Category Archives: Pipelines

Top 4 energy issues Ukraine’s new president will face in 2010

New year celebrations at Kyiv's central square, the Maidan

New year celebrations at Kyiv's central square, the Maidan - from

Happy New Year!  Celebrating 2010 and my return to blogging, I present the top four energy sphere issues that Ukraine’s new president — likely to be determined on a February 7th runoff election — will face in the coming year.

  • At #4, modernizations across the board. Ukraine’s coal mines are notoriously unsafe, its gas transportation system is in need of investment, and its refining sector is facing massive technological deficits.  Modernizations at an industrial level can improve energy efficiency and boost the competitive positioning factories facing difficult times.  How the government incentivizes locally-based investments and how it finds the money and partnerships for large-scale modernizations (particularly for the gas pipeline system) will be key.
  • At #3, inflation and gryvna depreciation. While not specifically energy-related, the potential for continued inflation and further depreciation of the gryvna have a range of implications to Ukraine’s energy sphere.  In particular, the majority of Ukraine’s energy sources are imported and bought with dollars while they are sold domestically on a gryvna basis.  For institutions like Naftogaz that are based on relatively strict gryvna-based budgets, any increase in the exchange rate makes payment for gas imports that much more difficult. ¶ For consumers, this is most evident with the price of gasoline, given Ukraine’s high reliance on crude imports.  Oil is bought with dollars, largely refined locally (where companies must pay gryvna wages) and the products are sold in gryvna terms.  As the exchange rate weakens, the nominal price of gasoline increases for consumers, a trend that can be particularly vexing if they notice global oil prices not rising in a similar fashion.
  • At #2, oil supply issues to refineries. Ukraine’s refining capacity is woefully underutilized and hampered by problems in securing adequate crude supply.  Kremenchug no longer receives Russian crude after Privat seized it in late 2007.  Neither of the two Privat-owned western refineries get Russian crude either, and both are operating at very low utilization rates due both to the supply issue as well as low complexity hampering the quality of product output.  Lisichansk gets fairly stable crude deliveries from TNK-BP, but is still only at about 40% of its potential capacity.  Odessa was near full utilization until a dispute with Ukrtransnafta forced a disruption and a new pipeline supply scheme in October 2009. ¶ If crude supplies stabilize, particularly for the key refineries, then an important industrial segment will have a stronger operating environment to push the recovery, and will be better prepared to make the investments in order to transition to higher fuel specification (see above).  Also, on a macroeconomic basis, the country’s current account balance should strengthen as oil product imports decline.  It would likely also represent a step towards more genial energy cooperation with Russia, since that is the most likely source of crude for Ukraine.
  • At #1, recalculating gas tariffs. Ukraine’s government needs to fix Naftogaz’s finances so it no longer relies on cash injections from the central bank or IMF funds.  The only way for this to happen is to bring revenues more closely in line with costs.  While the NERC (the regulating body) has been willing to pass along increases to industrial consumers, sometimes even at unjustified levels, pushing them onto residential and “budget” users has been more difficult.  It’s been impossible to do politically, with Tymoshenko being unwilling to take on the damage to her popularity such increases would bring.  Meanwhile, the IMF is screaming down Naftogaz’s door, essentially demanding a more realistic tariff for the currently subsidized users. ¶ While technically under the purview of the Prime Minister, how the new President (and likely the new PM) handles this issue will be very important for bringing Ukraine out of perpetual “crisis” mode, particularly given the monthly account settling Naftogaz faces with Gazprom.  A few different tactics need to be pursued, including increased energy efficiency to lower demand (current demand drops are relatively temporary due to slowed economic activity), a push toward individual gas metering to better measure consumption, and a shift away from blanket subsidies to a system of income-based assistance.  No one wants babushka to freeze, but that doesn’t mean that the middle-class family living three doors down should get the same discount that she does.

Gazprom steps up gas rhetoric following Ukraine’s steps toward removing intermediaries

Note: Been trying to get this up for a while, but battling computer problems. I’ll be gone for a few days, so will post it relatively unfinished — please forgive typos / undeveloped thoughts.  Also, there’s an extensive article in the Zerkalo Nedely about the issue, including statements from Dubina saying that Naftogaz doesn’t have any gas in storage — presumably, he is suggesting that the gas that is there belongs instead to Ukrgazenergo, or even RUE.

