Naftogaz vs Gazprom: Infinity War
Energy has been at the heart of Ukraine's troubles with Russia over the past two decades, typically as a means for Moscow to pressure its former province. The pressure points have changed over the years – moving from a focus on direct supplies to transit through Ukraine – but the battle remains a constant for regional energy and security.
For a moment it looked like the landmark 2017-2018 rulings in Stockholm broke the cycle, handing a victory to Kyiv. However, Russia's Gazprom is stalling, hoping to build new pipelines that circumvent Ukraine. Meanwhile, Ukraine's Naftogaz has taken the legal and diplomatic battle to Europe's institutions and capitals.
The stakes are as high as ever. The loss of transit revenues could deal a huge blow to Ukraine's economy. In turn, for Moscow the ability to deal directly with Europe's biggest economies gives it free reign to pressure former client states in Central Europe while limiting the fallout for relations with the West.
Ukraine's Achilles heel
Few industries in Ukraine have had a more nefarious impact on the country's development. Energy dealings played a role in such dark chapters as the imprisonment of former Prime Minister Yulia Tymoshenko, which soured relations with the West, or the rise of Dmytro Firtash, a gas mogul implicated in criminal activities, currently awaiting extradition to the United States.
Such episodes left Ukraine vulnerable to Russia, which has long sought to bring its imperial crown jewel back into the fold. Hugely significant for political and historical reasons, Ukraine also houses Europe's biggest gas storage facilities (over 30 billion cubic meters) and is the main conduit for Russian gas to Europe.
As one of the world's most energy inefficient economies, Ukraine long depended on Russian supplies. Moscow kept it in its orbit via a carrot and stick mixture of discounts and cuts, as well as presenting Ukraine as an unreliable partner for Western governments.
This changed after the 2014 revolution, when Ukraine embarked on an ambitious program to reduce consumption (see graph). By installing meters, insulating houses and slashing subsidies, among others, Kyiv cut overall consumption from over 50 billion cubic meters in 2013 to just above 32 billion cubic meters in 2018, an amount that could be covered by own supplies and purchases from Europe.
Meanwhile, Naftogaz's new leadership embarked on a long process to challenge unfavorable deals with Gazprom. In 2017-2018 final favorable verdicts by the Arbitration Institute in Stockholm saved Ukraine from a whopping $81.4 billion in potential damages, revised contract prices for gas delivered since April 2014 and granted Naftogaz over $4.6 billion in damages for failure to deliver contracted transit volumes.
Gazprom, however, has refused to pay. The outstanding $2.6 billion award (the damages offset by $2 billion owed for gas purchases) grows by $500,000 in interest each day. Further, the energy giant challenged the arbitral awards before Swedish courts, instead initiating claims to reverse previous decisions. According to Naftogaz's executive director Yuriy Vitrenko, none can sensibly be considered a challengeable error or have any serious prospects of success.
Volodymyr Omelchenko, head of the energy programs at Kyiv-based Razumkov think tank, believes Gazprom's actions are a purely political decision by Russian president Vladimir Putin. "It would be easier for Gazprom management to pay as it would solve many problems," he said. "Instead they are doing everything not to pay."
No longer able to use the pain point of demand Gazprom changed tactics. It's planned Nord Stream 2 pipeline, currently in the final stages of construction, will connect Russia and Germany, Europe's biggest consumer, starting in 2020. Together with the planned Turkstream pipeline, it will have enough capacity to supply Europe without Ukraine.
This would massively impact Ukraine's finances, potentially depriving the country of some $3 billion a year in transit revenues – enough to shave off up to 4 percent of GDP once knock-on effects are taken into account, according to experts.
These two factors would hobble Ukraine's position in talks with Russia. "Kyiv would have to negotiate with Moscow on a very unequal playfield," said Georg Zachmann, a senior fellow at Bruegel, a Brussels-based economic think tank.
A gas crisis could be around the corner – the current transit contract between Naftogaz and Gazprom will expire in end-2019 and prospects for trilateral talks between Ukraine, the EU and Russia are looking dim. On June 6 Naftogaz CEO Andriy Kobolev wrote that preparations were stretching the company's finances as it looks to accumulate the necessary gas reserves for the winter.
Meanwhile, diverging interests are driving a wedge between European partners. According to Zachmann, "Germany is a strong proponent [of Nord Stream 2] and is rightfully hoping for commercial benefits from the new pipeline" like becoming the key European gas hub and reducing prices.
On the other hand, Central European countries like Poland and Slovakia are concerned Gazprom can cut off supplies to the region without risking their sales to Western Europe.
- Slovakia's position is aligned with Ukraine in seeking fulfilment of Gazprom's long term capacity bookings, noted Marc-Antoine Eyl-Mazzega, director of the French Institute of International Relations Centre for Energy. Meanwhile, he added, Poland is concerned about security of its eastern neighbor and "sees Nord Stream 2 as a tool to weaken Ukraine."
The fate of energy security in Ukraine and the region is likely to be decided in Berlin and Brussels. Aligning itself with European partners would give Ukraine more leverage in negotiations according to Zachmann, suggesting Ukraine define a joint Ukraine-EU proposal on a gas transit contract so it would be much more difficult to undermine it by Moscow.
At the beginning of May, Naftogaz filed a complaint to the European Commission against Gazprom for abuses of dominance in European gas markets. According to Vitrenko, they focused among others on construction of Nord Stream 2, providing evidence that the pipeline project is based on anticompetitive rather than economic motifs.
Yet some experts argue the Naftogaz position is too focused on procedure, and not enough on searching for compromise.
- "Ukraine is having a very legalistic approach on the issue," said Eyl-Mazzega. He argued the Ukrainian position is based on referring to European law and arbitration, while Germany and Russia are currently successfully implementing a compromise based approach.
- Instead, Eyl-Mazzega suggested, Ukraine should focus on guaranteeing some minimal transit under a new deal but accept a significant transfer of transit to Nord Stream 2, and perhaps later TurkStream.
"Ukraine has to align itself with the Brussels position, which means it has to swallow some pills," added Zachmann.
Others see this as too big a risk. A European Parliament analysis sees Nord Stream 2 and a compromise with Russia is a "direct challenge to Europe's foreign policy towards Ukraine."
According to Stephen Blank, an associate at the American Foreign Policy Council, a compromise would be a "deal with the devil." In an Atlantic Council op-ed he argued Russia's energy revenues go to subvert European institutions and a strong European Commission position would underscore the need for transparent and fair energy policy practices.
"Those decisions certainly merit support by EU members in order to maximize opportunities for energy security and promote the rule of law and transparency in the energy business," Blank wrote.
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