Russian-Ukrainian Gas Transit Deal: A Collapse of Putin’s Gas Strategy or a Temporary Retreat? (Part One)

On January 1, the Gas Transmission System Operator of Ukraine (GTSOU) LLC began transporting Russian natural gas to Europe under a new five-year transit agreement (Gordonua.com, January 1, 2020). This contract (consistent with European Union regulations) was signed by representatives of the Ukrainian energy firm Naftogaz, GTSOU (established in line with Kyiv’s commitments to implement EU energy market “unbundling” legislation), and Gazprom on December 30, just one day before the previous ten-year gas supply and transit contract was set to expire. The issue of direct gas supplies to Ukraine was not included in the package agreements.

According to the new contract, Russia will continue shipping gas westward via the Ukrainian pipeline network through at least 2024, with the possibility of extending the deal for another ten years, on the same terms (Gordonua.com, December 30, 2019). Under the new agreement, Ukraine will transmit a minimum of 65 billion cubic meters (bcm) of Russian natural gas to Europe in 2020 and at least 40 bcm per year in 2021–2024. However, the actual volumes may be higher (Epravda.com.ua, December 21, 2019). Additionally, on December 27, even before the new contract was signed, Russia’s state-owned gas major Gazprom paid Naftogaz $5 billion. This sum included $2.9 billion of compensation following the Stockholm Arbitration Court ruling (2018) and $2.56 billion in repayment of both the previously unpaid compensation and of the interest accrued from the date that the decision was announced on February 28, 2018 (Epravda.com.ua, December 27, 2019). In exchange, Ukraine agreed to release the seizures of Russian property in England, Wales, the Netherlands and Luxembourg. The arrests of Gazprom assets abroad (worth tens of billions of dollars) were imposed at the request of Naftogaz in order to force the Russian company to pay the debt awarded by the Stockholm arbitration (RIA Novosti, January 20, 2020).

Andriy Kobolyev, the CEO of Naftogaz, stated that the 2020 transit deal is the result of an “acceptable compromise.” The Ukrainian company wanted to sign a ten-year contract with a minimum pumping rate of 60 bcm each year, while Gazprom favored only a one-year, temporary contract (Deutsche Welle—Ukrainian service, January 3, 2020). Moreover, among Russia’s key demands was the nullification of all of Naftogaz’s arbitration claims in Stockholm, including the $2.9 billion that Ukraine ultimately received under the new contract. Russia’s position had changed dramatically when it became clear the United States would impose sanctions on the Nord Stream Two gas pipeline across the Baltic Sea (directly linking Russia and Germany) (Biz.liga.net, December 23, 2019). Finally, Naftogaz and Gazprom entered into a peace settlement, under which Kyiv agreed to rescind its demands that the Russians pay the $7.4 billion fine imposed by the Antimonopoly Committee of Ukraine or the $12.2 billion of additional legal claims against the Russian gas company under consideration by the Stockholm Arbitration Court (5.ua, December 31, 2019). At the same time, Ukraine does not relinquish future claims on the Naftogaz’s illegally lost assets in annexed Crimea (5.ua, December 30, 2019).

The new gas transit deal has strategic meaning for Ukraine. According to Ukrainian President Volodymyr Zelenskyy, this agreement will bring more than $7 billion in revenue. And as a result of the negotiations, for the next five years the Ukrainian gas transit system will operate without loss, guaranteeing energy security and welfare for Ukrainians (Pravda.com.ua, December 30, 2019). The president’s statement was supported by Naftogaz’s business and development director, Yuriy Vitrenko, who stated that the deal is worth over $7.2 billion. Vitrenko asserted that this is the best transit deal in the history of Naftogaz-Gazprom agreements. For the first time, the contract contained not a “take-or-pay” but a “ship-or-pay” clause. In other words, the Russian company will be forced to compensate Ukraine for the transit of the contractually agreed minimum amount, even if it does not actually ship that much gas to the EU in a given year. Vitrenko assured that these guaranteed transit revenues will be sufficient to cover the transit costs with the margin. Additionally, according to Vitrenko, transit fees for extra volumes beyond the minimum amount will substantially increase (Facebook.com, December 30, 2019).

The latest standoff between Ukraine and Russia had again threatened to disrupt supplies to Europe and could have led to another protracted Russo-Ukrainian gas war if the two sides had failed to reach an agreement after December 31, 2019. But Ukraine demonstrated its reliability as an EU transit partner. By the end of last year, Kyiv fulfilled all the requirements put forward by the EU and finalized the unbundling process of Naftogaz (establishing GTSOU, thus separating the gas transmission system of Ukraine from gas supplier Naftogaz). According to Naftogaz officials, this is by far the most significant reform in the energy sector in the history of independent Ukraine (Naftogaz.com, January 1, 2020). The newly established GTSOU has already signed interconnection agreements with operators from Hungary, Romania, Poland, Moldova and Slovakia (Eustream) (Day.kyiv.ua, December 31, 2019). Also, the Ukrainian gas transmission system is expected to open a virtual gas reverse flow from Slovakia in 2020, which should be profitable since no money would be spent on unnecessary gas transmission (Nv.ua, January 21, 2020).

For his part, the head of GTSOU, Sergey Makogon, expects that the Ukrainian and Russian partners will eventually be able to return to the issue of Russian gas storage in Ukrainian underground facilities (UGS) (Interfax, January 9, 2020). He also argued that the new transit deal has strategically important implications for Ukraine. The total positive effect on the Ukrainian economy during the next five years, in addition to the revenue from the transit itself, is expected to reach approximately 150 billion hryvnia ($6.18 billion) and GTSOU’s total revenue during this period is forecast at about 115 billion hryvnia ($4.74 billion) (Interfax.com.ua, January 9). Moreover, Makogon contended that Russia will continue to transport at least 40 bcm of gas through the Ukrainian transmission network even after 2024 (Interfax.com.ua, January 14).

At the beginning of 2019, Russia was quite confident it would be able to either redirect its gas transit to the EU away from Ukraine before the expiration of the transit contract or renew the deal on Moscow’s own terms. But despite Gazprom’s (i.e., the Kremlin’s) transit diversification strategy, the new five-year deal shows that the Ukrainian transit corridor still remains of paramount importance for Russia.

*To read Part Two, please click here.