Half of Kommersant’s front page on Friday was filled by the headline “Crime and Punishment” and a menacing photo of Gazprom president Alexei Miller looking down upon the reader — not a good sign for the Ukrainian government in the continuing “gas war.” Gazprom is now threatening to shut off supplies of Russian natural gas to Ukraine on Monday Feb. 11th — a day before President Yushchenko visits Moscow –should Naftogaz not settle a $1.5 billion bill.

There are a few things to unpack about this threat:

  • Gazprom would halt the flow of Russian gas to Ukraine, but allow Central Asian gas to continue into the country.
  • Gazprom spokesman Sergei Kuprianov originally said that Ukraine owes Russia $1.5 billion, but even RosUkrEnergo admitted that Ukraine’s Naftogaz has no direct dealings with the Russian gas giant. Instead, the debt is likely between Naftogaz and Ukrgazenergo, which then owes RosUkrEnergo, which owes Gazprom.
  • $500 million was allegedly piled up since January 1st, due largely to higher concentrations of significantly more expensive Russian gas in the mix supplied to Ukraine. $1 billion is left over from last year. About halfway through January, Ukraine was looking at an overage of about $100 million based on increased precentages of Russian gas. Extrapolating that out to today, however, doesn’t reach the $500 million figure suggested by Gazprom.
  • Gazprom cited the debt as the reason for the threatened shutoff, rather than any actions by the Ukrainian government about changing the gas scheme.
  • Ukrainian PM Yulia Tymoshenko assured the public and Europe that Ukraine held sufficient volumes of gas in storage to cover both domestic consumption and European demand via Ukraine’s transit system in the event of a shut-off.

Russian gas now accounts for roughly a quarter of the supplies coming into Ukraine, an above-average percentage allegedly due to lower volumes of Central Asian gas available because of a regional cold snap (Friday’s high temperature in Ashgabat: 7 C). Exactly how much of the gas “cocktail” (mixed by RosUkrEnergo) should be Russian, however, is a bit difficult to discern. One set of figures suggests 18%. However, this is based on the importation of 75 billion cubic meters (bcm) of gas, which would correspond to Ukraine’s entire consumption (not accounting for about 20 bcm in domestic production). Earlier reports put the total import figure at 62 bcm, while another source says 58 bcm. In either of these cases, likely only a few bcm would come from Russia. The pricing system agreed upon between Russian and Ukraine at the end of last year posits an average purchase price of $140 per thousand cubic meters (mcm) with a retail price at the Ukrainian border of $179.50. Given that Russia is charging $315 per mcm of gas, there is little way for RUE to make a profit relying very much on supplies from Gazprom.

However, it appears that’s what it has been doing, and it passed the price increases down the line to Ukrgazenergo. This would appear to be in violation of the contractual terms — RUE agreed to provide gas at the Russian-Ukrainian border for $179.50, accepting this to be a reasonable price based on predictions. If those predictions don’t pan out, then the trader should be left with the consequences.

RUE may be trying to compensate for the high prices by taking advantage of its re-export quotas and selling some gas to the European market (at about twice the Ukrainian price). According to Korrespondent, RUE has already used up nearly half of its re-export quota for the year:

From this volume [of 58 total bcm], 55 bcm of Central Asian gas should be supplied to consumers in Ukraine. Only after fulfilling the needs of Ukrainian consumers does RosUkrEnergo have the right to export the remaining 3 bcm of gas to the countries of Europe.

Today, RosUkrEnergo has already exported 1.494 bcm — that is, half of the yearly volumes earmarked for export.

Indeed, Ukraine has emphasized that it has not overstepped its own allotment, saying that Ukrainian consumers have bought 4.72 bcm of gas so far this year, below the 4.85 bcm of Central Asian gas that was planned according to the contract. Therefore, Ukraine argues, it should not be charged for “extra” Russian gas since the total volume is still within the “normal” bounds. Instead, it is the trader’s fault for failing to mix the gas in the contractual manner.

