Russia and Eurasia

Preventing New Gas Wars

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Simon Pirani

28 January 2010

Although Ukraine’s troubles with Russian gas and Russia’s troubles with Ukrainian transit are not over yet, political relations between the two countries should improve after the second round of the presidential election on Feb. 7. Regardless of who wins the final vote, one thing is sure: The country’s next president will be less antagonistic toward Moscow than outgoing President Viktor Yushchenko.

Nonetheless, although the two countries avoided a “gas war” this year, the underlying problems that caused previous gas wars remain unsolved. Naftogaz Ukrainy, the country’s unreformed, heavily taxed national oil and gas company, will struggle to pay for imports. Ukrainian industry, battered by the world economic crisis, will struggle to pay higher prices. And Gazprom, itself coping with the recession’s hammer blows, will not be inclined to offer concessions.

 

Since the January 2009 gas war, Ukraine’s gas imports problem was converted into a cash problem. The Ukrainian government underwrote Naftogaz, and the International Monetary Fund underwrote the government. The IMF estimated Naftogaz’s operational deficit at just under $3 billion and treated it as part of the broader fiscal deficit. Without the fund’s acquiescence, Naftogaz could never have paid last year’s gas import bills of more than $6 billion. The Central Bank shifted money from Ukraine’s foreign exchange reserves into Naftogaz’s accounts to make sure that no payments were missed.

This year, European gas prices will come down a little, following the price of oil. But if oil is about $70 per barrel, as the market expects, Ukraine’s gas imports will probably cost more than $9 billion. Where will the money come from? Either the IMF will make a politically driven decision to underwrite the unsustainable for another year, or Russia will make concessions on price, which it is unlikely to do without getting something in return.

Presidential favorite Viktor Yanukovych has called for the January 2009 gas contracts to be renegotiated. The “base price” used in the contract, which is supposed to reflect European border prices, seems to be about 10 percent higher than it should be. Onerous penalties for failing to offtake monthly gas volumes, written into the contracts in addition to industry standard take-or-pay clauses, were waived this year on Prime Minister Vladimir Putin’s initiative. Couldn’t they be removed completely?

Ukraine’s underlying problem is that its gas consumption is profligate. Like Russia, Ukraine inherited a gas-intensive industry and urban infrastructure from the Soviet Union, which it has found difficult to modernize. But unlike Russia, Ukraine now has to buy the gas at European prices.

Worse still, the economic crisis has devastated Ukrainian industry, slashing gas demand among those Naftogaz customers who pay the highest prices and pay most reliably. This year’s gas truce could lead to a longer-lasting peace if someone finances Naftogaz’s payment gap. The Western powers might encourage the IMF to do so for their own political reasons, and Russia’s rulers might encourage lenders to do so for their own.

The truce will certainly break down if Naftogaz misses payments. It could also falter if contract renegotiations, however legitimate, ignite political hostilities. This is not only a political tug of war, though. It is a commercial relationship. For Gazprom, discounted sales to both Ukraine and Belarus — not to mention the Russian domestic market — carry heavy implied losses. Gazprom, too, has been hurt by the recession.

Gazprom, having tied Ukrainian import prices to European levels, will surely fight tooth and nail to keep them there. The company, with its European customers, will also press on with the Nord Stream pipeline — which is not a substitute for transit pipelines across Ukraine but would mitigate the impact on Gazprom from supply interruptions. That will reduce Ukraine’s ability to use transit as a bargaining chip.

The gas wars were largely caused by Ukraine’s dependency on Russian gas and Russia’s dependence on Ukrainian transit. Reducing those dependencies may hasten gas peace.

Simon Pirani is a senior research fellow at the Oxford Institute for Energy Studies. His most recent book is “Change in Putin’s Russia: Power, Money and People.”

 

The Moscow Times

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