Kiev and Minsk: the other side of diversification

The completion of the summer political season was marked by another flare-up in Russian-Ukrainian gas relations. Ukrainian Prime Minister Mykola Azarov declared that the contract of January 19, 2009 requires revision because it does not correspond with Ukraine's interests.

The reasons for such "friendly behavior" are clear. First, in summer Ukraine had to increase domestic gas prices considerably. By decision of the national energy commission, it raised the average gas price for the population from $78 to $118 per thousand cubic meters and from $110 to $165 for utility services. This is explained by the terms of the IMF loan, which requires tougher financial discipline and higher gas prices.

Ukraine is soon going to have elections to the local bodies of government. The voters need know who to blame for these higher gas prices. By talking about a "fettering contract" Azarov is shifting the blame to Russia. Since the contract of January 19 was signed by the then Prime Minister Yulia Tymoshenko, this scenario suits the Party of the Regions down to the ground.

Moreover, now many European gas consumers have asked Gazprom to revise their long-term contracts and Ukraine simply decided to join the line.

What do European wholesale buyers hope to achieve? They want to revise the system of fines based on the "take-or-pay principle" and also to partially link prices to the spot market. As for Ukraine, Russia did not fine it for its failure to take the required amount of gas last year, saving Ukraine eight billion dollars. Nor is Russia going to fine Ukraine in the future. As for the gas price formula, Ukraine hasn't just got it linked to the spot market - it has received a 30% discount because the export duty was cancelled. This is something other customers can only dream of.

But Ukraine is still not content. Its proposals to alter the old formula state that it is not appropriate to tie the gas price to the oil products basket. But this is how the price of gas is formed right across Europe. Setting the gas price independently is no guarantee of cheap gas, but that requires a separate discussion. What is important is that linking the gas price to oil products is not unique to the European market. Nevertheless, Ukraine proposes a radical revision of the price formulation principle. Since it is impossible to set the gas price based on the market (as Kiev has no gas exchange), Kiev suggests tying it to the price for Germany on the net back principle. In other words, let's take the gas price for Germany and minus transportation expenses. However, in Germany the price of gas is linked with that of oil products.

Even rough estimates show that Ukraine will not stand to gain from any change in contract terms. It's a simple calculation. The price of gas for Ukraine was $305 in the first quarter of this year. Let's apply the Kharkov coefficient to it, which is about $90. So, it works out at $215 for a thousand cubic meters. Now let's calculate the net back principle. In the first quarter of this year, the average price of Russian gas for Europe was $290. The price for Germany doesn't differ much from this figure. Let's minus the costs of transporting the gas through Poland. The road is about 700 km, and the transit rate is $2.1 per 100 km, so the total is about $15. As a result, Ukraine still loses $60.

In the third quarter Naftogaz purchases gas from Gazprom for $248 per thousand cubic meters. The price for Germany is approaching $300. Gazprom's average for the German market is $308 per thousand cubic meters. It appears that the transition to the new price formula will still increase the gas price, although not substantially.

It seems Ukraine wanted to exploit this net back principle and to keep its 30% discount. Then the gas price really could drop beneath $200 per thousand cubic meters. But why should Russia forego the 30% duty? Remember that the Kharkov agreements were based on the immutability of the pricing formula. If it changes, then these agreements are called into doubt. Hence, the 30% duty is back.

Ukraine's leaders understand this. In this context we should take into account the third reason behind Azarov's statements - the talks about Ukraine's gas transportation network (GTN). It is no accident that Ukrainian Energy Minister Yuriy Boyko has paid two visits to Moscow (last Friday and this Friday) for talks about the GTN. Azarov's speech may be considered an attempt to improve Ukraine's negotiating position ahead of another round of pipeline problem discussions.

If Russia starts construction on South Stream, Ukraine will soon lose its role of being a transit country. Needless to say, South Stream is a very expensive project and transporting gas via Ukraine is cheaper. But this requires ownership over the pipeline, because otherwise it is impossible to guarantee gas transit stability. But even this new Ukrainian government cannot hand over its GTN to Russia because it is considered a national asset even though without Russian gas it immediately becomes a worthless heap of scrap. Kiev is eager to get help from Europe, asking it to convince Russia to unconditionally guarantee gas transit. However, the European Union has distanced itself from any such mission.

Instead of trying to find a compromise, Ukraine has decided to attack. This does not involve only the gas contract of January 19, 2009. There is much speculation that it "can live without Russian gas." On the eve of his visit to Moscow, Boyko staged a news conference where he said that if Ukraine had a terminal for Liquefied Natural Gas (LNG), then the price for LNG would be $190 per thousand cubic meters. Such figures stoke the imaginations of those who have only a feeble grasp of the subject. Even though they're pure fiction because Ukraine has no such gas terminal.

Take Poland, Ukraine's neighbor: Poland is building a terminal, but it will take it at least four years before construction is complete and even then its initial capacity will be a mere 2.5 billion cubic meters. If Ukraine were to acquire a similar terminal within four years, it would profit little from it. Moreover, those four years may see serious changes on the gas market. Those countries that have LNG do not want to sell it at knock-down prices. Boyko is referring to agreements with Egypt but Egypt currently exports less than 13 billion cubic meters of LNG and has no surplus. Before the crisis Ukraine required about 45 billion cubic meters of imported gas. This is not to mention the navigability of the Turkish straits and other such trifles.

Ukraine has other "reliable sources," for instance, Poland's shale gas. Indeed, in the last four years 30 companies have received licenses for gas exploration in Poland but no one has yet started drilling. So, any talk of Polish shale gas is not serious. Poland understands this too. That is why it is in negotiations with Russia about expanding gas imports.

Belarus is, on paper at least, also playing an active part in gas supply diversification. President Alexander Lukashenko says that he has no great need for Russian oil and gas and that he will find an alternative to them. He has promised to buy LNG in Lithuania although it does not have any terminal for it, either.

In his address to parliament and the nation this spring, Lukashenko instructed the government and the National Academy of Sciences to intensify the exploration of promising, in-demand mineral deposits for industrial use. He referred to shale gas, among other things. Indeed, why buy it from Poland if it may be found at home? However, researchers have not yet acted on the president's instructions. So, such "diversification" may prove costly for Belarus.

In fact, Belarus has already suffered a bad experience with oil. Lukashenko boasted that Belarus will now buy oil from Venezuela. Several oil tankers even arrived in the country. However, according to its statistical bureau, in the first half of the year Belarus has reduced its oil imports from Russia by 49.8% (in annual terms). Exports of oil products have decreased by 40% and the production volumes in the Belarusian oil processing industry have fallen 30%. Such are the bitter fruits of this "diversification."

There is every possibility that Ukraine will go down a similar road, and be left without any fuel and also without the transit role. However, Kiev still has time to clean up its act, at least until the South Stream project gets underway.

Konstantin Simonov, general director of the National Energy Security Fund, for RIA Novosti

The opinions expressed in this article are the author's and do not necessarily represent those of RIA Novosti.


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