by Vladimir Socor

Denting Russian Gazprom’s monopoly, Ukraine is procuring small but growing
volumes of natural gas from Europe. The German Rheinisch-Westfaelisches
Elektrizitaetswerk (RWE) is providing the volumes through its subsidiary,
RWE Supply & Trading. Ukraine’s neighbors Hungary and Poland are providing
the transit services. The three countries have recently made technical
arrangements to use their pipelines in the reverse mode for pumping these

On March 28, Ukraine began importing natural gas from RWE through Hungarian
pipelines. Prime Ministers Viktor Orban and Mykola Azarov announced the
start of gas transmission via Hungary, effective that day, at their March 28
joint news conference in Budapest (MTI, Magyar Hirlap, Interfax-Ukraine,
March 28, 29).

According to Azarov, “The Hungarian government experienced considerable
pressure, but it took a good-neighborly stand” in authorizing the gas
deliveries to Ukraine. He stopped short of specifying where such pressure
had come from (Ukrinform, March 29).

Hungarian FGSZ (Foeldgazszallitasrol [Natural Gas Transmission], independent
transmission operator unbundled from MOL) is handling these gas shipments
under a technical agreement with its counterpart Ukrtranshaz (Naftohaz
Ukrainy’s gas transmission subsidiary).

According to Naftohaz officials, the transmission capacity from Hungary to
Ukraine currently stands at 3 million cubic meters (mcm) per day, and is
scheduled to increase to 15 mcm per day in the second quarter of 2013. In
annualized terms, this would translate into an increase from 1.1 billion
cubic meters (bcm) to some 5.5 bcm. Ukrainian Energy Minister Eduard
Stavytsky says that Naftohaz is purchasing gas from RWE at the spot market
price of $380 per one thousand cubic meters at this time. This is
significantly below Gazprom’s sale price of $406 per one thousand cubic
meters of gas to Ukraine in the first quarter of 2013 (Ukrinform, March 28;
Interfax-Ukraine, March 28, 29).

Ukraine had never procured natural gas from Europe until November 2012, when
it started importing gas from RWE through a Polish pipeline adapted for
bi-directional use (see EDM, November 20, 2012). Ukrtranshaz signed a
transportation agreement with Poland’s pipeline operator Gaz-System in
August 2012; and Naftohaz signed a sale-and-purchase contract with RWE in
October 2012, with trial-run deliveries starting on November 1, cumulatively
amounting to approximately 50 mcm by January 1, 2013. Deliveries reached an
average daily rate of 2 mcm in the first quarter of 2013 and are planned to
rise to 5 mcm per day in the second quarter. In annualized terms this would
translate into an increase from some 700 mcm to 1.8 bcm. The price was $417
dollars per one thousand cubic meters in November-December 2012, but dropped
to $390 in January 2013, while Gazprom was charging $409. RWE’s price
dropped again to an average of $380 per one thousand cubic meters, compared
with Gazprom’s average sale price of $406 to Ukraine in the first quarter of
2013. Ukrainian officials anticipate that Poland would complete this
pipeline’s upgrade before the end of 2013, enabling an annual flow of 2 bcm
to Ukraine in 2014 (Interfax-Ukraine, February 22, March 21, 28; Ukrinform,
November 1, 2012, and March 28, 29, 2013).

Slovakia’s transit pipeline operator, Eustream, is also negotiating with
Ukrtranshaz for possible transmission of gas supplies from RWE to Ukraine.
Like Ukraine, Slovakia is also concerned about the under-utilization of its
transit system, as Russia shifts export volumes into other corridors or
threatens to do so (North Stream, South Stream). Given Eustream’s transit
capacity of more than 90 bcm per year through its four parallel lines,
Ukraine sees in Slovakia the biggest opportunity for arranging
reverse-flows. Ukrainian officials allude to an immediate reverse-flow
possibility for 2 bcm per year, with a potential for 10 bcm per year, if one
of the four parallel lines is used for transmission in reverse. This might
necessitate construction of a new, bi-directional interconnection near the
Velke Kapusany compressor station, complete with gas metering, on the Slovak
side of the common border. Bilateral talks ongoing since mid-2012 have not
borne fruit thus far. The European Commission’s spokeswoman Marlene Holzner
has indicated that the Commission is willing to facilitate an
interconnection agreement (Interfax-Ukraine, January 21, March 28, 29;
Ukrinform, March 11, 29).

Ukrtranshaz is discussing also with Romania’s network operator, Transgaz,
the possibility of arranging reverse-flow transmission to Ukraine. A
memorandum of intent has been signed regarding possible use of metering
stations at Tekove (Carpathian oblast) or Orlivka (Odessa oblast), both
located on the Ukrainian side of the Ukrainian-Romanian border. The
reverse-transmission capacity at Tekove is cited as 5 mcm per day, implying
1.8 bcm if annualized (Interfax-Ukraine, Ukrinform, March 29). The supply
source, however, has not been publicly identified, nor is it readily
apparent. Hypothetically, it could be a correspondingly small volume from
Nabucco-West, in view of Ukraine’s declared interest in accessing
Azerbaijani gas from the Trans-Anatolia Pipeline.



