Russia-Ukraine gas dispute

The dispute between Russian state-owned gas supplier Gazprom and Ukraine over natural gas prices started in March of 2005 (over the price of natural gas and prices for the transition of Gazprom's gas to Europe). The two parties were unable to reach an agreement to resolve the dispute, and Russia cut gas exports to Ukraine on 1 January 2006 at 10:00 MSK. The supply was restored on January 4, when a preliminary agreement between two gas companies was settled. However, the inter-government treaty have not been signed yet.

Amongst speculations that proceeded the signing of the agreement, presidents of both countries declared on 11 January 2006 in Kazakhstan that both sides have indeed come through compromises into a mutually satisfying agreement, and have declared to plan more work of cooperation in other areas of conduct of the neighbour countries.

Background

Ukraine consumed around 80 billion cubic meters of natural gas a year in 2004–2005. 20 billion of that were of Ukraine's own production, around 36 billion were bought from Turkmenistan, and about 17 billion were received from Russia as a payment for transporting Russian gas to Europe. The remaining 6-7 billion cubic meters were purchased from Russia ^*. According to the CIA's World Factbook 2005, Ukraine is the 4th largest importer and 6th largest consumer of natural gas in the world. This is partly due to waste and inefficiency of industry dating back to the Soviet times.

Initial Situation

Russia supplies about 8% of Ukraine's annual gas requirements. This gas has in recent times been supplied at heavily subsidized prices - about 50 USD per 1,000 cubic meters compared to the market rate of about 230 USD per 1,000 cubic meters. Note, however, Ukraine charges Russia transit fees for gas Russia passes through the Ukrainian gas pipeline network to Western customers. Transit fees were taken in the form of gas, with Ukraine taking 15% of gas passing through their pipes.

Course of events

In March of 2005 Gazprom, the Russian State owned gas monopoly company, informed Ukraine that gas prices were to be raised to market rates. Ukraine objected; on one hand accepting the need to pay at the going rate, on the other hand objecting to the short notice of such a large increase in gas price. In March of 2005 Ukraine took steps to radically change the way of compensation for the transition of Gazprom's gas to Europe, requiring to change it from barter to actual money. The Russian company Gazprom (owned by the Russian state) took steps (March 2005) to radically change the prices for natural gas sold to Ukraine. Ukraine’s new government did agree to buy natural gas from Russia’s gas monopoly Gazprom at higher prices in return for increased gas transit fees (source: Russian newspaper Kommersant daily, Tuesday, March 29 2005). Negotiations started, Gazprom first suggested to raise the price with 300% and later by 460% (from $50 per 1,000 cubic meters to $150 to $230). The old price Ukraine paid was about 486% lower than Turkey paid Gazprom (Turkey pays $243 to Russia, $236 to Iran for gas The two parties were unable to reach an agreement to resolve the dispute, and Gazprom cut gas exports to Ukraine on 1 January 2006 at 10:00 MSK. Gazprom assured Western customers their gas supplies would not be affected. As it transpired, gas supplies were affected, with all customers reporting varying degrees of reduction in gas flow. Gazprom accused Ukraine of taking gas; Ukraine's state-owned energy firm Naftogaz admitted withholding some Russian gas intended for other European countries [http://news.bbc.co.uk/1/hi/world/europe/4642684.stm, but said it would still meet its contractual obligations. A spokesman for Naftgaz said the excess gas was needed to cope with the especially cold January 2006 weather. After great media interest and political discussion in the two countries, the EU and the U.S. a compromised contract was reached, where gas prices were roughly doubled, but Ukraine transit fees also increased, offsetting the increase in cost. The supply was restored on January 4, when the preliminary agreement between Ukraine and Gazprom was settled.

Many (European and US) media and analysts saw the conflict as the Government of Russia 'punishing' the new Government of Ukraine, who is considered more pro-NATO and EU than its predecessor. Gazprom say that that's nonsense, they just don't want to subsidize former Soviet republics. However Gazprom are in no hurry to stop subsidies to pro-Moscow republics such as Belarus.

During speculation about the signing of the agreement, the presidents of the two countries declared on 11 January 2006 in Kazakhstan that both sides had indeed come, through compromise, to a mutually satisfying agreement. They declared plans for further cooperation.

Gas supplies to Western customers has since returned to normal levels. To date, this agreement appears to be in force but unratified.