RUE appears to be attempting to re-export as much gas as possible, stooping to buying extra quantities of Russian gas, attempting to pass the price on to the Ukrainian side, while making profit off sales of cheaper gas to Europe. RUE may very well recognize that its days are finally numbered, and is undertaking these actions in order to make as much money as quickly as possible, without much regard to the future.

While Ukraine has been making noises of removing RUE and its subsidiary Ukrgasenergo from the gas scheme since Tymoshenko became PM, recent actions in the Ukrainian government appear to have hastened the removal process of the intermediaries.

Last week an all-day session of Ukraine’s National Security and Defense Council — President Yushchenko’s answer to PM Tymoshenko’s Cabinet of Ministers — discussed national energy company Naftogaz Ukrainy and the natural gas trade, including the use of intermediaries between Central Asian producers and Ukrainian consumers. Tymoshenko, who has long been calling for the removal of RosUkrEnergo, announced that the council had reached an agreement on the necessity of the gradual removal of these figures from the gas scheme.

“A decision was taken to move away from the services of the companies RosUkrEnergo … and other intermediaries, which are absolutely ineffective and destructive for Ukraine’s gas transport system, and to move towards direct contracts,” she told a news conference.

Talks on the matter, she said, would “involve the government and will take place gradually in order not to destabilise any of the processes, including the transport of gas across Ukraine’s territory and transit”.

Tymoshenko has apparently begun the process of investigating the legality of the decrees that established Ukrgazenergo as a key player in the gas market. She hopes to replace the trader with Naftogaz, and eventually work her way up to getting rid of RUE as well.

Naftogaz, apparently feeling out the possibility of shifting to direct Central Asian purchases, is planning on holding negotiations with Turkmenistan and Uzbekistan about providing 5 billion cubic meters (bcm). This would roughly correspond to the 5.76 bcm Naftogaz is expecting to sell to Ukrainian consumers on the unregulated market, as stipulated by the the National Committee for Regulation of Energy (NKRE).

While Gazprom essentially has a monopoly on purchasing Central Asian gas (either for re-export or for Russia’s domestic consumption), two players have key connections to the two countries being approached as suppliers.

Ukraine’s Industrial Union of Donbass (IUD) had been importing about 3 bcm of natural gas per year from Uzbekistan, apparently up until last year. This gas was used to power their steel factories, with the refined product often used as barter for the fuel. Vitaly Gaiduk, a key figure in the IUD, is in line to become Tymoshenko’s deputy PM in charge of the energy sphere (though apparently Tymoshenko’s other deputy PM Alexander Turchinov has been consolidating his power within the Cabinet of Ministers and is currently filling that role). Gaiduk is also seen to be a strong supporter of Tymoshenko.

The sale of Turkmen gas, on the other hand, had been coordinated by the trader Itera up until 2004. Since then, Itera was kicked out of the scheme by Eural Trans Gas which eventually gave way to RosUkrEnergo. The firm, registered in Florida and led by an ex-cycling champion from Turkmenistan, allegedly used some contacts within Gazprom to obtain favorable transmission rates for its trading deals. Itera eventually expanded into upstream production and is now a relatively significant independent gas producer in Russia. However, it was this expansion that apparently soiled its relationship to Gazprom, as the strategies of Alexei Miller and Dimitry Medvedev (implemented in the early 2000s) called for the return of assets that had left Gazprom’s fold–including the Central Asian trade and many of Itera’s Russian gas fields. Since then, the two firms’ relationship has been relatively sour. However, Tymoshenko apparently shares connections with Itera’s head Igor Makarov from her time at UESU (United Energy System of Ukraine)

Naftogaz’s expansion into the Turkmen and Uzbek markets makes recent news of the re-emergence of Makarov and Bakai more understandable. Makarov shared a private jet with Oleg Dubina following his talks in Moscow a couple weeks ago. Also in the plane were other Itera and Naftogaz representatives. Meanwhile, Tymoshenko apparently enlisted the help of Bakai–who now holds Russian citizenship after fleeing Ukraine due to corruption charges–in the possibility of upcoming negotiations with Moscow. Bakai sits on the board of Oleg Deripaska’s Basic Element and is apparently also deals with Itera in that regard.

