Ukrainian pipe: business or politics?

Hardly had the stir caused by the signing of the so-called gas-for-fleet agreement calmed down, a new turn in Russian-Ukrainian relations emerged. Russia proposed a project of amalgamation of Gazprom and Naftogaz, which immediately became the breaking news. This topic is clearly to be a key one during Russian president Dmitry Medvedev’s visit to Kiev.

After the new gas accord was signed a number of experts accused Russia of deviating from the principles of economization of relations with post-Soviet states. Now we see this is not true. Russia made a commercial proposal to Ukraine, which is economically beneficial to all sides. But it became clear that the gas pipeline system for Ukraine is rather politics than business.

So, what are the benefits Ukraine will get as result of the Gazprom-Naftogaz merger? First of all, it will retain its status of a transit state staying in the gas business of selling Russian gas to Europe. Ukraine has a chance to find money to repair pipes and replace gas compressor stations as well as pay foreign debts. For that purpose Naftogaz needs about $7bn to $9bn that it lacks. And no one, except Russia, will give it to Ukraine, because only Russia is interested in the Ukrainian pipe.

This idea is beneficial to Russia and Europe too. The EU will have a clear understanding who is responsible for the transit – this will be Gazprom that will own the pipe. The Russian gas giant will have an export channel of a 141bn cu m capacity with a possibility to relatively quickly and cheaply expand it by 30bn cu m. In this case we can cancel construction of the expensive South Stream.

So why is Ukraine stalling for time not signing the accord? It is simple. Ukraine has not learnt to consider its gas transportation system as business. For Ukraine this is still an instrument of geopolitical influence on Russia that should not be lost.

Russia’s proposals certainly look very harsh. We are not ready for a compromise any longer – we can call this process amalgamation not to hurt Ukraine’s feelings. But in reality this is a takeover. Russia cannot be satisfied with a variant of a consortium or a joint venture. The latest statements by foreign affairs minister Konstantin Grishchenko that integration is possible only if Ukraine retains control over the GTS in fact mean rejection of Russia’s proposals. Viktor Yanukovich’s statements that the Gazprom-Naftogaz merger is possible only on a parity basis are in line with the previous words.

But Russia is not satisfied with such an approach. It is clear why. We have had enough of partnership games. Only the GTS transfer to Gazprom will give Russia guarantees of trouble-free transit through Ukraine even if a political conjuncture changes in this country. This deal will be hard to contest because it will be recognized by the EU. Europe has clearly indicated its position – it does not care how gas is delivered to its territory and everything happening to Ukraine is of little concern to the EU.

Russia has reasons to demand additional guarantees from Ukraine, because the gas transportation consortium idea did not live up to our expectations; so we cannot revive it again. Let’s briefly recall that story.

In October 2002 top managers of Naftogaz Ukrainy and Gazprom signed constituent documents on establishing an international consortium to manage and develop Ukraine’s GTS on a parity basis. In January 2003 in Kiev the consortium on a parity basis was registered as a limited liability company with a $1m authorized capital.

However, negotiations on main conditions of cooperation within the framework of the consortium failed very quickly. The matter was that the Ukrainian side wanted to have the right to resale the whole volume of export gas in exchange to transferring control (or concession) over the GTS to the consortium. But this was nonsense. Russia did not plan to grant the gas re-export right to Ukraine. Moreover, now this contradicts the European regulations on gas transit, according to which a pipeline’s owner provides only transit services and cannot resale gas.

In 2002 we were persuading Ukraine to jointly manage the GTS on conditions beneficial to Ukraine. However, the situation has changed. Seven years ago variants of laying pipelines bypassing Ukraine looked like a fantasy. But today they are becoming a reality. Construction of Nord Stream’s sea section has already begun. The South Stream project is developing at a very high pace. Agreements have been reached with all counties participating in the land section of this route. Although Turkey demands some preferences, it will give its consent to lay a sea section in autumn. This means that in five to seven years there will be no need in Ukraine as a transit state. And suddenly Ukraine realizes that this threat is real. The main evidence of this is the contract, which is in reality not a gas-for-fleet contract but a payment to Ukraine for its nice behavior (i.e. not to steal gas). We are paying a huge sum but the risks are also high. If there is another suspension in gas supplies at Ukraine’s fault, our image will be strongly affected. We suffered from the 2009 gas row. Ukraine indeed fully discredited itself but this does not make our situation easier. We cannot let a second suspension of transit occur.

These were the circumstances we made our proposal to Ukraine. The offer is certainly made on our conditions because we were cheated by Ukraine’s different state authorities. This proposal gives Ukraine a chance to stay in business. From the economic point of view the proposal is beneficial to Ukraine, because otherwise it will lose transit revenues in several years.

Yet, Ukraine is absolutely not going to treat its GTS from the economic point of view demonstrating that it is an instrument of influence on Russia. This is why our negotiations on the Gazprom-Naftogaz merger are developing slowly.

New Ukrainian authorities are also afraid to openly tell their people that they have been somewhat mistaken: something they have called national pride over the past twenty years is in reality just rusty metal without Russian gas and nothing else. And Europe absolutely does not need Ukraine’s GTS, which Yanukovich quickly found out during his first presidential visit to Brussels.

Ukrainian elites certainly understand that refusing the merger is strategically disadvantageous. But they cannot live with plans for the next five to seven years. Yes, it is possible to lose the whole business bringing several billion dollars in budget revenues per year in this period. But this will not happen soon. And nobody knows how many events will happen in this period of time. Meanwhile, they will soon have to deal with voters, especially in western Ukraine, with the opposition accusing state authorities of betraying national interests. And in this case throwing eggs at each other in the Supreme Rada may not be enough. So, developments may be rather scary.

And this fear and inability to plan the future cause regrets. This is why we continue developing the South Stream project. There was time when we were ready to give up the idea of Nord Stream in exchange to establishing a consortium. But Ukraine did not agree. Today we are building this pipeline and again expecting Ukrainian elites to take into account not only conjuncture sentiments of the electorate but also long-term objectives of their country.

By Konstantin Simonov, the head of The National Energy Security Fund