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Nord Stream 2 and Ukraine: Costs Should Decide

Nord Stream 2 and Ukraine: Costs Should Decide

On February 23, 2017 in Brussels Mr. Konstantin Simonov, the head of the National Energy Security Fund, will present the special analytical report “Nord Stream 2 and Ukraine: Costs Should Decide”.

There has been much discussion about how Russia – Europe’s biggest gas supplier – can continue to supply gas to Europe over the coming decades in the most secure and cost efficient way. Gazprom and its European partners have decided that building two additional pipelines through the Baltic Sea (Nord Stream 2) is the best commercial solution to secure future gas supplies for the EU, where gas production continues to decline and demand is expected to grow.

Ukraine and its supporters may disagree, because the transit country could face a reduction in its revenues from transportation services and may require additional funding from international financial institutions to support the current government. However, in the end the market will decide: the supplier and the consumers have to find the best transportation options to fulfil their trade agreements between each other.

Ukraine has been the major corridor for Russian natural gas supplies to Europe since the Soviet period. Until the late 1990s, transit through Soviet-era pipelines in Ukraine accounted for over 90% of Russian gas deliveries to Europe, and even in 2011, about 70% transited through Ukraine. According to NESF calculations based on data from Gazprom, Naftogaz, BOTAS, Eustream, Gaz-System, FGSZ and Bulgartransgaz, volumes of Russian gas transported to European countries in 2011 accounted for 88,8 bcm, net of 12,3 bcm that went via Ukraine to Turkey. While total Russian gas exports to Europe were 124 bcm in 2011 out of 150 bcm exported to Europe and Turkey according to Gazprom’s report.

It was this situation of almost total dependence on Ukrainian transit in Russian gas deliveries to Europe in 1990s and the first decade of the new millennium that led to regular disputes as Ukraine tried to convert its transit power into gas price privileges and other non-market advantages in gas supplies coming from Russia. Some of those disputes were small scale, but others grew into full-scale disputes, such as the 2006 or 2009 crises with disruption of transit flow via Ukraine to European customers. Before 2006, Ukraine paid for Russian gas USD 50-80 per 1000 cu m, much cheaper than European buyers. From 2006 to 2011, Ukraine obtained gas from Russia at final prices that were USD 70-130 lower per 1000 cu m.

In 2009 after three weeks of transit violation, which was unprecedented in 50-years of Russian gas supply to Europe, the first common long-term contracts for supply and transit between Russian Gazprom and Naftogaz of Ukraine were signed. Firm agreements with precise provisions on mutual obligations, price formulas for gas supply and transit fee and a dispute resolution procedure in international arbitration made it possible to maintain Russian gas supplies to Europe via Ukraine even in difficult times. However, both contracts are due to expire on January 1, 2020, which could put Russian gas flow via this country at a high level of political risk. Thus, the security of the European gas market requires an alternative transportation option to be in place by the time that the contract expires.

If the only way to fulfil their obligations under valid long-term sales and purchase agreements between Gazprom and its European partners is to use Ukrainian pipelines post 2019, it will provide Kiev with great power over the EU’s energy stability and security and make gas supply even more politically motivated than it is now.

On the other hand, having other options does not mean that Ukraine will cease to be a gas transit country after 2019: it will compete with other transportation options in terms of commercial attractiveness, technical safety and overall security for supplier and customer.

Contents of the report:

INTRODUCTION 3
SUMMARY 5
Chapter 1. UKRAINIAN PIPELINE SYSTEM – SOVIET UNION’S HERITAGE COMES TO AN END 6
Chapter 2. NORD STREAM-2 AND UKRAINIAN TRANSPORTATION COST ASSUMPTION 16
CONCLUSIONS 22
Date of release: November, 2016

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