Making sense of a gaseous situation

Note: A version of this article is posted at www.oilandgaseurasia.com.

Tymoshenko explaining her position on Ukraine's gas supply issue - From unian.netFollowing through on its threat, Gazprom today reduced supplies of natural gas to Ukraine by 25% due to unpaid debts and the failure of both sides to reach an agreement on the future of the gas scheme. The news stories covering the situation are rife with inconsistent numbers, timelines and explanations. Here is my own labored attempt at explaining how Ukraine and Gazprom have arrived at this point.

The main problem is that the agreement reached between Yuri Boyko and Alexei Miller in early December 2007 was never fully agreed upon and implemented by all parties involved. (The agreement was also incomplete, failing to address and formalize terms that relied on mutual cooperation in the past.) The key reason for this was the transition in Ukraine’s government following the September 30th parliamentary elections and the ensuing coalition deal that (eventually) propelled Yulia Tymoshenko to Prime Minister and replaced the Yanukovich-led government under which Boyko served.

Flowchart outlining Ukraine's gas supply scheme - From vedomosti.ru The transition period–which resulted in Yuri Prodan being appointed as new Fuel and Energy Minister and Oleg Dubina to the head of Naftogaz–also apparently disrupted the in-place structures for payment between the government, Naftogaz, and Ukrgazenergo (UGE). Disruptions to the money flow at this level traveled up the line to RosUkrEnergo (RUE) and on to Gazprom (see the excellent structural flowchart by Vedomosti for more information on the connections between these firms). Tymoshenko’s long-running pledge to clean up the gas scheme fed the instability and contributed to uncertainty by the involved parties towards the recently-struck gas deal.

As a result, Gazprom was unwilling to put up with debts and promises of repayment that had been typical in the scheme up to this point. It was also in the process of signing deals for a new bypass pipeline, South Stream, and was interested in painting Ukraine as an unreliable partner.

Ukraine’s President Viktor Yushchenko, uncomfortable with changing the status-quo and not eager to pave the way for a Tymoshenko “victory” in the flashpoint gas issue, reached a hand-shake agreement with his Russian counterpart Vladimir Putin aimed at defusing the situation by creating a compromise. Except for expelling private Ukrainian business interests, the structure of the scheme would essentially remain the same–as would the price charged to Ukraine. Tymoshenko originally embraced the new deal, but then realized–along with many other critics–that it resembled a redux of the January 4th, 2006 agreement that inserted RosUkrEnergo in the first place. Indeed, the scheme proposed by the presidents would increase Gazprom’s presence within Ukraine’s domestic market and not significantly improve Naftogaz’s own financial footing.

Tymoshenko dragged her feet on agreeing to the presidential deal while looking for ammunition to rework the terms in Ukraine’s favor. Gazprom sensed this delaying, and clamored for immediate debt-repayment. It further increased the sense of urgency by emphasizing that current gas supplies to Ukraine are being delivered without the presence of a contract. This is only partly true, as Central Asian gas is being supplied according to the terms of the deal reached in December of 2007; there apparently is no structure in place, however, to regulate excess purchases of Russian gas. (After Boyko and Miller reached their agreement, I noted that it only clarified the terms for Central Asian supplies and gave no figures for Russian gas. This appears to be an issue now.)

That is the surface overview. Here are some underlying issues feeding the situation:

  • An earlier conflict between Ukraine and Gazprom over unpaid debts was settled in October 2007 by returning 12 billion cubic meters (bcm) of gas in Ukraine’s storage facilities to Gazprom’s control after RUE and UGE were slow in coming up with funds (partly due to delays in repayment by Naftogaz) to pay for it. Gazprom earmarked 4 bcm for re-export to Europe while saving 8 bcm for sale within Ukraine. Gazprom considers that gas to be “Russian” now and has been charging Ukraine the $314 per thousand cubic meters (mcm) price (as opposed to $179.50 for Central Asian gas) to dip into those reserves this winter.
  • The inflexibility of production capabilities within Central Asian countries means that shortfalls of supply to Ukraine during the winter months are normal and are compensated by Russian gas. Ukraine received about 3 bcm of extra Russian supplies over the first 3 months of 2007, but this didn’t create the stir that it is now. As noted by LEvko, Yuri Boyko explains that this excess was typically repaid “in-kind” later in the year, with Ukraine exchanging control over corresponding volumes of Central Asian gas to Gazprom from regular deliveries when Ukrainian demand is lower. Because this provision was not included into the official contracts (which aren’t signed / being followed anyway), that isn’t the case this year. Assuming this issue gets settled, this would presumably mean that Ukraine will have excess volumes of gas later in the year which it could export west for profit to compensate for the current financial crunch.

These two factors have been artificially inflated to contribute to the antagonistic situation between Gazprom and Ukraine which has led to this current dispute. Adding in the political factors–Tymoshenko looking to make an impression during her second PM stint with both her and Yushchenko eying the presidency, and the election of Gazprom chairman Dimitry Medvedev as Putin’s replacement in Russia–further complicates the economic rationale. Geopolitical factors–pipelines, NATO, and spheres of influence–add yet another layer to the overall issue.

5 responses to “Making sense of a gaseous situation

  1. You have done an excellent job!

    Europe is going to decide whether it will put its money where its mouths are.

    On the one hand, Europe pushes for democracy and transparency of government and business transactions. It also resists any sort of geopolitical bullying by Russia.

    The situation with Gazprom is clearly a crooked, deliberately muddled mess to hide all of the sticky fingers that siphon off money in these gas transations, both in Russia and Ukraine, for the benefit of only a handful of individuals. On the Ukrainian side, those include Firtash (who has given plane rides to President Yushchenko’s wife) and Boyko, and quite possibly Semion Mogilevych, who was up until recently living freely in Moscow, and is wanted by the FBI for massive fraud schemes.

    The system is set up deliberately to hide graft and corruption – and ownership.

    On the other, there is a question as to whether Europe wants to take a “practical” approach to obtaining its gas.

    If Europe wants to take a “practical approach,” it won’t be long before Russia makes severe inroads into European autonomy, independence and democracy.

    Just as they are now trying to do in Ukraine.

  2. Thanks for the comments. I was glad to see Jerome a Paris quoted in the NYTimes article — I’ve read his articles on the issue and they give a very good insider view. Much more concentrated on the economics–who’s getting money from where–which is what ends up being the main driver of these types of things.

    The contracts Gazprom signs with European consumers are lengthy, air-tight documents with input from teams of lawyers. Yet for Ukraine, it’s these two-page contracts, or deals between leaders that are hashed out by the insiders. More formal contracts, with measures for dispute arbitration and penalties, could go a long way to normalizing Gazprom-Ukraine gas relations and preventing this type of boondoggle. Of course, that would mean cutting out (some of) the graft, which isn’t popular with some people…

  3. Pingback: Kremlin, Inc » Gas supplies to Ukraine drop further, allegedly affecting European deliveries

  4. Pingback: Kremlin, Inc » Gazprom and Naftogaz sign gas supply deal

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