Gazprom, Naftogaz Codify Political Agreement in Deal to Reduce Ukrainian Gas Imports

Putting Words on Paper

Since early September, when Ukrainian prime minister Yulia Tymoshenko claimed to have reached a verbal agreement with Russian prime minister Vladimir Putin under which state-run Naftogaz Ukrainy would be allowed simply to pay for the gas it purchases (rather than the gas it committed to buying in the January 2009 supply agreement with Gazprom), Ukrainian president Viktor Yushchenko and his chief energy envoy, Bohdan Sokolovskyi, have challenged Tymoshenko to get this "promise" in writing (see "Related Articles"). With Naftogaz importing well below minimum "take-or-pay" (ToP) levels this year due to the sharp contraction in Ukraine's economy, Yushchenko and Sokolovskyi repeatedly have warned Tymoshenko that Ukraine could still face huge fines—estimated at US$8 billion—without legal clarification of Putin's verbal commitment.

Last week, Tymoshenko met Putin again, and with the drumbeat of concern about a new potential Russia-Ukraine gas war growing louder by the day, the two prime ministers reiterated their earlier verbal agreement, announcing that they had reached a compromise to avert—or at least reduce the threat of—a new dispute. This time, however, the two leaders charged their respective state-run gas firms with hammering out the details of their political arrangement, post-haste. Yesterday, Gazprom and Naftogaz Ukrainy did just that, translating the verbal deal into a formal legal document that addresses issues relating to the disparity between Naftogaz's contractual import obligations in 2009 and 2010 and the firm's actual purchases this year and planned imports next year.

In the amended terms, Gazprom agreed to allow Naftogaz to avoid any ToP penalties for its lower-than-expected imports this year. Through the first 10 months of the year, Naftogaz imported just 18.85 bcm of gas from Russia, less than 60% of the 31.7 bcm of gas that was slated to be purchased according to the January supply agreement. ToP penalties were supposed to kick in for gas purchases below 80% of the planned volumes, but Gazprom agreed not to fine Naftogaz for the "non-use" of gas, citing the economic crisis in Ukraine that has led to a collapse on gas consumption. Ukraine was originally slated to purchase 40 bcm of gas in 2009.

Furthermore, Gazprom and Naftogaz agreed that the Ukrainian firm would purchase 33.75 bcm of gas next year, down from the 52 bcm written into the January contract. This volume is on the high end of what Tymoshenko had originally sought for Naftogaz to import in 2010, but the reduction nevertheless eases the threat of a dispute that would surely have arisen without this alteration, as even with a recovery in Ukrainian demand Naftogaz would not have come close to importing such an amount in 2010. The company's actual imports next year will be determined by a combination of import prices, the severity of temperatures in the winter heating season (and related drawdowns on gas already in storage), Ukraine's economic situation, and potential reforms to the domestic gas market—that is, once Ukraine's presidential election campaign plays out and assuming that a post-election government will actually move to implement market-oriented reforms in the gas sector.

Outlook and Implications

Indeed, not to be overlooked in the clarifications on Naftogaz's import obligations in the new agreement was a reaffirmation by both Gazprom and Naftogaz to complete the transition to market-based prices for gas import and transit tariffs in 2010. Gazprom and Naftogaz laid out plans in their parallel January 2009 supply and transit agreements to shift to "European-style" prices and transit tariffs in 2010, using established formulas. Thus, yesterday's deal confirms that both sides accept that Naftogaz will no longer receive a 20% discount to European prices for its gas imports, while Gazprom will no longer benefit from a transit tariff of US$1.70 per 1,000 cm per 100km that was held steady in 2009.

Naftogaz, which is paying US$208 per 1,000 cm for its gas imports in the fourth quarter, is likely to pay US$270–280 per 1,000 cm in the first quarter of 2010, while Gazprom is facing approximately a 60% hike in the transit tariff for sending gas to Europe via Ukraine's gas transmission system next year. However, the fact that both sides yesterday reiterated their acceptance of the standard European formulas by which these transit tariffs and import prices are established is important in removing the scope for a potential new disagreement that could spark a new conflict and result in a disruption in Russian gas supplies to Europe. Yushchenko once again raised his objections to the low transit tariffs agreed in the earlier version of the contract, but by lowering Naftogaz's import obligations next year and waiving the threat of penalties this year, the main thrust of Yushchenko's argument has been neutralised.

Still, a multitude of Ukrainian presidential candidates weighed in on the efficacy of yesterday's Naftogaz-Gazprom deal, indicating just how politicised the gas sector is in Ukraine while serving as a reminder that the risks of a new gas conflict have not entirely been mitigated. Although most of the actual commercial issues that could be a bone of contention between Gazprom and Naftogaz have now been addressed, there are numerous political and economic hurdles that may yet pop up, particularly as Ukraine continues to suffer through a sharp economic downturn and as the 17 January presidential election draws nearer. In the meantime, the stability of the bilateral gas relationship will face another test on 7 December, the deadline for Naftogaz to make its payment to Gazprom for November gas supplies.

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• Ukraine: 27 February 2009: Stress Builds on Russia Gas Deal as Naftogaz Seeks to Reduce Import Obligations
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• Ukraine - Russia: 20 January 2009: Gazprom, Naftogaz Sign 10-Year Gas Supply and Transit Contracts, Formally Ending Dispute