Publication: Eurasia Daily Monitor Volume: 2 Issue: 139

Ukraine appears to have found a short-term solution to the problem of gas supplies from Russia for the remainder of 2005. However, the issue of supplies beyond December 31 — that is, during the peak heating season, in the run-up to the March parliamentary elections — has yet to be resolved.

Naftohaz Ukrainy chairman Oleksiy Ivchenko made public in Kyiv on July 18 the content of agreements signed on July 17 in Moscow. Under these agreements, Gazprom will use Ukraine’s transit pipelines to export a total of 128 billion cubic meters of gas to other countries this year. This volume represents approximately 85% of Gazprom’s overall anticipated gas exports to Europe in 2005. It adds 8 billion cubic meters to the volume hitherto envisaged by the Russian-Ukrainian agreement for 2005. A further above-plan increment, of 8 to 11 billion, is envisaged for 2006.

Russia will continue compensating Ukraine with gas, in lieu of cash, for the transit services in 2005. The Russian compensation gas will continue to be valued at $50 per 1,000 cubic meters, and the Ukrainian transit service remains priced at $1.09 per 1,000 cubic meters per 100 kilometers of pipeline, until December 31. Ukraine will receive the previously planned 23 billion cubic meters in compensation, and an additional 2.55 billion cubic meters on account of the increment in the Russian gas transit via Ukraine in 2005.

Key to this agreement is a resolution of the acrimonious Russian-Ukrainian dispute over the 7.8 billion cubic meters of Gazprom-owned gas that has been in Ukrainian underground storage sites since at least 2004. Moscow seemed prepared to countenance the Kuchma regime’s presumed intention to redirect this gas to its own needs, but would not tolerate this from post-revolution Ukraine. Gazprom had earmarked that gas for delivery to European countries in peak heating seasons. However, that volume is pivotal to Ukraine’s 2005 gas balance, particularly in view of Kyiv’s difficulties in paying its debts for Turkmen gas.

During the last three months, Ukrainian officials alternately denied storing those 7.8 billion cubic meters; described it as buffer gas that cannot be released from storage due to technical reasons; demanded advance payment for the storage service as a condition to returning that gas to Gazprom; or proposed to return it in tranches until 2007. The prevarications prompted Russian President Vladimir Putin twice — most recently at the G-8 summit in Scotland — to accuse Kyiv of pilfering Russian gas. Gazprom threatened to cut in the volume of compensation gas to Ukraine by a corresponding 7.8 billion cubic meters, from some 23 billion to approximately 15 billion in 2005.

Under the agreement just reached in Moscow, Gazprom will use 2.55 billion cubic meters, out of those 7.8 billion, to compensate Ukraine for the transit of the extra volume of Russian gas now envisaged for the remainder of 2005. Kyiv will return the remaining 5.25 billion cubic meters to the owner in three tranches of 2.55 billion cubic meters each, during the autumn-winter 2005-2006 and autumn 2006 heating seasons.

However, in anticipation of this agreement, Gazprom has sold the right to those 5.25 billion cubic meters for $800 million to the RosUkrEnergo company, which will sell it on European markets. The Swiss-registered RosUkrEnergo served as operator of Turkmen gas deliveries to Ukraine in 2004 in a highly controversial arrangement. The post-revolution government dispensed with that arrangement, decided to avoid further dealings with RosUkrEnergo, and launched an investigation into its activities.

The existing valuations for Russian compensation gas and Ukrainian transit services are deeply discounted by comparison to European market rates. These arrangements favor Ukraine because they guarantee low-priced Russian gas covering a sizeable part of Ukraine’s internal consumption. Kyiv is asking Moscow to retain the compensation-and-discount arrangements, at the very least into 2006. Practically all Ukrainian officials insist on this, though some — led by First Deputy Prime Minister Anatoly Kinakh — seem reconciled to a gradual transition to market rates starting in 2006.

Gazprom insists on switching to European market valuations for its compensation gas and for Ukraine’s transit rates after December 31, 2005. The Russian government has not yet taken a clear position. Prime Minister Mikhail Fradkov has not yet responded to the Duma’s July 8 address to him to initiate the switch to European market for Russian gas to Ukraine and other formerly Moscow-ruled countries after December 31.

The Kremlin will ultimately make a political decision on the matter. The Ukrainian governing coalition’s prospects in the March 2006 parliamentary elections depend to a significant degree on ensuring full and affordable gas supplies to the country. Russia may use this situation for political leverage on Ukraine already now, while the supply arrangements for the upcoming heating season are being negotiated.

(Interfax, UNIAN, Inter TV, July 16-18)