Russia and Ukraine have a long history of disputes revolving around natural gas since Ukraine’s independence in 1992. In the last ten years the world witnessed three fallouts. The most recent of these came with a political background that proved neither simple, nor easily resolved. The current economic sanctions on Russia, which were imposed as a reaction to the political turmoil in Ukraine, affected the gas industry in numerous ways. While Russia is conquering new markets in China, Europe is feverishly diversifying its energy market.

History of Russian-Ukrainian Gas Tensions: The 2005-2006 Dispute

Gas related problems started reaching new levels of tension between Russia and Ukraine for the first time in 2005. Political tensions started earlier as Ukraine elected pro-western Viktor Yushchenko, who won the presidential elections in 2004 after sparking the Orange Revolution as a result of election fraud allegations against his opponent Victor Yanukovych.

In the second quarter of 2005, Russia’s national gas supplier Gazprom informed the Ukrainian Naftogaz that it was increasing the gas price to market levels of $230 per 1,000 cubic meters from the earlier $160 per 1,000 cubic meters, and Naftogaz was not willing to meet the asking price.

Long months of negotiations stretched until the last weeks of the year but did not result in any agreement. Gazprom, during the negotiations, was willing to lower the asking price if Ukraine agreed to allow Gazprom equity stakes in the transit pipeline network crossing its territory, according to Oxford Institute of Energy Studies Director of Gas Research, Jonathan Stern. Russia also offered Ukraine a loan to cover the prices hike, an offer the Ukrainian president refused. European Union countries fearing supply cuts were urging for the crisis to be solved.

Russia Cuts Off Ukraine

After the failure of talks between the two companies, and with Gazprom refusing the Russian president’s call for gas prices to be frozen until January 10, 2006, on the first of the year, Gazprom cut its gas supplies to Ukraine. “There is information that Ukraine has begun siphoning off Russian gas that is designated for European users,” Gazprom spokesman Sergei Kuprianov was quoted saying a few hours after the Ukrainian supply was cut. The Ukrainian Prime Minister Yulia Tymoshenko, denied Gazprom’s allegations of tapping into the EU’s gas supply going from Russia through Ukraine, and accused Gazprom of cutting off European supply. Gazprom denied this. At the time, Gazprom was supplying 22 EU countries with gas, 80% going through Ukraine. Russian gas accounted for 40% of all EU gas imports and 28% of the year’s demand.

Poland and Hungary were the first EU states to have their supply disrupted. In the first days of 2006 France reported a 25% – 30% drop, while Italian supplies dropped by 24%. Austria, Romania, and Slovakia reported a drop in Russian gas supplies of about a third according to the BBC, with Hungarian energy ministry spokesman confirming to Reuters that his country had seen a sharp 40% fall in supplies and the Polish PGNiG reported shortfalls too. Gazprom reacted by announcing the pumping of an extra 95 million cubic meters (mcm) a day to cover the EU gas that Ukraine was allegedly tapping. By January 3, EU countries were no longer reporting decreases in supply.

Crisis Ends         

Gazprom and Neftogaz announced the signing of a five-year agreement on January 4. The gas prices were fixed for only six months, leaving the issue unsolved. The so-called “middle-man” RosUkr-Energo, a Swiss registered company half-owned by Gazprom was now responsible for importing Russian gas to Ukraine and levering the gas prices through other imports. The agreement was reached between Russia’s Prime Minister Vladimir Putin and his Ukrainian counterpart Yulia Tymoshenko, and Russia started pumping gas to Ukraine once again.

The European Union’s Position

Following the crisis, the EU Energy Commissioner, Andris Piebalgs said Europe needs a more “cohesive policy on security of energy supply.” Austrian Energy Minister Martin Bartenstein said, “We have to think about energy supply security in general, gas supply security… and we have to learn the lessons,” but he also stated that Russian gas would remain the backbone of the European energy supply mix.

A report issued by the EU Energy Commissioner in 2009 stated that Russia had provided 32.6% of the EU’s imports in 2007, which amounted to 82% of the consumption, while Norway provided 14.8%, and Libya and Saudi followed with 9.8% and 6.9% respectively. It also put the EU’s imports of natural gas at 61% of the consumption, of which 38.7% was supplied by Russia, followed by Norway at 25.3%, and Algeria, where gas exports were showing promises after the Hydrocarbon Act of 2005, with 16%. After the crisis, the EU remained one of the major importers of Russian gas.

