On October 2nd, just two days following Ukraine’s early parliamentary elections, Gazprom sent a message to its European partners warning of possible problems with future downstream gas flow due to Ukraine’s $1.3 billion debt accumulated for gas deliveries since January 1st, 2007. The Russian gas company said that the country may face a reduction in gas supplies if the issue is not resolved soon, an action that could potentially affect a large portion of Gazprom’s export clients since over three quarters of Russian gas sent to Europe flows through Ukraine’s pipelines. The last time Gazprom reduced supplies to Ukraine in response to a price dispute—January 1st, 2006—European customers became alarmed as they noticed a reduction in their own gas deliveries, due to Ukraine continuing to withdraw its normal volume of gas.
The recent announcement by Gazprom appears to be an attempt to improve on its communication surrounding potential disputes, an issue that has plagued Russia for years. Following a row over oil deliveries through Belarus this past winter, President Putin promised to German Chancellor Merkel that more direct communication surrounding pricing negotiations would be a key part of Russia’s pledge to contribute to European energy security. However, Ukrainian officials felt miffed that the warning over potential problems was given first to European customers (and the press), before a similar announcement was issued to relevant Ukrainian parties.
Ukrainian Prime Minister Viktor Yanukovich immediately dispatched the Fuel and Energy minister Yuri Boiko to Moscow to hold talks with Gazprom leadership. It was soon announced that the issue would be resolved (somehow) by November, reducing a bit of the sudden urgency the original announcement had created. However, the Ukrainian government is in the process of rearranging and the current officials have an unclear mandate, complicating the legitimacy (and efficacy) of the negotiations.
The expectation remains that the two major “orange” forces—Yulia Tymoshenko’s bloc and the pro-Yushchenko Our Ukraine—will attempt to team up, hopefully with better results than last time immediately following the Orange Revolution. Yushchenko was forced to dismiss Tymoshenko from the premiership last time due to conflicts over the direction of economic policies, as well as mutual accusations of corruption. However, the two forces pledged to team up before the election, with Yushchenko agreeing to back Tymoshenko for prime minister again. The conflict over gas supplies will likely be the coalition’s first major test, similar to the situation the government faced in the 2005-6 winter. That pricing dispute—which left Ukraine paying about 50% more for its gas, though still well below Western European prices—struck a blow to Yushchenko’s administration, and there is some speculation that this round of talks could in effect cut the legs out of the new government before it even has a chance to get going.
Indeed, the timing of the announcement seems a bit suspect, given its proximity to the Ukrainian elections. Gazprom has stressed that they deliberately waited until after the poll to make the announcement, recognizing the effect of gas problems (har-har) on the Ukrainian government. However, there is really no time when such an announcement would not affect the political situation of Ukraine. Yanukovich is often accused of closer relations to Moscow, and the gas conflict could be seen as a ploy to enable him to keep a measure of power—he may claim to have the best chance as striking a beneficial deal with Gazprom / the Kremlin, particularly when compared to the fiery Tymoshenko. The pending negotiations may even allow Boiko, the energy minister, to remain in his powerful post while the conflict remains unresolved—or longer, depending on how it plays out. Tymoshenko’s potential choice for Fuel and Energy Minister is not known (by me, at least), but it is doubtful she would keep the scandal-ridden Boiko, who is a member of Yanukovich’s Party of Regions, if she can help it. She has expressed anger over the debt, calling on a criminal investigation into how such a large figure could have been accumulated under Yanukovich’s watch.
Part of the issue to be resolved is in determining exactly who owes the $1.3 billion. As a result of the January 2006 negotiations, the importing of Russian and Central Asian gas to Ukraine is to be solely coordinated by one company, the Swiss-registered RosUkrEnergo (RUE). RUE is 50% owned by Gazprom, with the remaining 50% originally anonymously held by Ukrainian interests. It was later revealed that those interests were two businessman, principally one Dmytro Firtash. RUE later entered into a joint partnership with Naftogaz Ukraina, the Ukrainian national oil and gas company, creating a vehicle (UkrGasEnergo, UGE) for delivering the imported gas to customers within Ukraine. In general, this company would be in charge of supplying gas to Ukraine’s industrial customers, leaving Naftogaz to supply the much more problematic residential users.
So then, whose debt is it? RUE, which is in charge of the imports from Gazprom? UGE, which delivers much of that gas to customers throughout Ukraine? Or Naftogaz, with its own delivery responsibilities? Or the people of Ukraine collectively? In the past, the problems have come from the middlemen—they were generally collecting gas bills from the customers, but were often not passing them along to Gazprom. It was expected that Gazprom’s 50% involvement in RUE would help alleviate this problem, along with the exclusion of the historically reticent Naftogaz. That does not appear to be the case now, however. Instead, the problem likely stems from massive under charging of Ukrainian customers, often a social necessity (at least, at the moment). The government had agreed to keep end user prices depressed, despite the previous rise in import prices, agreeing to take on the difference itself while slowly readjusting domestic prices. However, the political climate has made passing on those price increases difficult, especially to the more vulnerable residential population. (Russia is facing a similar problem, but can rely on its gas exports to generate profit.)
The current debt negotiations also reopen the question of contractual gas prices for Ukraine. Dmitry Medvedev, Gazprom’s chairman, announced on Sunday that Ukraine’s price for gas would be “fair and market-based.” Determining that, however, is a bit difficult. Should Ukraine be charged as much as Germany? As Poland? As Britain? As Kazakhstan? Unlike oil, there is no global natural gas market, particularly for pipeline-delivered gas. There is much more of a mutual dependency between the buyer and seller—the destination of the pipeline cannot be simply changed, should a disagreement arise. This has led to the prevalence of long-term gas contracts, guaranteeing a minimum volume of delivery and a minimum amount to be paid for (whether it is used or not). The price to be paid for the volumes is typically renegotiated annually or biannually. Oil remains the de facto standard that gas prices are typically pegged against, and as global oil prices have risen lately, so too have the prices associated with typical gas contracts.
Complicating the matter is the involvement of Turkmen gas in the supply delivered to Ukraine. There is a long historical precedence for this relationship, and by relying on the cheaper Turkmen gas, Ukraine has been able to keep the price it pays down. Turkmenistan is in a bit of difficult situation—it must rely on Russia to help coordinate the export of its own gas, given the layout of the Soviet-era pipelines. Indeed, Ukraine is essentially Turkmenistan’s only export partner, besides Russia (and Kazakhstan), though Gazprom will sometimes re-export Turkmen gas that it ostensibly buys for domestic use. (Ukraine does the same thing with some of its gas imports.)
The winter has been Gazprom’s favorite negotiating period lately, with the threat of cold temperatures a reminder of the necessity of providing gas at a social level. The further coincidental timing with the election may or may not be an accident, but there is no doubt that the outcome of the negotiations will have a significant impact on the early health and success of the soon-to-be formed Ukrainian government.