Unpicking the Russia-Ukraine Agreements [Global Gas Perspectives]
The last-minute signing of the Ukraine gas transit deal and other agreements was a victory for all three parties: Ukraine, Russia and the EU. Even more so, when one considers the multitude of players in the game: representatives of ministries, Naftogaz, Ukrtransgaz, the new operator GTSOU, MGU, Ukraine's energy regulator NEURC, Gazprom, The EU Commission and Germany.
Russia – until almost the last day – had insisted it could do without Ukrainian transit; but its bluff was called. The deal signed will have important implications not only for the gas relations in the Ukraine-EU-Russia triangle but also for gas market developments in Ukraine and Europe and for Russia’s export strategy and options. At the same time, a number of issues related to it remain unclear.
The agreements removed some long-standing causes of friction in Russia-Ukraine gas relations, the biggest of which was the Stockholm arbitration award. Gazprom paid Naftogaz almost $3bn, of which $2.56bn was the award and the remainder was the interest after a two-year refusal to pay.
The December 27 payment was in the protocol agreement signed the week before as a condition precedent for a transit agreement. The two also agreed to drop all other mutual claims under the 2009 contracts and that Ukraine would drop its anti-mponopoly claim.
Gazprom’s payment confirmed Ukraine’s victory and vindicated Naftogaz persistence in pursuit of its award. The money is material as Ukraine faces the challenge of reduced annual transit income. And last but not least, Gazprom confirmed that it recognises the Stockholm tribunal in the event of possible future disputes.
The new transit agreements, if fully implemented and contain no hidden, tricky provisions – there is no public information on all the details nor actual text of documents avaliable – have established new rules for the next five years at least. After six years of perpetual uncertainty this is an important achievement and a change. The new agreement creates a stable, rule based situation related to Russian (or other) gas transit through Ukraine.
As the deal is based on the ship or pay formula it should also guarantee stable (although lower than in previous years) income to the Ukrainian side. And it seems to confirm that both sides accepted the hard reality: Russia that Ukraine is implementing EU law and integrating its gas market with EU’s one & Ukraine that gas transit via its pipelines is set to substantially decline. This was the key condition to move forward.
This stability would be a new quality in Russia – Ukraine relations and is very important for Kiev, Moscow, the EU, but also for all participants of the European gas market. At the same time, agreements on transit and arbitration (and other) claims have allowed for kind of a political détente and have enabled a new opening in other areas of Russian-Ukrainian gas relations. They may even result in new agreements, such as restarting direct imports of Russian gas to Ukraine.
Questions and ambiguities
Despite the fact that the Russian-Ukrainian package gas deals constitute significant and multi-dimensional success, there are still questions and ambiguities related to the details and how it will be implemented: this will be crucial for the long-term effects on each of the parties. The uncertainty is partly related to the unprecedented pace at which the rules of the game regarding Ukrainian transit and the organisation of the Ukrainian gas sector have changed. Both the process of ownership unbundling that formed a new operator GTSOU, and the new Russian-Ukrainian agreements (accompanied by signing by Ukrainian operator interconnection agreements with operators from neighbouring countries, such as Eustream) were concluded at the very last moment (end of December 2019).
Both of them constitute a fundamental systemic and regulatory change. As such, they require time to enable good implementation – testing the new solutions and allowing the gas systems - Russian, Ukrainian and European - to adjust gradually to the new situation. Some earlier measures undertaken by both the Ukrainian TSO (such as the introduction of daily balancing in March 2019, or investments enabling reverse flows) and European ones, especially those in southeast Europe did help avoiding problems in the very first days after transition to new system, especially bearing in mind the record low Russian gas flows via Ukraine (on January 2 it was 4% of the average daily flow in December 2019) and the redirection of gas flowing through the TransBalkan gas pipeline to TurkStream. However, the pace and complexity of introduced changes has not been the only challenge.
Although it took persistent effort to reach the Russian-Ukrainian agreements, not to mention lobbying and mediation by the European Commission and Germany and the Energy Community - it is not entirely clear how exactly they relate to EU law and the EC’s goals related to achieving the third energy package compliant rules for Ukrainian transit that the EC has been pursuing for months if not years. The package gas agreement reached does not exactly contain a detailed transit contract nor multiple entry/exit contracts at various interconnection points that would be expected based on EU legislation.
At the end of October, Maros Sefcovic insisted that the contract should be based on EU legislation.
Under current Russian-Ukrainian package deal the future of transit through Ukraine has been interlinked with several, not directly related to transit conditions (like giving up claims). And there are actually three agreements regulating the transit issue, including the agreed annual capacities and regulated tariffs: one between Naftogaz and Gazprom, the other between the new operator GTSOU and Naftogaz and the last being the interoperator agreement between Gazprom and GTSOU (establishing technical procedures and rules for co-operation between the operators of the adjacent networks, but unknown if and how it resembles standard EU non-discriminatory and transparent interconnection agreements, as those signed by Ukrainian TSO with operators from Poland, Slovakia, Romania and Hungary).
As a result, Naftogaz (being no longer the owner of the operator of Ukrainian gas network) becomes a kind of intermediary between Gazprom and the new operator GTSOU, and as such is responsible for organising the transit on behalf of the Russian company. Allegedly that was Gazprom’s idea to have such intermediary in place. Since January 1, Naftogaz has managed Gazprom’s agreed capacity rights, which include booking capacity. Naftogaz is also to bear the risks associated, among others, with the possibility of changes in tariffs or other conditions or any failure by the new operator. Setting aside the fact that neither Ukraine nor EU has had good experience with previous intermediaries in Russian-Ukrainian gas relations with companies such as Eural trans Gas and Rosukrenergo, it is not clear how this current type of intermediation relates to the EU rules implemented by Ukraine.
