Tuesday, May 24, 2011

Russia-Ukraine Price Dispute

Gazprom's CEO Alexi Miller visited Kiev on 24 May, to meet with Ukranian Energy Minister Yuri Boiko and discuss natural gas pricing. UPI reports that the government of the Ukraine is looking to change the price they pay the Russians for natural gas deliveries. "We need to find mutually beneficial solutions," said Ukranian President Viktor Yanukovych.

The problem is that Russia charges Ukraine the same fee for natural gas as they charge Western Europeans further down the pipeline. The Ukrainians are asking for a discount, claiming that the shorter transit distance does not cost the Russians as much as a delivery further West. UPI quotes Yanukovych as stating, "Both the base price and the formula itself raises questions."

The issue is larger than a pricing formula, however. Russia has been pursuing a strategy for some years to become less reliant on Ukraine as a customer and as a delivery mechanism to the West. Price disputes in 2006 and 2009 led to temporary gas cutoffs to Ukraine, and Russia is now attempting to build the South Stream pipeline to deliver gas to Europe while bypassing Ukraine all together. According to Boiko, this decision does not make economic sense. "The Ukrainian gas route is better for Russia economically, even historically if you will, than the construction of any alternative pipeline. The Ukrainian GTS is one of the world's largest and is capable of transporting up to 200 billion cubic meters a year, even with modest upgrading investments."

Yanukovych made a similar case in Davos in January, when he said that a $5 billion Russian investment in Ukrainian infrastructure would yield better results for Gazprom than the $25 billion the Russians plan to sink in the alternative pipeline. His arguments are receiving short shrift in the Kremlin, however. Gazprom has already procured half of the Ukrainian pipeline Naftogaz, had its naval basing rights extended on the Black Sea, and succeeded in replacing a pro-Western government in Kiev with a pro-Moscow government. Under these circumstances, it makes little sense for the Russians to bail out the Ukrainian pipeline system.

There is one situation in which the Russians would come to the Ukrainian rescue: if Ukraine will sell its remaining 50% interest in Naftogaz. The Russians have been trying to obtain that energy gem since at least 2009. The Russians all but admit their arguments about the need for South Stream are specious. In a February interview with Platts, Gazprom's Miller stated that if the "merger" between Gazprom and Naftogaz took place the Ukrainian gas system would be "filled to the maximum," according to UPI.