Gas Wars

Economic News

22 Jul 2010
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The government of Prime Minister Yulia Tymoshenko accelerates ahead with its ambitious efforts to reshape Ukrainian energy policy. On February 1, the National Security and Defense Council adopted a plan to revoke the contracts of gas intermediary companies RosUkrEnergo and UkrGazEnergo. This development marks the first steps of Tymoshenko's wide-scale plan to overhaul energy relations between Kiev and Moscow.



Currently, the two middlemen operate an import monopoly of natural gas. Ukraine purchases Turkmenistani gas from Russia's Gazprom through RosUkrEnergo, which is 50% owned by Gazprom and the rest owned by Ukrainian billionaires Dmytro Firtash and Ivan Fursin. Meanwhile, UkrGazEnergo - a joint venture between RosUkrEnergo and Naftohaz Ukrainy - sells gas on the Ukrainian domestic market.



The National Security and Defense Council's decision marks the second major initiative to reshape Ukraine's gas policy since Tymoshenko assumed the post of prime minister. In January, the National Commission for the Regulation of Electric Power (NKRE) substantially cut quotas of UkrGazEnergo for the sale of gas to industrial enterprises. This will allow cheaper gas to be sold to residential consumers at the expense of UkrGazEnergo.



These decisions follow Tymoshenko's election promise to dismantle the two companies that assumed control of the Russian-Ukrainian gas trade after the January 2006 gas crisis. According to Tymoshenko, the intermediaries "contain elements of corruption and are unprofitable."



By removing the middlemen of the Ukrainian-Russian gas trade, Tymoshenko hopes to use the strengthened position of Ukraine's state-owned Naftohaz Ukrainy as a bargaining chip - in order to reestablish direct energy relations with Russia and Turkmenistan without any Gazprom-backed intermediaries - when gas prices are renegotiated in 2009.



Under the current arrangement, UkrGazEnergo buys 55m cubic metres and sells 25m cubic metres to Naftohaz Ukrainy to cover municipal needs, which are subsidised. Due to this complicated set-up, RosUkrEnergo reaped massive profits last year, while state-run Naftohaz Ukrainy lost $1bn from selling gas at subsidised prices to municipal customers. As a result, Naftohaz Ukrainy now teeters on bankruptcy while the intermediaries enjoy healthy profits.



Tymoshenko will visit Moscow later this month to discuss energy issues with Russia.
In October, Dmitry Medvedev, the chairman of Gazprom and Russian president-in-waiting, told German media, "We will probably revise the scheme of our relations and give up any intermediary structures that are not clearly understandable." This suggests that a future price rises is on Gazprom's agenda once RosUkrEnergo and UkrGazEnergo are abolished.



Ukraine buys gas from RosUkrEnergo at the rate of $179.5 per 1000 cubic metres - 40% cheaper than global prices of $250 per unit but a lot higher than the $70 it paid two years ago. If during the course of negotiations Gazprom decides to boost prices to European levels, Tymoshenko will seek to drastically increase transit tariffs for Gazprom's use of the Ukrainian gas transit system from $1.70 per one cubic metre per km to $9.32 per unit.



Another aspect of the current government's strategy is to counteract the influence of Gazprom and diversify away from Russian gas by offering the European Union a key route for energy diversification. During her visit to Brussels last week, Tymoshenko appealed to the EU to support White Stream, a proposed gas pipeline to carry Azerbaijani natural gas to Central Europe via the Ukrainian gas transit system. However, critics say it is unlikely to spark interest in Europe, which already faces the choice between Nabucco and an alternative South Stream pipeline being developed by Gazprom.



The Tymoshenko government is sending a clear message to Brussels: while Ukraine guarantees transit of energy to the European Union, Kiev requires commitments from Europe for the realisation of its ambitious energy strategy. Minister of Energy Yuriy Prodan confirmed that Ukraine needed over $3.5bn to modernise its gas transportation system. Speaking to Western investors, he stated, "cooperation in the energy sphere is a priority of bilateral relations between Ukraine and the EU." As former head of the National Security and Defense Council, Prodan has long argued that Ukraine must keep its gas transit system in state control, or in other words, not fall into the hands of Gazprom.



Tymoshenko has taken up the dismantling of the gas intermediaries in a crusade-like fashion. Unfortunately, she faces numerous domestic difficulties. President Viktor Yushchenko, who heads the National Security and Defense Council, is against the government's plans to scrap the business of the gas intermediaries. The president argues that renegotiations of the gas trade will force price rises that would hurt Ukrainian industry.



Since 2005, a series of governments have continued to raise the bankrupt Naftohaz Ukrainy's tax burden. Despite the fact that prices for imported gas have risen by 38% in 2007, and an overall 156% since 2006 when Russia started to rise prices, the Tymoshenko government does not plan to reduce subsidies and pass the cost onto Ukrainian consumers. Although Tymoshenko has declared war on the gas intermediaries, her government has not maximised its options to improve the status of Naftohaz Ukrainy by other means.

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