Privat making moves in Ukraine’s oil sphere

Note: I started writing this on Monday but my computer crashed on Tuesday and I have been struggling to get it working again since then. I’ll follow up this post with one covering the further developments (including the reappearance of some figures from the past — Igor Makarov and Itera along with scandal-ridden Igor Bakai) in the on-going gas negotiations.


Much attention is still focused on Ukraine’s evolving “gas war” with Gazprom (Igor Didenko walked out of negotiations over Naftogaz’s debt to UkrGazEnergo, though follow-up meetings showed progress; Yulia Tymoshenko reiterated her pledge to remove middlemen even as her counter-point Raisa Bohatyryovna is in Moscow to pass along Yushchenko’s promise of stability; gangster Semyon Mogilevich’s arrest fueled speculation on imminent shakeups, while Dimitry Firtash once again denied any connection between the two within the gas sphere), despite calls by Naftogaz to de-politicize the ongoing and oft-contentious negotiations.

Honoring Naftogaz’s request (kind of), I’ll turn to some recent developments in Ukraine’s oil sphere.

Privat in Ukraine's oil sphereLate December 2007, Igor Kolomoisky, one of the major owners of the Privat Group, bought a 12.6% stake in British firm JKX Oil & Gas. The deal, valued at over $150 million based on stock price, makes Kolomoisky the second largest shareholder in the company behind only Alexander Zhukov. JKX’s presence in Ukraine is an 80% holding in the country’s largest private oil producer Poltava Petroleum Company (PPC). With production levels of about 800 tons of oil and 1 million cubic meters of natural gas per day, PPC trails only Ukrnafta (50%+1 owned by Naftogaz, 42% owned by Privat) in output for Ukraine.

Following the sale, Kolomoisky’s Privat partner Gennadiy Bogolyubov announced the possibility that the powerful financial group would divest from its 42% holding in Ukrnafta. Besides facing a 25% increase in oil extraction rental rates that severely limits profitability, firms with significant state ownership are also obliged to sell natural gas production to Naftogaz at the fixed rate of $53 per thousand cubic meters–well below market value. This provision, Decree 31 from the previous Yanukovich-led government, already forced out independent producer Cardinal Resources and appears to be pushing Privat into the private sector.

However, some analysts consider Privat’s statements on selling out of Ukrnafta as only a threat, as the group attempts to wrangle a better tax situation within the hydrocarbon sector from a government seen to be sympathetic to Kolomoisky. Indeed, Naftogaz today announced the possibility of raising the price for domestic (non-industrial) consumers at the end of the current heating season, recognizing the detrimental effect the depressed rate has on Ukrainian gas production sphere (which is tasked to supply the regulated market). It is unclear if these moves are related, but reform of the tax and fee structure surrounding Ukrainian hydrocarbon extraction is a key step in boosting domestic production figures, insuring adequate upkeep and attracting foreign investment.

Naftogaz and Privat are also apparently sparring over Ukrnafta’s profit allocations for 2006, with the government calling for 50% of the $480 million net profit to be distributed as dividends. The minority shareholders (including Privat), on the other hand, felt that number was too high and that more should be re-invested into production capabilities. The shareholders were set to vote on the issue in May 2007, but it was tabled until a shareholders meeting last week. However, neither Privat nor state representatives attended the meeting, leading to the absence of a quorum. The new leadership of Naftogaz apparently has to reach an agreement (.doc) on the fate of the profits, and the issue has been pushed back to a later (undetermined) meeting.

Meanwhile, Privat is making moves concerning its refineries, as well. Given Kremenchuk’s supply issues, the two smaller Privat-controlled refineries in Western Ukraine (Galichina and Neftekhimik Prikarpatia) have been forced to shut down production and undergo modernization repairs. Recently, however, the management of the refineries sent a letter to the government asking about the possibility of reversing the Odessa-Brody pipeline and sending Caspian crude north. Some would then be exported into Europe while the two refineries committed to processing 5 million tons per year. Responding to the letter, Fuel and Energy Minister Yuri Prodan instructed Ukrtransnafta to study the possibility of reversing the flow and including the two refineries in planned shipments.

