Why Ukraine Can Live Without Russian Gas for Now

Analysis

• As a result of differences over pricing, a natural gas cutoff from Russia to Ukraine that began July 1 could last until early winter.
• The cutoff is unlikely to stop or to negatively affect the flow of Russian natural gas supplies to downstream countries in Europe.
• Negotiations between Ukraine and Russia will continue, though real urgency to strike a deal will only be felt after summer because Ukraine has enough alternative resources and stored supplies to meet demand for several months.
• A settlement will eventually be reached this year on resuming natural gas flows from Russia to Ukraine, while in the meantime Moscow and the West will have thornier issues to address in their broader standoff such as the conflict in eastern Ukraine.

Following unsuccessful EU-mediated negotiations in Vienna on June 30 over a new natural gas agreement between Russia and Ukraine, Russian energy firm Gazprom announced July 1 that it had halted natural gas exports to Ukraine. The main sticking point between the two is the price of natural gas for the third quarter. Russia had offered a continuation of the second quarter price of $247 per thousand cubic meters (tcm) while Ukraine was pushing for closer to $200 per tcm. With neither side budging, Ukrainian state energy firm Naftogaz announced that it would cease purchasing Russian natural gas at the current price, leading to the cutoff.

Natural gas cutoffs have become a recurring issue in the volatile relationship between Russia and Ukraine. Major natural gas cutoffs occurred in 2006 and 2009. Both took place during the winter, leaving many households and businesses in Ukraine and elsewhere in Central and Eastern Europe literally in the cold. Another natural gas cutoff occurred in June 2014, with Russia shutting down supply flows for roughly four months following a deterioration of ties between Kiev and Moscow after Ukraine's Euromaidan uprising. 

Though the 2014 cutoff lasted much longer than the previous ones, in many ways it proved less damaging in terms of its consequences. First, it occurred during the summer, which sees much lower household and industrial natural gas consumption. It also did not affect European countries downstream, as the European Union became an important mediator and pressured Ukraine not to siphon off Europe-bound supplies as it had done in previous cutoffs. (Previous siphoning by Ukraine has spurred Russia to seek alternative transit routes to Europe, such as Nord Stream and the proposed Turkish Stream pipelines.) And finally, the European Union managed to oversee an agreement between Russia and Ukraine known as the "winter package," which restored flows in October just as the energy-intensive winter set in.

While the winter package only ensured supply flows until the end of March 2015, all parties agreed to extend this same agreement three months, until the end of June. Russia offered the same pricing and contractual terms ahead of the expiration, but several circumstances caused the Ukrainian side to harden its position and request a lower price.

One is a drop in Ukraine's overall consumption levels, which fell from 50.4 billion cubic meters (bcm) in 2013 to 42.6 bcm in 2014, and are projected to drop further to 34 bcm in 2015. This partially resulted from reforms aimed at increasing efficiency and reducing corruption in Ukraine's energy import system, and partially as a result of Kiev's loss of energy-hungry territories in Crimea and parts of eastern Ukraine. Another is an increase in Ukrainian natural gas imports from European countries via the reverse flow mechanism. According to Ukrainian state firm Ukrtransgaz, reverse flows from Europe totaled 6.3 bcm in the first six months of 2015, with Slovakia providing the largest volume. Ukraine meanwhile reduced imports from Russia by nearly 75 percent to 3.7 bcm over the same time frame, with lower prices for natural gas imported from European countries also playing an important role in that decline. 

Given that it has more options for natural gas imports and consumes less natural gas, Ukraine decided to seek a better deal from Russia. It is also summer and Ukraine has about 12 bcm of natural gas in storage. Because of this, Kiev does not need a deal right away.

This does not mean that Ukraine can do without Russian energy altogether. Ukraine does not want to drain its stored supplies completely, and supplies from Europe do not meet Ukraine's overall natural gas needs for the year. Russia has also shown that it can pressure certain European countries, such as Hungary, to reduce or even halt their flows to Ukraine. While Hungary has been a minor provider to Ukraine (sending an average of 3 million cubic meters per day compared to 23 mcm from Slovakia), Russia does hold certain leverage over these countries as their main supplier of natural gas.

But access to some European supplies and a healthy amount of natural gas in storage does mean Ukraine has room for maneuver during summer. This means that while EU-mediated talks are likely to continue between Ukraine and Russia, the Ukrainian side will not have a real sense of urgency to strike a deal with Russia until the colder autumn months approach, as seen in the run-up to the agreement reached in October 2014. As long as European supplies are not affected, something Kiev and Moscow both have an interest in preventing, the European Union is likely to be patient regarding the brokering of a deal. And since Russia's and Ukraine's price points are not that far off, there is room for negotiation. It is therefore likely that a deal will eventually, though not immediately, be reached — leaving Ukraine, Russia and the West with the thornier issue of the conflict in eastern Ukraine and the broader standoff between Moscow and the West. 

Natural Gas Europe is pleased to provide this article in cooperation with Stratfor, a Natural Gas Europe Knowledge Partner.  For more visit http://www.stratfor.com/   Follow Stratfor: @stratfor on Twitter | Stratfor on Facebook