2002 contract

According to the contract signed by Russian state company Gazprom and Ukrainian state company Naftohaz Ukrainy on June 21 2002, which was supposed to be valid to the end of 2013, the payment for the transfer of Russian natural gas through Ukrainian pipeline system had been made in the form of barter exchange – up to 15% of gas pumped through the Ukrainian territory was taken by Ukraine instead of payment for the transfer transport. Originally, the amount of gas to be shipped as payment for the transfer was supposed to be negotiated every year and to be fixed by inter-governmental protocols.

Addendum #4

On August 9 2004 the two companies signed an addendum #4 to the contract, according to which the amount of gas given as a payment was calculated based on the tariff of $1.09 for transportation of 1,000 cubic meters over a distance of 100 km and the price of the natural gas was $50 per 1,000 cubic meters (approximately $1.40 per mmBtu, see Calorific value of natural gas). According to the addendum the price was not subject to changes until the end of the year 2009 ^*.

Gazprom argued that addendum #4 was only applicable provided that the two countries sign an annual Intergovernmental Protocol specifying the terms of gas transit. According to Gazprom, the addendum #4 becomes void as the annual Protocol had not been signed for 2006 under the required terms.^*.

Initially, Russia insisted on a new contract in which Ukraine would be paying about $160 per 1,000 cubic meters (approximately $4.40 per mmBtu). However, under Ukraine's hesitations, on 14 December 2005 Gazprom demanded $230 per 1,000 cubic meters (~ $6.35/mmBtu) claiming that such a price hike would reflect the trends in the world markets ^*. Still, the market price for natural gas traded in NYMEX was significantly higher than many existing contract prices due to the price hike of oil and gas in 2005. As of January 2006, the price for natural gas on NYMEX was about $10/mmBtu. The spot prices in Europe ranged from $10 to $20 per mmBtu. Existing Russian contract prices to most European countries ranged from $110 to $280 per cubic meter.).

Russia agreed that the tariff for transit should be also increased, but only to $1.74 per 1,000 cubic meters/100 km (Transportation tariffs in Western Europe in 2005 ranged from $0.9 per 1,000 cubic meters/100 km in Belgium to $4.5 in Greece; in the most important transit countries the tariff were: $2.5 in Germany and $2.7 in Austria [http://www.dti.gov.uk/energy/publications/policy/truly_competitive_gas_report.pdf Competitive Gas Report, p. 85). However, there were no market prices for transit; they were formed by the specific service costs of a pipeline, and in the EU subject to national energy market regulators' approval.

Russia claims that Gazprom's subsidies to the Ukrainian economy amounted to billions of dollars. Russian President Vladimir Putin claimed that Ukraine has enough money in its budget to pay the market price: "This is a heavy burden for the Russian budget... The consumers in Ukraine are getting gas today for a much lower price than Russian citizens pay in their own country! And we still have about 25 million citizens, who live below the poverty line". June 21 2002 and the addendum #4 to it of August 9 2004. Gazprom insisted that both contract and the addendum #4 were not and could not be active without the annual Intergovernmental Protocol that is the base and that has higher legal status.[http://www.gazprom.com/eng/news/2005/12/18443.shtml" target="_blank" >^*

2005 negotiations

The 2005 negotiations for new contracts were conducted between Russian Gazprom and its Ukrainian counterpart Naftohaz Ukrainy. At first, the Ukrainian side staunchly opposed any gas price increases, proposing to pay for gas with weapon supplies ^*, but eventually Ukrainian President Viktor Yushchenko agreed to some concessions, in which the price of gas would be gradually increased over time. He stated that Ukrainian industry would become unprofitable if the price of gas rose above $90. He also called for avoiding the politicization of the dispute, and expressed his confidence that the problem could be solved by economical rather than political means.

About 80% of Russian gas exports to Western Europe were made through Ukraine. Russia stated that it would like to have a consortium company created from Gazprom and Naftogaz, while Ukraine opposed that as it would mean that it would lose control over its own gas pipeline structure. Some Ukrainian officials called for a review of the lease price Russia paid to Ukraine for keeping its Black Sea Fleet in Sevastopol, Crimea: Russia currently pays about $97 million per year for the lease. Ukrainian officials declared that the lease of the port facilities to Russia is underpriced and called for a complete valuation of inventory of the facilities, which as some suggest could be worth up to $2 billion while Russia resisted any discussions that might affect the conditions of the lease. There were speculations that the calls to reconsider the lease price were prompted by US pressure, especially since they were made within hours of the US State Secretary Condoleezza Rice's visit to Kiev on December 8 2005. ^* in which Russia acknowledges predominantly Russian-populated Crimea as part of Ukraine in the first place, so it is a sensitive issue with further potential repercussions.