Post 2006 Russian-Ukrainian Gas relationship

In 2007, Russian gas import prices were set at $130 per 1,000 cubic meters for Ukraine and transit tariffs were set at $1.60 per 1,000 cubic meters per hundred kilometers. In late 2007 however, Ukraine imported Russian gas for $179.50 per 1,000 cubic meters and the tariff for transfer went up to $1.70 per 1,000 cubic meters per hundred kilometers. The price agreement was reached with the government of Ukrainian President Viktor Yushchenko. In February 2008, Presidents Putin and Yushchenko agreed that a joint trader owned by Naftogaz and Gazprom would replace RosUkrEnergo as of 2009, Naftogaz would be the sole importer of central Asian gas, and for Gazprom’s fully owned wholesaler to be licensed work on the Ukrainian market.

The 2009 Dispute – Ukraine Cut off Again

As disputes and disagreements regarding gas and transit prices went through 2008, Putin and Ukrainian Prime Minister Tymoshenko agreed on further details regarding the February agreement in a memorandum signed by both in October of the same year. The memorandum stated that Naftogaz is to buy gas directly from Gazprom. The two companies then signed a contract with Naftogaz being the sole Ukrainian importer of Russian gas.

Though the contract did not fix a price for the imports, it was agreed between both parties to fix the 2008 price of $179.5 per 1,000 cubic meters until the end of the same year.

The dispute between the two parties went on about debts nonetheless. By the last week of December Gazprom threatened to cut off supplies to Ukraine unless Naftogaz paid $1.67 billion debt for gas supplies and $450 million in fines.

On the first day of 2009, Gazprom cut off their supply to Ukraine for the second time after the 2006 disruption. Gazprom’s Chief Executive Alexei Miller said, “The debt to Gazprom for gas supplied earlier was not paid. Despite verbal statements from Kiev, Gazprom did not see any money in its account.”

On January 3, the BBC reported that Romania, Hungary, Poland and Bulgaria reported a drop in their pipeline pressure.

On January 5, after meetings between Putin and Gazprom’s Alexei Miller, Gazprom announced the halting of nearly all its exports to Europe. Miller announced the supplies to be cut by 65.3 million cubic meters (mcm), an amount Ukraine is allegedly “siphoning”. Ukraine denied the accusations. Disagreements were then sparked between the two countries regarding technical (fuel) gas.

It became clear that the companies did not only disagree on debts but also on the pricing of gas in 2009 and on transit tariffs and terms for European gas.

The EU Intervenes           

As the gas row entered its next phase and EU supplies halted, talks between Czech Prime Minister Mirek Topolanek, German Chancellor Angela Merkel and Putin resulted in a monitoring agreement. A declaration issued on January 8 by the Czech presidency of the EU urged Russia and Ukraine to fulfill their obligations as supplier and transit country, and called for independent monitoring of the pipelines.

Soon after, an agreement was drafted and signed by Putin, then by Tymoshenko. Although international monitors from European gas companies, EU officials, and experts from Gazprom and Ukraine were deployed on January 12, there was nothing for them to monitor, as gas was not pumped through Ukraine again. The Telegraph reported that Gazprom had indeed started gas pumping, but Naftogaz had blocked the transit as a result of unacceptable transit terms.

Gas Flow Resumes

On January 18, Putin and Tymoshenko reached an agreement following bilateral talks held after the summit Putin called for in Moscow. The agreement stated that Ukraine would pay 80% of the European gas price in 2009 of about $360, increasing to a full 100% in 2010. Transit fees were fixed at their 2008 tariff of $1.70 per 1,000 cubic meters per hundred kilometers for 2009, increasing to $2.60 per 1,000 cubic meters per hundred kilometers in 2010. The deal also stated that gas sales between Gazprom and Naftogaz would now be done directly, thus eliminating RosUkEnergo.

On January 20, gas supplies were resumed to Ukraine. In 2011, Tymoshenko was found guilty for profiting from her position during the signing of this agreement and was sentenced to 7 years in jail.

