Essay: Ukraine’s gas relationship with Russia

Ukraine’s gas relationship with Russia can easily be described as complicated. During the 1990s high levels of debt characterized the Ukrainian/Russian gas relationship as Ukraine was unable to pay for its gas consume (J. Stern, 2006, s. 2). In order to restore payment discipline Russia reduced supplies too Ukraine on several occasions, which resulted in illegal siphoning of gas in transit to Europe. (J. Stern, 2006, s. 2). This proved to be an effective mechanism able to severely impact large groups of the population as well as damaging their bilateral relationship.
Former Soviet states have enjoyed favorable prices on gas, however after the collapse of the Soviet Union, Russia wanted to increase the prices to market levels (J. Stern, 2006, s. 16). This was easier said than done. Ukraine was unable to pay back its debt let alone to pay higher prices. As Ukraine remained the main transit corridor for Russian gas exports to Europe was not defenseless against Russian pressure. As the main transit country Ukraine could relieve shortfalls in supply by siphoning gas in transit and at the same time require transit fees from Russia (Pleines, 2008, s. 9). Close to 80 per cent of Russian gas exports are made through Ukrainian territory and two thirds of Gazprom’s revenue comes from sale of gas that passes through Ukraine (Chow & Elkind, 2009, s. 78).
The stalemate and hence the interdependence between the two states led to the agreement of an initial compromise in the mid-1990s. Under this arrangement, Ukraine would be compensated for the transit fees with more than half of its gas imports (Pleines, 2008, s. 9). Furthermore, Russian leasing fees of the Black Sea Fleet and suggestions of using barter deals (through i.e. the delivery of military aircrafts) was being used to repay Ukrainian debts (Pleines, 2008, s. 9). In order to protect its Western European exports, Gazprom accepted this agreement, thus resulting in rising Ukrainian gas debts (Pleines, 2008, s. 9).
In the beginning of 2000, Ukrainian gas debt to Russia had reached $1.4 billion (Pleines, 2008, s. 9). Gazprom demanded an additional $ 700 million in interest, penalties, and refund payments for theft of transit gas (Pleines, 2008, s. 9). At the same time, the first deliveries of gas through the Yamal Pipeline on Belarusian and Polish territory were being made (Pleines, 2008, s. 9). Gazprom had been able to avoid Ukrainian territory, increasing the pressure once again. This belligerently pushed for resolution of the gas thefts and primarily the outstanding debt. At the same time Gazprom pursued with plans to build further alternative export pipelines avoiding Ukrainian soil (Pleines, 2008, s. 9).
In the summer of 2004, the Russian government, Gazprom and the Ukrainian government settled an agreement to arrange for delivery of Central Asian gas to Ukraine and to settle past debt (J. Stern, 2006, s. 2). Besides technicalities the agreement included provisions designed to establish more predictability in the relationship between the two countries over the next five years. Gazprom loaned the Ukrainian gas company Naftogaz enough to pay past gas debts, and to provide the agreed deliveries of at least five years of Turkmen gas and transit of Russian gas to Europe (J. Stern, 2006, s. 2). The agreement foresaw deliveries of Russian gas to Ukraine of 21-25 Bcm/year for the period 2005-09 as a barter payment for transit of gas to Gazprom’s European customers (J. Stern, 2006, s. 2). Under this agreement, where no actual money changed hands, the theoretical price of Russian gas sold to Ukraine was $50/mcm (J. Stern, 2006, s. 2). This constituted a significant discount as compared to the price charged for EU importers (Pleines, 2008, s. 9). Ukraine had solved its debts with Gazprom but would no longer receive gas in lieu of transit fees from 2005 onwards (Pleines, 2008, s. 9). A consortium of Gazprom and Naftogaz had been founded with the goal to operate and refurbish the Ukrainian transit pipeline network (J. Stern, 2006, s. 3). Gazprom had long expressed interest in taking ownership in the Ukrainian transit system to minimize transit costs and risks (J. Stern, 2006, s. 3).