Refining Caspian crude, which is a higher quality than Ukrainian or Russian varieties, would prevent Privat from having to invest in long-delayed upgrades to the Galichina and Neftekhimik Prikarpatia refineries. Newly-enacted government regulations on the quality of diesel fuel for Ukraine would have likely forced the refineries to close for repairs anyway, regardless of the availability of supply. Tapping into Caspian crude, however, would allow them to reopen without the costly improvements.

Ukraine’s President Yushchenko met with his Azeri counterpart Ilham Aliyev in Davos last week to discuss energy issues. A couple days later in a meeting with Prodan, Azerbaijan’s ambassador to Ukraine said they are willing to provide 5 million tons of Azeri crude per year should the pipeline reverse direction. However, there was talk of sending the crude (via the Druzhba pipeline) to a Czech refinery, or even building a new Azeri-sponsored plant within Ukraine.

TNK-BP has been coordinating the shipment of Russian crude southward through the line and managed to increase volumes in 2007 by 160% to 9 million tons for the year. Much of this increase was due to an agreement between Russia’s pipeline operator Transneft and Ukraine’s Ukrtransnafta to lower tariffs on Russian crude so long as the total volume exceeded 9 million tons for the year. However, this provision expired on December 31st and Transneft promptly increased tariff levels by 38 percent. While TNK-BP is working on reaching a similar deal, in all likelihood this year’s volumes will be down significantly due to the less attractive economic situation.

This should open the door for Ukraine to push through its reversal plans, presuming it can get all the players on board. The 5 million tons requested by the Privat-controlled refineries is considered to be overly ambitious for their production capabilities, and was likely meant to try to dissuade the construction of a new refinery (leading to more domestic competition) to handle the crude. While Prodan asked Ukrtansnafta to examine the scenario, it is unclear how strongly he would lobby for Privat’s interests. Privat, while perhaps not playing a central role through its refineries, would be key due to its strong position at the Odessa oil port. Of course, this is even assuming that the government decides (and manages to) actually reverse the pipeline.

Privat and Ukrtatnafta In the meantime, despite the closing of its two Western Ukraine refineries, Privat maintains a strong position within Ukraine’s refined products sphere due to its alleged control over Ukrtatnafta and the Kremenchuk refinery. Indeed, the halting of production at Galichina and Neftekhimik Prikarpatia–predicted due to the change in fuel regulations–has been suggested as an impetus for Privat to take control of Kremenchug, thus ensuring a market for its domestically produced crude (via Ukrnafta) and a continued presence in the refined products sphere. While Pavel Ovcharenko ascended to the top of the company pledging to remove shadowy middlemen from Ukrtatnafta’s supply chain and resurrect the firm’s financial status, nearly all of the refinery’s products are apparently sold via Privat-controlled Optima Oil or even Ukrnafta itself.

Ukraine’s vice prime minister Alexander Turchinov has stated that the Cabinet of Ministers will work to resolve the issue for the benefit of all parties (though he is also quoted as saying “for the benefit of Tatneft”), which is at least a welcome change from the silence the conflict had been generating from the government before. There is no word on exactly how this will happen, and Tatneft and Naftogaz (the two major shareholders fighting for control, despite Privat apparently pulling the strings) didn’t respond to my requests for a comment. However, Ukrtatnafta is apparently on a list of firms drawn up by PM Yulia Tymoshenko’s office for privatization (working on confirming this), and the government may attempt to structure any future sale in a manner that would create some form of resolution.

Even as Turchinov stressed the possibility of ending the conflict, though, Yuri Prodan ensured that an underlying source of tension–also involving Privat–will continue. The Privat-controlled financial company Ukrneftegaz is in charge of managing the shareholder registers for energy firms that have significant Ukrainian state ownership–including Ukrtatnafta. Tatneft accused Ukrneftegaz of manipulating the list for Ukraine’s benefit, leading to the eventual management dispute. Ukrneftegaz has also been accused of lobbying for the interests of Privat in energy deals and using its powers to dictate shareholder meetings. Prodan recently defended Ukrneftegaz’s performance, and said the state plans on continuing to use the financial company’s services.

