By Hook or by Crook

1 November 2011, 15:38

Reformatting gas cooperation with Russia continues. So far we know that Viktor Yanukovych met Vladimir Putin and Dmitry Medvedev in Zavidovo and they agreed on … something. The agreement was reached behind the scenes and is far from completely transparent. Meanwhile, the announced deadline – by November – suggests that we should expect new, perhaps even less transparent deals within a month. On the one hand, Moscow is trying to exert more pressure on Yanukovych to talk him into integrating into the Customs Union and the Common Economic Space. One of the arguments may be that the Party of Regions will lose the support of its electorate if high gas prices persist. On the other hand, it appears a plan B is being promoted, namely imposing a package of non-transparent agreements on Ukraine that further Gazprom’s plans regarding Naftogaz’s future.


Gazprom gave its “preliminary consent” to cut the gas price for state organizations and the population to USD 120 for 1,000 cubic meters. It looks like blackmail based on the principle: Either you are friends with us or your electorate is not friends with you. Polls carried out by the Rating group confirm as much: if gas prices drop, 51% of Ukrainians may feel better toward the Yanukovych administration. But if they rise, nearly 48% will feel worse. Thus, the Russians may demand virtually anything from Yanukovych & Co. in exchange for a lower gas price, excepting, perhaps, direct loss of sovereignty – an issue posed by membership in the Customs Union. The longer gas prices soar, the more Yanukovych will feel the pressure.

Meanwhile, Gazprom will not lose much by discounting its gas price for the Ukrainian population. How much gas falls into this category will probably be calculated as the difference between Ukraine’s own production and the consumption volume of the population and state organizations. The figure will come out at 6-8 billion cubic meters per annum. Cutting the price of this gas from USD 300 to USD 120 means losing a total of USD 2 billion next year.


Compensation to Gazprom for slashing this gas price will most likely take the form of Ukraine’s gas transportation system (GTS). Moscow seems to be intent on having Yanukovych take into consideration its interests in restructuring Naftogaz. If Kyiv does not take preventive measures, this process may help Gazprom take over Naftogaz indirectly if not directly. A case in point is the situation with Serbia's Naftagaz which was reformed and then purchased by Gazprom’s subsidiaries. Most importantly, this approach will certainly not anger the public as much as any other scheme. The EU is also aware of the risks. Riccardo Puliti, Managing Director for Energy, EBRD, recently said that privatizing Naftogaz is an extremely important element of reforms, but it should take place at the final stage of reforms rather than replace them.

One scenario that seriously troubles Gazprom is that the enterprise that owns Ukraine’s GTS, i.e., Ukratransgaz, may be converted into a joint-stock company and its shares may be sold on international stock exchanges. In April 2011, a number of mass media reported, citing anonymous sources, that the Russian gas monopolist gave Naftogaz with an ultimatum: Ukraine would receive a gas price discount only if Naftogaz refused to float shares through IPO. Gazprom feared that Ukraine would contribute its GTS to the joint venture and would put the rest on the stock market. Jointly managing property is an altogether different thing than managing shares of stock and dealing with hundreds of European stockholders as partners.

It appears Putin wants to achieve this goal by setting up a trilateral consortium to manage Ukraine’s GTS (via Ukrtransgaz or a separate enterprise). This initiative was “agreed upon in principle” in Zavidovo. At first glance, it has a nice formula – “with the involvement of European companies.” Unofficial sources say that Ukraine and Russia will each have a 40% stake in the joint venture, while European gas companies will receive the remaining 20%. In reality, this may turn out to be plain fiction, because the European partners most interested in this business are closely linked to Gazprom. Thus, their alliance in this consortium will certainly outweigh Ukraine. This is not to mention losses to Ukraine’s national budget, which will receive only 40% of gas transit fees at best.


How much industrial consumers in Ukraine will have to pay for Russian gas is still an open question, because Putin said he did not understand why “certain individuals in Ukraine should reap excess profits at the expense of Russia.” He meant, no doubt, oligarchs controlling chemical and metallurgical plants whom Moscow may blame for preferring sales markets (WTO and a free trade zone with the EU) over energy supply sources (the Customs Union and the Common Economic Space with Russia). So Russia may start forcing them to expand their cooperation with Gazprom.

More than two-thirds of Naftogaz’s overall revenue come from gas sales on the domestic market. Thus, control over this market is even more important to Gazprom than the GTS. Moreover, it is Gazprom’s strategy to penetrate retail domestic markets in consumer countries: according to expert estimates, the Russian gas monopolist has doubled its share on the EU’s retail market from 8% to 17% in the past three years.

Gazprom may receive help in carrying out its plan to monopolize Ukraine’s domestic gas market from an unlikely source. In addition to the fact that there is no alternative source of gas, Ukraine passed a law in April 2011 to meet its commitments before the European Energy Community. Under this law, Naftogaz lost its monopoly on customs clearance of gas. As is always the case with piecemeal and selective implementation of reforms, this step may prove to be counterproductive.

The only barrier keeping Gazprom from monopolizing Ukraine’s domestic gas market is the 2009 accords which clearly set the Ukrainian quota for Gazpromzbut. However, Moscow is no longer reluctant to admit that if agreements are cancelled or revised in some way or another, the new ones will not include a provision for Naftogaz’s monopoly to purchase Russian gas. Thus, gas will be freely supplied to Gazpromzbut and Ukrgazenergo (owned by Gazprom and Dmytro Firtash) which already have licenses to sell a total of 21 billion cubic meters of gas a year, i.e., almost as much as Ukraine’s entire industry consumes.

By allowing Gazprom to penetrate its domestic market, Ukraine will only cement its dependence on Russian gas. The experience of Naftogaz has shown that even the national monopolist has had a hard time diversifying supply. Individual companies and consumers will be even less equipped to do so. Giving a monopoly on gas supplies to specific enterprises opens the way to influencing large businesses and eventually taking control over them. Ukrgazenergo already has experience putting pressure on its competitors this way.


This scheme may be realized only under pressure from sources that have vested interests in the deal and enough sway with the Yanukovych administration to force it into decisions that clearly go against the interests of the state, as was the case with writing off the debts of regional gas companies and returning gas to RosUkrEnergo.

In early September, the Russian mass media reported that Gazprombank opened a credit line worth over USD 1 billion to Firtash for purchasing chemical enterprises. As a result, his companies bought Severedonetske Azot Association, Azot, Cherkasy-Azot and Stirol in Horlivka. Since April 2011, chemical plants controlled by Group DF have been importing Central Asian gas via Gazprom’s gas pipelines at much lower prices than what Naftogaz is paying. The supply volumes are fairly high – up to 0.5 billion cubic meters per month. The question is what Firtash will offer in exchange for this discount?

The above is relevant in analyzing the case of Ukrgazenergo, a state company that is now close to being taken out of the state’s control (The Ukrainian Week, Is. 41, 2011). The company is now an ideal tool for accumulating necessary financial resources to purchase shares of enterprises established on the basis of Naftogaz. The decision to remove Naftogaz from the structure of Ukrgazenergo saved the latter around UAH 2 billion in dividends for 2006-2007. Since then the gas prices and thus Ukrgazenergo’s profitability have increased several times.

From now on Ukrgazenergo will be an ideal symbiosis of Ukrainian oligarchs’ vested interests and Putin’s “energy empire.” Therefore, there is no reason to rejoice at the triumphant calls about the coming “end of gas misunderstandings” and “new, brotherly” agreements.


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