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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

Pitfalls in Ukraine’s energy sector

Viacheslav KNIAZHNYTSKY: Making a consortium with Gazprom is impossible unless Ukraine discards the European vector
20 December, 2011 - 00:00

Talks on lower gas prices for Ukraine appear to have entered a phase that doesn’t serve the Russian monopolist’s interest. “There will be no Christmas gifts, Gazprom’s CEO Aleksei Miller summed up the talks with Energy and Coal Minister Yurii Boiko. In other words, the two monopolists won’t sign a gas agreement before the end of December. This U-turn in gas rhetoric makes one wonder about the reasons. Quite recently the same Russian functionaries promised to make a deal before the New Year. Was it because the Ukrainian side turned out to be less agreeable to the imperial tone Russia is accustomed to adopting, even in a dialog? If so, Russia’s expectations of Ukraine’s quick surrender (including its national interests) in return for cheap gas supplies proved ungrounded. In fact, Prime Minister Mykola Azarov has promised to fight to the last man: “If we have to pay 400 dollars for [a cubic meter of] gas, we will.” Ukraine may win these polemics by playing the trump card of getting closer to the European energy standard. How can Ukraine get the upper hand in the gas talks? What diplomatic experience in the energy sphere should be employed? More on this in the following exclusive interview with Viacheslav KNIAZHNY-TSKY, energy, nuclear safety and ecology adviser with the Ukrainian Representation at the EU (2004-09), Ambassador at Large of the Mi-nistry of Foreign Affairs of Ukraine (in charge of energy security: August 2009-May 2011).

Ukraine and Russia are trying to make a lower gas price agreement. What do you think of the current status of this gas diplomacy?

“These talks must continue because the price Ukraine is paying is really unfair – and I mean imported gas for Ukraine. However, assessing this process takes a broader range of issues, including Ukraine’s relations with the EU and the kind of legal framework Ukraine already has with the Union, primarily the memorandum on understanding in terms of cooperation in the energy sphere, signed December 1, 2005, which outlines a bilateral cooperation strategy. This instrument reflects Ukraine’s intention of becoming a civilized operator on a single European energy market, joining the European Energy Community (it did in February 2011). All these years Ukraine has been taking an active part in the

Energy Charter process, implementing the Energy Charter Treaty (ECT) that has been a law of Ukraine since 1998, and taking part in the talks on the draft ECT transit protocol. After signing the FTA and gaining associate membership, Ukraine’s cooperation with the European Union will reach a new quality level.

“I think that, stating in 2004 and until now, despite the changing administrations and ruling political trends in Ukraine, this country has generally remained on this strategic course. In fact, there should be no problems for as long as Ukraine adheres to these parameters and arrangements. Problems may appear if whatever accords made between Ukraine and Russia do not fit with this legal framework. In my opinion, Ukraine shouldn’t alter its current European energy course.”

One of the options is the establishment of a bilateral consortium that will manage Ukraine’s Gas Transportation System (GTS). Won’t this become a barrier on [Ukraine’s] road toward the European energy standard?

“I have no information about this kind of consortium [this interview was recorded on December 8, 2011. – Ed.]. Besides, Ukrainian legislation doesn’t provide for a consortium within which Gazprom can run Ukraine’s pipeline. Let me explain. One of the compulsory clauses of the protocol on Ukraine’s Energy Community membership concerns the implementation of the second energy package (June 2003). It reads that the main objective is to separate the owners and suppliers of energy resources from the transit operator. In view of this, the Ukrainian government, instructed by the head of state, is preparing a Naftohaz restructuring plan that envisages the detaching of a part of this company and reorganizing it as a separate business entity known as Ukrtranshaz. Among other things, this operator company will take care of gas transit across Ukrainian territory. In other words, Ukraine has started implementing the second energy package. In view of this, Gazprom can’t be a de jure member of a consortium to manage the Ukrainian GTS, simply because Gazprom is an energy producer and supplier. Therefore, making a consortium with Gazprom is impossible unless Ukraine discards the European vector.”

Is there any other way to make this bilateral consortium?

“In any case Ukraine would have to disown the abovementioned commitments to the EU. No other way.”


What then could be the subject of this gas bargaining?

“No consortium is needed to agree on a lower gas price. Ukraine is reforming its gas sector, so the pipeline manager (Ukrtranshaz, for example) will eventually become an independent company. Whoever wants to run the Ukrainian GTS will have to accept the fundamentals of EU energy politics.”

