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Russia-EU-Ukraine: How Not to Be Drowned in a Gas Triangle

The Russia-EU-Ukraine gas negotiations have not yet yielded results

As Russia approaches the expiration of the gas transit contract with Ukraine, as well as the contract for the supply of gas to that country (this will happen at 10:00 on January 1, 2020), nervousness is growing. The parties have put their trump cards on the table, hoping that they will be enough for the opponent to change his position. After all, so far the views of Russia and Ukraine (which, so far, is supported by European officials) diverge greatly. Ukraine offers Gazprom a 10-year contract with an obligation to pump 60 billion cubic meters annually. To understand why Gazprom won't do this, it’s enough to recall three numbers. Last year, transit through Ukraine amounted to about 86 billion cubic meters. The capacity of Nord Stream-2 is 55 billion cubic meters, and Turkish Stream - 31.5 billion cubic meters. It is clear that there are seasonal peaks and geographical restrictions, but the new infrastructures are not built to stand empty.

The paradox of the situation is that in fact the main requirement of Gazprom is the need for Ukraine to comply with European regulatory rules. Gazprom really just wants Ukraine to implement the Third Energy Package and begin to live according to European mechanisms. Everything is very simple. This will allow Gazprom not to conclude a multi-year agreement, but buy annually, at auction, the transport capacity that is really needed. Brussels has no formal arguments against this. After all, Brussels itself said that long-term contracts are a relic of the past. The Europeans themselves wrote the rules, which in case with Ukraine turned out to be more profitable for Gazprom. But this means that Gazprom will very soon reduce transit through Ukraine to a symbolic 7-8 billion cubic meters. That is why Ukraine is delaying the transition to European energy legislation by any means - and with the tacit consent of Brussels. Obviously, by the new year Ukraine will not start “life with the Third Package”.

It should be noted, that in the future it is precisely the unbundling of Naftogaz and the transition to European rules for trade that could well be a way out of the situation. Of course, this will lead to the loss of transit money by Ukraine, but, in the end, it wasn't Russia that came up with such a way of organising gas transportation. That is why Ukraine and the EU are demanding a long-term agreement right now, while Ukraine has not yet switched to the new rules, and bypassing routes have not earned their full potential. Gazprom, on the other hand, proposes either to conclude an annual contract, or to extend the existing one, but without possible penalties for the “load or pay” system.

This is the particular drama of the moment. It turns out that Brussels has already figured out how to regulate relations between Russia and Ukraine. But since this scheme is not beneficial for Ukraine, it is in no hurry to apply it. However, the old contract will end in three months. Which makes a new "gas war" quite likely.

The parties so far expect that their opponent will flinch. Ukraine focuses on the impossibility for Gazprom to fulfil its contractual obligations in the coming winter season without transit through old routes. Europeans are trying to reinforce the position of Ukraine by the fact that they are ready to impose restrictions on bypassing gas pipelines. Obviously, a few days before the start of negotiations in Brussels, the EU court returned restrictions on the operation of the OPAL gas pipeline. And why is Denmark dragging out with a permit for the construction of Nord Stream-2, although there are no legal grounds for this?

Gazprom, in response, continues to pump gas intensively into European storage facilities. In addition, before the new year, the Turkish Stream will definitely enter operations, as well as its extension to Bulgaria and Greece. This means that these countries will not depend on Ukrainian transit. In addition, the first line of the Eugal gas pipeline will be completed, which runs parallel to OPAL and so far can be used to deliver gas from Nord Stream-1 to consumers.

However, Gazprom understands that there have been certain risks in the “life without Ukraine” option since the beginning of 2020. Any failure of the contracts will be unambiguously interpreted as the unreliability of Gazprom as a supplier and is fraught with serious reputation losses. Today the competition in the European market is escalating.

True, for Ukraine the risks are much higher. And it’s not even a possible loss of transit money. The question is: how will the gas supply can be organised by Ukraine itself in the winter period without Russian gas. In fact, Ukraine did not stop consuming Russian gas. And the matter is not even in the carousel reverse, organized on the border with Slovakia. Gas coming from Russia is consumed in the east of Ukraine; its delivery to the EU border is virtual. In reality, Ukraine does not drag gas from Slovakia to Kharkov and other regions in the east. But if there is no Russian transit, it really will have to be done. As a result, there could be serious additional expenses for gas transportation to the east. Moreover, it is not clear whether the rather obsolete Ukrainian gas transportation system can cope with a serious change in the principles of function. And the accumulated 20 billion cubic meters of gas in storage, which Naftogaz proudly says, may not help here. Because they are all located on the western border of Ukraine - they were built to provide transit from Russia to Europe.

In addition, if the EU will limit gas supplies through bypassing routes with the help of "minor dirty tricks" like the story of OPAL, then in winter there will not be enough gas, first of all, for Ukraine itself. Naturally, at first gas will be consumed by Europeans, and to Ukraine it will be supplied according to the residual principle.

And this will be a serious challenge primarily for Zelensky. He came to power not with slogans about "victory over Russia at any cost," as Poroshenko suggested, but with promises to improve people's lives. Zelensky realized that the majority of Ukraine’s population no longer wants to “tighten the belts” for the sake of geopolitics. But a refusal to compromise with Gazprom may lead to a decrease not only in the temperature of apartments and houses, but also Zelensky’s rating. He will not be able to explain to his voters why he started a new “gas war” with Russia.

Actually, these risks make the parties sit at the negotiating table. It was clear that the September round could not bring results. If the parties agree, then this will happen “at the eleventh hour”. And the differences are very serious. However, each party has serious arguments against the start of a new “gas war”. And that means that a compromise is possible.

However, one should not forget about the fourth risk factor which can manifest itself. This is the USA. Washington is not happy with today's low prices in European gas hubs. After all, the United States really wants to expand its gas exports to Europe. And what is the best way to increase prices? The answer is obvious - a new gas clash between Russia and Ukraine. In addition, the new conflict may discredit Gazprom as the EU’s dominant supplier. Therefore, the US choice in this story is not difficult to reconstruct. The United States will push Ukraine towards the toughest option. So it is not surprising that in Ukraine today, the most rigid position is held by the old Naftogaz management. And there is a lot of choice for Zelensky. Because ultimately it will be him “under the gun”. Whether he is ready to oppose Washington’s position is a big question. But there is an indicator - these are personnel changes in Naftogaz. If they do not bring changes in the company, this is a signal that, alas, the radical version of the gas dispute will become the main trend.

By Konstantin Simonov, the head of NESF

Valdai, October 04, 2019


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Analytical series “The Fuel and Energy Complex of Russia”:

Energy Transition and ‘Green Agenda’ in Russia: Fashion or Hard Reality?
Druzhba Pipeline Accident: Key Implications
New OPEC+ Deal and Future of Oil Business in Russia
Gazprom on the background of external and internal challenges
Regulation of Oil and Gas Sector in 2019 and Prospects for 2020

All reports for: 2015 , 14 , 13 , 12 , 11 , 10 , 09 , 08 , 07

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