Tension developed over Turkmen gas supplies. In December 2004, the Turkmen authorities requested a price increase from their Russian and Ukrainian counterparts from $42/mcm to $60/mcm (J. Stern, 2006, s. 3). Neither parts were willing to accept this request; subsequently Turkmen gas supplies were halted on December 31 (J. Stern, 2006, s. 3). This hastened a rapid negotiation between Ukraine and Turkmenistan resulting in resumed flows to Ukraine on January 3, 2005 at a price of $58/mcm (50/50 cash/barter) (J. Stern, 2006, s. 4).
Seemingly the agreement would result in stability in the Russian-Ukrainian gas trade for supposedly five to ten years to come (J. Stern, 2006, s. 3). However, in December of 2004 unrest broke out in Kiev as response to the flawed election of President Yushcenko; the so called ‘orange revolution’ (Office for Democratic Institutions and Human Rights (ODIHR), 2004, s. 1). The new administration made it a priority that Ukraine should be treated as an independent nation. However, in march/april 2005 the Yushchenko administration suggested that gas transit tariffs should be raised to market levels and paid in dollars (J. Stern, 2006, s. 5). The proposal was received with enthusiasm by Gazprom as this raised the possibility of also increasing prices for Russian gas. Additionally, in June 2005 the Yushchenko government announced that the consortium had collapsed (J. Stern, 2006, s. 4). It was suggested that the consortium should focus on new pipeline construction projects rather than the existing network as the Russians claimed (J. Stern, 2006, s. 4). By July 2005 the optimism in Kiev had faded and virtually all elements of the 2004 agreement settled a year earlier were back to scratch, there was little sign of resolution.
As negotiations stagnated Gazprom was demanding a price increase to match European netback levels (J. Stern, 2006, s. 6). In December of 2005 Gazprom threatened to raise the price to $ 230/mcm unless Ukraine was prepared to allow Gazprom an equity stake in the transit pipeline as initially agreed upon in the consortium (J. Stern, 2006, s. 6). Gazprom suggested that if Ukraine were unable to afford the ‘new’ price, the company would extend loans for this purpose, a final effort to postpone the price increase by three months before switching to market prices (J. Stern, 2006, s. 7). Ukraine rejected both proposals and called Russian actions a violation of the bilateral treaty on gas supplies (Pleines, 2008, s. 9). On 1 January, at 10.00 am Moscow time, Russia cut off gas supplies to Ukraine (J. Stern, 2006, s. 7).
The consequences of the shutdown had immediate implications for European consumers in the subsequent days from 1-3 January 2006. Hungary were reported to have lost 40% of its Russian supplies, Austria, Slovakia and Romania were said to be down by one third, France 25-30%, Poland by 14%, Italy 25% and Germany was also affected (BBC News, 2006). Gazprom claimed it was supplying the right volumes to its European customers, however it became evident that Ukrainian companies were diverting gas destined for Europe. Gazprom tried to compensate for the siphoned gas meant for Europe by supplying additional volumes into the system. By January 4 the Russian gas deliveries were back to normal levels (J. Stern, 2006, s. 9).
Already on January 4 Gazprom and Naftogaz announced an end to the dispute by signing a five year contract (J. Stern, 2006, s. 9). The content of the agreement showed that the parties wanted to reach a solution quickly. The issue of setting a gas price beyond June 2006 was not resolved. The domestic discontent with the Yushchenko administration’s handling of the conflict was emphasized in the inability to reach a sustainable agreement. This could have been one of the contributing factors to Yushchenko’s demise from political power after the 2006 election, where the alleged Russian-friendly Yanukovych became prime minister. In 2007 a new agreement was reached after the political transition of power within Ukraine. Inherent in this deal was a gradual increase of Ukrainian gas import prices of 30 ‘ 40 % each year until 2011 (Johansen, 2010, s. 3).
Following is an account of the central bilateral events and disputes in Russia-Ukraine relations, in the time around the 2006 gas row.

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