A Pipe of Discord

22 February 2013, 10:42

The Ukrainian government’s declarations regarding the “end of Gazprom’s domination in Ukraine” give the impression of unsubstantiated bravado. While the neighbouring Poland, which is no less dependent on Russian gas than Ukraine is, has expressed its intent to invest EUR 1bn in the construction of branch lines from the LNG-terminal on the Baltic coast, which will be put into operation as early as next year, the Ukrainian government gives ever more grounds to suppose that it is deliberately delaying already started projects for the diversification of gas supplies. The most likely scenario appears to be an agreement to create a joint venture (JV) with Gazprom to manage the Ukrainian gas transportation system (GTS) in exchange for the possibility of transporting theoretically cheap gas from Turkmenistan or other Central Asian countries via the Russian pipeline. This is proven by the campaign from the lobbyists of this decision in the Ukrainian mass media. Even Russian opposition member Boris Nemtsov came to Ukraine to convince Ukrainians that the GTS must be given to Russia, otherwise it will die.

The Russian party has often sent signals that Ukraine has to take some fundamental concessions in exchange for a reduction in the price of gas. Firstly, Ukraine should reject its obligations under the Energy Cooperation with the EU regarding the Third Energy Package. Secondly, it should transfer the management of the Ukrainian GTS (this should occur without the EU involved given the latest statements of the Russian Ambassador, Mikhail Zurabov) to Gazprom. Thirdly, it should drop the idea of importing gas from alternative sources, since this reduces the volumes of Russian fuel sold in Ukraine.

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In the last month, highly placed Ukrainian officials, from President Yanukovych to Eduard Stavytsky, the Minister of Energy, have also sent out signals – one way or another, Kyiv is ready to fulfil all three demands. Viktor Yanukovych has criticized the European Energy Community for its lack of support in the conflict with Gazprom. Europe immediately responded to this by saying that no one had even applied for assistance. Moreover, in a letter to Yanukovych, Janez Kopac, Director of the Energy Community Secretariat, complained that to this day, Ukraine has not invited it to participate in negotiations with Gazprom. The impression is that it was not invited intentionally, and is now being blamed, so there are grounds for Ukraine to refuse to meet the obligations undertaken when it was accepted into the Community. Mykola Azarov has found a potential excuse to slow down the construction of the Southern LNG-terminal, saying that “Turkey is not readily considering the prospects of tankers with liquefied petroleum gas passing through its straits”. However, based on the reaction of Vladyslav Kaskiv, the Head of the State Agency for Investments and Management of National Projects and most importantly, the Ukrainian ambassador in Turkey, it became clear that the problem of the reluctance to come to an agreement lies with the Ukrainian government, rather than Ankara. The Energy Minister, Eduard Stavytsky, virtually confirmed the readiness to reject the purchase of gas elsewhere, if only Russia offers Ukraine a favourable price, saying “negotiations are underway regarding a price reduction. The volume will depend on this, because we are conducting negotiations regarding diversification at the same time”.


Meanwhile, information has leaked to the media that agreements can be reached regarding the establishment of a Russian-Ukrainian JV to run the Ukrainian GTS in exchange for a reduced price of Russian gas or permission to transport gas from Central Asia. Yanukovych’s visit to Turkmenistan at this time, where a document on cooperation was signed, could be a certain confirmation that this subject is being addressed in negotiations with Russia. The Memorandum signed between Naftogaz and Turkmengaz in Ashkhabad provides for a renewal of gas supplies to Ukraine and European countries.

Azarov has already authorized officials to draft documents for the implementation of Yanukovych’s agreements with Turkmenistan. There is no point in doing this if there are no agreements with Russia. This is so obvious, that such actions cannot be viewed as a means to put pressure on Gazprom, as could have been the case with the LNG-terminal. The only alternative corridor for Turkmen gas could only be the route along the Caspian seabed, via Azerbaijan, Georgia and then via the Black Sea or via pipeline on its seabed to Ukraine. But since the current Ukrainian government cannot even complete a significantly smaller project for the construction of a gas terminal, such a global project is unlikely.

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Thus, the issue is the readiness to come to an agreement with Russia on a short-lived “exchange of transit capacities”, which, however is extremely unfair: Ukraine has to literally give up its GTS to a JV with Gazprom as a stakeholder, but without the participation of the EU, while Russia will give Ukraine the right to transport fuel from Central Asia via its pipelines. In this case, Ukraine will most likely be represented by a kind of reincarnation of RosUkrEnergo, but it’s very likely that Dmytro Firtash, without whom such schemes were impossible until recently, will have a significantly lower share, if any at all. The key element will be the interest of the Family.

This will likely be presented to the Ukrainian public as a “brilliant mutually-beneficial cooperation scheme”, with which Yanukovych will lead Ukraine out of the slavery of the 2009 gas agreements and rescue Ukraine from multi-million penalties for gas shortages. Behind this hide the “minor factors”, such as the corrupt interests of highly placed officials in each cubic metre of gas, the intensification and cementing of Ukraine’s gas dependence on Gazprom, the refusal to liberalize and transition to European competition standards on the energy market, which will also lead to complications in Ukraine’s integration into the EU as a whole, and finally, the continued energy ineffectiveness of the Ukrainian economy. These “minor factors” are the ones that will shape Ukraine’s prospects as a sovereign state, as well as the actual upgrade of its economy. This is likely to take place even though the realistic benefits from a reduction in the price of imported Russian gas in exchange for the GTS will be extremely short-lived and very insignificant given the current developments on the European and world markets – a global reduction in gas prices in view of the shale gas revolution.