Cutting off the supply

On December 13 2005, Gazprom threatened that if an agreement about the new price is not reached before January 1 2006 10:00 MSK, it would cut off supply of natural gas to Ukraine. The next day, December 14, Gazprom stated unilaterally that the new price would have to be $220-230 per 1,000 cubic meters. Ukraine claimed that such steps would violate the past contracts and brought up the possibility to resort to international arbitration. On December 19 2005, Ukrainian Prime Minister, Yuriy Yekhanurov, traveled to Moscow but was unable to reach any agreement on the prices. The next day, December 20, Yekhanurov stated that Ukraine would be able to do without Russian gas and urged development of energy efficiency technologies ^*.

European transit withdrawals

On December 26 2005, Yekhanurov stated that Ukraine had a contractual right for 15% of the Russian gas transiting to Western Europe in his interview to the Ukrainian 5 Channel TV company. This statement came largely in response to the Gazprom threat to resort to the Arbitration Institute of the Stockholm Chamber of Commerce should Ukraine engage in unlawful withdrawal of Russian transit gas. ^*." target="_blank" >Earlier, Yekhanurov announced that Ukraine could refer the case to the Institute if the compromise is not reached. [http://www.interfax.com/3/116428/news.aspx Both countries are signatories to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards since 1960, so a decision by the Stockholm Institute in the case would be legally binding. According to Ukraine's government, its transit arrangements allow it to siphon off 15% of gas moving through the country.

On December 29 2005 Vladimir Putin offered Ukraine a $3.6 billion loan to cover the cost of transition to market natural gas prices. His Ukrainian counterpart, Victor Yushchenko, promptly rejected the offer In the last days of 2005 European countries, which had stayed out of the dispute until then, began urging Russia and Ukraine to find a compromise. On December 31 2005, in a last-ditch effort to solve the dispute, Russian president offered to postpone the price increase until April of 2006 if Ukraine immediately agreed to the new prices. Ukraine, however, rejected the offer [http://www.forbes.com/work/feeds/afx/2006/01/01/afx2422361.html.

On January 1 2006 Gazprom started reducing the pressure in the pipeline system ahead of the deadline of the Russian ultimatum set for 10:00 MSK. On January 2 2006 Russia accused Ukraine of stealing US$ 25 million worth of gas. ^*

It is worth noting that as supply reductions are known to be occurring, either Ukraine is siphoning off gas, or Russia is undersupplying and falsely accusing Ukraine of siphoning. To address the latter speculation, Gazprom has invited the Switzerland-based goods inspection and testing company SGS to record the amount of gas that is entering Ukraine's pipeline network.

The EU-Russia gas supply contract requires Russia to supply gas to the former USSR border. Therefore, if Ukraine steals from or blocks the pipelines, the EU could sue Russia for violation of the contract. Therefore, as soon as the pressure fell in the EU, Russia had no choice but to turn back on the supply to Ukraine on January 3 ^*.

Impact on European countries

Despite Ukrainian reassurances to the contrary, many European countries have seen an immediate drop in the supply of the gas ^*:

Austria – supplies down by around 33%
Croatia – supplies down by around 33% ^*
France – supplies down by 25–30%
Germany – supplies down by an unspecified amount
Hungary – Russian imports down 40%
Italy – Russian imports down 24% (6% of total imports) ^*
Poland – supply down by 14%
Romania – supplies down by around 20%
Slovakia – supplies down by around 33%
Slovenia – Russian supplies down by around 33% (40% of average annual gas supply).

The United Kingdom has expressed concern that there would be a drop in their supplies in the near future, though none had yet been reported. In response to these drops Gazprom announced that more gas would be pumped to Europe [http://news.bbc.co.uk/1/hi/world/europe/4575726.stm.

The alternative gas pipeline across Belarus only has a capacity of 30 billion cubic meters a year, compared to 120 billion cubic meters a year flowing west across Ukraine, and has little spare capacity ^*.

