Russia could overcome one of these objections if it owned or controlled the pipeline network. An unidentified Ukrainian Presidential aide reported that Gazprom had offered $4 billion for the system. The Ukrainians refused to transfer ownership of the pipelines, however, and various proposals for joint operations remained unconfirmed. In December, 2011, Kommersant-Ukraine quoted an unnamed official in the Ukrainian Energy and Coal ministry as saying Ukraine and Russia had agreed to form a group to handle the pipelines. The only real disagreement was that Russia wanted the new unit to be formed bilaterally, while Ukraine was hoping for European participation. According to Ukrainian Ambassador Viacheslav Kniazhnytsky, however, "I have no information about this kind of consortium. Besides, Ukrainian legislation doesn't provide for a consortium within which Gazprom can run Ukraine's pipeline."
To force the ownership issue, Russia is trying to use transit pricing as a weapon. In December 2011, Prime Ministers Putin of Russia and Azarov of Ukraine failed to agree on a Ukrainian-demanded reduction in the price of gas, because Ukraine would not give Gazprom a stake in the pipeline network. Gazprom CEO said Kyiv was demanding a $9 billion annual reduction in price, while citing the cost of modernization of the network between $3-8 billion. Kyiv estimated the value of the system as roughly $20 billion, but Miller speculated the value could drop significantly once South Stream had been constructed.
In reply, Ukraine announced it would reduce the volume of gas it would purchase from Russia from 40 billion cubic meters (bcm) in 2011 to 27 bcm in 2012 unless the price came down. An angry Miller replied that gas sales to Ukraine were on a "take or pay" basis, and the price would be the same (based on 33 bcm per year) regardless of the quantity Ukraine imported. "We are working strictly in line with the contract, strictly in line with this volume, " Miller told reporters. Gazprom spokesman Sergei Kupriyanov added, "The time for discussion on contract volumes in the new year has passed. And, unfortunately, we must remind our Ukrainian friends again that the terms of gas delivery are determined only by contract, and cannot be changed unilaterally by this or that letter." Kuriyanov believed that time was on the side of the Russians: "South Stream to full capacity, Nord Stream with additional lines and our existing capacity through Belarus and the Black Sea will reduce Ukraine's importance for transit to zero," he wrote in an email.
Ukraine may have felt pressured to procure a lower gas price because of pressure on its balance of payments position. Deputy prime minister Serhiy Tigipko said that if the Russians did not agree to a lower price, the country would be forced to raise household gas fees by 30 percent. Renaissance Capital's Anastasia Golavach explained: "It is becoming crucially important for Ukraine either to reduce the volumes of the gas it buys or renegotiate the price, otherwise there will be huge pressure on its balance of payments, which are especially strained in the current global environment." Golavach predicted it was only a matter of time before Ukraine gave in to Russian demands and sold the pipelines. "The government realizes it's high time to sell the network because Russia has already launched one alternative pipeline and is planning construction of another. But they won't do it before the elections because the move would be too unpopular domestically." In the end, the government did not raise the rates.
Ukraine decided to up the ante by exploring alternative sources for its energy needs. In January 2012, Minister of Energy and Coal Industry Yuriy Boiko told journalists he had entered into negotiations with Turkey for gas shipments via a new route. There were also reports of plans to purchase LNG from Azerbaijan. Prime Minister Azarov discussed plans to buy the gas from Germany. No one addressed how any of these purchases would take place, since there was no direct pipeline connection with any of these countries, and Ukraine lacked a gasification plant if it tried to buy LNG.
In the midst of the controversy, Russia reduced the flow of natural gas to Western Europe because of a spike in domestic demand caused by an abnormally cold winter. The Kremlin blamed the shortage on the Ukraine, arguing that the transit country was stealing the gas destined for Europe. Ukraine denied the charges. (See my blog entries "Kyiv Pulling Away from Moscow" and "Russia-Ukraine Price Dispute" for additional details.)
As Moscow threatened to cease using Ukraine for any gas transport, the European Union weighed in on the side of Ukraine. EC spokeswoman Marlene Holzner demanded Ukrainian officials develop a plan to maintain their crucial role."The unique geographical location of Ukraine and its gas storage capacities mean that Ukraine can offer increased flexibility of gas supply. The European Commission is convinced that Ukraine needs to elaborate a long-term strategy to ensure its position as the leading gas transporting country." To help, the European Bank for Reconstruction and Development agreed to a $308 million dollar loan for emergency repairs, but only if the state energy firm Naftogaz agreed to a restructuring.
