A global challenge to Ukraine and Europe: new gas transit format

15 June 2019
gas contract between Ukraine and Russia

A 10-year transit contract between the NJSC “Naftogaz of Ukraine” and the Russian “Gazprom” ends on January 1, 2020. Earlier, the Stockholm arbitration court recognized the requirement for Gazprom to refund Naftogaz $ 4.6 billion for violating the terms of this contract and the contract for the supply of gas to Ukraine. Now, Gazprom doesn’t actively negotiating a new long-term transit agreement on gas transit through the Ukrainian gas transmission system (GTS), and it is actively continuing to build offshore gas pipelines (Nord Stream-2, Turkish Stream) bypassing Ukraine. The joint venture between the Russian company Gazprom, Engie of France, Austria’s OMV, the Anglo-Dutch company Royal Dutch Shell, and the German companies Uniper and Wintershall aims to supply the European Union with 55 billion cubic meters of Russian natural gas a year through Baltic Sea bypassing Ukraine.

Since the share of net gas imports compared to total gas consumption in the EU in 2017 was almost 74%, the construction of gas pipelines is not a purely economic, but also a political and geostrategic project. The largest gas exporters to the EU are Russia (42%), Norway (34%) and Algeria (10%). ). In the long term, this causes great concern in the United States. Central and Eastern Europe strongly opposed the Nord Stream-2 project, as well as the United States that are strategically interested in supplying LNG gas to the EU market. Therefore, for Russia, the only one way is to remain the largest exporter of gas in Europe.

At the same time, Ukraine’s strategy is to remain a gas transit country. The cost of the Ukrainian GTS was estimated several times by reputable global consulting companies, the last estimate in 2018, which was conducted by the international auditing company PricewaterHouse Coopers, was at $ 14 billion. Ukrainian legislation still allows one to sell up to 49% of the GTS.

So, do we still have to fulfill the long-standing goal of the Ukrainian gas transmission system operator and attract international investors to manage the GTS and, accordingly, invest in the Ukrainian infrastructure?

The main barriers to reaching an agreement with Russia on gas transit through the territory of Ukraine after 2020 are political, not economic.

In Ukraine, the presidential election of 2019 brought the negotiation process back to uncertainty. According to officials, negotiations between Ukraine and Russia on a new gas transit contract may be restored after a conversation between the newly elected President and the President of Russia.

Related analytics: How to take the energy independence away from Ukraine or a Story of one Prime Minister.

At the same time, the influence of Germany on the results of subsequent negotiations will be essential, since it is almost direct lobbying of the project by Germany in the EU that affects the launch of Nord Stream-2. The success of the negotiations will largely depend on how far Russia could move in the construction of Nord Stream-2 in 2019, as well as on the political situation in Ukraine after two electoral processes. However, the position of the United States regarding sanctions against the Russian Federation and the ability of Naftogaz to continue Gazprom’s proceedings for compensation of 12 billion dollars in the case of the signing of a new transit contract will also have a certain impact on the workload of the Ukrainian GTS.

Minimizing dependence of Ukrainian transit route is one of the strategic goals of Russia’s energy policy. Russia’s goal within the trilateral negotiations is to conclude a temporary transit agreement that would regulate the conditions for the transit of Russian gas through Ukraine until the new pipelines are fully ready to supply gas to the EU market. Nord Stream-2 is estimated to be completed in 2020. In 2019, Gazprom will be able to supply up to 157.5 billion cubic meters of gas via the most up-to-date Turkish stream as an alternative to the Ukrainian route.

Most likely, Gazprom will be forced to use the Ukrainian transit network at a level of 51 to 777 billion cubic meters of gas, at least until 2021, unless there is a sharp drop in demand in the European market. If the Russian company can use the full capacity of Nord Stream-2 and TurkStream in 2021, gas transit through Ukraine will already be questionable.

Given the time constraints, Ukrainian officials and managers of Naftogaz have been trying to catch up with a train called “sale of GTS” for the third year in a row, which actually means attracting investors to the Ukrainian GTS and creating a consortium of companies.

If we recall and analyze the number of strategic meetings, draft appeals of the Verkhovna Rada to the EU countries, other political statements and the corresponding heaps of ministerial instructions, it turns out that a lot of work has been done at the level of Naftogaz.

