Ukraine squeezed by Russian and Turkmen gas pricing ambitions

by Simon Pirani

Turkmen president Saparmurat Niyazov last month responded to Ukraine’s latest requests for a new 30-year supply contract by insisting that long-term arrangements could only be made in three-sided talks with Russia. And with current direct contracts between Naftogaz Ukrainy and Turkmenneftegaz set to expire at the end of 2006, and a new 30-year Turkmen-Russian deal signed, Ukraine seems to be losing the latest phase of the “gas wars”.

President Niyazov met Ukrainian energy minister Ivan Plachkov and Naftogaz Ukrainy boss Aleksei Ivchenko in Ashkhabat on October 11-13, and the two sides agreed on a schedule for clearing $475.8 million debts owing for gas delivered to Ukraine in the first half of this year. They also agreed to push forward talks on co-operation in developing Turkmenistan’s offshore reserves, and on the agenda for new Ukrainian prime minister Yuri Yekhanurov’s visit to Ashkhabat on October 26.

The Ukrainian energy ministry said that the price for gas delivered in 2006 has been set at $44/Mcm (see GMT, October 17), but the Turkmen state news agency simultaneously said that this issue would be “dealt with in the near future”. And Niyazov loudly and publicly insisted that long-term arrangements would only be made together with Russia.

The episode is a reminder that, along with Russia and the controversial transit contract, there is a Turkmen aspect to Ukraine’s supply problems. Gazprom’s determination to move towards market prices is headache enough for Ukraine; the Turkmen president’s efforts to play his two big customers off against each other makes things worse.

Ukraine’s $475.8 million debt to Turkmenistan comprises the portion of its gas bill for the first half of 2005 that, under previous payment arrangements, was covered by barter. In December 2004, Turkmenistan threatened to increase prices for both Russia and Ukraine unilaterally and $58/Mcm, part paid in barter, was agreed. Crisis talks in June led to barter for Turkmen gas being suspended. Instead both Russia and Ukraine are paying $44/Mcm in cash in the second half of this year. But Ukraine’s back debt is unpaid.

During the continuing political row in Kiev over gas, some contours of how the barter system worked have become clearer. Goods provided to Turkmenistan as payment for gas were ordered from manufacturers by Naftogaz Ukrainy and priced at a “coefficient”, so that the Ukrainian seller received from Turkmenistan between one-and-a-half and three times the current value. Yuri Boiko, the former Naftogaz Ukrainy boss who went into politics after being sacked in February by president Yushchenko, in a recent newspaper interview slammed his successors at the gas company for agreeing to settle the debt to Turkmenistan “not at a coefficient of 1.9-2 [i.e. not with the bartered goods being priced at 1.9-2 times their average prices], as was provided for when the contract was agreed, but at ‘average world prices’ [of the bartered goods], i.e. without coefficients”. It would be unsurprising if the opaque array of companies that sold goods, including consumer goods and steel and engineering products, for twice their market value under this scheme had now lost interest in participating at market prices.

Observers of gas industry corruption in Ukraine in the wake of the “Orange revolution” will want to keep a close eye on the price negotiations with Turkmenistan. Although political leaders of both countries have said that they prefer cash settlement, cynics believe that barter payment, from which many Ukrainian businessmen made their initial fortunes, may be revived. For one thing, Ukraine will struggle to pay higher prices in cash.

Of greater importance for the wider gas industry is the concerted effort by Gazprom, with Kremlin support, to move towards market prices for Ukraine and other former Soviet states, and to take firmer control of transit. Officials in Moscow have been insisting since the spring that Ukraine must pay European prices for its gas, and they said so again during Ekhanurov’s visit to Moscow in early October. Valerii Yazev, head of the Russian Duma committee on energy and transport, set out the Russian stance in an interview with Gas Matters: “We are ready to pay transport tariffs at market levels, and Ukraine must pay market prices for gas”, i.e. $170+/Mcm at the Russo-Ukrainian border.

Yazev pointed out that the agreement signed in September by Gazprom and Uztransgas of Uzbekistan, under which in 2006-2010 Gazprom will use all of Uzbekistan’s pipeline capacity, “raises problems that will also need to be solved in Russia’s negotiations with Ukraine”. This is because Turkmen gas must travel through the Uzbek system to reach Russia or Ukraine. This Uzbek agreement, like the agreements Gazprom has signed with Turkmenistan (see below), are hefty levers in Gazprom’s price negotiations with Ukraine. And if Ukraine continues without an energy policy that reduces its reliance on Russian gas, this will spell serious economic trouble.

Nevertheless, talk of an immediate shift to European prices is dismissed by industry observers as an extreme negotiating stance. Some industry observers say Ukraine might pay $100/Mcm or so; others doubt whether prices can rise far above $50/Mcm. Asked recently what gas prices he was using to calculate the 2006 budget, the Ukrainian finance minister, Viktor Pynzenyk, insisted that he is using current prices and would not comment further.