You mean incorporation?

“The second package requires no specific kind of management, like in a joint stock company. Its main task is to draw the line between the energy company, as an owner/supplier, and transportation services. This privatization may result in producing an acceptable kind of management, in terms of private or other ownership, but on one condition: GTS must be run by an independent operator, the way it’s practiced in Europe. This operator can in no way depend on energy prices, particularly those of gas being transported.”

Indeed, such an operator should care less about these prices, yet I personally (along with many experts) am concerned about who will take possession of an economic tool known as the Ukrainian pipeline, considering that its importance can hardly be overstated in terms of geopolitics.

“As a matter of fact, a truly independent operator won’t be able to influence anyone or anything. This operator’s activities must not – and cannot – be politicized. This operator’s sole duty is to provide services, make them economically effective, keep the pipeline ticking and [gas] transportation cost-efficient.

“I would like to quote from a do-cument that shows just how much the European side is concerned about the strengthening of Russian companies in Ukraine’s energy sector. True, the European side doesn’t say this in so many words, but the message is clear. I mean Item (x) in the Section ‘Economic and sectoral cooperation’: ‘(x) to note that, although the liberalization of services and investment in the energy sector would be beneficial to the EU, taking on commitments in respect of particular energy services may involve some risks, since strong energy players controlling Ukrainian companies could use the free trade agreement to dominate transmission networks in the EU…’

“Never before in my diplomatic line of duty in the energy sphere have I come across such a strong warning signal from the European Union. I think this statement cannot be ignored. In the context of Ukraine-EU cooperation, this country has enough arguments to prove that fearing such risks is ungrounded. Although the EU resolutions are actually recommendations, one ought to bear in mind whom these recommendations are addressed to: the EU Council, European Commission, and Foreign Policy Instruments Service. For all I know, none in Ukraine, not a single media, has commented on this item. Several days ago I read Energy and Coal Minister Yurii Boiko’s response, to the effect that Ukraine would maintain its European course.”

Do you think Russia will simply discard the gas factor in order to reach its foreign [political] goals?

“It won’t discard it of its own accord; it will be forced to do so. Talking of Russia, one ought to keep in mind that the European Commission firmly keeps its gas and power market li-beralization stand in the energy dialog with Russia. This issue will remain on the agenda for the next three to five years. It’s just possible that Gazprom will vanish from Russia’s business chart in the meantime, that it will be replaced by another company.”

Please explain. What could make Russia scared so much it would disown its beloved gas child, considering that Gazprom currently controls a major part of energy supplies to Europe?

“Gazprom’s monopoly balance will be upset by excessive market demand using supply routes from the West (liquefied gas from the US) and East (Nabucco and White Stream, along with liquefied gas from the Persian Gulf). These options may prove effective before long, considering that Gazprom stocks have dropped by 30-40 percent on the European market, compared to previous years, elbowed out by liquefied gas from the US, Qatar, Norway, and Algeria. Today few doubt the possibility of a strong gas exchange being formed in Baumgarten, in Vienna’s suburbs, or that it will average lower gas prices for Europe, relying on liquefied and pipeline gas supply offers. Supplies expected from Turkmenistan (considering the November 18 report that only one gas field was confirmed to hold 26 trillion cubic meters) and Azerbaijan, via the Nabucco pipeline (possibly via White Stream), alongside liquefied gas from the US and Persian Gulf, will even out gas prices, thus drawing the line between these and the prices of oil supplies. Russia will then have to liberalize its energy sector. Besides, there is no ruling out the possibility of gas supplies from Israel in the next decade. A year ago, experts confirmed that the Leviathan gas field contains 457 billion cubic meters of natural gas. Also last year, the United States Geological Survey reported that the gas deposits on Israel’s shelf could amount to some 3.43 trillion cubic meters, about 10 percent more than consumed across the world back in 2008.

“Ukraine should keep such scenarios in mind while holding talks with Russia, particularly when deciding on timeframes for such agreements or contracts. What should be determined now is a gas price rather than lower gas price formula. I think that determining this gas price formula would allow to envisage and discuss various scenarios, whereas sticking to a lower gas price one would make Ukraine hostage to all those political concessions regardless of the market situation; in other words, this would expose Ukraine to political blackmail.”