Crisis Effects on EU Countries: The EU Diversification

During the period of the 20-day crisis, several EU countries reported shortfalls in their supplies during the hard winter. Most European countries however coped with the decreased amounts by increasing imports through other transit lines or by tapping into their own storages. Several countries could not cope with the shortfall in supplies including Bulgaria, Romania, Slovakia, Moldova, and Serbia. European countries resolved to reverse gas flow–flowing the gas in the opposite direction than the usual transit; however, difficulties in transit or the lack of a sufficient storage facility made it a tough task to provide territories with the gas needed.

Supply disruption affected 18 countries; the crisis was referred to by the IEA as the “worst gas crisis in IEA history”.

The need to find alternatives to the Russian gas supply became obvious to Europe during the crisis. “I think it became clear, and there is agreement on this, that of course there must continue to be energy supplies from Russia but that on the other hand, other regions are needed to ensure security of (European) energy supplies,” German EU Minister Guenter Gloser said.

According to a report by the IEA, the gas demand in Europe decreased by 8.2% from 2010 to 2011 to 521 billion cubic meters (bcm), while demand was reduced by a further 1.6% in the 2012 estimates of 513 bcm. The decline was attributed to several reasons: a milder winter, and the stagnant economic condition and gas-pricing environment. With the European gas-to-coal switch and Europe’s increasing reliance on renewables, the gas demand decline did not come as a surprise. EU countries like Belgium, France, Italy, Spain, and Portugal started to rely more on liquefied natural gas (LNG) imports from countries including Algeria, Norway, and Egypt. Several countries in Europe turned to shale gas an alternative to natural gas; Poland started fracking in 2009 and was estimated to hold Europe’s largest recoverable shale reserves of 146 Tcf (trillion cubic feet) according to a report by the Energy Information Administration. In the same year, Ukraine signed with ExxonMobil for exploration of its 128 Tcf recoverable shale resources. The UK followed suit in 2010 and started fracking for its 26 Tcf.

However, in 2013 the EU was still receiving 30% of its gas imports from Russia, half of which were pumped through Ukraine.

The Recent Gas Dispute: Political Background

By the end of 2013, protesters took to the streets in Kiev as President Viktor Yanukovych postponed the signing of an association agreement with the EU. The Ukrainian president instead signed a cooperation agreement with President Putin in December for the buying of Ukrainian bonds and Russia reducing Ukraine’s gas price by a third. The agreement sparked more anger on the Ukrainian streets with clashes between pro-EU and pro-Russia protestors.

Kiev politicians voted to overthrow Yanukovych, Tymoshenko was freed from jail, and presidential elections were scheduled for May 25. In March, Crimea held a referendum for its separation from Kiev, the UN Security Council members condemned the move. An asset freeze and visa bans were imposed by the US and EU. As Crimea voted 95% in support of the union with Russia, the Kremlin is not affected, as Putin signs a bill formally annexing the peninsula.

Russian troops deployed to the Ukrainian border claiming to protect ethnic Russians, while Ukrainian troops tried to regain control of the eastern cities. Late in March, the UN declared the annexation illegal while the US expanded the sanctions to include several individuals in Putin’s inner circle. A few days later on April 1, NATO announced suspending all practical civilian and military co-operation with Russia.

As EU countries threatened to up the sanctions against Russia, fighting went on in Ukraine’s Eastern cities and the Ukrainian armed forces continued to fight against the separatist rebels. On May 25, Petro Poroshenko won the presidential election in Ukraine. On June 27, he signed the EU association agreement after 8 months of it being abandoned by his precursor.

Third Time’s a Charm

In April, talks between Gazprom and Neftogaz were ongoing regarding Ukranian debts. On May 12, Gazprom gave Ukraine until June 9 to pay about $1.695 billion of the $4.5 billion in debts owed by Naftogaz.

On June 16, Gazprom announced in a statement the halting of gas supplies to Ukraine. “Today, from 10:00 Moscow time [06:00 GMT], Gazprom, according to the existing contract, moved Naftogaz to prepayment for gas supplies. From today, the Ukrainian company will receive Russian natural gas only in the amounts it has paid for.” Gazprom also raised the price for the Russian gas from $285.5 to $485.5 per 1,000 cubic meters.