"On the very day it takes over chairmanship of the G-8, it cuts off supplies to Ukraine, which indirectly at least threatens gas supplies to Europe. It undermines Russia's credibility straightaway," said Christopher Weafer, chief strategist at Moscow's Alfa Bank. On January 2, "economic ministers of Germany, Italy, Austria and France warned the government in Kiev that their nations' "perfect relations" with Ukraine could be affected if it failed to deliver all of the gas meant for European countries" On January 3, Russian Prime Minister Mikhail Fradkov "asked the European Union Tuesday to influence Ukraine to ensure full and uninterrupted gas transit from Russia to EU countries" [http://en.rian.ru/russia/20060103/42838359.html. In response to Russian demands, EU Energy Commissioner Andris Piebalgs from Latvia warned Russia not to make out of EU a "hostage" of its dealings with Ukraine, "I don't think making the EU a hostage is the proper way".^* Austrian Minister of Foreign Affairs Ursula Plassnik criticised Russian action against Ukraine^*. On 4th January Poland presented the position of Visegrad Group countries alongside Austria during special meeting of EU devoted to the gas issue. The statement included the opinion that it is unacceptable to demand higher prices by blocking of gas deliveries and that the EU has to find other sources of gas besides Russia^*.

Agreement to end the dispute

On January 4 2006 the two countries reached an agreement to end the dispute.The 5-year contract was signed, although with the prices set for the next 6 months only. In the deal Gazprom "secured the hefty price hikes it had been demanding, raising the cost for its supply" to US$230 per 1,000 cubic metres to Russian-Swiss company RosUkrEnergo, which after mixing it with two thirds of cheaper supplies from Central Asia will resell it to Ukraine at a price of US$95 per 1,000 cubic metres.^* The parties also agreed to raise the tariff for transit from $1.09 to $1.60 per 1,000 cubic meters/100 km which concerns not only the transit of Russian gas to Europe but also Turkmen gas through Russia to Ukraine. The agreed price would fluctuate with the market, according to a Gazprom spokesman. Most analysts see it as a face-saving deal as both countries announced they were fully satisfied with the result.

However some experts doubt that this deal is profitable for RosUkrEnergo. The company has to buy 16 bln cubic meters from Russia at $230/1000 m³, 40 bln cubic meters from Turkmenistan and Kazakhstan at price of $60-65/1000 m³, and then sell this gas to Ukraine at $95/1000 m³. Besides, RosUkrEnergo has to transport 40 bln cubic meters of gas to Europe at price $1.60 per 1000 m³ per 100 km, or $1920 mln. Total expenses become $2500 +$3800 + $1920 million, or $8.2 billion. Revenues from selling the gas are just $5.5 billion. Likely the loss of $2.7 billion is compensated by some undisclosed agreements, possibly covering Ukrainian debt as well as lease of the pipeline. (source in Russian, Another analysis shows that, depending on the price from Turkmenistan, assuming the transit revenue, RosUkrEnergo's breakeven point is around $70/tcm for Asian gas. At $65/tcm it could make a small profit. [http://sun-bin.blogspot.com/2006/01/how-ukraine-russia-rosukrenergo-gas.html After the agreement was settled, ex-Prime Minister of Ukraine Yulia Tymoshenko said that she is going to sue Naftogas of Ukraine for the violation of state-interests of Ukraine. However, the leader of the Liberal Democratic Party of Russia Vladimir Zhirinovsky said that he is going to bring forth a parliamentary investigation because of the possible violation of state interests of Russia.

On 11 January 2006, Vladimir Putin and Viktor Yushchenko confirmed that the conflict was all gone and more cooperation in the fields of science, education and public health services is to come. ^*

Alleged political motivation

Many observers around the globe allege that Russia's step is an act of political retaliation for Ukraine's moving out of Russia's sphere of influence and for its pro-Western policy. Others allege that the move to increase gas prices during the winter season may be intended to decrease the popularity of the Ukrainian president and his NSNU party among the voters, before the parliamentary elections in spring 2006 or that it is a Russian attempt to win control over Ukrainian pipeline system.

