Ukraine threatens to abandon Russian gas as EU supplies more fuel

1/23/2015

By OLGA TANAS and ELENA MAZNEVA
Bloomberg

As warmer spring weather approaches, Ukraine is feeling bold enough to talk tough with Russia on natural gas supplies.

The country is willing to cut imports from its eastern neighbor to a minimum this year unless the former allies overhaul their price agreement, the head of Ukraine’s state energy company said in Davos.

“We could get as much as 90% of the gas from Europe if we fail to agree on a price with Gazprom,” NAK Naftogaz Ukrainy CEO Andriy Kobolyev said in an interview. “We can see Europe’s desire to work with us because we proved this year that we’re a very dependable and financially reliable partner.”

European suppliers, including RWE, GDF Suez and Statoil, stepped into the gap left when Russia cut supplies during a payment dispute in June, according to Kobolyev.

Their price is more than 10 percent lower now than that of Russia’s OAO Gazprom, which is charging Ukraine about $330 per 1,000 cubic meters in the first quarter with payments upfront.

Ukraine is trying to reduce reliance on gas shipments from Gazprom, the world’s biggest supplier of the fuel. A deadly conflict in eastern Ukraine has ruined relations with Russia, which depends on Ukraine’s Soviet-era pipeline network to help supply about 30% of Europe’s gas.

Slovakia Pipeline

European suppliers can provide at least 12 billion cubic meters, which accounts for 60% of this year’s imports, Kobolyev said. The main point of entry is through Slovakia’s Vojany-Uzhorod pipeline, while smaller quantities can be supplied from Poland and Hungary.

The three countries have the technical capacity to deliver as much as 21.9 billion cubic meters of gas to Ukraine per year with the European Commission today announcing the expansion of the Vojany link from Jan. 24.

Still, Ukraine’s neighbors with gas interconnections must walk a fine line between helping the country and not incurring Russia’s wrath. In the past several months, Gazprom has cut gas deliveries to Slovakia, Poland and Hungary, ostensibly because it was building up its own storage for the winter.

“Ukraine still needs the Russian gas, especially to prepare for the coming winter heating season,” said Alexander Kornilov, an energy analyst at Alfa Bank in Moscow. “We may see the conflict escalating by September or October.”

Tricky Situation

Despite Kobolyev’s comments at the World Economic Forum in Davos, he confronts a tricky situation: negotiating a gas deal with Russia, while simultaneously finding new supply routes from the EU and convincing Ukrainians they must reduce domestic consumption.

The 36-year-old has warned that prices for Ukrainian consumers will have to be raised drastically because the country can’t afford to continue subsidizing the fuel. The former PriceWaterhouseCoopers consultant, who became Naftogaz CEO last March, is also trying to reform the inefficient and financially unstable state monopoly, a relic of the corruption-ridden era of former President Viktor Yanukovych.

Ukraine’s domestic gas production is set to rise as much as 5% this year, while imports will remain at about 20 billion cubic meters, Kobolyev said.

Previously the largest importer of Russian gas in the former Soviet Union, Ukraine cut direct deliveries from Gazprom by 44% to 14.5 billion cubic meters last year. That’s the lowest level from the Moscow-based exporter or its affiliates since at least 1999.

‘No Problems’

At the same time, Ukraine bought a record 5 billion cubic meters, mostly re-directed Russian gas, from Slovakia, Poland and Hungary.

Russia restarted flows to Ukraine in December after the EU brokered an interim deal through the winter heating season. That included a $3.1 billion gas-debt payment from Ukraine and a price discount of as much $100 per 1,000 cubic meters on deliveries until March 31.

Kobolyev said he expects “no problems” from Russia in the first quarter as Ukraine has fulfilled all its obligations.

Ukraine and Russia may be headed for another dispute when the EU-brokered deal expires. Naftogaz and Gazprom filed arbitration proceedings against each other in Stockholm in June over prices and debt, and are still awaiting the outcome.

While Naftogaz expects the panel to support its demand for a new pricing formula with Gazprom, the Kiev-based company is ready to negotiate, Kobolyev said. Naftogaz is insisting on a fair, market price, he said.

Alternative Suppliers

Gazprom’s oil-linked price in Europe is about $300 per 1,000 cubic meters now and may fall below $250 by the middle of the year, according to Mikhail Korchemkin, founder of Malvern, Pennsylvania-based East European Gas Analysis.

Gazprom plans to return to working with Ukraine under their main supply contract, which was signed to the end of 2019, the company said Jan. 21. A day earlier, Russian Prime Minister Dmitry Medvedev ordered Gazprom CEO Alexey Miller to seek the remainder of Ukraine’s gas debt, which wasn’t covered by the EU-brokered deal. Ukraine owes $2.44 billion including penalties, according to Miller.

“We still have an outstanding amount of debt,” Kobolyev said. “It will be resolved after the trial. Gazprom says that we owe them $2 billion, while we believe that we overpaid $6 billion. The court will decide where the truth lies.”

As Ukraine seeks alternative suppliers, Gazprom is threatening to shift all its natural gas flows crossing the country to a proposed route via Turkey after its transit contract with Naftogaz expires in 2019.

Kobolyev shrugged off the plan, announced earlier this month, saying it makes no sense.

“We’re thinking about building long-term relations with European suppliers,” Kobolyev said. “Ukraine is a big gas market.”