Russia and Ukraine Revisit Gas Conflict

Publication: Eurasia Daily Monitor Volume: 6 Issue: 104

Russian Prime Minister Vladimir Putin (R) and his Ukrainian counterpart Yulia Tymoshenko in Astana, Kazakhstan on Friday, May 22

In what is becoming a monthly ritual, the Russian leadership has publicly stated that they fear Ukraine will be unable to pay its upcoming bill for Russian gas delivered in May. On May 27 Gazprom’s spokesman Sergei Kupriyanov stated "Naftogaz is finding it enormously difficult to pay its bill for May" (Moscow Times, May 27). Furthermore, Russian President Dmitry Medvedev told EU leaders gathered at the EU-Russia summit in Khabarovsk on May 22 that Ukraine will be unable to pay the $4 billion to fill its underground storage facilities with the 19.5 billion cubic meters (bcm) of gas it requires to supply both its domestic needs and to meet the EU’s demand during the fall and winter. The consequence of such a default, according to Medvedev, might result in another stoppage in the deliveries of gas supplies to the European Union at the height of the heating season.

On May 22 Ukrainian Prime Minister Yulia Tymoshenko met with Putin during the CIS summit in Astana, but failed to negotiate the $5 billion loan from Russia needed to fill the underground storage facilities. On May 27, the Warsaw-based East Week Analytical Newsletter alleged that Medvedev had proposed during the Khabarovsk summit that the E.U. and Russia might jointly offer a loan to Ukraine, as the first step towards creating a Russian-E.U. consortium to manage the Ukrainian transit gas pipeline network. The Ukrainian state-owned gas company, Naftohaz Ukrayiny has promptly paid its recent monthly bills to Gazprom, yet Russian Prime Minister Vladimir Putin and President Medvedev continue to warn E.U. leaders that this is about to end and that Naftohaz is on the verge of bankruptcy.

During the height of the fall-winter heating season, Ukrainian households obtain gas from Russia, while deliveries to the E.U. originate from its underground storage facilities. These underground caves traditionally begin to be filled on April 15, however Ukraine only managed to purchase 800 million cubic meters of gas for storage in April -and in May it purchased no gas for storage. The almost 20 bcm in reserves which were in storage from 2008 were used in the first quarter of 2009 to replace expensive imports from Russia, and are now mostly depleted.

In the first quarter of 2009, Naftohaz bought only 2.5 bcm of gas from Russia, while the quantity envisaged by the annual supplies contract signed in January 2009 was 35 bcm, or 8.75 bcm per quarter. Under this "take or pay contract" Ukraine is obligated to pay for the total quantity regardless of whether it decides to receive it. In order to pay for gas purchases in the first quarter of 2009, Naftohaz was able to obtain from Gazprom a prepayment for the entire gas transit fee for Russian gas transiting to Europe in 2009. This prepayment was used to pay Gazprom for delivered gas. Naftohaz also relied on the state budget and loans from state-owned banks, which the government insisted on being lent to the company in order to settle its debts with Gazprom.

Gazprom can, under the terms of the January 2009 contract, demand a penalty payment from Naftohaz for $2 billion for the first quarter of 2009 for gas it did not receive. In addition, Naftohaz is obligated to buy its existing bonds for $500 million in September, although this unlikely to occur. As the East Week Analytical Newsletter concluded: "In the absence of external financing, Naftohaz will be unable to buy any gas to build up the necessary reserves." If this indeed transpires, Europe might be faced with another major gas supply crisis by the autumn of 2009."

As the relentless Russian pressure on Naftohaz proceeds, Moscow appears intent on modifying the Ukrainian-E.U. agreement on renovating the Ukrainian main gas trunk pipeline. Russia not only wants to be included in the project, but to play a decisive role in its development. This went not only against the Ukrainian-E.U. concept of making the Ukrainian pipeline a more reliable route for Russian gas, but provided further proof of Moscow’s intention to obtain ultimate control over the pipeline, and further consolidate its monopoly on gas transit routes to the E.U. for political purposes.

The European Union’s response to the Russian proposals has been cautious. According to statements made by the European Commission president Jose Manuel Barroso following the Khabarovsk summit, the E.U. is ready to discuss the Russian proposals concerning the rules for energy cooperation and take them into account, but it will only do so as part of the Energy Charter Treaty review currently in progress.

The ultimate reason behind these maneuvers however, appears to be the Russian insistence that the E.U. accepts its strategy of building the South Stream and Nord Stream pipelines. By convincing the E.U. that Ukraine is an "unreliable" transit route for Russian gas, the Kremlin gas monopoly can sabotage the Nabucco pipeline; gain full control over gas transit routes to the E.U. and reduce Ukraine to subservience to Moscow.