Gas Leverage A Possible Russian Tool

BMI View : Russia has a considerable lever on Ukraine through the gas it supplies to the country. Given that Russia has on two occasions used gas supply cuts as a political leverage on Ukraine, the current situation is certainly one in which Gazprom could once more use this lever to create pressure on a new Ukrainian government from re-orienting themselves towards a more pro-EU stance. While this could create some supply problems for several Central European and Balkan states, we note that the situation is slightly different than during the gas supply disruptions in 2006-2007: European gas storage inventories are high and the current mild weather is resulting is weak gas consumption. In addition, the Nord Stream pipeline pumping gas from Russia directly into Germany means that Europe has alternative delivery options.

Russian has considerable influence over Ukraine through the gas it supplies to the country. Ukraine is reliant on Russian gas imports for about 60% of its consumption needs and 100% of its imports. In 2012, Russia was the supplier of all imported gas into Ukraine, representing about 29.8bcm according to the BP 2013 Statistical Review of World Energy. In 2012, Ukraine produced about 18.6bcm of gas and consumed 49.6bcm.

Russia has previously used this leverage over Ukraine on two occasions, in 2006 and in 2009, when Russia used pricing disputes to pressure Ukraine from orienting itself increasingly towards Europe. As Ukraine in recent years increasingly positioned itself towards the European Union (EU) and away from Russia, Russia responded by vastly increasing gas prices to Ukraine to reflect those paid by central European customers, rather than those paid by Russia friendly states such as Belarus or Moldova. Gas prices rose from under US$100 per 1,000 cubic metres (/mcm) in the 1990s, to US$160/mcm in 2005, and to among the highest paid in Europe at US$400/mcm by the end of 2013.

Gas Imports Stabilise, But Highly Dependent On Russia
Ukraine Gas Consumption (bcm), Production (bcm) and Net Exports (y-o-y growth %)

BMI View : Russia has a considerable lever on Ukraine through the gas it supplies to the country. Given that Russia has on two occasions used gas supply cuts as a political leverage on Ukraine, the current situation is certainly one in which Gazprom could once more use this lever to create pressure on a new Ukrainian government from re-orienting themselves towards a more pro-EU stance. While this could create some supply problems for several Central European and Balkan states, we note that the situation is slightly different than during the gas supply disruptions in 2006-2007: European gas storage inventories are high and the current mild weather is resulting is weak gas consumption. In addition, the Nord Stream pipeline pumping gas from Russia directly into Germany means that Europe has alternative delivery options.

Russian has considerable influence over Ukraine through the gas it supplies to the country. Ukraine is reliant on Russian gas imports for about 60% of its consumption needs and 100% of its imports. In 2012, Russia was the supplier of all imported gas into Ukraine, representing about 29.8bcm according to the BP 2013 Statistical Review of World Energy. In 2012, Ukraine produced about 18.6bcm of gas and consumed 49.6bcm.

Gas Imports Stabilise, But Highly Dependent On Russia
Ukraine Gas Consumption (bcm), Production (bcm) and Net Exports (y-o-y growth %)

Russia has previously used this leverage over Ukraine on two occasions, in 2006 and in 2009, when Russia used pricing disputes to pressure Ukraine from orienting itself increasingly towards Europe. As Ukraine in recent years increasingly positioned itself towards the European Union (EU) and away from Russia, Russia responded by vastly increasing gas prices to Ukraine to reflect those paid by central European customers, rather than those paid by Russia friendly states such as Belarus or Moldova. Gas prices rose from under US$100 per 1,000 cubic metres (/mcm) in the 1990s, to US$160/mcm in 2005, and to among the highest paid in Europe at US$400/mcm by the end of 2013.

The financial impact on Ukraine's already strained finances has been significant, causing the country state oil and gas company Naftogaz to rack up large volumes of debt with Gazprom. As a result, in both winters of 2006 and 2009, disputes over pricing between the two countries led Gazprom to reduce gas supplies to Ukraine, as the company stated that it did not receive contractually obligated gas payments. This also by extension resulted in supply disruptions to many European countries as Ukraine is a critical transit country for gas going into Europe. Disruptions were particularly severe in 2009, where 18 European countries reported large drops or complete cut-offs of their gas supplies from Russia which transited through Ukraine.

Russia's support of ousted Ukrainian President Viktor Yanukovych and the country's refusal to recognise the new Ukrainian interim government, the current situation is certainly one in which Gazprom could once more be prone to use its gas leverage on Ukraine to put pressure on a new government, if it takes a pro-EU stance. Although there has been no official statement thus far suggesting that Moscow might cut off gas supplies, the past precedence suggests that this is a clear short-term possibility.

This would likely manifest itself in the form of Russia taking back the recent gas price concessions made to Ukraine in January 2014, lifting the price of gas back to at least pre-December levels. These concessions were made when Ukraine refused to sign a far-reaching political and trade agreement with the European Union (EU) in late November 2013, instead choosing to take on Russia's offer that included a 33% reduction in gas prices among other economic largess. The deal, which was formalised on January 10 2014, saw Ukraine paying US$268.50 per million cubic metres (/mcm) for gas in Q114 - or about US$7.20 per million British Thermal Units (mnBTU) - compared to US$406.00/mcm (US$10.89/mnBTU) that it paid in Q113.

While Russian Prime Minister Dmitry Medvedev said that the country will uphold the deal of discounted rates, which lapses at the end of March, on expiry it could return to the previous pricing structures with which Ukraine severely struggled. This could particularly be the case if a new government reconsiders signing the trade and political agreement with the EU that Yanukovych had rejected.

Ukraine would unlikely be able to pay for this gas, given the country's dire financial situation, its increasingly large deficit and the depreciation of its currency. As such, Russia would once again be able to cut supplies transiting through Ukraine to create pressure on a new Ukrainian government from re-orienting themselves towards a more pro-EU stance. Ukraine's Naftogaz seems to already be preparing for such an eventuality, as it slashed gas imports from Gazprom to 28mn cubic metres per day (mncm/d) as of February 24, from 147mncm/d, according to Reuters. This could be a pre-emptive move to take the upper hand away from Russia, as the country expects repercussions from the recent uprisings.

Another European Gas Crisis Looming?

About 50% of Russian gas deliveries to Europe pass through Ukraine, eliciting concerns that continental Europe, which received 30% of its gas from Gazprom in 2013, could see shortages if Russia cuts supplies as it has during previous pricing disputes with Ukraine. However, while this situation could create some supply problems for several Central European and Balkan states, we note that the situation is slightly different than during gas supply disruptions in 2006-2007. Europe may have learned from previous supply disruptions, which have in the past seen storage volumes reduced to just days worth of supply - most major central European countries can store in excess of 50 days gas supply.

According to a Reuters February 2014 report on key European gas inventories, Central Europe currently has a healthy stock level, with Czech and Slovak inventories filled between 40-50%, and Polish reserves at over 70% of capacity. Germany, which is Europe's biggest gas consumer and Russia's largest consumer, has its inventories filled to more than 60% of capacity, which represents around 60 days of demand. France has more than 50 days of consumption left in inventories, and the continued spring-like weather should not see continued weak gas demand and high storage levels.

In addition, the Nord Stream project is already pumping Russian gas directly from Russia to Germany via a subsea Baltic pipeline. Thus while Ukraine remains a critical transit country, there are alternative delivery routes. The North and South Stream pipelines were indeed proposed by Russia in order to maintain a monopoly over European gas, however it may now also allow Europe to send more gas to Ukraine from central Europe, vastly reducing the importance of the country as a transit route.

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