Disaster for Ukraine, in the form of steep price increases, may also be averted if voices in Moscow urging pragmatism towards Russia’s southern neighbour are heard. The economic reformers’ camp in Russia, with which economic development minister German Gref and deputy prime minister Dmitry Kozak are associated, is now actively agitating against the provocative political tone struck in the gas negotiations with Ukraine. Aleksandr Milov, a former deputy energy minister who heads the Institute for Energy Policy, in a magazine article last month denounced “the unleashing of dead-end confrontational actions against Ukraine and other transit countries” and urged “a mutually acceptable and civilised regime for gas trading and transit”. He complained that constant Russian references to the North European Pipeline as an alternative to Ukrainian transit were “misleading” since, if and when it is built, most Russian gas will still go via Ukraine to an ever-expanding European market.

That Russia’s negotiating stance includes a degree of bluff is nowhere better illustrated than with the example of the (roughly) 8 Bcm of Russian gas in underground storage in Ukraine, that Gazprom claimed in June had gone missing. After a heated exchange with Ukraine, in which president Putin intervened (see Russia and Ukraine remain tetchy despite storage agreement, Gas Matters, July page 15), it was agreed that about 2.5 Bcm of the gas would be taken by Ukraine as payment for transit, and about 5.5 Bcm would be sold at $150/Mcm to Rosukrenergo (the transport company owned half by Gazprom and half by Raiffeisen Investments on behalf of Ukrainian investors). A source close to the process has confirmed that Rosukrenergo will re-sell the gas to Gazexport at a premium. This means either that Gazprom is buying back its own gas at European prices, or that, if the gas really did disappear from storage, Gazprom has been willing to use its good offices with Rosukrenergo to avoid turning the problem into a major scandal, or both.

Gazprom’s seriousness about taking greater control of Turkmen-Ukraine gas transit is clear. On top of its agreement with Uzbekistan, mentioned above, Gazprom has agreed with Turkmenistan that from 2007 it will buy all Turkmen gas. It has also agreed with Rosukrenergo that from 2007 it will sell it this gas with a 2% commission. The current arrangement, under which Naftogaz Ukrainy buys gas in Turkmenistan from Turkmenneftegaz, sells it to Rosukrenergo at the Turkmen-Uzbek border and buys it back at the Russo-Ukrainian border, will end. “There will be no direct contractual relationship between Ukraine and Turkmenistan”, Rosukrenergo board member Wolfgang Putschek confirmed to Gas Matters.

And while Naftogaz Ukrainy’s position in central Asia has weakened, Rosukrenergo’s has become much stronger. During the summer the company faced a political threat from former Ukrainian prime minister Iuliia Timoshenko, who had prioritised the need for direct transit contracts with Uzbekistan, Kazakhstan and Russia. It had also faced persistent claims by Aleksandr Turchinov, former head of the SBU (Ukrainian security service) and a leading member of Timoshenko’s political party, that he was close to arresting people close to the company on corruption charges. So persistent have been the reports in Kiev that Aleksandr Tretiakov, Yushchenko’s chief of staff, had intervened to halt Turchinov’s investigation, that he robustly denied doing so in a recent interview on the political web site Ukrainska Pravda.

With Timoshenko’s exit from government, these dangers to Rosukrenergo have been averted. The prospect of Naftogaz buying the 50% of Rosukrenergo managed by Raiffeisen has also receded. While Gazprom has said that it has no objections to such a sale, Naftogaz has been unable to strike a deal with the current owners.

Timoshenko and Turchinov continue to concentrate fire on Rosukrenergo, probably because they assume that the investors on whose behalf Raiffeisen acts are allies of former president Leonid Kuchma. Neither these beneficiaries, nor the directors of Rosukrenergo except for Putschek, nor any executives apart from CEO Lars Haussmann, have been named publicly by the company.

Rosukrenergo is set to continue managing the transit contract as Euraltransgas and Itera did before it. Putschek confirmed to Gas Matters that, as payment, the company takes 37.5% of the transit gas, i.e. around 13.5 Bcm. (Euraltransgas and Itera were paid at a similar level, although some sources in Kiev claim that it was higher, i.e. 38-41%). Rosukrenergo pays Gazprom “around $500 million a year, depending on volumes”, for providing transport services, Putschek said. It has sales contracts for “about 8 Bcm” in Poland (mainly with PGNiG) and Hungary (mainly with Mol). The rest would be sold “mainly to Gazexport”. Rosukrenergo does not sell to the domestic Ukrainian market, he added.

When Euraltransgas published its first year’s accounts, Gazprom’s critics said that the gigantic profit it made from the transit contract showed that Gazprom was frittering away money that could have been on its own books. Rosukrenergo’s first reporting year ends on December 31; whether the same will be said when its numbers are filed with Swiss regulators remains to be seen.

A version of this article appeared in Gas Matters magazine, October 2005.
Posted October 2005; © 2005 Simon Pirani

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