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.

BP-Rosneft Deal a Victim of Russian Presidential Politics

Russian presidential politics may have been directly responsible for the collapse of the joint venture between British Petroleum and Rosneft. The deal, which was launched in January 2011 with great fanfare and the blessing of Russian Prime Minister Vladimir Putin, was allowed to die quietly at midnight on May 16. Members of the Alfa, Access and Renova Group (AAR) who are supporters of President Demitri Medvedev, placed insurmountable obstacles before the deal. These oligarchs, who included billionaires Viktor Vekselberg, German Khan, Len Blavatnik and Mikhail Fridman, stood to gain $32 billion if the deal were completed--and yet they refused to grant their blessing.

What happened? In January, BP CEO Robert Dudley inked a deal with his Russian counterpart, Rosneft CEO and Deputy Prime Minister Igor Sechin. Sechin is a Putin protoge. The deal proposed a stock swap: 5% of BP would go to Rosneft; and, in return, 9.5% of Rosneft would go to BP. The deal, valued between $16 billion and $18 billion, was designed to give the Russians access to BP's artic driling technology. In return, BP would have a production sharing agreement for access to the oil. At the conclusion of the ceremony, Putin told a press conference that the BP-Rosneft partnership "may become large-scale and have a serious impact on the global oil and gas industry." Later, when things turned nasty, Putin would distance himself from the project stating the government would not intervene in the controversy--but the prime minister's fingerprints were all over the deal.

It didn't work out. BP was already in Russia, in a 50-50 partnership, called TNK-BP, with the AAR oligarchs. As the former president of this partnership, Dudley should have been aware of the details governing the cooperation between the shareholders, including the granting of exclusivity for BP operations in Russia to TNK-BP. When the BP-Rosneft deal was announced, the AAR consortium promptly filed in a London court to stop the merger. According to sources close to TNK-BP, the oligarchs sought and received Prime Minister Medvedev's support for the legal defense of their interests. One of the oligarchs (Viktor Vekselberg) was involved in an innovatin hub near Moscow that was the result of a Medvedev policy initiative. Medvedev further signaled his displeasure by ordering Sechin (and other government officials) to give up corporate posts to stay in the administration. The battle over the merger became a battle between forces loyal to the Prime Minister, and forces loyal to the President.

The issue ended in an arbitration court that issued a consent order permitting the share swap to proceed, but only with the approval of TNK-BP. Without that approval, the rights to drill in the Artic would devolve onto TNK-BP (and not the parent BP corporation), with the approval of Rosneft. Rosneft officials, however, did not want to work with the AAR partners. Efforts began to purchase AAR's 50% share of the partnership. Bidding rose from $27 billion to $32 billion, but to no avail. The Financial Times quoted one observer as saying, "The feeling is they (AAR) did not want to do a deal at all. They were forwarding conditions that they knew ahead of time that BP and Rosneft could not accept."

The blame game has already begun. According to Bloomberg, President Putin blamed BP's Dudley, stating the CEO had left him "completely unaware" of a potential dispute with AAR. Medvedev, by contrast, blamed Putin protoge Sechin and the entire Putin-led government. "Those who prepared the deal should have paid more attention to the nuances of the shareholder agreement. They should have had better due diligence inside the government," he said.

How could BP have ignored its responsibilities under the TNK-BP partnership agreement? According to the managing partner of Goltsblat BLP, Andrey Goltsblat, the problem lay in the informal nature of the Russian legal and business systems. As published in Business RT, Goltsblat said, "I do believe that lawyers knew about that clause and lawyers informed BP, but unfortunately sometimes in Russia more people rely on relations with the government or with the other level of officials, rather than on the law...BP probably thought that the clause is not that important, yet, as they are dealing with the government they are told that the deal is blessed by the Prime Minister and that there shouldn't be problems to overcome that clause."

The issue now moves to the courts. The Moscow Times provided an analysis of the situation from Russian attorney Vsevolod Miller (Yukov, Khrenov & Partners). According to Miller, there would be a guarantee warranty clause in the Rosneft-BP deal, and BP would be in breach because of its probable failure to disclose the TNK-BP shareholder agreement. "Rosneft will sue BP for breach of warranty--they will sue for direct damages, which are likely to run into the millions," he said. Miller added that there were no grounds for a case against AAR (presumably because AAR was only defending its legal rights). Reuters reports that according to a source close to TNK-BP, the company is considering suing for damages of up to $10 billion.

It is still a couple of years until the Presidential contests but, if one considers this skirmish as the first Presidential primary, Medvedev has emerged in the lead.