“Gas triangle” under pressure

by Simon Pirani

The gas-for-transit payment arrangement between Russia and Ukraine is unravelling under the weight of political change and to the sound of mutual public accusations – and the stand-off is adding to the likelihood of gas shortages in Ukraine this winter. The barter method used to pay for Turkmen gas exported to Ukraine is being phased out. But the most opaque element of the CIS “gas triangle” – the extraordinary contracting-out of the Turkmen-Ukrainian transport contract to lucky trading companies whose ownership is shrouded in mystery – may not disappear quite so quickly.

It is above all the political changes in Ukraine – the election of pro-western president Viktor Yushchenko and the consequent souring of relations with the Kremlin, which openly supported his opponent – that have put strain on Russian-Ukrainian gas cooperation.

In August last year, Russia and Ukraine signed a landmark agreement that drew a line under the disputes of the 1990s, and set prices and payment methods for Russian gas imports to Ukraine and transit services up to 2013. At least 110 Bcm/ year of Russian gas was to be transported to Europe, and the transit fee, of $1.09/Mcm/100km, was to be paid partly with cash and partly with gas priced at $50/Mcm.

Nevertheless, as soon as president Yushchenko’s new government was appointed in January, it declared publicly that it would seek to diversify energy supplies away from Russia, and announced plans for gas transportation routes from Turkmenistan that bypassed Russia. In March it called for Russia to raise the proportion of payments made in cash for the transit of Russian gas through Ukraine and for an increase in the transit fee from $1.09/Mcm/100km up to $1.75-$2.00. Gazprom managers responded that Ukraine would in that case need to pay European prices of $160-$170 in cash for its gas, rather than $50.

No-one believed Ukraine would end up paying as much as that – at an informal meeting with journalists in late June, Gazprom deputy ceo Aleksandr Riazanov described $160-$170/tcm as “unrealistic” – but analysts saw a trend towards cash settlement, and towards higher prices and higher fees. But in the last two months, two factors have aggravated existing tensions: first, Gazprom’s accusations that 7.8 Bcm of its gas held in underground storage in Ukraine has disappeared, and, second, the Ukrainian authorities’ announcement that they will pursue criminal proceedings against RosUkrEnergo, the Russian-Ukrainian operator of the Turkmen-Ukraine transportation contract.

Gazprom first indicated on April 28 that 7.8 Bcm of gas put into underground storage in Ukraine during 2004 had disappeared during the “Orange revolution”. It claimed that it had made more than 40 requests for gas to be withdrawn for export delivery, but these had not been fulfilled – and proposed that Ukraine purchase the gas at the European export price of $160/Mcm.

On June 13, the mystery appeared to have been resolved: Gazprom deputy ceos Aleksandr Medvedev and Aleksandr Riazanov met with senior managers of Naftogaz Ukrainy and signed a declaration accepting that the gas was in storage and available for export. But the very next day, Russian president Vladimir Putin told journalists he was concerned about “the shortfall”. And at the Gazprom AGM on June 24, Gazprom ceo Aleksei Miller angrily told a press conference that “on paper everything looks great – but in reality it’s not like that”.

On June 27 Gazprom unilaterally announced that it was transferring the gas to Ukraine as part payment for this year’s transit fees – a stance that Naftogaz Ukrainy president Aleksei Ivchenko describes in an interview with Gas Matters as unlawful and in breach of contract. Ivchenko repeats the terms of the Naftogaz offer to the Russian side, to deliver the gas starting in the fourth quarter of this year, but industry observers are sceptical about his claim that 2-3 Bcm of it is cushion gas needed to maintain pressure in the transportation system. “The cushion gas belongs to Ukraine, and was there long before the Russian gas was deposited”, says Jonathan Stern, director of gas research at the Oxford Institute of Energy Studies. “Looking at the numerous statements on this subject, it remains unclear where the 7.8 Bcm is.”