Russia rejects the accusation that there is any political motivation behind gas prices pointing at the fact that the Russian ally Armenia pays the same price as Georgia which is known to have frosty relations with Russia. Russia contends that the move to higher gas prices is economically, and not politically, motivated and points out that other post-Soviet countries, such as Armenia, Georgia, Moldova, and Baltic states, are also seeing their prices increased. However, the prices for Armenia, Georgia, and Baltic states remain in the much lower range of $110-125 per 1,000 cubic meters in the year 2006 According to Gazprom, the reason for that is said to be that the gas for Transcaucasia originates from gasfields that are not connected to the European market and thus there are no opportunity costs for Russia for not selling this gas to Europe.[http://www.5tv.com.ua/video/192/0/907. Concerning the Baltic states Gazprom pointed at some infrastructure units in common possession as well as timely signing of agreements on transient prices when the difference to European prices was not as high yet. Moreover, Russia does not have to offer the same prices to all its customers as long as it is not a World Trade Organization member.

In the Belarus case, lower prices are due to the fact that Gazprom owns Belorussian pipelines and that it has a long-term lease of the land where the pipelines run. Because of this, as of 27 December 2005 contract, Belarus will be paying only 47 USD per 1,000 cubic meters in 2006 ^*. Gazprom pointed out the fact that a similar kind of deal was offered to Ukraine to keep the prices low, but was rejected. On March 30, 2006, Gazprom announced that Belarus will have to pay market prices for gas starting in 2007.

Earlier this year Gazprom declined Turkmenistan's offer to buy natural gas at $58 per 1,000 cubic meters as too expensive, in December 2005 it made an unexpected deal to buy additional 30 billion cubic metres of gas at $65 (with 15 billion cu metres to be delivered in 1Q2006). Many observers say that was done to limit Ukraine's options to seek alternative sources of the gas.[http://en.rian.ru/russia/20051229/42778226.html. While that may be the motivation, one should note that oil and gas price doubled during the year of 2005. At the same time Russia openly admitted it had limited Ukraine's access to the gas that Ukraine had been importing from Turkmenistan.

Some observers point out that it is hard to regard economic motives as being the basis for Gazprom's behaviour, since Gazprom's behaviour is economically inconsistent; however, it is possible to regard political motives as the basis for Gazprom's behaviour, since it is largely State-owned and the prices it charges seem on the first sight to correlate with the political friendliness of the purchaser (although Armenia, which is politically friendly to Russia, still gets the same price as the rest of the less-politically-friendly Transcaucasia, thus Moscow denies the claim that political friendliness plays a role in the formation of the prices ^*). On the other hand, the price offered to Ukraine is still lower than that to Romania, and to EU, since transport cost to Ukraine are significantly lower than to Western Europe. (For EU, there was long term contract dated back to 1970s which helped to lower the average price.) Therefore, one could also argue that Russia is offering a discount to market price to Ukraine. It is the deal with Belarus, not the one with Ukraine, which is at a deep discount, which is politically minded.

Some analysts attribute recent Russian actions to the start of a parliamentary election campaign in Ukraine, in which the pro-Western forces are bound to face a challenge from opposition parties dedicated to tightening Ukraine-Russia relations. ^*

WTO: Post-Soviet states must pay market energy price

It was noted by Pascal Lamy of the World Trade Organisation that all Post-Soviet states that buy gas from Gazprom must pay today's market prices for their energy needs in order to improve the efficiency of their economies. [http://www.newkerala.com/news.php?action=fullnews&id=77576 Lamy recalled, that it would have been much easier to resolve the conflict if both Russia and Ukraine had been WTO members. Moreover, he added that the problem had arisen in the first place due to the fact that neither Russia nor Ukraine have true market prices for energy resources, thus resulting in an inefficient energy uses amongst the states. He added that the incident would not have any influence over the acceptance of Russia into the WTO.

Household consumers in Ukraine have gas prices lower than those in Russia

On 8 December 2005, Russian President Vladimir Putin noted in his speech that household consumers in Ukraine get gas for lower prices than do household consumers in Russia, the country that sells gas to Ukraine. He noted that Russia subsidised Ukraine on the gas matter by the amount of 1 billion dollars a year from the Russian budget (money that Gazprom would have paid into the budget from its revenues) — given that 25 millions of Russians still live below the poverty line, such a load onto the Russian economy is more than questionable, Putin noted. ^*

On 26 December 2005, Prime Minister of Ukraine Yuriy Yekhanurov confirmed that public-utility prices for gas are lower in Ukraine than those in Russia, and said that a change is to be made, although the officials of the public utility company "Gas of Ukraine", which is the supplier of gas for household and budget consumers, said that they are going to keep the same prices for households and budget-organisation in 2006 as they were in 2005. ^*

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