How to make Gazprom become civilized

Nana Chornaya 

Ukraine has put forward new conditions for the transit of Russian natural gas, in line with the European and national legislation. Gazprom considers them unacceptable and could trigger another scandal. This will lead the parties to arbitration, which is likely to decide in favor of Ukraine.

Ukraine is entering a new phase of gas relations with Russia – the talks on Ukraine-proposed changes of conditions for gas transit will be held in the near future, and they will shift the situation radically, not in Gazprom’s favor. And it certainly will provoke another scandal and yet another litigation.

On January 19, 2016, the National Energy and Utility Commission (NKREKU) raised the tariff rate for Gazprom for transit of gas to the EU by 50%, to $4.5 from $2.8 for 1,000 cubic meters per 100 km (Gazprom set the rate at $2.5 in its 2016 budget).

*** According to law "On the natural gas market” which came into force on October 1, 2015, the tariff for transportation, which previously depended on the price of gas, is now subject to government regulation.

But that is only in case 110 bcm (billion cubic meters) of gas is pumped via the Ukrainian gas transport system per year, according to the contract of 2009, which Gazprom has repeatedly referred to as "spelled out perfectly." If the transit volume is lower, like it has been happening for many years, the tariff rate shall increase – the Russian gas monopoly will have to reserve capacity of Ukraine’s GTS (gas transportation system) for the contracted volume of 110 bcm.

In addition, Ukraine has completely changed the approach to the transit of Russian gas by setting tariffs for entering the GTS and exiting from it, also reformatting the transit accounting mechanism. This suggests that Ukrtransgaz will receive the entire volume of gas transit to the EU's eastern border and will deal with it at its discretion, including as a virtual reverse supply. This mechanism will resolve the existing problem with Gazprom’s shipper codes Ukraine needs to obtain to work with European traders. Ukraine requested the codes back in 2015, but the Russian energy monopoly sharply refused to provide them, as it would then cease to be a mediator in gas trading operations.

All these conditions are not Ukraine’s whim. This is a total transition to the rules of the European energy system, which is an obligation enshrined in international agreements – on the membership in the Energy Community and in the Ukraine-EU Association Agreement. Besides, this is in line with the national legislation – the law on the gas market which Ukraine adopted to implement the EU's Third Energy Package, designed to eliminate the monopoly on the European energy market in Europe, that is, to cancel the dependence on Russian gas.

In principle, fundamental changes are not just about a transit tariff rate for Gazprom. Ukraine has also asked its European partners to revise approaches to the Ukrainian transit because transportation of gas through Ukrainian territory should be exactly the same in practice as it is in European countries, said president of Strategy XXI Center Mykhailo Honchar.

"The base that we will come to with time is transportation of energy, not cubic meters of gas. In trading operations, we will use European-style MW and BTU (British thermal units), that is, it’s the energy which is transferred," said the expert.

All of these transit innovations were supposed to be introduced on January 1, 2016. But, according to Minister of Energy and Coal Industry Volodymyr Demchyshyn, Ukraine will continue the transit of Russian gas under the old rates until the new contract is signed.

"Now we have no basis to [bill Russia] under the new tariffs, because the contract is not signed. We are working according to the existing contracts," he said.

Naftogaz CEO Andriy Kobolev and head of Gazprom Alexei Miller planned to meet on the issue in late January. But there was no meeting. Now, the sources say it should be expected later in February.

Recognizing the legitimacy of Ukrainian conditions and possible risks, the Kremlin launched its favorite algorithm.

"Ukraine’s increase of the rates for the transit of Russian gas to Europe once again proves the unreliability of this country as a transit state, and it can also become grounds for the beginning of a new gas crisis and disruption of gas supplies to the EU," said deputy director of the Russian foundation for national energy security Alexei Grivach.

Thus, the transit issue is beginning to gain momentum. UNIAN figured out what to expect from the first negotiations between Moscow and Kyiv, and what may be the further developments.

Ukraine. Arbitration. Gazprom. Surrender

According to Honchar, Gazprom is obliged to accept the innovations in the Ukrainian energy system, but this implies an adjustment of the existing contract to the new reality. Gazprom will therefore be calling the conditions of Ukraine unacceptable, and the talks will yield no results. The question can only be solved in arbitration.

"And here it is important that Gazprom actually makes the corresponding adjustments of certain articles of long-term contracts with its European partners, at the same time refusing to do so with regard to Ukraine, which, though not an EU member, has implemented the European rules for the energy market. 