Given these examples, it is clear that Privat–that is, Kolomoisky and Bogolyubov–are major players in Ukraine’s energy sphere, particularly within the oil market. While the rise to power of Industrial Union of Donbass-connected officials within Yulia Tymoshenko’s government may somewhat temper this involvement (IUD is a rival business conglomerate from Donetsk), Privat is still seen to be close to various factions within the ruling coalition. While Privat recently failed at its attempt to block Rinat Akhmetov’s deal with Dneproenergo, most observers are expecting the business group to use its political connections to launch another attempt at halting the transaction and increasing its presence within Ukraine’s energy market.

South Stream reflections

Gazprom strikes South Stream deal - from gazprom.comA colleague asked for my thoughts on Gazprom’s $15 billion South Stream project, which includes a 31 bcm/year pipeline across the Black Sea into Bulgaria, where it would branch to serve Italy and Southern Europe as well as Central Europe. Here are my off-the-cuff reactions:

Gazprom did pretty well on the Blue Stream line, completing it in 4 years (a bit longer than expected, and over budget, but not too badly, I think). That was a key catalyst in drumming up support for the Nordstream line, the experience in undersea construction hopefully translating to the Baltic. But Gazprom is facing more delays and cost overages there, despite an arguable more secure end result (fulfilling rising German demand while tapping into the extensive Northern European gas network more directly than before). 2013 seems reasonable for a timeline at this point for South Stream though my bet would be actual full operation by 2014, but who knows at this point –still lots to work out. But reaching the Bulgaria and ENI deals is pretty good progress.

The Black Sea is still within Russia’s sphere, more so than the Baltic / North Sea, so Gazprom won’t be facing the same protests regarding the use of national sea space that are slowing the Nordstream project. Plus, it has fairly good relations with the countries on the other side of the sea. Putin (and Medvedev) just nailed down the Bulgarian support, though they had to sacrifice the 1% they are used to while negotiating joint ownership of the transport pipes (Gazprom would of course prefer to have 51% control, rather than just 50%, but no luck with Sofia). Their close relationship to Serbia will be key, as routing the pipeline through Serbian territory is both a bargaining stick in Gazprom’s bid for Serbia’s NIS and an opportunity to keep the path of the pipe in a closely allied — and dependent — country.

Gazprom also has a very solid relationship with ENI, both from working together on the Blue Stream project, and through later negotiations. ENI’s head Paolo Scaroni is close with Gazprom management, and is very willing to work with the company. Italy is a huge gas consumer, and Gazprom is willing to edge into the market dominated by Algerian / North African supplies. Italy doesn’t mind because diversification is one of its goals, and unlike Germany and other Northern European countries, it isn’t too heavily reliant on Russian gas yet. And because Italy lacks the nuclear industry of France, Germany and England, it feels more pressure to make good with gas suppliers.

That was one of the issues with Blue Stream — a secure source of demand. Turkey backed down from its original volumes, due to an economic downturn that depressed demand. Nowadays, Turkey is feeling a bit of a pinch from ripples in Central Asian / Iranian supplies, and its economy has developed enough to create a sufficient demand to pretty much fill the pipeline. But Gazprom isn’t expecting that problem with Italy / Southern Europe, and South Stream likely means the end to talks of a laying another pipe along the Blue Stream route. I think that confidence is why Gazprom is pushing for a 30 bcm line, much more ambitious than the Blue Stream, and bigger than the first
line of the Nordstream.

I was talking with someone earlier who asked if I thought that the push for the South Stream, along with the big investment into the Nordstream, is likely to deter Gazprom’s desire to take control of Ukraine’s transit system. While I think that it may very well dampen some of Gazprom’s perceived need (adding over 50 bcm — 80, with Nordstream’s second line — will do that), there’s also a less
tangible desire behind Gazprom’s wish for control over the export lines (and storage sites). Besides making them feel more secure about their exports, Gazprom still feels that the pipelines are “theirs,” since they built them back in the day, and Ukraine shouldn’t deserve them. Maybe not as extreme as that, in reality, but a bit of that sentiment exists, I bet.