According to Naftohaz Ukrainy officials, all the ongoing natural gas
purchases from German RWE (see accompanying article) are carried out under a
framework agreement signed in May 2012. This envisages deliveries of 5
billion cubic meters (bcm) in 2013, with the subsequent possibility of
expansion to 10 bcm per year. Following up on that framework agreement,
Ukrtranshaz signed bilateral technical agreements with the Polish and
Hungarian pipeline operators, respectively (Interfax-Ukraine, March 28).

This development marks the start of a de-monopolization of Ukraine’s gas
market, long captive to Gazprom. Growing volumes of gas reaching Western
European spot markets tend to reduce prices through competition.
Bi-directional use of transmission pipelines, now mandatory in EU member
countries, enables Ukraine to access gas supplies from RWE through Hungarian
and Polish pipelines. The volumes seem likely to grow, and the potential
exists for adding to the range of suppliers.

Ukraine intends to increase those imports if European gas prices continue to
be lower than those charged by Russia to Ukraine. The Russian price
(considerably above $400 per one thousand cubic meters) incorporates the
$100 discount applying since 2010 for ten years ahead, in return for
Ukraine’s consent to prolong the Russian Black Sea Fleet’s basing rights
until mid-century. Without that discount Ukraine would have had to pay more
than $500 per one thousand cubic meters of Russian gas. Yulia Tymoshenko
negotiated and agreed that pricing formula as prime minister in 2009, and
Viktor Yanukovych concluded the naval basing agreement as president in 2010.

Compared with Ukraine’s gas imports from Russia, the volumes imported from
Europe look modest at present and in a short- to medium-term perspective.
The net dynamic, however, looks promising for Ukraine as it rapidly cuts gas
imports from Russia while gradually raising those from Europe.

According to the State Statistics Service, Ukraine imported 33 bcm of
Russian gas in 2012, down by 27 percent from the 45 bcm it had imported in
2011. The price of Russian gas supplied to Ukraine in 2012 averaged $426 per
1,000 cubic meters, up by 4.5 percent from the 2011 price (Interfax-Ukraine,
March 21). The import in 2012 is a far cry from the 52 bcm under contract,
and also way below the 42 bcm subject to take-or-pay clauses (which Ukraine
disregards). Ukraine proposes to cut gas imports from Russia even further in
2013, thanks to import diversification and decreased consumption.

Ukrainian officials offer various scenarios for 2013, ranging from 27 bcm to
less than 20 bcm of Russian gas imports. However, the picture becomes more
complicated when taking into account the new role of Dmytro Firtash’s
Ostchem as a significant gas importer and trader in its own right,
separately from Naftohaz (see EDM, March 25). According to Firtash, he plans
to import Russian gas in 2013, mostly for Ostchem’s own fertilizer
production, but partly also for re-selling to other Ukrainian industrial
consumers (Komersant-Ukraine, March 20). Thus, Ostchem’s imports from Russia
may partly offset the decline of Naftohaz’s imports of Russian gas. While
Gazprom begins losing its supply monopoly in Ukraine, Naftohaz begins losing
its procurement monopoly.

Russia will in any case remain by far the largest gas supplier to Ukraine
into the foreseeable future, albeit declining in both absolute and relative
terms. Meanwhile, gas imports from Europe are starting to replace some of
the Russian volumes that are no longer reaching Ukraine. Ukraine’s incipient
diversification of gas supplies in itself is a more consequential fact than
the price advantage at this stage. The inter-connection arrangements already
made, and those in prospect, should result in a steady growth of supplies
from Europe to Ukraine, aligning their price with European spot market
prices. These twin processes of volume substitution and price alignment seem
set to advance. They should translate into some degree of financial relief
for Ukraine and counter-leverage in negotiations with Russia.

Ukraine is a party to the Energy Community and its Treaty (along with the
European Union as a “party” and Ukraine’s direct neighbors in Central Europe
as “participants”). The Energy Community aims to extend the EU internal
energy market’s regulatory framework to the EU’s neighboring countries. This
facilitates the coordinated reverse-use of their gas pipelines and their
inter-connection for deliveries to Ukraine.

Russia is pressuring Ukraine to abandon the Energy Community, in return for
Russian investments in the overdue modernization of Ukraine’s gas transit
system, which still carries the lion’s share (albeit diminishing) of Russian
gas exports to Europe. The proposed Russian “investments” would take the
form of Gazprom sharing control over Ukraine’s transit system, not
necessarily in co-ownership but under some other forms of de facto control.
In that case, with Gazprom in a decision-making role, Ukraine would be
pulled out of the Energy Community. It would also lose the opportunity to
freely use its pipelines in the reverse mode for accessing gas supplies from
Europe. The de-monopolization process would be rolled back in that case.

Ukrainian government officials, preeminently Energy Minister Eduard
Stavytsky and Foreign Affairs Minister Leonid Kozhara, are ruling out the
idea of abandoning the Energy Community (Interfax-Ukraine, March 27). Prime
Minister Mykola Azarov’s statements, however, could be more convincing if he
ruled out not only an outright “sale” of equity in Ukraine’s gas transit
system to Gazprom, but also the more creative forms of handing over control
de facto, which would re-instate the monopoly that Gazprom is now losing.

— Vladimir Socor


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