Gazprom and Naftogaz both filed lawsuits in the International Council Commercial Arbitration in Stockholm on the same day. Gazprom said it wanted to recover $4.5 billion from Naftogaz, while Naftogaz said it was seeking to recover about $6 billion in “overpayment” for gas since 2010, the lawsuits were later joined by the court at the end of July. Transit through Ukraine to the EU remained at the same level of 185 mcm per day, 15% of Europe’s gas supply from Russia. Ukraine started receiving gas through reverse flow from several European countries and via Slovakia – which started in September.

The EU Commission kept urging for talks between the two conflicted parties. They supported reverse supplies from EU countries to Ukraine, with the country relying on it to fill up its storage facilities for the winter. As Gazprom and Naftogaz fail to reach any agreements, the EU’s concern for the transit gas grew and both Ukraine and Russia assured stable transit volumes.

In the second half of August, Gazprom made a $10 million payment to Neftogaz for transit gas, later they offered to decrease the asking price for the gas by $100 – a price Ukraine did not accept. Meanwhile, Rosneft President Igor Sechin said in an interview with Der Spiegel that his company had estimated damages done to its oil refinery in Lisichansk, Ukraine’s Lugansk region, by the Ukrainian Army’s at $140 million and said Rosneft planned to launch talks with the Ukrainian government regarding damage reimbursement.

In September, Ukraine’s pipeline operator announces that the country has increased its storage of gas to 16 bcm. EU Energy Commissioner Gunther Oettinger arranged for a talk between the parties, which eventually were scheduled for October 21.

As the crisis continued into October, Ukraine struggled to ensure its gas supply and storage, the EU continued its efforts to resolve the situation, and Russia continued vigorous negotiations.

The Sanctions

As the crisis in Crimea continued, several countries led by the US and EU imposed sanctions on Russia over three stages. The first came in the first quarter of 2014 with the NATO suspending military and civilian cooperation with Russia. Travel bans and asset freezes were imposed on Russian and pro-Kremlin individuals for undermining Ukrainian sovereignty by the EU. Russia reacted by banning 10 US officials visas, including House of Representatives Speaker John Boehner and Senator John McCain.

By late April, the US imposed new sanctions against seven Russian politicians and businessmen, including Putin’s long-time ally Igor Sechin, and 17 companies. The EU implemented sanctions imposed by the UN and imposed an arms embargo, travel bans and asset freezes on further individuals and businesses.

The sanctions escalated with more imposed by Australia, japan, and Canada, and further sanctions imposed by the EU and US including barring American companies from using certain technologies to exploit oil in shale, deep sea, and arctic fields. On August 4, Russia imposed bans on agricultural produce, foods and raw materials from countries that have earlier sanctioned Russia.

On September 12, the EU announced sanctions targeting Russia’s state finances, energy and arms sectors. Rosneft, Transneft and Gazprom Neft, the oil unit of Gazprom were targeted. Gas, space technology, and nuclear energy were excluded nevertheless.

As the threat of the sanctions loomed over Russia’s privately owned companies, Lukoil sold several gas station networks in Slovakia, Hungary and Czech Republic in August. Earlier the same month, the company sold 240 stations in Western Ukraine. Analysts saw the move as a preemptive measure against the EU and US sanctions. Lukoil President Vagit Alekperov said, “The sanctions are related to the country, we are a Russian company. This will impact us, just like everyone else.”

The Russian government reacted by commencing a long-awaited deal with China, opening an alternative (prospective) gas market in Asia. The deal was initially signed between Gazprom and CNPC in May – after years of negotiations – to supply China with 38 bcm of natural gas per year over a period of 30 years through the “Power of Siberia” pipeline.

Pipeline Alternatives

Russia and Europe both pushed for pipeline projects in the light of the 2006 and 2009 disputes with Ukraine, and the disruptions of European gas. Nord Stream pipeline, which was proposed years earlier to transfer gas from Vyborg in Russia to Greifswald in Germany under the Baltic sea, was welcomed by Germany as it would save transit fees and eliminate the security concerns rising from the Ukraine transit route. “The Nord Stream project must be an important part of that diversification of energy sources,” said German Europe Minister Guenter Gloser. Nord Stream’s first line was inaugurated in November 2011, while its second line was inaugurated in October 2012.

To connect Nord Stream to the existing grid in Central and Western Europe, two pipeline extensions were constructed, OPAL and NEL pipelines in Germany. OPAL was completed in 2011 and connected to Nord Stream the same year, while NEL started complete commercial operations in November 2013.

