It’s hard to understate the significance of this agreement if, indeed, it moves from a deal in principle to an actual deal. This would mark the first economic/trade deal of any note between Ukraine and Russia in the period since the EuroMaidan Revolution that deposed President Viktor Yanukovych in 2014.
And let’s not forget that, over this period, the Ukraine-Russia trade/economic relationship has been beset by legal battles, court cases and collapsing trade flows.
To put things into perspective, at the time of the EuroMaidan, something like 35-40% of Ukrainian trade flows were with/to Russia, and now they are in single digits. In 2009, at the time the prior to the Russia- Ukraine gas pricing/transit agreement, Ukraine was set to import around 40 billion cubic meters of gas from Russia for domestic consumption, with around 117 billion cubic members in gas set for transit through Ukraine to Europe. Since then gas imports from Russia (which had been costing something like $12 billion annually) were down to close to zero over the past year, while gas transit flows had more or less halved.
What is going on?
Well in part, this reflects the fact that Russia needs Ukraine for at least the next year, until Nord Stream 2 is fully up and running, it still is unable to fully cut Ukraine out of gas transit, albeit Nord Stream 2 significantly reduces its dependency. So it does need some kind of deal with Ukraine – it pitched for a one-year deal, but given the Ukrainians were looking for another 10-year deal, it had to give something up to Ukraine, and under strong pressure from the Europeans. It seems like the Ukrainians got much more than they expected – a 5-year deal perhaps.
Why is Putin being so generous?
In part, I think he feels he has won the geopolitical battle with the West, with Trump looking set to get a second term in the US, Brexit, and with French President Emmanuel Macron, et al., looking to normalize the relationship with Russia. Being seen to be reasonable over gas talks with Ukraine – which really are about assuring gas supplies to Europe, not Ukraine, plays well to the agenda of those in the West wanting normalization in the relationship with Russia. And Vladimir Putin knows this – a similar theme is perhaps playing out now in terms of peace talks under the Normandy format with Ukraine. Russia is not giving up that much, but perceptions in the West matter – and Putin is plying a line that Russia is being reasonable. Prisoner swaps, et al play to this. And really what is Moscow giving up? Not much in terms of gas – as it lost the Stockholm ruling over $3 billion or so owed to Naftogaz, and Gazprom will have to pay, eventually, while it still looks set to get Nord Stream 2 completed sometime in 2020. So it is actually further down the line of cutting Ukraine out of gas transit to Europe.
And what about the Ukrainians?
The Ukrainians were hoping that U.S. sanctions on Nord Stream would come much earlier, and scupper the project. But Trump administration and Congress stalled on this – to the point that Nord Stream 2 is now a done deal. But I think over the past 4-5 years, Ukraine has come to the realization that it can live without gas supplies from Russia, and also the $3 billion annual gas transit fees it earns in that respect.
Indeed, in some respects, moving out of Russia’s gas supply chain could be a big positive, as this whole business has in the past bred a dependency on Russia and corruption culture amongst Ukraine’s elites (an estimated $3 billion disappeared in graft annually amongst Ukrainian elites from this business). Thinking beyond this business has allowed Ukraine to further reform in the energy/gas sector (rationalize prices, cut demand and increase supply), and to realize that it can actually be self-sufficient in energy in the medium term, and even a gas exporter over the longer term. Ukraine has already cut its annual gas import bill from $12 billion as mentioned to $2 billion or so, and this could easily move into a net export earner. A remarkable turnaround in just over a decade.
And I guess this particular gas deal accepts the inevitable that Nord Stream 2 is now a reality, and from a Ukrainian perspective better use what remaining leverage it has, screwing Russia for as much as possible. And in this respect it looks like a five-year deal, where Russia pays the sums owed as per the Stockholm arbitration ruling, perhaps having this set against discounted gas prices from Russia for a period, and being assured of some gas transit fees for at least the five-year period.
Perhaps gas transit will be set at 60 billion cubic meters on a declining scale over the five-year period. But from a Ukrainian perspective, this buys Ukraine more time to build alternatives for the time when Russian gas transit stops. And perhaps therein, Ukraine is mindful that Russia’s natural gas transit business to Europe is in decline anyway, as it faces increasing competition from the Gulf and the U.S. in terms of LNG imports to Europe. Why fight for a business which might soon be a shadow of what it once was?
