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No Panacea for Ukraine Gas Trade

gas050510.jpgThere appear to be two counter-opposing narratives circulating out there in response the latest natural gas agreement between Russia and Ukraine, as well as Vladimir Putin’s provocative suggestion that Gazprom could swallow up Naftogaz. 

On the one hand, there is the view that the Russian government has scored a major coup in its bid to gain control of the Ukrainian economy, and that in this aggressively political business deal, Moscow has set forth an example of its expansion of empire.  Craig Pirrong described it as part of Russia’s economic “anchluss” of Ukraine, arguing that this could have a profound impact on domestic politics, while other panicked observers see this as the end of Ukrainian sovereignty and independence.  Alexander Rahr sees it as a sneaky move that Europe would somehow have prevented if they didn’t have Greece weighing on their mind:  “This is pushy. It’s Putin’s way of negotiating, of showing that Russia is on the winning side.”

On the other side, there is a celebratory feeling among some in Russia that they have turned back the clock to the halcyon days of Leonid Kuchma, and that there not won’t be anymore of those gas wars we have come to expect every New Year.  Derek Brower, an energy reporter who used to blog here, has punched up a piece titled “Peace at last,” while President Viktor Yanukovych declared an end to the period of confrontation with Russia.

Naturally these two views aren’t mutually exclusive … perhaps the Kremlin has successfully used Gazprom to begin the annexation of Ukraine and there will no longer be any problems in the gas trade.  I don’t really believe that either is true.


First of all, the proposal to have Gazprom merge Naftogaz is not within the realm of feasibility.  The Ukrainian state gas company is riddled with bad debt, and posted a loss of some $250 million in 2008, and likely much more in 2009 (the figures haven’t been released yet).  Watching this company has been nerve-racking for the markets:  on more than several occasions they have danced around defaults and gone through numerous restructuring arrangements to handle the debt.  The disruptions and price hikes since 2006 haven’t helped matters either, and the IMF even had to suspend payments of its stabilization package because of non-payment.  It’s also interesting to note that Gazprom shares took a 2.5% dip after this news.  Gazprom is not the world’s most transparent company, but next to Naftogaz it’s a shining example.

Another problem standing in the way of suddenly harmonious energy relations between Russia and Ukraine is that the shadowy network of Swiss-based gas traders remains entirely intact, and will continue to bite off the edges of supplying 20% of European gas.  Although RosUkrEnergo is no longer officially involved (in name), Naftogaz still owes them $197 million, shaved down from $1.4 billion.  Dmitry Firtash didn’t go anywhere, and neither did Gunvor, and the interests of these parties could quickly come into conflict with the Kremlin’s foreign policy plans for control of the pipes. 

Andrew Wilson of the European Council of Foreign Relations nails it down:  “Ukraine’s rent-seeking energy ‘businessmen’ have no real business modelother than arbitrage profits; and one remaining opportunity for them isthe still considerable difference between the prices paid by industrialand household consumers in Ukraine. Another comes from the fact thatTurkmen and Russian gas enters Ukraine through the same pipe, but withdifferent transit fees and re-export prices. The Kharkiv agreementmentions a new ‘intermediary’ company, and deliberately confusing thetwo types of gas is another way it could make money.

Problems in the Ukraine-Russia natural gas trade are just as likely to return to the fore as before.  It is simply much too large a piece of the country’s economy, and stricken with the kind of corruption that the political culture relies upon.  On paper, it’s understood that Ukraine will be handed a 30% discount on gas prices, which will add up to $30 billion over the period of the contract.  It’s understood that prices could drop to $240-$260 per 1,000 cubic meters for 2010 … but for how much longer?

It doesn’t even seem that Russia really believes that their problems with Ukraine are over – they are keeping the boot on Yanukovych’s neck by insisting that South Stream is still going forward, and other gestures to keep the leverage up.

Yanukovych may be riding high for the moment on his Russia embrace, but in the near future he could find himself in a tight spot, especially if some of his inner circle get their slice of the gas pie taken away.  I could easily see him going the route of a Lukashenko-like fair-weather friend to both Russia and Europe – but any suggestion that Europe could have done anything to prevent these most recent moves is quite far-fetched.