On that topic, I really wouldn’t be surprised if there is eventually (in 5 years) a consortium that brings Gazprom into some sort of minority position (25% maybe) in a managing entity for the export lines (a la Gazprom’s deal with Total at Shtokman). Perhaps coinciding with Russia, under European pressure, finally ratifying the Energy Charter, and the further liberalization of Russia’s (and Ukraine’s) domestic gas market. But I don’t want to get too optimistic…

Kovykta delay

As I was wrote, it looks like the development of Shtokman — despite reaching a deal with Total — will remain a ways off into the future and will not be promoted to a top priority for Gazprom’s investment plan. Indeed, funds for the project in this year’s investment budget were cut, making room for other moves.

Earlier this year, Gazprom managed to take over control over the operation of the giant Siberian gas field Kovykta. It appears that a similar lack of urgency has overtaken the company with regard to this field, which had been under development by BP’s Russian joint venture, TNK-BP. In MinPromEnergo’s latest report on the development of Eastern energy projects, Kovykta has been pushed back to 2017.

While it was unlikely any significant gas exports would have been flowing until at least 2013 (despite past hopes that Gazprom would be exporting to China by 2011 or 2012), pushing the date back to 2017 is a significant delay. Even more so given the industry’s propensity for time overruns.

Kovykta’s position — near Lake Baikal in Eastern Siberia — suggests slating the field for export to the east, rather than connection the UGSS for export to Europe or LNG. However, Gazprom was not getting very good cooperation from the Chinese side of the bargaining table, and they have been unable to come up with a firm pipeline route. The Chinese shot down the most obvious path — straight south, through Mongolia — and were instead aiming for a longer pipe that would drop down into eastern China nearer to Korea.

However, it is unclear that the Chinese market is prepared for the kind of large scale imports from Russia that the expensive pipeline would necessitate. Chinese infrastructure is not geared towards gas consumption, with China currently relaying on oil and coal for a majority of their energy needs (coal: 69%; oil: 22%; natural gas: 3%). The country produces about 40 bcm per year and has about 1.5 Tcm of gas reserves. The Kovykta pipeline would likely have to transport around 10 bcm per year to be viable, so there just wouldn’t be a market for it in China alone without including Korean or LNG export routes.

Perhaps in 10 years, Chinese demand will change, leading to a more viable situation. But until then, Gazprom will be content to sit on the 1.5 Tcm Kovykta field.

Shtokman is more suited to pipeline export westward, as suggested by Gazprom’s goal of eventually routing the field’s gas production towards the Nordstream pipeline. Gazprom also envisages extending the undersea route further, eventually reaching Britain, which has recently switched from becoming a net gas exporter to a net importer due to declining North Sea production. This ambitious aim would need much more of a resource base than the 300 bcm Yuzhno-Russkoye field currently slated as a source. Shtokman has a much more solid predicted demand than Kovykta, thus bumping the Siberian field down the time line.

Gazprom may be now attempting to shore up production numbers by concentrating on some smaller developments before tackling either of the major super-giant fields, accounting for the shifting demand. At least, that could be a possibility, but in reality, the company spent much of the increased investment budget on capital, rather than infrastructure, pursuits — stakes in Sakhalin-II, Belarus’ Beltransgaz, and Mosenergo. It remains to be seen how these investments effect Gazprom’s future medium term production levels.

Belarus’ gas bill

From - LukashenkaBelarus has agreed to pay out a portion of the $456 million the country owes Gazprom for natural gas payments originally due by July 23rd. When it had become obvious Belarus was not going to pay by then, Lukashenka was given until today to coordinate the payment. This first chunk, $190 million, has bought Belarus an additional week to come up with the remaining money, at the cost of supposedly emptying the country’s reserve fund. From RIA Novosti:

Alexander Lukashenko said: “I have instructed the government to take $460 million from our reserve and pay for Russian gas supplies. This is not a major sum for the country.”

“Our reserve fund will be emptied, but other countries are ready to help us, including [Venezuelan President Hugo] Chavez and foreign commercial banks,” Lukashenko said.

(Venezuela hasn’t confirmed agreeing to an actual loan, but Chavez visited Minsk in June and apparently is seeking a $1 billion arms deal with Belarus, suggesting that future cooperation is possible.)

