Gazprom simply wants to get paid

Peter Lavelle'S BLOG
January 7, 2009, 15:51

It would appear to be an annual event: At the end of each year and the start of the next, Russia and Ukraine have a nasty natural-gas dispute.

Moscow is adamant that it will not resume gas supplies to Kiev until arrears are paid and a new contract reflecting world gas prices is signed. Kiev remains defiant, hoping the European Union will eventually step in to mediate.

This is the last thing Brussels wants at this point, but there is a sense of urgency that the EU must admit that its energy security is threatened by Ukraine. In the meantime, gas supplies to Europe are being interrupted.

As of January 1, Russia had no contract to sell natural gas to Ukraine. Without a contract, the export gas monopoly Gazprom is not only under no obligation to continue supplies, it also has no legal basis to do so. Thus, Gazprom was given no choice -- it had to cut supplies (and lose revenues in the process).

The energy giant has made it clear that it will honour its contracts with European consumers and there is no evidence that it has failed to do so. As Ukraine is the transit country for 80 percent of Gazprom's natural gas to Europe, it is Kiev that must shoulder complete responsibility for any shortages experienced by Gazprom's consumers.

A great deal of the commentary on the current dispute -- as has been the case for the past few years -- has focused on the tense relations between Moscow and Kiev. There can be no doubt there are political undertones to the current dispute. Russia has made it clear that NATO membership for Ukraine would pose an existential threat to Russia. The fact that Kiev sold arms to Tbilisi at discounted prices definitely heightened tensions. But at the end of the day, these gas disputes are all about commercial relations and irrefutable energy realities: Gazprom simply wants to be paid.

Ukraine continues to purchase subsidized gas from Gazprom. Last year the price for 1,000 cubic meters was $179.50. In contrast, Gazprom's European customers pay up to $500 for the same amount of gas. Before Ukraine's 2008 contract with Gazprom expired, Kiev was offered a new price for 2009 -- $250 per 1,000 cubic meters.

By any standard this was a very generous offer. To top this off, the transit fees Gazprom must pay Ukraine to get its product to market in Europe would also have been increased.

Kiev rejected this deal. And it owes Gazprom hundreds of millions of dollars for gas supplies and penalties. In response, Gazprom made a new offer: Kiev would have to pay $481 per 1,000 cubic meters in any future contract.

Getting tough with Kiev

The facts of this energy dispute speak volumes about Gazprom's determination to force Kiev to act responsibly.

First, the volumes: Gazprom sells about 55 billion cubic meters (bcm) of natural gas to Ukraine annually. This is compared to the 155 bcm sold to Gazprom's European customers. Gazprom's yearly production is about 610 bcm, and the Russian energy flagship purchases about 50 bcm annually from Central Asia.

Now for the dollars and cents of this dispute: In 2008, Gazprom sold Ukraine gas at a price of $179.50 per 1,000 cubic meters, totalling around $10 billion. Then consider the average price of about $400 to the rest of Europe. At this price, Gazprom's annual revenue from the 155 bcm sold is about $65 billion.

Do the math: Gazprom earns more than six times the revenues for only three times the volume of gas by selling to Europe. This is an incredible shortfall in revenues for Gazprom and unfair to its other customers who pay market prices. Selling Ukraine gas at the same price paid by the rest of Europe would raise Gazprom's revenues by about $12 billion annually, based on the 2008 sales volume. This figure would probably diminish slightly when factoring in the higher transit fees Gazprom is expected to pay Ukraine in any new contract. Nonetheless, Gazprom has a strong, compelling argument for its get-tough policy with Kiev.

I have been covering the Russia-Ukraine gas disputes closely for years, and it is obvious to me that Kiev is conducting a "the-worse-the-better" strategy. Ukraine is in dire economic straits and has been kept afloat by a $16 billion loan from the International Monetary Fund. Under these conditions, Kiev desperately hopes Brussels will negotiate a better deal with Moscow on its behalf. Brussels should do just the opposite -- demand Kiev transit Russian gas purchased by European countries without hindrance or delay.

In the meantime, Brussels simply must get serious about developing a long-term and integrated energy policy for the entire bloc. This is what Gazprom has repeatedly requested -- a European energy partner with whom it can speak with one voice and negotiate with without troublesome in-betweens like Ukraine.

Also, instead of fearing the "Russian energy bully," Brussels should help Russia build the Nord Stream and other new pipelines. Ukraine is a thorn in Gazprom's side. If Brussels isn't careful, Ukraine will become a thorn for the EU as well.

First published at Radio Free Europe – Radio Liberty on January 7, 2009