Gas war reignites in a big way

A couple friends have mentioned my lack of blogging, and its absence is particularly notable now during the latest iteration of the Ukraine-Russia gas spat.

I’ve been working on the conflict at work (which has kept me busy, and away from this blog) and following it quite closely.  However, at this point I don’t feel I can put the time and effort into a post that the current situation would deserve.  Hopefully I’ll be able to do a “postmortem” roundup, though that of course has to wait until it’s actually more-or-less resolved.

I say more-or-less because there’s no way that any agreement reached in the next weeks (and it could stretch that long to get something relatively concrete) will solve the underlying issues, just as none of the past contracts since the breakup of the Soviet Union have.

Here’s the deal though.

Gazprom has announced that they will be buying Central Asian gas at essentially netback European prices, as opposed to the rock-bottom prices that they’ve gotten historically.  (Whether or not they actually are paying what they say they are is another matter though.)  Europe obviously pays European prices.  The only cogs in the system that don’t pay “European” prices then, are Ukraine and Russia (internally) itself.

Russia was apparently willing to continue “subsidizing” Ukraine by passing along a set price for the year of $250 per mcm, so long as Ukraine froze transit fees, ceded more of the internal industrial market to its local marketing arm Gazprom Sales Ukraine (GSU), and opened up some strategic infrastructure within the country to ownership by Gazprom. Late in 2009 would bring more negotiations for the price in 2010, before moving to a formula indexed off of gasoil and heavy fuel oil prices in 2011.

Ukraine balked, and Yushchenko ordered Dubina home from negotiations in Moscow right before the deadline.  The two sides made good on their posturing, and have ground the gas flow westward to a halt.

Putin has grown angry, suggesting Ukraine move to the “market” rate of about $450 / mcm immediately.  Yushchenko came back with his own $201 figure.  Based on the lag time in gathering the average oil product prices incorporated in Gazprom’s sales contracts, gas prices would be pretty much reaching their peak around now (corresponding to the all-time oil price highs in July and August 2008).

So if Ukraine were using a formula to determine their prices, they’d be stuck with a figure roughly corresponding to Putin’s threats.  But that price is adjusted quarterly, and because of the rapid fall in oil prices at the end of 2008, it is guaranteed to go down by about $50 by the time it’s recalculated in April 2009 — that is, if Ukraine moved fully into this “European”-style arrangement, which doesn’t appear to be likely.  If they did however, and if oil product prices stayed at about the same levels they are at now partway into this year, by 3Q2009 the gas price would drop nearly $100 and by 4Q2009 it would even be below the $250 / mcm originally offered.

Gas pricing is a tough job because it lacks the market drivers and signals of other commodity exchanges.  It’s particularly obtuse when two monopolies are the buyer and seller.  Add in the political back-story behind each country and their historical relationship, and you have a rather complicated situation.

P.S.  Check out the coverage by LEvko, Taras, and Adrian for more regular news updates.  The Oil Drum also has been posting about it, as has the local press (once they came back from their New Year’s breaks).

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