Belarus had been negotiating with Russia for a $1.5 billion loan that would be used to cover the gas cost, but talks fell through last week during PM-level meetings. Two Gazprom-connected banks had also offered Belarus loans to cover the payment, but they were refused by Minsk.

The obvious question for me is why Belarus didn’t pay the bill with the $625 million it received from Gazprom earlier this year as payment for a 12.5% stake in Beltransgaz, the first transaction in a series of four that would give Gazprom a 50% holding in Belarus’ domestic gas pipeline system. This arrangement was at the crux of the gas deal worked out at New Years, when the price and payment deadlines that are now the issue were worked out.

Belarus would keep its sub-European price levels for the gas it was receiving from Gazprom, but in return, it would have to allow the Russian gas company to acquire a stake in its domestic pipeline operator. Gazprom already controls the company that runs the major Yamal-Europe pipeline, which passes through Belarus and into Poland and Germany. That pipeline is where the majority of Russian gas exports through Belarus traverse, and is key for bypassing Ukraine (which has much more of a stranglehold on Russia’s export routes). Control over the domestic pipeline network is less important for securing the reliability (and profitability) of its exports, but it does give Gazprom more leverage in securing payment from its deliveries to the internal Belorussian market. It also strengthens Gazprom’s general hold on the region’s natural gas infrastructure, a goal it has been pursuing lately.

The deal reached back in January kept Belarus’ gas prices well below Western European (and Ukrainian, Georgian, etc.) prices, but at the cost of Beltransgaz. Lukashenka really had no option; his economy–what there is of it, at least–is largely kept afloat through Russian energy supplies that are in effect subsidized. Forcing a dramatic increase in price would devastate the country’s energy-intensive industry. In addition, Gazprom’s payments for Beltransgaz would correspond to Belarus’ gas bills, ensuring the beleaguered country would have the funds available to keep Gazprom happy and at bay, (at least for the next few years) as Belarus transitions into prices more in line with market forces.

What exactly happened to the $625 million Lukashenka was supposed to spend on his country’s gas bill is not clear (though I can guess…). Instead, Belarus is trying to play the victim and Gazprom is forced into the position of threatening a gas shutoff, which is quite damaging to its already suffering public image.

However, I have no pity for Belarus on this. They new this date was coming, and they should have kept the funds available for it. Despite suggestions that this pressure is corresponding to requests for Russian access to Belorussian privatization deals, or calls saying this is just a further example of energy blackmail, Gazprom really does have a case here.

Gazprom’s shutoff to Ukraine on Jan. 1, 2006 was incredibly harmful to its reputation, and should a further cut off be necessitated, the company needs to do a better job of explaining its position–and the Western press needs to do a better job of listening to it. It appears efforts are being made in that regard, as noted in the Wall Street Journal:

Foreign Minister Sergey Lavrov reassured his audience that Russia was a reliable energy supplier. “I would like to stress that Russia has never violated its obligations under any contract to deliver energy,” Mr. Lavrov was quoted as saying by Interfax.

Russia guaranteed energy supplies “to every country, not only friends or allies,” he said.

Quotes like these, however, along with any mention of the $2.5 billion deal for Beltransgaz that was meant to pay for this sort of thing, are only mentioned at the end of these articles.

Update: Kommersant reports that the $625 million was put into the reserve fund now being tapped for the gas payment. Apparently, Lukashenka also got some of the country’s largest businesses to “donate” $100 million a piece to the fund as well, suggesting that raiding the account for the $460 million bill should not bottom it out.

In May, the Belorussian vice-premier Vladimir Semashko said that the money paid for Beltransgaz “will not be returned to Gazprom — it will [instead] go into the National Development Fund.”

While the sentiment may be appreciated–using money from the sale of a key national asset for strategic national development–it also suggests a lack of foresight on the Belorussian side. Just how did they expect to pay the bill? The government is apparently receiving payments from individual domestic gas customers, it is just refusing to pass along that payment to Gazprom. Now it is forced to go back on its assertion of not using Gazprom money to repay the Russian company. Long term, Belarus will have to increase collection efforts, raise domestic prices, and diligently repay gas contracts–or else it will once again have to raid its depleted cookie jar.

Check out more coverage from David Marples on the EDM, including some reactions from