Wherever this gas is really located, what is becoming clearer is that Ukraine is likely to have to pay for it at anything up to European export prices. Analysts at Commerzbank put the liability at anything between $360 million (7.2Bcm @ $50/Mcm) and $1,248 million (7.8Bcm @ $160/Mcm). They add in a recent report: “We expect that the missing gas will be deducted from next year’s gas transit at a price of around $80-$84/Mcm, which would not present any immediate cash liability but which would lead to some decrease in future budget revenues.”

Some sections of Ukraine’s new political elite, on the defensive on gas prices and the 7.8Bcm, have gone on to the offensive over one of the least transparent aspects of former Soviet gas relations: the transportation of Turkmen gas to Ukraine. On June 18 Aleksandr Turchinov, the director of Ukraine’s state security police (SBU), announced that a series of criminal cases had been opened following an investigation into EuralTransGas, which took over from Itera as operator of the Turkmen transit contract in January 2003, and RosUkrenergo, which was set up by Gazprom and Naftogaz last year to transport the gas by means of a purchase-and-sale arrangement.

The transit management contract awarded to Itera in the mid 1990s was criticised for being, at least, grossly ineffective for Gazprom, and, at most, a means of corruptly diverting revenues to unknown beneficiaries. Under the contract Itera was paid handsomely for managing transit, although a part of that involved buying security and maintenance services from Gazprom. Payment for the contract was made with 13 Bcm of gas. EuralTransGas, a Hungarian company whose beneficial owners are unknown, was reported to have made a profit of $180 million from its first year of managing the contract.

Partly in response to criticism of these transit arrangements, Gazprom last year agreed with Naftogaz to set up RosUkrEnergo as an alternative. It is owned 50% by Gazprombank and 50% by Raiffeisen Holdings, a subsidiary of Raiffeisen Bank of Austria. Turchinov said in a newspaper interview that there had been “serious abuses” by both companies, with respect to barter payments for Turkmen gas, resulting in losses to the state budget of more than $1 billion. He added that the investigation “will lead to people in very serious posts, who stand behind these schemes”.

Turchinov claims that Raiffeisen holds the stake nominally for Ukrainian investors, and there is widespread speculation in Kiev that the ultimate beneficiaries of the arrangement are people close to former Naftogaz chief Yury Boiko and former Ukrainian president Leonid Kuchma. Wolfgang Putschek, executive board member of Raiffeisen Investments, told Gas Matters that his company acts as trustees for “a consortium of gas people” that did not include Gazprom or any of its managers. He said that neither his company nor RosUkrEnergo had been contacted by SBU investigators.

Putschek said that from January 1 this year RosUkrEnergo has been buying gas from Turkmenistan, paying transit fees to Gazprom and Naftogaz, and exporting it to Ukraine and to central European customers. This new arrangement runs alongside some old contracts that are still in place. But when these expire, RosUkrEnergo will be buying 44 Bcm/year, 36 Bcm for Ukraine, 8 Bcm for other destinations.Total purchases would rise over the next five years to 60 Bcm/year, dependent on the upgrading of infrastructure on the Central Asia-Centre pipeline system. Putschek said all transactions are in cash and all proceeds are paid in to a single account in Raiffeisen Bank Austria.

The new Ukrainian government appears to be split over what to do with the Turkmen transit arrangements. Some want to give a free hand to criminal investigators to examine the use of funds from the contract, trash RosUkrEnergo, and talk to Gazprom about a new method of managing Turkmen exports – a course of action that would land powerful blows at the out-of-favour political forces around Kuchma. Others in the Ukrainian government want to continue with the current arrangement, on condition that the 50% currently held by Raiffeisen is acquired by the Ukrainian state.

Prime minister Iuliia Timoshenko, who has herself been alleged to have made a fortune in the 1990s on gas trading schemes, is in the first camp. Alongside the investigation by Turchinov, a political ally of hers, she has stated publicly that she wants the contract managed with no intermediaries. Naftogaz chief Ivchenko appears to be in the latter camp: in his interview with Gas Matters he repeats that a RosUkrEnergo-structure could remain, provided the Ukrainian stake went to Naftogaz.

