Gas trumps

Gas has always been a hot subject in Ukraine. In recent years the energetic bargaining for the blue fuel has traditionally commenced in the fall, and it seldom ends before the advent of the first heavy frosts.

This year promises to be an even hotter one. Long-term contracts are about to be signed, and Russia’s Gazprom is promising to set European prices for Ukraine.

Does Ukraine have any aces up its sleeve in order to conduct successful gas talks? Or will the events in Georgia and Ukraine’s response to them trigger another gas war between Russia and Ukraine?

Below we offer an interview with Ukrainian gas expert Oleksandr NARBUT.

Even the Ukrainian president’s sharp comments and his stand on the independence of South Ossetia and Abkhazia will not determine Russia’s gas and energy strategy. Why is this? After all, Russia has operated cold-bloodedly in the gas and energy sphere for a long time. For Russia this is not just an extremely profitable business but also a truly powerful financial instrument of geopolitical influence. Ukraine will have to go through a long and difficult period of adjusting to the high gas prices. Its economic dynamics during this period will undoubtedly fluctuate, but at the same time it won’t serve Russia’s interests to destroy Ukraine’s Russian-gas-consuming market.

Assuming that Europe’s gas prices will rise to zero level and we will have to pay the same price, Ukraine’s metallurgy, chemistry, and power industries will collapse. On the other hand, Russia is well aware that any national market has its own price elasticity. You can’t charge 9.5 per thousand cubic meters of gas today and raise the price 2.5 times tomorrow. Industry won’t be able to adjust to the new costs that fast. This will be a shock leading to a substantial decrease in the rate of consumption of Russian gas. Russia doesn’t need this. It is important for Russia to increase its gas revenues by raising its consumers’ ability to pay for its energy resources. Of course, the political component will influence gas prices, but only within a certain range.

How much will Ukraine have to pay for imported gas in view of this political component?

There are three options. The first will manifest itself if events in the gas sector follow the current scenario, meaning, if the president and the prime minister fail to take a consolidated stand in the gas talks – which means that there will be no joint directives or an improved energy strategy. Given these conditions, gas prices may reach the ceiling this fall.

The second option is an idealistic one, with Ukraine playing its trump card during the talks with Russia. For this to happen, it is necessary to start gathering creative and professional experts who have a profound understanding of the nuances in the gas sphere. These people will form a top-level working group, which will determine the contours of the new gas-energy strategy. They will figure out the most likely scenarios for the development of the gas negotiations, and on their basis they will produce directives that will have to be signed by the president and the prime minister. This is the only approach that will allow the negotiating group to defend Ukraine’s gas interests and agree on prices within the 0-0 limits. In addition, negotiations should be held not only with Russia. Separate influential member countries of the European Union should be approached within the framework of the new and ex­panded Ukraine-EU treaty with regard to energy security questions.

The third option is the golden mean between the two scenarios described above. If some positive ideas occur to the top government leaders, it is possible to expect that the price of gas will be within the 0-0 limits. I believe that this option is the most realistic one. This increase will place many Ukrainian businesses on the verge of profitability, but will keep them from stepping over.

Today Naftohaz Ukrainy is not conducting gas talks with the Russian side because it does not have official directives. It is not entirely clear whether these talks will be held between two business entities, Naftohaz Ukrainy and Gazprom, or on the intergovernmental level. The latter option is something that should be done. There is a large package of intergovernmental agreements that serve as the legal framework for Russia’s gas supplies to Ukraine. These instruments also envisage sanctions in case of unauthorized gas extraction. These agreements should be upgraded and implemented on the intergovernmental level.

Under the agreements signed by Ukraine and Russia in January 2006 and March 2008, Russia must provide gas supplies to Ukraine to secure its gas consumption balance. Ukraine, in turn, must arrange for Russia’s gas transit to Europe. One of these agreements reads that, in case of excessive gas consumption by Ukraine, it must pay for it proceeding from the basic price for 1,000 cubic meters of gas, which was in effect on the date that the agreement was signed. Had Ukraine used this clause when it was resolving the gas problems in the first-quarter of 2008, today’s gas payments could have been smaller.

In view of the current Uk­rai­nian-Russian talks on inventorying and analyzing the current intergovernmental agreements in the gas sphere, will these particular clauses become the focus of special interest?

I think other aspects will also have to be considered. There are a number of clauses that have to be coordinated. Ukraine has signed a number of agreements providing for guarantees for transporting Russia’s gas to Europe; here the gas transit rate is at least 110 billion cubic meters. For reasons we can well understand, Russia is trying to reduce this rate by using alternate routes. In fact, Russia doesn’t have many such bypass routes, yet it is resolved to use them.

On the other hand, it is apparent that, without launching the other Russian gas pipeline across Belarus (Yamal-Western Euro­pe), implementing these plans will be easier said than done. This is precisely why issues pertaining to Russia’s long-term guarantees for using Ukraine’s transit routes must be a priority on the agenda of the intergovernmental dialog concerning the signing of long-term gas contracts. Ukraine must be officially informed by Russia whether the latter needs Uk­rai­ne’s gas transportation system (HTS). Here business must be done on the pay-and-pump basis. In other words, regardless of how much gas will be transported by Russia through the Ukrainian HTS within the agreed-upon timeframe, Russia will have to pay for the capacities that will be ready to transport the agreed-upon volume of gas. This is the international principle in the oil and gas transportation field.