In 2011, The EU commission approved the North-South Gas Corridor project connecting the LNG terminal in Poland’s northwest city of Swinoujscie with the Baltic Pipe, through central Poland, the Czech Republic, Slovakia, and Hungary with the proposed Adria LNG terminal in Croatia. It is seen as an effort to create a gas hub in Poland to ease the dependence of Central and Eastern Europe on Russian gas and to enhance security of supply to the EU. “The north-south corridor, currently under construction, could be an interesting alternative, particularly for the southern countries, as it will make it easier for them to access non-Russian gas,” Tomasz Chmal, an analyst at Poland’s Sobieski Institute, said. “We will build parts of the north-south gas corridor in such a way to make it ready in the years 2018-2019,” Jan Chadam, CEO of pipeline operator Gaz-system said. “They will allow for high flexibility, adjusting the direction of flows to the geopolitical conditions and prices.”

Meanwhile, Germany’s RWE urged for the need of the Nabucco pipeline, carrying gas from Turkey to Austria through Bulgaria, Romania and Hungary. RWE’s CEO Ulrich Jobs said to Reuters, “The current incident shows all [Nabucco] partners and transit countries how important the project is for Europe’s gas supply.” Nabucco was intended to diversify the EU’s supply of gas and decrease its reliance on Russia. Pipeline construction has not begun to date and the project is thought to be abandoned.

Another Euro-Russian pipeline project is the South Stream pipeline, proposed to carry Russian gas through the Black Sea to Bulgaria through Hungary, Serbia, and Slovenia further to Austria. Construction of Russian onshore facilities started in December 2012. The pipeline was seen to rival Nabucco, allegations which were dismissed by Gazprom officials and the EU. “In the worst case scenario, the two pipelines will be complementary,” Ferran Tarradellas, the European Commission spokesman on energy issues told the BBC. However, the EU has opposed the project, as it does not comply with the Third Energy Package. Russia did not see any basis to the claim, as the bilateral inter-governmental agreements with participant EU countries were signed before the energy legislation came into force. This October, the EU Energy Commissioner Gunther Oettinger stated that the EU no longer opposes the project but still does not see it as a priority. The pipeline was expected to start operation in 2016, now its fate remains unknown as the political and gas disputes between Russia and Europe intensify.

The newest addition to the pipeline saga is the “Power of Siberia” pipeline. The 4,000 kilometers pipeline is to carry natural gas from Eastern Siberia to the country’s Far East and buyers in China. Gazprom expects the pipeline to go on-stream in late 2017. The project was made possible when Russia signed a 30-year contract with China for natural gas supplies. Some analysis suggest that the project is a daring move by the Russian government towards opening a new gas market in Asia, especially considering the sanction and political turmoil with Europe.

The gas pipelines are playing a major role not only in Europe’s diversification efforts but also in Russia’s quest for new gas markets.

Where Are We Now?

On October 15, the Russian and the Ukrainian presidents met in Milan to discuss the current situation in Crimea and the gas crisis. They announced a potential deal only two day after the beginning of the talks on October 17. “[We] reached an agreement,” Poroshenko said in an interview with Ukrainian TV channels. “Until March 31 we will fix the price at $385.” Mr. Putin said they agreed on the Terms of the Russian gas supply until “at least the winter,” according to Reuters. However, he urged European countries to help Ukraine meet a debt for gas, which he said stood at $4.5 billion.

The political side of the talks didn’t seem as productive though. Arguments about Ukraine’s sovereignty and Crimea remain heated and might be making way for more gas disputes. Although signing this deal (which EU officials expected during the last week of October in Brussels) would ensure the EU stable gas supplies during the winter, the likelihood of another disruption lingers, leaving the EU vulnerable.

Efforts are put into diversifying the EU supply and reducing reliance on Russia, Europe is eyeing LNG and gas imports from Mediterranean countries, US gas – which is considered to be effective only as a long-term solution– as well as coal, shale and renewables. Still, the IEA expects the EU to rely mostly on Russia for gas supplies until 2030. The coming period would prove crucial not only politically, but also for the gas supply and demand dynamics, shifting the current market in a new direction.

By Passante Adel

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