Because of the opacity of the transit arrangements in the past, and in particular the contract operated first by Itera and then EuralTransGas, there is widespread suspicion in Kiev that they were a feeding-ground for corrupt elements of the old political regime. The importance that many in Kiev attach to greater transparency was underlined by one of Ukraine’s foremost newspaper columnists, Iuliia Mostovaia, who suggested in a recent article in Zerkalo Nedeli that Ukraine faced “Hamlet’s choice” over Turkmen transit. If president Yushchenko gave the go-ahead for action on the 70-page report on Euraltransgas and RosUkrEnergo drafted by 40 SBU officers, that would mean a “genuine revolution in Russian-Ukrainian relations” and cash settlement for gas at European prices. If the scheme was maintained, Ukraine would remain forever “hooked on Russian forgiveness and energy dependence”, she wrote.

In reality, reducing Ukraine’s energy dependence on Russia also depends on sourcing other supplies of gas, and for this reason the new government is working to improve relations with president Saparmurat Niyazov of Turkmenistan – which has proved tricky. On January 1 this year, Niyazov unilaterally raised the price of gas for both Ukraine and Russia to $58/Bcm. On June 20 he stepped up pressure on the Yushchenko government, accusing Ukraine of owing $61 million on last year’s barter deals and $500 million for gas delivered this year. Niyazov telephoned Yushchenko, and then used a national television broadcast to denounce Ukraine’s “intolerable blackmail” and “breach of undertakings”.

From July 1 the barter element of the sales contract was cancelled and Turkmenistan has insisted that all payments are made in cash, at $44/Bcm – a system welcomed by Ivchenko (see interview). The extra cost to Ukraine of paying in this way for the remaining 15.8 bcm of Turkmen gas to be delivered this year is $237 million, according to Commerzbank estimates.

As Russo-Ukrainian-Turkmen gas relations shift, one victim that has fallen by the wayside is the plan mooted from 2003 to put the Ukrainian transport system under the management of a Russian-Ukrainian consortium with possible German participation. Last month Gazprom and Naftogaz decided that the consortium will no longer be tasked with the management and modernisation of the system, but with concrete projects only, starting with the Bogorochan-Uzhgorod pipeline (see interview).

The toughest immediate battles in the “gas wars”, as they are being called, are faced by Ukraine. Not only is the country acquiring substantial liabilities as a result of the moves towards cash settlement, but it may have a shortfall in its gas balance (see table). Various official sources have put the gas deficit at between 5 and 12 Bcm in 2005, without it being clear whether that includes some or all of the 7.8 Bcm mentioned above. On July 11, Ivchenko announced that 11 Bcm of new purchase contracts – 6 Bcm with the Russian state-owned oil transport monopoly Transneft and 5 Bcm with RosUkrEnergy had been signed, bridging a gap that had been reported previously. The terms of these contracts have not yet been made public. As winter draws in, the true state of the gas balance, the fiscal cost of the conflicts with Russia and Turkmenistan, and the possible impact on the Ukrainian economy, should become clearer.

That is not to say that Russia has a free hand. It remains reliant on the Ukrainian pipeline system to get gas to Europe. As a western industry executive based in Kiev commented: “When Moscow talks about the North European pipeline as a ‘bypass’, that’s a misnomer. Russia needs to raise exports to Europe, so even when that comes on stream, it will continue to need transport through Ukraine.”

What seems certain is that the form of gas cooperation between the three sides is changing. Cash settlement will become predominant, and Ukraine will step up its efforts to diversify supply. What is uncertain is how quickly these arrangements can proceed.

This first appeared in Gas Matters magazine, July 2005.
Posted September 2005; © 2005 Simon Pirani

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