Every few years, Russian and Ukrainian leaders announce with great fanfare that they have resolved all outstanding disputes over gas and stabilized this contentious relationship for years to come. The fact that Ukraine transits 80 percent of the gas Russia sells to Europe means that this is always greeted with a sigh of relief, without much examination of the quality of the deal itself.
Inevitably the promising new deal is quickly found wanting and breaks down, with Russia asserting that Ukraine now owes it billions of dollars for failing to meet its contractual obligations. This has been a consistent pattern, even during the decade before the 2004 Orange Revolution.
Since 2005, the perennial Russia-Ukraine gas fight has taken on additional political and, indeed, geopolitical tinge. It goes beyond normal brinksmanship of the murky gas trade in Eastern Europe that led to interruptions of gas flow for Europe twice in the last five years. In January 2006, ex-President Viktor Yushchenko and then-President Vladimir Putin embraced a new gas deal that was supposed to bring market practices to previous counter-trade arrangements, but in fact expanded non-transparency in the gas trade.
In January 2009, ex-Prime Minister Yulia Tymoshenko and Putin, as prime minister, concluded another new deal that was supposed to bring European gas pricing to Russia-Ukraine relations, but was so fundamentally flawed that its terms had to be adjusted within a couple of months.
On April 21, the world watched again with interest and apprehension as another set of Ukrainian and Russian leaders proclaimed in Kharkiv a gas agreement that, in the words of President Viktor Yanukovych, is “unprecedented in the history of our relations.” Before the world reflexively applauds the avoidance of future gas wars between Russia and Ukraine, it may well want to examine details of this deal from what has been announced so far and what information may come out in the days and weeks ahead.
The Russian missile cruiser Moskva sits anchored in the Black Sea port of Sevastopol, Ukraine. The presidents of Ukraine and Russia announced an agreement on April 21 to extend the stay of Russia’s Black Sea Fleet by 25 years after the existing lease expires in 2017. In return, Moscow is willing to give Kyiv a 30 percent price break this decade on the nation’s vast imports of Russian natural gas. (AP)
What we already know from the two sides is that they amended the January 2009 agreements on gas supply and transit, which were rightly criticized by the new government as being unfavorable to Ukraine, and did not draw up new contracts. This allows the deal to be sold publicly on a false premise, which is unquestioningly reported by the news media, that Ukraine will be getting a “discount” on gas pricing. This is far from the truth.
One of the fundamental flaws of the Jan. 19, 2009, gas sale and purchase agreement is that it set too high a base price for Russian gas to Ukraine. The $330 per 1,000 cubic meter price we are told Ukraine would have had to pay for Russian gas this quarter is higher than the Russian gas sale price to Western Europe today.
A price of $230 would be closer to the European price after accounting for transportation cost differential between Ukraine and West European destinations. It is still higher than current spot gas prices in West European markets. So the “30 percent discount” of 2010 is just as phony as the “20 percent discount” of 2009.
There is no price discount, but a normal price that Ukraine should have been able to negotiate without undue concessions.
What’s more, according to Gazprom, the so-called discount is linked to the Russian government exempting an export duty for deliveries to Ukraine.
What happens if, at some future date, the Russian government chooses to remove the export duty exemption as it recently did with oil to Belarus?
The new Ukrainian government could have chosen to fundamentally revise the January 2009 agreements, including its faulty price formulae for gas and transit and related escalation clauses, or reach a new short-term agreement in order to buy time to negotiate properly a new long-term sustainable agreement. Instead, it committed itself to the previous government’s technically flawed agreement which continues until 2019.
One hopes that more details will be forthcoming on what the two sides agreed to. Much of what has been released raises more questions than answers. In addition to the price formula, the “take or pay” principle of the previous agreement was also affirmed. However, the Russian side has repeatedly made the magnanimous gesture of not collecting the financial penalty under the take-or-pay provision when Ukraine has failed to meet its off-take volume obligations almost from the start in 2009. Why does a provision that is not enforced have to be specifically restated in the new addenda signed in Kharkiv? Could it lead to future Russian claim on some residual contractual obligation by Ukraine, as has frequently happened in the past?
Indeed the risk of purchases lower than agreed to buy is now higher. The new government committed to a purchase obligation of 40 billion cubic meters annually starting in 2011, which is more gas than Ukraine bought in 2009 or will buy in 2010. Ukraine is already one of the most gas-intensive economies in the world. What does this contractual obligation do to Ukraine’s plans to improve energy efficiency, increase domestic gas production, or diversify energy sources? In order to protect the nation from being obliged to pay for gas it might not need, will Ukraine have the right to re-export Russian gas? Russia has refused to allow Ukraine to do this in the past, but removing any destination restriction would be consistent with European practice.
Will the illusion of “discounted” gas price lead to further avoidance of much needed and delayed reform of the gas sector in Ukraine, where low prices cause wasteful consumption, especially by politically favored industries; where multi-tiered pricing leads to grey market operations; where domestic production is discouraged by depressed wellhead prices and is used to subsidize higher-priced imports; where a dysfunctional and technically bankrupt state monopoly continues to drain state coffers; and where the truly needy in the population do not get energy assistance and suffer shortages instead?
Curiously the new addenda addresses some minor changes in payment dates for Russia on the transit fee to Ukraine, but fails to mention whether Russia has any “ship-or-pay” obligation to transport a defined volume of gas through Ukraine, which would be a natural companion to Ukraine’s take-or-pay obligation. Unlike the gas price for Ukraine, the gas transportation price for Russia is also not stated, although it was previously reported to have been improved in 2009.
This results in a set of agreements in which Ukraine is contractually obliged to buy gas from Russia, but Russia is not obliged to ship gas through Ukraine. This was another fundamental flaw of the Jan. 19, 2009, agreements that did not seem to have been addressed by the new government. It may matter little in the short run, but will matter quite a bit if Russia completes all its Ukraine bypass pipelines, Nord Stream and perhaps South Stream, before 2019.
What is additionally worrisome is that the new gas deal is tied to the politically charged issue of extending the lease for the Black Sea Fleet at Sevastopol by 25 to 30 years. As an energy expert, I instinctively cringe when a long-term commercial transaction hinges on political rather than economic considerations, since political conditions and needs can change during the course of a contract which one hopes will be honored by all sides. Interestingly my concern may be shared by Russian Energy Minister Sergei Shmatko, who reportedly said on April 7 that, when it comes to Gazprom’s contract talks with Ukraine: “The less politics is involved, the better it would be.”
Perhaps one day Ukrainian politics will allow or better still compel its leaders to look out for the country’s long-term economic interests when it comes to gas rather than short-term political expediency. Maybe the Verkhovna Rada can embark on this path next week.
Edward C. Chow is a senior fellow at the energy and national security program of the Center for Strategic and International Studies in Washington and a long-time observer of the Ukrainian energy scene.
