Rocky Road to Yamal 2

Polish Prime Minister Donald Tusk has asserted his control over Polish infrastructure projects, by firing state officials who signed a memorandum with Gazprom without his knowledge.  The Yamal - Europe 2 gas pipeline has been on the planning books for twenty years, and and had been almost forgotten.  In the midst of Russia's latest quarrel with Ukraine over transit rights, however, Russian President Vladmir Putin revived the dormant proposal on April 3.  Putin requested Gazprom CEO Alexei Miller to take another look at the proposal, despite no additional gas supplies available to fill the pipeline.

Miller quoted a market analysis that Gazprom could transport 15 billion cubic meters of gas to Hungary and Slovakia.  He proposed construction could begin in 2018-19 after the completion of the South Stream project.  Polish Treasury Minister Mikolaj Budzanowski dismissed the possibility out of hand.  "I approach media speculation regarding a second branch of the Yamal gas pipeline with great caution, because the consent for such a project should depend on the price of the raw materials and its suppliers," he said.  "The European Union does not need more supplies of natural gas from Russia," he told Polish radio.  A separate report quotes Budzanowski in even stronger terms.  "No one, except for the Polish company and the Polish government is entitled to make decisions about transit via the Polish territory.  That's why we would like to tactfully remind that we are not going to build a new gas transportation network to Poland or the European Union on instructions from anyone, especially from Gazprom."

Polish Minister of the Economy Janusz Piechocinski recognized that the new pipeline's sole purpose was to divert gas from the pipeline that transits Ukraine, putting more pressure on that state to accept Russian demands to pay more for gas.  He said Poland should be "very careful" about getting involved in the spat over the gas price.  These cautions were echoed by Polish Prime Minister Donald Tusk.  "Poland won't participate in these political contests.  For us, gas isn't a tool to conduct politics and we very much want, in agreement with European Union laws, to keep gas issues free of politics."

With the major Polish officials all opposed to the new pipeline, it came as a shock to all when Gazprom announced that it had signed a memorandum of understanding with Miroslaw Dobrut, CEO of Polish pipeline operator Europol Gaz.  "The document envisages the implementation of the Yamal-Europe 2 project through  Poland," the Russian company stated in a press release.  It envisioned the completion of a feasibility study in six months.

The Prime Minister was furious that such an agreement could be signed without his approval.  Grazyna Piotrowska-Oliwa, head of PGNIG SA (part owner of Europol Gaz) immediately tried to backtrack.  She said Gazprom was exaggerating the significance of the memorandum, which was merely an agreement to evaluate the project.  "Nobody knows what the result of the analysis will be, whether it's going to be profitable at all," she said in a television interview.  "The memorandum does not include a decision to build the pipeline and is not a legally binding agreement or pledge to conclude any agreements or contracts."

The dominoes quickly fell.  On Friday, April 19, Prime Minister Tusk fired Economics Minister Budzanowski for failing to monitor the activities of the state-owned PGNIG.  "In my view, the oversight function was not fully implemented," he said.  Budzanowski was replaced by Wlodzimierz Karpinski, whom the Prime Minister warned about needed personnel changes in the gas  company. Ten days later, PGNIG's board let go CEO Piotrowska-Oliwa and her deputy, Radowslaw Dudzinski.

In the face of such insubordination, the Polish government was not satisfied with the personnel changes.  In June, the Treasury introduced a proposal to change the statutes under which PGNIG operates.  Under the new plan, PGNIG's management board would be required to report on any agreements with foreign entities.

The Yamal - Europe 1 pipeline was originally conceived in 1994, and began operating in 1999.  It is the main pipeline for Gazprom's Eastern European clients (Western Europe gets its gas from the Ukrainian pipeline and, more recently, Nord Stream.)  It stretches over 2,000 kilometers over Belarus and Poland.  In Poland, the pipeline is owned by Europol Gaz, which in turn is owned jointly by Gazprom and by the Polish state-controlled gas company PGNIG SA (48% each.)   Yamal - Europe 2 was proposed in 2008, but in 20009 the Russian then-president Dmitry Medvedev postponed the project, citing inadequacy of supply to meet all the Gazprom agreements with the EU.  If completed, Yamal 2 will have a 15 bcm capacity.

While Prime Minister Tusk may not have been happy with the way Yamal 2 was resurrected, there are signs that planning for the project is continuing.  Russian Ambassador to Belarus Alexander Surikov has confirmed that the feasibility study proposed in the memorandum of understanding is continuing, and will be completed by November 2013.  "Poland has confirmed its willingness to have an additional 15 billion cubic meters of gas," he said. "All these issues will be resolved...in November."

Ukraine's Days Numbered as Natural Gas Conduit

Ukraine continues to argue that repair of its aging pipeline structure is an economical alternative to construction of the more costly South Stream pipeline.  According to Uralsib's Chris Weafer, however, such an alternative is a non-starter from Russia's point of view.  Weafer argues that repairs would continue to deprive Russia of control over the delivery of Russian oil, would remove Russia's ability to extend its economic interests into countries to be serviced by South Stream, and it would provide Central Asian gas a viable alternative transit route to Europe--thereby depriving Gazprom of its Eurasian monopoly. 

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.

Russia Buying Belarus

Despite the December 2010 creation of a Russian-Belarusian common economic zone, and the January agreement between Vladimir Putin and the Belarusian prime minister Mikhail Myasnikovich to provide $4.1 billion in subsidies to Belarus through the lifting of tariffs on Russian oil, the Belarusian economy is near collapse. Russia has decided to cometo the rescue, but at a price--Belarus has to sell its half of its gas pipeline network, Beltransgas, to Gazprom. Reuters quotes an EU diplomat as stating "Russia is not going to give free money to Belarus. They want a piece of Belarus in return." In the same article, Russian international relations professor Kirill Koktysh says, "Loans will be granted in an amount that is enough to avert a collapse but in no way enough to preserve the status quo." What is Russia's goal? According to Fyodor Lukyanov, editor of the journal Russia in Global Affairs, the Kremlin's ultimate hope is "to make it so that Belarus is oriented, irreversibly and forever, toward economic cooperation and integration with Russia."

The first step in this transformation of the Belarusian economy is privatization of Belarusian resources, and Gazprom's purchase of the gas pipeline. Gazprom already owned 50% of the pipeline before the economic crisis. On May 20, PM Myasnikovich told reporters that Gazprom would acquire the remaining 50% for $2.5 billion, the same price they paid between 2007 and 2010 for the initial 50% share. Russian finance minister Alexi Kudrin intimated that additional funds--up to $9 billion--could be made available for other state assets such as oil refineries, the main mobile phone provider, and a potash production complex, according to Reuters.

Kudrin has offered an additional $3 billion loan, but then denied the money would come from Russia. Instead, Kudrin said the loan would come from a Russian dominated regional grouping, the Eurasian Economic Community, according to RadioFreeEurope. Russia will use its allies' money to obtain its own geopolitical advantage.

Of course, Russia is not the only country trying to buy Belarusian assets. Oil and Gas Eurasia reports that Venezuela may seek shares in Belarusian refineries. Belarus ambassador to Venezuela, Valentin Hurinovych, said "We need this so that they can have their own assets and allow their capital to be part of our industry...I think that Venezuela will soon be our partner." Venezuela is already in the country in a joint venture to exploit Belarusian oil fields.

As Lukyanov noted, Russia's purchase of Beltransgas is not just the purchase of an energy asset, but it is the purchase of Belarusian sovereignty. Once Russia controls the Commanding Heights of the Belarusian economy, no leader of Belarus will have the room to decide against Moscow's interests.