And this is the Kyiv’s argument. Therefore, the way Gazprom tries to put it – as if Ukraine is attempting to shape foreign relations according to its national legislation – is unsustainable as the contract between the two business entities cannot be deemed to have more legal power than the international legal obligations," said Honchar.

The expert recalled that the law was recently passed in Russia, stipulating  precedence of national law over international legislation. "Therefore, Gazprom will insist that as long as the principle of the 2009 contract is under consideration in the Stockholm arbitration, the parties must execute it," said Honchar.

Director of the Energy Research Center Oleksandr Kharchenko also said that the talks will be formal. Given the Ukraine-Russia political situation, the parties are unlikely to reach any compromise solutions in the arbitration.

"I think that the talks are the formal, procedural part of the process. Everyone understands that Gazprom will say that a valid contract has provisions including an agreement on gas transit and gas supplies. And this is confirmed by the fact that to this day, Gazprom has been putting forward completely bills, and it is absolutely clear that the matter the matter is unlikely to be solved any way other than in court. The Stockholm arbitration will make a decision following consideration, and I think, it will clearly be in favor of Ukraine," said the expert.

Director of energy programs at the Center for World Economy and International Relations Valentyn Zemliansky said that Gazprom would not agree to the Ukraine’s conditions on gas transit. He is also of the opinion that Ukraine will lodge a claim with the arbitration on this issue.

"The problem is not so much the tariff rate, but in changing the system of transit accounting. That is, Ukraine is becoming a full-fledged part of the system of European operators. Accordingly, this entails a complete revision of Gazprom contracts. Therefore, the issue will not be resolved through negotiations, even if we hypothetically assume that Naftogaz and Gazprom have reached an agreement. 

This requires revision of all contractual framework of Gazprom, and there is no way Gazprom will go for it. The arbitration will be still continuing on this issue. The current question is likely to be a supplement to the claims already filed by Ukraine. But arbitration is a long story," said Zemliansky.

Thus, the experts agree that the transit issue will not be resolved without arbitration.

In 2014, Ukraine filed a suit in the Stockholm arbitration to revise the gas contract with Gazprom from 2009, including with respect to transit. At the same time Ukraine has addressed to partners from the European Union to jointly conduct an antitrust investigation against the Russian energy giant. Ukraine’s Antimonopoly Committee for its part has already established the fact of abuse of dominant position in the Ukrainian market by Gazprom, imposing a $3.4 billion fine. The relevant decision will be attached to the arbitration claims.

According to a procedural schedule, the Russian monopoly must provide a response to the arbitration claim by October 9, 2016.

Prime Minister Arseniy Yatsenyuk earlier forecast that the final verdict will be handed down in 2016, and it will be in favor of Ukraine.

But, as the experts assure, the verdict will not affect the transit issue in question.

"Arbitration is not to draw conclusions on this issue, because it only considers that what has bound the parties from the beginning of the contract until the date of the claim. This is another story, and it will be considered in arbitration in the future. Nothing can be achieved simultaneously," said Honchar.

Ukraine’s first claims have been considered for almost two years already. Meanwhile, the notorious gas deal expires in three years. Honchar did not rule out that arbitration will wait for its completion and issue its opinion for the parties to settle. Moreover, the arbitration does not normally take definitive decisions in favor of a certain party.

But it is still a huge risk for Gazprom. According to statistics, in recent years, the gas monopoly tended not to wait for the court rulings, going for concessions to the opponents in fear of losing markets. Besides, Gazprom has been suffering significant losses amid plunging oil price (since the summer of 2014, oil quotes have dropped 75%), as its long-term contracts are tied to it. It has also been suspending its projects against the background of Western sanctions that deprived it of lending opportunities in foreign markets and of purchasing equipment for the new production. 

The monopoly has canceled or postponed projects worth $20 billion. In addition, according to Brand Finance market research firm, Gazprom has lost 187 positions in 2016 compared to the previous year in the ranking of the most expensive brands published on February 1. The company ranks 299th now place, being the “leader” in positions lost. In 2015, Gazprom also dropped out of the top ten in the Platt’s Top 250 Global Energy Company Rankings. The Russian giant has fallen down to the 43th position from spot 4 in 2014.

So, we can’t totally rule out that Gazprom might as well be a little more pliable this time on the transit issue with Ukraine. In addition, it has lost almost all of the Ukrainian market – for the first time ever, Ukraine has managed to survive through the winter without Russian gas, and Kyiv does not plan any further purchases from Russia in the future. Full transition to a reverse flow scheme is predicted.

The main thing is that Ukraine has made its position clear. And Gazprom will have to negotiate. Moscow realizes that this issue just cannot be wiped off, and the truth the truth is with Ukraine.

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