The Ukrainian parliament agreed to the breakup to the company in March 2012, lifting a previous ban on any reorganization of the company. The law required, however, that the successor gas companies to be fully state owned--which would prevent Kyiv from selling shares to Gazprom, according to Reuters.
Ukrainian President Viktor Yanukovych held out hope for a new gas deal with Russia, but IHS Global Insight analyst Andrew Neff said such a deal "would probably be part of an agreement that would give Gazprom a stake in or control over Ukraine's gas transmission system." Russia cranked up the pressure, with Gazprom confirming they were redirecting gas to the newly-opened Nord Stream and through Belarus. Gazprom spokesman Kupriyanov e-mailed, "We are at the start of a big move to redistribute gas transit volumes from Ukraine to our Beltransgas unit and new undersea pipelines." Naftogaz's deputy CEO Vadym Chuprun admitted at the end of March that gas-transit flows to Europe had been halved.
In April, the Ukrainian National Commission of Energy Regulation announced the gas distribution and storage system would be open to any gas producer, Ukrainian or foreign. In theory, this removed the monopoly held by Gazprom; in practice, however, without alternative sources of gas, nothing changed.
Gazprom then agreed to make an advance payment of $2 billion to Naftogaz so the company could purchase sufficient gas to fill its storage facilties. "If Ukraine needs more money to fill up underground storage facilities in order to live through the next winter without any issues, we will consider providing these additional funds," said Gazprom's Miller. Such actions would indicate that, while the Russians continue to pressure Ukraine by reducing gas flows, they are not abandoning the transit route entirely. It is unclear that this money was ever received, however; as President Putin in December 2012 said Russian would have filled the system with fueld if Ukraine had agreed to its offer to lease the pipeline network--implying that it had not occured.
In a July meeting with Russin President Putin, Ukrainian President Yanukovich held out a possible compromise: instead of giving Gazprom ownership rights in the transit network, Ukraine would consider a different Russian request--Ukraine might join a Customs Union with Moscow. "We are not saying 'No', we are thoroughly and seriously studying these integration processes," he said.
Such words were not backed up by action, however. Instead of pulling closer economically to Russia, in August Ukraine passed over the Russian oil company Lukoil in favor of ExxonMobil and Shell for an $8.1 billion project to develop the Skifska hydrocarbon field in the Black Sea. Prime Minister Azarov expressed confidence that Ukraine could become energy independent. He predicted domestic gas production would increase 25% over the next three years, and opined that hydrolic fracturing technology could cover all of Ukraine's needs. (There is an estimated 5.5 trillion cubic meters (tcm) of shale gas in Ukraine, of which 1.18 would be recoverable using current technology).
Boyko announced the country had begun importing gas from Germany, at a price 20 percent cheaper than Gazprom. He also said there were plans to build an LNG terminal on the Black Sea, to be completed by 2015. Buying gas from Germany is a reversal of gas flows, which traditionally have been East to West.
Azarov again brought up the possibility of a trilateral consortium (Ukraine, Russia, Europe) as a way to modernize the pipelines, He proposed transferring control of the network to the group, which would then involve all members in the projected 4.5 billion Euro modernization project. The EC's Holzner's response was coy, stating no specific proposals had been presented. She then offered qualified support to the idea: "The EU has consistently emphasised that it is up to Ukraine to decide how to manage its gas transmission system and should Ukraine and other parties be willing to move in the direction of a consortium, including the EU gas industry, the European Commission is ready to play a facilitiating role, provided that the application of EU and international law, including as enshrined in the Energy Community Treaty, is guaranteed."
Putin claimed that Russia supported the consortium, and that Ukraine had ultimately rejected t. "It was a strategic error on the part of Ukraine to turn down an offer by Russia and its European partners to lease its gas pipeline network without breaching the Ukrainian legislation and providing for it to remain Ukrainian property," he said.
In the end, the two countries appear to be in a lose-lose situation. Ukraine wants to remain the main transit route for Russian gas, but only if Russia will sell gas to that country at rates significantly below those stipulated in the 2009 project. Russia refused, and Ukraine unilaterally announced a reduction in the amount of Russian gas it would take. In retribution, Russia reduced the amount of gas it was selling--to the levels Ukraine had previously unilaterally set. Russia, on the other hand, wants to buy or lease the Ukrainian network, a demand Ukraine has refused. In the meantime, the valuable transit route continues to age, without sufficient money to effect necessary repairs.
