation were probably the clash for spheres of influence between frenemies from the power conglomerate and the interests of the key decision-makers in the industry. 

Who is now responsible for the actions or the inactivity that has resulted in this situation? Who allowed the long sabotage of preparation for the expected gas war with the enemy? All this may be revealed quite soon. What is known is that Ihor Kononenko, one of Petro Poroshenko’s closest allies, initially opposed the 20/20 program and insisted that private companies had to increase gas extraction, meaning the companies possibly related to him. The role of state companies was to fill in the state budget, he claimed. Interestingly, Petro Poroshenko Bloc had a strong presence in the Poltava Oblast Council for five years, while its representatives were actively justifying the non-authorization of extraction by UkrGazVydobuvannia. 

The need for imported gas equals the gap between consumption and domestic production. Therefore, the non-implementation of plans to shrink gas consumption was another of the government’s failures. Quite on the contrary, it grew from 31.9 to 32.3bn cu m in 2018. The key consumers were households accounting for 17bn cu m, while industrial consumers got 9.3bn cu m. 18.9bn cu m was used by households in 2015. This shows that a mere 10%-decrease over all these years. It is the household sector that still has the most potential for further decrease, even after the serious increase of utility rates that was supposed to incentivize gas saving. Industrial consumption shrank from 11.2 to 9bn cu m over the same period. 

The reason is the lack of real investment into energy efficiency. As gas price rose, the government offset this with a wasteful system of subsidies that supported further consumption, leading to the negative consequences. Ukraine spent billions of dollars for subsidies over the past years. Just under US $300mn was channeled to the decrease of gas consumption by households. Meanwhile, the industrial sector is slowly exhausting its reserve for consumption decrease. Therefore, the only way to save is to decrease the consumption of gas by households. This can amount to 6-7bn cu m on the nationwide scale. These savings can be accomplished in the peak winter periods when the price of gas and the rates of consumption are the highest on the European market, making the imports more difficult and pricey for Ukraine. Other categories of consumers, especially the industrial sector, uses gas evenly throughout the year. 

Ukraine lacks over 11bn cu m of gas annually with the current consumption rates, which is far higher than what one could have expected five years ago. The pace of consumption decrease and domestic extraction increase then inspired expectation of cutting the amount of imported gas to 5-6bn cu m by 2020. Importantly in this context, Ukraine failed to use other opportunities to improve its position vis a vis Gazprom in advance of a gas conflict with it. Ukraine failed to implement plans to build a pipeline to transport extra gas from Poland to Ukraine. It does not have any serious initiatives for using the Trans-Balkan pipeline (which used to transport gas to Turkey through Ukraine) to deliver gas for Ukraine. Turkey could potentially have serious excess gas from different sources and sell some of it to Ukraine. Instead, Ukraine is almost fully dependent on gas supply from Slovakia and Hungary (the capacity has recently expanded to 0.6bn cu m per month). But both directions are uncertain: if transit through Ukraine’s system stops, these countries will have a problem meeting their own demand. 

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Counter the The Ukrainian Week’s proposals from a year or so ago, the government has failed to use the potential of the underground storage facilities. With the capacity of 31bn cu m, they only held 20bn cu m in the past winter heating season even though Naftogaz managers realized how serious Russia’s blockade was. Given the time lost, there is no technical capacity to pump more gas there. According to Naftogaz, the facilities held a mere 11.46bn cu m as of June 1, even after a dynamic growth of 1.97bn cu m in May. But even this pace will hardly allow Ukraine to accumulate 20bn cu m in its storage facilities by September. Time and opportunities were still wasted this spring. When the heating season ended on April 4, Ukraine’s storage facilities still held 8.75bn cu m of gas, adding just 0.7bn cu m (or 1bn cu m less than possible) in April. 

Stumbling blocks of direct supply

Media controlled by Viktor Medvedchuk and the top speakers of his party have lately been actively promoting a trap for Ukrainians and the new team in power, seducing them with direct supply of Russian gas at 25% less than what Ukraine pays for reverse supply from the EU. This is further aggravation of Ukraine’s dependence on monopoly supply from Russia, and free cheese in a mouse trap. What can come with the 25% discount is Ukraine’s recognition and payment of the debt for gas supply from Russia to the occupied parts of the Donbas in 2015-2019. Gazprom was officially supplying it through the Prokhorivka and Platovo gas meters based on its own interpretation of the contract with Naftogaz and billing Ukraine for it. The sums are huge.  

According to Gazprom’s statements, it supplied 1.7bn cu m to Ukraine (to the occupied parts of the Donbas after Naftogaz stopped buying gas from Gazprom) in 2015 (Naftogaz stopped supplying gas to that territory or recognize supplies from Russia in February); 2.39bn cu m in 2016; 2.43bn cu m in 2017; 2.74bn cu m in 2018, and 1.2bn cu m in Q1 of 2019. Therefore, Gazprom supplied almost 10.5bn cu m to the occupied parts of the Donbas by the early April 2019. This is almost equal to the amount Ukraine has been importing in a year lately. Gazprom billed Naftogaz at US $1.3bn by December 2017 for the gas supplied to the territory Kyiv does not control. Obviously, the payment for gas supplies to the occupied parts of the Donbas would double the price of gas for Ukraine purchased under direct contracts. So the 25% discount promised by Russia is just a trap. 

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