Getting back to Ukrtranshaz, should this company turn out in the red, it would interest only the Russian companies that have long visualized Ukraine’s pipeline as one of their winning cards in this geopolitical game. What do you think?

“Ukraine should make every effort to upgrade this pipeline and keep this company independent and cost-efficient. There is no alternative. Also, even now it’s worth considering alternative energy sources that could be an alternative to Russia’s gas being transported through the Ukrainian pipeline. This pipeline must be kept full regardless of a single supplier’s moods.”


Are there any realistic ways to strengthen Ukraine’s energy security?

“Ukraine’s energy security should rely on a better exploitation of domestic resources, power efficiency, modernization and diversification of gas supply sources, with an eye to improving each of these indices.

“I remember that, back in the 1960s-1970s, Ukraine extracted over 70 billion cubic meters of gas, and that the first pipelines to Europe were from Ukraine, not from Russia. Increasing Ukraine’s extraction to 10 billion cubic meters within five to seven years sounds quite realistic. Given energy-saving and green energy measures, Ukraine could show an output of 15-20 billion cubic meters in a decade.

“Another trend is upgrading the GTS, in accordance with the 2009 Brussels Declaration, while implementing the Energy Community Treaty. These instruments make Ukraine part of the EU uniform energy security system, allowing to synchronize the performance of the Ukrainian and European gas transportation systems. This synchronization provides for the reverse transportation mode (i.e., gas from Europe to Ukraine, if need be, which would be diversification, indeed). Also, Ukraine must hurry, considering that the EU will launch a single gas and electricity market in 2015. Lagging behind with legislative and GTS upgrading, Ukraine could find itself outside the process. The Ukrainian political leadership should make every effort to have Ukraine as an operator on Europe’s single energy market in 2015, otherwise Ukraine will find itself in a tight embrace by a single oil and gas monopolist.

“Another direction is taking part in new pipeline construction projects. There are investors interested in White Stream, a pipeline crossing Ukraine and Azerbaijan’s territories, supplying Turkmen gas to Europe. I think this project is more realistic than Russia’s South Stream. Reinhard Mitschek, managing director, Nabucco Gas Pipeline International GmbH, told an energy security conference in Budapest (November 2009) that this project allowed gas supplies to East Balkan countries and to Ukraine. Ukraine joining the European Energy Community would stand to logic. The viability of these pipelines is reaffirmed by the above data, especially considering the gas fields in Turkmenistan.

“The competition between the transportation routes and market operators will eventually allow to reduce gas price manipulations to a minimum. European standards must be introduced in Ukraine, so that each consumer who pays for gas out of his pocket can have a choice. The government should secure two or three options for each such consumer, then there will be no tampering with gas prices. You pay your money, so you’re entitled to make a choice.”

Such big projects in the energy sector can be effective if and when supported by investors. How can Ukraine return its former visage as a reliable gas transit entity?

“The only way is to have an adequate legal framework, bringing it closer to the European standard, establishing an independent regulatory authority – this is an absolute priority. Once the European side sees actual progress, rather than declarations, Ukraine will start receiving actual assistance.”

Doesn’t the launch of South Stream imply Europe shifting its attention from incomprehensible Ukraine to Russia?

“After the launch Europe declared that the Ukrainian GTS remains important. The EU remains convinced that energy source diversification should be on the agenda, so the more gas pipelines from Europe, the better.

“One, also, has to realize that the South Stream, unlike the Ukrainian GTS, doesn’t have a duplicate infrastructure, so in case of breakdown Gazprom will have no alternative other than turning to Ukraine for help. The Ukrainian political leadership should bear this scenario in mind and make the best of it during the gas talks. There are no Gazprom annual [gas supply] commitments – i.e., guaranteed gas transits via Ukraine – on the agenda. Instead, the supply-or-pay principle applies. In an emergency situation, like a South Stream breakdown, it would stand to logic for Ukraine to increase the transit price by three to five times, considering the emergency workload. Ukraine has to act on a transit-or-pay basis and keep its GTS ticking at its own expense during the year, while Gazprom doesn’t always honor its gas transit commitments, explaining this by market fluctuations.

“Russia ought to guarantee Ukraine a certain amount of gas pumped through the pipeline every year, so the EU customers can get the agreed-upon amounts of gas. Ukraine has gas transit commitments while having no adequate guarantees from Russia and EU.”

By Natalia BILOUSOVA, The Day