Gas or No Gas?

29 June 2014, 21:08

The Ukrainian-Russian gas story is about to culminate. On June 16, Gazprom switched Ukraine’s Naftohaz to a prepaid basis and stopped supplying natural gas to Ukraine, while maintaining its supply volumes to Europe. This happened amidst mutual lawsuits which both companies filed to the Stockholm Court of International Arbitration. The third Ukraine-Russia gas war has entered an active phase. It is not clear what the outcome will be, but it is evident even now that Ukraine stands to gain more than it loses if it succeeds in taking advantage of Russia’s strategically weak position.

This turn was preceded by a long period of preparations – nine rounds of trilateral consultations (Ukraine, Russia and the EU) and several bilateral meetings. The key demands that have been made public by the participants are quite simple. Russia demands that Ukraine pay what it owes for gas consumed. In response, Kyiv wants Moscow to reduce the price of gas down to the market level and fix it in a new contract. However, the negotiations themselves and gas-related events that seemed to take place concurrently show that it is not so much about the price and debts but about establishing new geopolitical realities in the relationships between Gazprom, Naftohaz and Europe.

RELATED ARTICLE: Gazprom’s Nightmare

The first round of trilateral consultations involving Russian and Ukrainian energy ministers and European Commissioner for Energy Günther Oettinger was held on 2 May 2014.The very fact that they were held proved two important points. First, by putting their man behind the negotiation table with a representative of the new Ukrainian government, the Russians de facto recognized its legitimacy and showed that in business matters, especially gas issues, Russia’s political position on Ukraine would recede into the background and become fairly flexible. Second, the presence of the third party, the EU, safeguarded Ukrainian delegates against attempts at bribery which the Kremlin has always tried to use in bilateral talks. It was a sign that from now on Moscow will have to deal with both Kyiv and Brussels in solving many issues between Ukraine and Russia. The Kremlin will have an increasingly hard time outplaying Ukraine, because Kyiv’s previously narrow arsenal of official tools with which to sway Russia stands to be greatly expanded with European leverage. Russia is not thrilled by the prospect but has to accept it as a given.

The Kremlin started the negotiations in its favourite style – using the language of ultimatums and mounting psychological pressure. Initially, its position was that until Kyiv paid off its debts, there could be no talks. Moreover, Gazprom threatened to put Naftohaz on a prepaid basis as soon as on June 2. However, the Russians sat down to negotiate and then moved the debt payment deadline several times, eventually settling on June 26. Moreover, on June 11, Putin, speaking out of character, publicly acknowledged that the Russians were forced to seek a compromise at the trilateral consultations to keep Ukraine as a consumer of Russian gas. So what made Moscow weaken its position so much?

Ukraine itself is the primary suspect. Naftohaz transferred USD 786mn to Gazprom for gas purchased in January and March at USD 268.5 per 1,000 cu m. On the same day, Ukraine was ready to take Russia to court in Stockholm. Whether it was because of the payment or Naftohaz’s readiness to sue, but Gazprom started looking for a compromise at the June 2 negotiations, according to Ukraine’s Energy Minister Yuriy Prodan. The mass media even reported that the parties were revising the price of gas imported in April and May and Russia was ready to give Ukraine a discount not only through a lower export duty but also through commercial negotiations and possibly a new agreement.

RELATED ARTICLE: Ukraine Must Change Its Position In Gas Talks

One week later, on June 9, Gazprom threw it all out of the window and began insisting, again, that Ukraine immediately pay its debt and that the price had to be USD 385 per 1,000 cu m with a USD 100 customs discount.

The EU’s representatives may have played a key part in the negotiations. As long as the Europeans kept threatening Russia, the Kremlin took part in the consultations and softened its stance. On June 1, Oettinger said that the South Stream project would not move ahead until Russia changed its course on the political crisis in Ukraine. This was the likely reason why Gazprom was very willing to make concessions for Ukraine the next day as it hoped to exchange these for guarantees that the South Stream would be implemented. However, when the EU moved on to take real action, Moscow adopted a more radical position. On June 2, the European Commission called on Bulgaria to suspend the construction of the pipeline, because the project did not agree with the European legislation. On June 3-4, a number of European officials, including President of the European Commission José Manuel Barroso, spoke in favour of stopping the pipeline construction project. Clearly, at this juncture the EU had to put some pressure on Bulgaria, which has always been loyal to Russia despite having EU membership. The USA did not stand aside, either – after a meeting with senators McCain and Murphy on June 8, the head of the Bulgarian government ordered to suspend all work on the project. However, the Bulgarian minister of energy said the next day that Bulgaria was not abandoning this strategically important project. On June 24, Gazprom and Austrian OMV signed a deal to construct the Austrian section of South Stream. On July 2, after summit with the Serbian leader Aleksandar Vucic a day earlier (South Stream would run through Serbia as well, if implemented), Hungarian Prime Minister Viktor Orban said that Hungary is committed to the South Stream project.

Another motive that could have forced the Russians to cooperate was the need to win time. On April 1, Ukraine had a mere 7.2bn cu m of gas in its underground storage facilities, too little to ensure gas supplies to the European consumers in the autumn and winter. In that case, Gazprom would be in breach of contract. A similar situation arose last year when Gazprom for a long time tried to persuade Naftohaz to fill its storage facilities with gas but eventually used the services of tycoon Dmytro Firtash. The necessary amount was pumped under the ground at a discount price and for Russian money. This year, Firtash is out of the game, so Gazprom decided to wait until Naftohaz pumped enough gas into its storage facilities (even without payment) before giving any ultimatums. As a result, by mid-June some 14bn cu m, nearly twice as much as by the end of May, were stored. Europe prefers to have 18-20bn cu m to secure uninterrupted supply, but this much is enough for Gazprom. Now, it can raise hell and issue ultimatums, all the more so if it is not going to gain anything by granting concessions to Ukraine and bargaining with the EU.

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No matter how the Kremlin manoeuvres as it tries to protect its “lawful interests”, time is working against it. As it bargains for trifles and avoids local concessions to keep strategic positions, Gazprom only loses in the long-term perspective. No-one mentions Russia’s possible involvement in modernizing Ukraine’s gas transportation system anymore. Instead, the European Bank for Reconstruction and Development and the European Investment Bank are working on this project, primarily to expand the ability for reverse supply and later reconstruction of the pipelines on a larger scale. Europe has a vested interest in burying South Stream, because the pipeline upgrade will then be repaid.

Once Naftohaz is divided into separate companies for extracting, transporting, storing and delivering gas (the process has already started), Ukraine will join the EU common energy market. This will bring large European energy companies to Ukraine. They are already offering to sell gas at USD 300-320 per 1,000 cu m. Reverse supply from Slovakia will need to be enabled for that, but there is still plenty of time. Ukraine can do without Russian gas at least until October to December. Thus, it will finally gain energy independence. It turns out that the only thing that stood in its way was a state-comes-first position that was never adopted by the Ukrainian government before.

Russia is gradually losing civilized leverage with Ukraine. It is now left with aggression only: emotional aggression (untimely gas cut-offs, unjustified threats to the EU and the hysterias of officials) as an expression of its helplessness and military aggression (annexation of the Crimea, support for separatists in Eastern Ukraine and its own military actions) as the last chance to destroy the state of Ukraine which is slowly gaining momentum on its way to the civilized world.

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