Ukrtransgaz, which operates the gas transmission system, and Ukraine’s Trunk Gas Pipelines (the company has not yet received a gas transmission system as a result of the reform of Naftogaz) signed an agreement on setting up a joint working group with leading European operators that was aimed at fixating European interest in creating independent GTS operator in accordance with European legislation, and the further management of the GTS.

At the beginning of December 2017, a memorandum was signed with the French operator and the Dutch Gasunie, a similar memorandum was signed with the Slovak operator and the Italian Snam. The most likely partners of the Ukrainian GTS were then considered Eustream and Snam, which operate on gas pipelines that are a continuation of the Ukrainian GTS outside Ukraine.

Subsequently, Naftogaz announced the signing of an agreement with five major foreign gas pipeline operators. Previously, companies that signed up were considered full-fledged partners of the Ukrainian GTS, who could get it under its management and, as an option, partly into ownership.

On June 3 2019, representatives of the companies GRTgaz S.A. (France), Gasunie (Netherlands) and Snam S.p.A. (Italy) began working as full-time advisers to the general director of the newly established branch of the Operator GTS of Ukraine in Ukrtransgaz. Within the framework of the working group, they will provide consulting services in the process of creating an independent operator of the GTS.

In addition, the company is making efforts to operational activities – the creation of a plan for the modernization of the GTS in order to ensure its technical reliability and efficiency. Ukratransgaz continues to exploit 38.8 thousand km of gas pipelines, including trunk pipelines, 72 compressor stations and almost 1.5 thousand gas distribution stations. The separation process of the GTS operator function will be completed in early 2020, after the expiration of the gas transit contract with the Russian Gazprom. Optimization of pipeline systems and a network of underground gas storage facilities is planned with the help of the introduction of modern computer software. The company’s financial plan for 2019 takes into account the repayment of a World Bank loan in the amount of EUR 395 million. Despite this, Naftogaz expects to receive a net profit of UAH 16 billion in 2019. It is also important that Naftogaz and the Chinese Sinosure Corporation signed a memorandum on the insurance guarantee from the Chinese side in the amount of 1 billion US dollars, which opens the way for lending and foreign direct investment by Naftogaz from Chinese banks.

So, Ukraine’s GTS remains a rather attractive asset in terms of the development of the EU markets and future geopolitical sources of influence. The participation of European companies in the ownership structure or management process of the Ukrainian GTS is necessary for Ukraine to strengthen its position in the further negotiation process with Gazprom, to negotiate with the Russian monopolist regardless of the distribution of political high positions in Ukraine based on European rules and European standards. Only in such case, Gazprom will have to extend the contract and agree to the conditions that will meet the expectations of European partners.

Since it is impossible to divide the Ukrainian gas transportation system quickly and painlessly into two parts, one of which would provide international transit and the other will provide internal distribution among consumers, it is necessary to coordinate the efforts of the team of the new President, the new Verkhovna Rada, the Cabinet of Ministers, the national regulator and Naftogaz itself to ensure fair and efficient tariffs for both gas transportation in order to attract investors, and for distribution and consumption to ensure gas supply for the population in the district in the new heating season.

At the same time, Hungary annually consumes more than 10 billion cubic meters of natural gas, while only about 20% of consumers are satisfied by domestic production. About 60% of Russian gas consumed by Hungary is transported through Uzhgorod. Ukrainian underground storage facilities may further help Hungary to ensure uninterrupted gas supply to Hungarian consumers next winter, even if Russia stops gas transit through Ukraine to the EU countries on 01/01/2020.

Ukraine is a reliable gas transit country and it shouldn’t hesitate, since time is running out. Regardless of whether an agreement is reached by 2020 on transit or not, it is likely that by 2022 two new Russian gas pipelines will be operating at full capacity. But there will be a certain demand for the rest of the transit through Ukraine, which mainly depends on the level of demand for Russian pipeline gas in Europe, seasonal factors and the political agility of the Ukrainian side in the top-level negotiations. It remains to hope that by joint efforts of the Ukrainian side and European partners, the Ukrainian GTS will be on time prepared to reduce operational capabilities at the same time as improving efficiency and attracting a strategic partner to the management of the Ukrainian pipeline system.

Hlib Strygunenko

Ex-head of the department for EU-Ukraine cooperation in the field of energy and environment of the Secretariat of the Cabinet of Ministers of Ukraine, expert and advisor to the Center for Energy Reforms of Ukraine.

Source: Center of Energy Reforms of Ukraine