It also somewhat reduces the role of the new GTSOU operator (which does not manage the relationship with its key external capacity user – Gazprom). It also seems to go contrary to the logic behind the unbundling process, which has just been completed and approved by the EC as compliant with EU requirements: they are primarly aimed at separating gas transmission activities from Naftogaz.
It is also not entirely clear how the minimum annual transit volumes agreed by Gazprom, Naftogaz and GTSOU (65bn m³ in 2020 and 40bn m³ in 2021-2024) are to be booked in accordance with the EU auction system, under which products ( annual quarterly, monthly, daily) and at which exit points - i.e. whether and how the new Russian-Ukrainian transit agreements are compatible with EU network codes (CAM NC). As media reports suggest GTSOU receives from Naftogaz monthly payments for capacities equivalent to uniform daily flows of 178mn m³ (equivalent to 65bn m³ divided by 365 days) Gazprom could have done annual bookings. It is also not evident when and on what terms the capacity auctions available to all interested parties will take place (probably it will be in line with capacity allocation management network code calendar). Neither it is clear how these regular auctions will interact with Gazprom's agreed transit volumes and bookings (or those by Ukrainian Naftogaz, acting on behalf of Gazprom).
The total costs of gas transit through Ukraine are also unclear – the fee that Gazprom pays Naftogaz for organising the transit is unknown. It is also unknown who and how will assess the competitiveness of the Ukrainian transmission tariff, which under the terms set in the Russian-Ukrainian agreements is a condition for booking capacity in the agreed yearly volumes.
The final shape of the Russian-Ukrainian agreements takes into account EU law to some extent but they are not fully based on it, and sometimes may even appear to undermine some of its provisions (in spirit if not letter). It is also clearly a reflection of the interests and fears of Russia and Ukraine, as they relate to bilateral gas co-operation. That is illustrated among others by the role of Naftogaz as an intermediary in the organization of transit through Ukraine. It is unclear if and how this and other arrangements resulting from bilateral Ukrainian-Russian agreements may impact the implementation and application of EU regulations in the Ukrainian market.
The elimination of the direct risk to stability of Russian gas transit through Ukraine, the two sides' agreement on the rules of the game for the next five years, and decreasing the role of Ukrainian transit enshrined in the agreements may lower EU’s interest in Ukrainian gas issues in future. This would also be consistent with the current EU policy focus on the green energy transition and the related lesser interest in gas.
Meanwhile, the systemic and regulatory change of the functioning of the Ukrainian gas sector sealed at the end of 2019, is directly related to EU requirements and has just begun to be translated into new business and institutional models. To ensure that this is completed, EU involvement at the technical and expert level will be crucial. It is also important to rethink and clarify the priorities of the EU energy policy towards Ukraine in the coming few years.
One should expect greater volatility and uncertainty related to actual gas flows through Ukraine following the new rules, than applied in the past. Gazprom has committed to less transit than in previous years (which also remains conditional on the competitiveness of transit rates). It has also already launched new supply routes to the EU and connecting links (TurkStream and Eugal) and is planning completing further ones (NordStream 2), and it also has storage facilities in the EU that started the new year at full. At the same time the rules for Russian gas transmission through EU countries are changing: the gradual termination of existing transit agreements in central, eastern and southeast Europe.
As a consequence, Gazprom is in a good position to adapt its capacity bookings and transmission routes to market conditions and to its own immediate or long-term interests related to supplies to the European market or other issues – as we saw in early January. Gazprom has become better equipped to do what it sees best for its commercial and/or strategic goals, in an increasingly integrated and liquid EU market, defending its share despite continued competition from highly available and cheap LNG.
The conditions set in the package gas deal confirm a significant decrease of the role of Ukrainian transit route in the near future. From 2021, it guarantees the transmission of 40 bcm a year, i.e. 64% less than in 2018. According to GTSOU transit at 40 bcm means it needs only two out of nine entry points at Russian-Ukrainian border and that about 75% of compressor stations become redundant. Also sometime during 2021 NordStream 2 is expected to be launched and TurkStream to achieve its full capacity. That means that on expiry of the agreements Ukraine will face again a completely different and unfavourable situation.
The significance of Ukrainian gas transit post 2024 will depend on future EU demand for Russian gas and the competitiveness of Ukrainian transit. The country has five years to increase the attractiveness of its transit and improve access to its gas infrastructure (storage, gas pipelines). The EU regulations – including interconnection agreements signed with all but one (Belarus) neighbouring states – and making available spare capacity (Gazprom’s quota even for 2020 is significantly lower than the nameplate capacity) mean it may be already ready to start making the whole system accessible to third parties.
Some of the recent actions (offers of discounts for cross-border gas transit capacity with European neighbours) suggest it is already going in that direction. The next five years of probable stability could be spent adapting to the new, low-transit reality (GTSOU is already planning to optimise its gas infrastructure) and developing a new 'post-transit model' for its gas sector and its economy, as well as its economic and political relations with Russia and the EU.
The statements, opinions and data contained in the content published in Global Gas Perspectives are solely those of the individual authors and contributors and not of the publisher and the editor(s) of Natural Gas World.
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