Gas issue escalating between Ukraine and Gazprom amid push for changes by Tymoshenko

Talks between Gazprom and Ukraine over the natural gas sphere are escalating - from unian.netA week before Ukraine’s Prime Minister Yulia Tymoshenko travels to Moscow to meet with her Russian counterpart, talks are being held between top energy officials in Ukraine and Gazprom over potential changes to their recently-agreed upon natural gas deal. Tymoshenko has already proposed reform in the domestic gas market and is now pursuing the removal of the middlemen that operate between Ukraine’s Naftogaz and Russia’s Gazprom.

While there appears to be some potential support for this move within Gazprom’s establishment, it would likely mean an increase in gas price for Ukraine from the $179.50 per thousand cubic meters (mcm) currently agreed upon to a figure at least $50 more expensive, and potentially up to around $315 per mcm (versus $130 in 2007). Ukraine has countered by suggesting raising the transit tariff Gazprom pays for piping around 115 billion cubic meters of gas per year westward through Ukrainian territory. Gazprom is currently charged $1.70 per thousand cubic meters per hundred kilometers while the proposed rate is $9.32 — over 5 times higher. (This price originated with a recent article in the respected Mirror Weekly based on input from experts. However, it is far above any tariff charged elsewhere; I sent an inquiry to the publication asking for clarification and greater background on its source, but am still awaiting a response.)

These drastic price differences — both for the cost of gas and for its transit — have sparked fears of a contentious round of negotiations between the two sides, hearkening back to the 2005-2006 pricing dispute that led to brief dips in gas pressure to Europe. Thankfully, this time around there exists a contract that ensures adequate deliveries, so a gas shutoff is much less likely to occur. (Also, both sides probably learned their lesson from the storm of negative reaction from Europe that ended up damaging both the supplier’s and transitor’s reputations.)

However, a gas shortage from Central Asian suppliers has forced RosUkrEnergo (RUE), the currently in-place trader that coordinates the import of gas to Ukraine, to rely on more expensive Russian gas to supplement Ukraine’s need. Russia is charging $314.70 per mcm for these supplies; with deliveries of 740 million cubic meters so far, that totals to $233 million, which is about $100 million more than expected based on the stated sale price for gas provided by RUE.

Konstantin Chuichenko, executive director of RUE and member of Gazprom’s board (and classmate of chairman Dimitry Medvedev at law school), stated that UkrGazEnergo (UGE), the 50/50 joint venture between RUE and Naftogaz that coordinates much of Ukraine’s internal gas market, owes RUE $830 million. It is unclear if the unexpected cost increase facing RUE got passed down to UGE and is included in that figure, or if that is debt from past operations alone. (Update: UGE says not to worry, it will pay off the debt — accumulated through stocking up on extra gas for next year’s heating season already — soon.) One would expect that RUE would be the company stuck with the overage, given that the $179.50 price charged by RUE to Ukraine is apparently the only figure enumerated in the contract — the costs of the supplies of gas from some Central Asian countries had not yet been nailed down when the agreement was reached. However, the contract has not been released to the public so it is unclear.

Also, RUE typically no longer buys Russian gas to supply Ukraine, instead relying solely on Central Asian (principally Turkmen) volumes. Last year, RUE only very rarely was forced to supplement supplies with Russian gas, which is key to the intermediary’s profit margin, given the large discrepancy between Russian and Central Asian gas prices. In 2007, Gazprom was charging RUE $230 for Russian gas, making it unreasonable for the trader to rely on it to supply Ukraine.

These negotiations come after Tymoshenko pushed for a shakeup in Ukraine’s internal gas market by severely limiting the role of UGE and hoping to eventually remove RUE completely. To help her in this politically difficult process, she recently nominated Vitaliy Gaiduk to be her vice premier for fuel and energy. Gaiduk is from Dnipopetrovsk and is one of the heads of the powerful Industrial Union of Donbas (IUD). Oleg Dubina, the newly-appointed head of Naftogaz, is also connected to IUD, and the two are allies. Along with Tymoshenko, the three of them have extensive experience in Ukraine’s energy market, particularly in the gas sphere.

Naftogaz is looking to reassert itself in the domestic gas market at the expense of UkrGazEnergo They appear to be drawing on that experience by re-emphasizing the quota structure that dominated the gas market for the mid- to late-1990s. A government commission allocates quotas to trading firms on the amount of gas they are allowed to sell to unregulated (i.e. private) customers. UkrGazEnergo, however, was given an exceedingly large quota when it entered the market two years ago, and has since dominated the sale of gas to the most lucrative consumers — the factories and chemical plants. State-owned Naftogaz, meanwhile, is left to provide gas to the regulated (that is, subsidized) communal heating and generating market. Due to problems in collecting payment and depressed margins, Naftogaz is faced with a difficult financial situation. (However, recently-surfaced financial results for the first 10 months of 2007 show Naftogaz with UAH 1.46 billion — about $29 million — in profits. The 2006 results have yet to be released, though, which precludes a complete financial analysis.)

However, Tymoshenko has cut the quota of UkrGazEnergo from 32 bcm to just over 5. The idea is to then force UGE to resell its gas to other firms (including Naftogaz) and open up the market. Tymoshenko herself flourished in a similar situation, as her gas trading company was awarded a lucrative quota allotment in the 90s. But the scheme was rife with corruption and led to a series of quarrels, before Naftogaz entered the scene and attempted to more closely regulate the market and the importation of gas. We’ll see if Tymoshenko’s experience will help her create a better situation this time around…

(P.S. LEvko has more coverage on Tymoshenko’s gas sphere moves.)

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