Russia-Ukraine gas deal needed soon as winter looms

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With the end of summer now in sight, the need for a deal between Russia and Ukraine on natural gas supply is starting to look urgent. At the end of August, that sense of urgency was much in evidence when Vice-President of the EU Commission, Günther Oettinger, met with Russia’s energy minister, Alexander Novak, in Moscow to thrash out the terms of an interim solution. However, the recent escalation of Russian military involvement in Ukraine makes finding a solution trickier than ever.

"I came to Moscow to prepare the next trilateral gas talks as agreed in Minsk,” said Oettinger. “At the same time, I have to express my concern. The news that Russian soldiers are operating inside Ukraine does not reflect the spirit of Minsk. Respecting the sovereignty of national borders is vital to preserve peace."

Russia currently accounts for almost a third of gas imports into Europe and more than half the volumes still flow through Ukraine, despite Russia’s efforts to develop alternative export routes such as Nord Stream. Russia stopped supplying gas to Ukraine earlier this year, leaving Ukraine largely dependent on storage for its supply.

Escalating dispute: The ongoing gas payment and pricing dispute between Russia and Ukraine escalated to worrying levels in mid-June, when Gazprom announced that it would cease supplying gas to Naftogaz – Ukraine’s state-owned energy company – unless payment was made in advance.

Both parties at the same time initiated legal proceedings at the Stockholm International Arbitration Court. Gazprom is seeking to recover $4.5 billion of debt; Naftogaz is seeking $6 billion in compensation for over-priced gas supplied since 2010 and a fair price for future supplies.

At the same time, transit volumes of gas bound for markets in Europe have continued to flow uninterrupted through Ukraine. However, as winter approaches, Ukraine will find it increasingly tempting to access some of this gas as its storage volumes run low.

Map showing Russian gas transit pipelines to EuropeRussian gas transit pipelines to Europe (Source: J Stern, Chapter 3, in J. Henderson and S. Pirani, the Russian Gas Matrix, to be published by the OIES later this year.)

Interim price: At their meeting in Moscow, Oettinger and Novak, agreed that an interim solution should include an interim price, the fulfilment of all supply and transit obligations, a repayment plan for the unpaid bills, and the use of the OPAL pipeline.

Following the meeting, Oettinger said: “We have to agree on an interim gas price for the next few months, while waiting for the Stockholm arbitration court to decide on the final price.  In addition, Ukraine has to pay an account for the gas to be delivered in the months to come.

“Our main goal is to secure gas supply to the EU and its citizens, but also to the citizens in Russia, Ukraine, the Western Balkans, including accession countries and Moldova.”

Looking to US LNG: Meanwhile, political pressure is intensifying for Europe to wean itself off Russian gas over time, perhaps by looking to LNG exports from the US. That said, US LNG exports will not begin until late 2015/early 2016 and will not reach the kind of volumes that would make a significant impact until into the 2020s. Moreover, US LNG exporters are primarily targeting markets in Asia Pacific where the price of gas is still largely determined by linkage to oil prices.

The utilisation rates of European LNG import facilities are currently low, giving Europe the physical capability to import large additional volumes of LNG. However, as winter approaches and the LNG market tightens there would be significant price implications, not just for consumers in Europe but also those in Asia Pacific. European gas demand has already been depressed by high gas prices, especially when compared with the price of coal.

By Alex Forbes