Russia’s occasional bullying over its rejection of the Ukrainian GTS is a bluff, while the pressure from Ukraine’s intent to reduce the amount of gas purchased from Russia, in view of Gazprom’s share on the European market falling down to almost that of Norway, is a real threat to the Russian monopolist. All Ukraine needs here is to be consistent in bringing this to a logical conclusion. The transit of Russian gas via the Ukrainian GTS in 2012 fell by 19.1% to 84.2bn m3, and Ukraine’s gas purchase – by 24.5% to 32.9bn m3, while next year, it could fall by at least another 5-6bn m3. However, even a reduction in the transit volume via the Ukrainian pipeline in 2012 is, first and foremost, related to significant reductions in the volume of Russian supplies to the EU (by 12bn m3, or almost 10%), not switching to bypassing routes.

Currently, the demand for gas in Northern Germany, where the North Stream is laid, is insufficient to use even half of the pipeline’s capacity, while the Ukrainian GTS is generally used to transit gas to Southern and South Eastern Germany, as well as Southern Europe. Thus, Gazprom is counting on various transfers, such as from the GAZELLE gas pipeline in the Czech Republic, which connected the German OPAL gas pipeline (a branch line of North Stream) and the MEGAL pipeline, via which Russian gas is transported via Ukraine and Austria to Southern Germany and France. This is an original surrogate substitute for South Stream, since the latter is too expensive a luxury. It was recently made known that the cost of the project, together with inlet pipelines along the territory of Russia alone, is estimated at USD 37-38bn (according to estimates, the expansion of the Russian GTS for additional volumes alone will cost at least USD 17bn). This is for the potential maximum flow capacity of all South Stream branch lines at 63 bn m3 which is half the available capacity of the Ukrainian GTS.

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However, even the full capacity of North and South Streams will not allow Russia to reject the Ukrainian GTS completely. The prime cost of the transit of Russian fuel to the EU will increase significantly as a result of the construction of the new and expensive gas pipelines. The prime cost of Russian gas supplies will be of ever greater significance, since the era of never-ending increases in gas prices as well as demand for it on the world market, is coming to an end. Even taking transportation costs into account, European consumers still pay less for Russian gas than Ukraine does, but continue to demand further price reductions. Recently, the French GDF Suez, the Austrian Econgas, as well as the German Wingas and Wintershall Erdgas Handelshaus (WIEH) sent Gazprom letters, demanding a revision of gas prices, with a view to reducing them as of 2013.


First of all, this is facilitated by the shale gas revolution, which led to the United States rejecting the import, and in the short term, a transfer to the export of LPG. This could shortly be followed by a methane hydrate revolution. Towards the end of this January, the Ministry of Economy, Trade and Industry of the largest importer of gas – Japan – announced the start of gas exploratory extraction from marine methane hydrates. Scholars insist that improved technology and today’s high fuel prices are capable of turning what was once an unprofitable matter, into an efficient one that will grow to the industrial level within 5 years. In the long-term, there will be sufficient methane hydrate reserves for Japan to stop importing fuel, and possibly start to export it to neighbouring countries in the Far East – the market Gazprom had intended to expand.

Secondly, the exports of traditional gas through both LNG-terminals from Africa or Qatar, and pipelines from Norway and, most importantly, from post-Soviet countries that were formerly subordinate to Russia, will increase. The fact that the Ukrainian leadership proves helpless in taking the opportunity does not prevent others from taking them, including some of the biggest consumers of Russian gas. Italy, the second largest importer of Russian gas in the EU, (17bn m3 versus Germany’s 34bn m3 in 2012), has signed an agreement with Greece and Albania to build the Trans Adriatic Pipeline (ТАР), which is designed to transport 10 bn m3 of Caspian gas (with a possible expansion to 20 bn m3). Currently there is talk about transporting fuel from Azerbaijani Shah Deniz-2, however, in the long-term it could transit fuel from other countries located around the Caspian Sea. Even 10bn m3 is more than half the current volume of Russian gas imported by Italy. One of the main shareholders of the consortium is Gazprom’s main competitor on the European market, the Norwegian Statoil holding 42.5% of shares. It is currently squeezing out Russian fuel by simply offering a more flexible pricing policy.

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Russia’s closest competitor on the European gas market, Norway, will have greater opportunities in the battle for consumers if the high prices for Russian gas and Gazprom’s uncompromising behaviour continue. According to Eurostat data, in 2012 alone, Norway expanded its presence on the European market by 16% (to 107.6bn m3, which is almost the same level as Russia’s).  In contrast, Gazprom supplied almost 145bn m3 to Europe, including Ukraine but not Turkey, last year, so, overall, it has lost the opportunity to sell at least 25bn m3 of gas on the expensive EU and Ukrainian markets in the last several years. As a result, the Russian monopolist is increasing the share of gas it sells on far less favourable domestic and Belarusian markets. As a result, the company’s performance is plummeting by 15% in 2012 alone.

In any case, all of Russia’s concessions to the Yanukovych regime will only be short-term. Russia is implementing a programme of the annual increase in domestic gas prices until they reach world level. According to earlier forecasts, it should have been completed by 2015-2016. Even if deadline is delayed, it will hardly change anything much. Therefore, even if a Russian-Ukrainian JV is set up to run the GTS, gas prices for Ukraine will not be lower than those for Russian consumers. So already within 2-4 years, any price concessions and reductions could be minimized, if not completely wiped out. As a result, the increase of prices for Ukraine will be completely opposite to the global trend of a steep fall in gas prices.

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