Russia will be interested in transferring Ukraine-Russia gas relations to the business entity level, in which case none of the intergovernmental agreements can be relied on.

Incidentally, when Ukraine was drafting its gas accords with Russia, our country succeeded in signing and ratifying the European Energy Charter. Russia only signed it. Ukraine should consider which of the charter’s clauses to use as the basis for its new relations with Gazprom. In addition, taking advantage of the charter’s advantageous energy clauses will be an important political aspect: Ukraine may find not only understanding but also support from a number of European countries in this new format of relations with Russia.

What clauses are you talking about?

I mean, in particular, equal right of access to energy transportation resources for both consumers and manufacturers. In Ukraine, gas relations are formulated in such a way that Europe does not see Ukraine. Although Europe appears to care for what is happening to the transport of gas by our country, legal relationships exist only between Gazprom and European energy companies. Ukraine could become a player there if it proposed to the Europeans equal access to gas transit and undertook to transport Russia’s gas to the European companies after receiving this gas on the Ukraine-Russia border.

You mentioned an important trump card during the setting of gas prices for the next few years. What should Ukraine’s action plan be like in view of the inevitable increase in prices for gas imported from Russia?

We must start by building an effective domestic energy market model. A market for oil products, oil deliveries, and electrical energy is developing in our country, but do we have a gas market? I say that we do not. Today there is a monopolistic model of supplying gas to consumers, which does not conform to the market mechanism. The Russian supplier, Hazprombut Ukraina, has been allowed entry into the domestic market. I don’t consider this decision an adequate one. Consumers are in fact denied freedom of choice. What should be done?

The price-setting mechanism for domestically extracted gas has to be changed. Then the 20 billion m3 of gas that are being extracted by Naftohaz (by its subsidiary Ukrhazvydobuvannia, Ukrnafta, and other companies) will start forming the gas segment of the market. The gas supply market can also be de-monopolized by liquefied gas container deliveries or by active talks with the Mediterranean countries. In addition, the diversity of energy supply derived from various energy resources must become a reality for consumers. Then gas will be one of these components and will have a market price.

Generally speaking, the setting of an optimal price for imported gas depends on the art of negotiation. The Ukrainian state has a much larger arsenal of arguments (not only economic ones) to be able to avoid trading away its national interests in gas issues. For example, Russia could be reminded of the incomplete process of distributing the assets and liabilities of the former USSR, the cost of deployment of the Russian fleet in the Crimea, and so on.

A new strategy is impossible without launching new gas pipelines. Word has it that 100 percent of the capacities of the Nabucco pipeline project have already been reserved by the potential gas suppliers. Does this mean that Ukraine’s version of the “White Stream” pipeline has failed?

The EU and Brussels are making every effort to launch the Nabucco project. Today there is the Baku-Tbilisi-Erzurum gas pipeline, which is the Caucasus component of the Nabucco project. It will be enough to build a more than 200 km– long gas pipeline across the Caspian Sea, thereby joining its right and left sides, and allow Turkmenistan to start supplying its own gas, which the EU has already attempted to reserve for 2009. There is a problem, however. It has to do with Turkey’s special position on this matter. Turkey doesn’t want simply to be a territory that will be crossed by this gas pipeline. The Turkish government has proposed this option: Turkey will purchase this gas on its border, transport it across the country, and then sell it to the EU. One should also bear in mind the length and cost of the Nabucco pipeline. Ukraine has objective possibilities. The real danger for Ukraine is not Nabucco but the Southern gas pipeline, which is aimed at the resource base of the Caspian Sea and the countries of Central Asia.

If the Russia and EU bypass pipelines start operating, will this mean an end to Ukraine’s transit fortune?

For the Ukrainian HTS to keep on transporting at least 120 billion m? of gas, millions have to be invested every year, and for this we don’t need any consortiums. If the bypass pipeline scenario is played out, Ukraine’s energy transit may drop to 50 billion m? a year or less. Since the cost value of transit services depends on the volume of oil or gas being transported, the transit price will increase, thus encouraging our customers to look for or build bypass routes. Where do we get the money for upgrading the HTS?

I believe that we should long ago have set up a company on the basis of the national HTS, which would finally start discharging its main functions: earning money and expanding its capitalization. Ukrtranshaz isn’t doing this today because all decisions are made by Naftohaz Ukrainy. Our political leadership, particularly the government, must do everything to ensure that competitive Ukrainian companies (not just those in the gas and energy complex) become at least trans-European businesses, if not transnational ones. This will mean true European economic integration.

Gazprom will instantly turn this scenario to its own advantage, while Ukraine will lose its important trump card with regard to gas price-setting questions.

I am a patriot, but I am also a proponent of common sense. If we don’t have enough sense to protect our own interests, then perhaps it would be best to find a good investor, which can only be Gazprom. Is there any sense in deferring the solution of problems and hoping that a magician will appear and fix everything? We have to make active decisions today, because tomorrow the Uk­rainian pipeline will lose investment attractiveness. Right now it is still convenient for the Europeans to invest in it.