Getting a Gas Deal for Ukraine. Is the EU Helping or Hindering?
In June as part of the continuing Russia-Ukraine conflict Gazprom cut off gas supplies to Ukraine. With winter approaching the EU has sought to bring the Ukrainian and Russian sides together to do a deal. EU Energy Commissioner Oettinger has sought to hammer out an agreement to ensure Russian gas will flow to Ukraine this winter. However, the deal he has been promoting appears to leave Ukraine with high gas prices while undermining its contractual, legal and strategic position. The European Commission with this proposal appears to be unwilling to apply its own leverage or even apply its own legal regime.
As part of the ongoing conflict with Ukraine in June Russia cut off gas supplies. This meant that while transit flows continued providing approximately 15% of EU’s gas supplies across Ukrainian territory, Ukraine itself no longer received gas from Russia for its own consumption.
Faced with this supply disruption Ukraine has focused on three pronged strategy. First, demand management to reduce gas consumption, second increased domestic production and third, increased ‘reverse flow’ of gas from EU countries to Ukraine. Already Ukraine has approximately 16bcm in storage. With effective demand management, a little more domestic production and the reverse flow contracts that Ukraine has arranged with EU suppliers Kyiv is seeking to get through the winter without Russian gas. Meanwhile in response Gazprom has recently sought to cut supplies to states it believes is reverse flowing Russian gas back to Ukraine.
Clearly the optimal solution would be for Russia and Ukraine to come to a deal and for supplies to be restored. Especially with the onset of winter. EU Energy Commissioner Oettinger has sought to broker a deal to restore gas supplies. His proposal is for Ukraine to accept a price of $385 per thousand cubic metres (thcm); an minimum obligation to take 5bcm; all gas purchases should be prepaid and Ukraine would be required to pay $2billion in ‘gas debts’ before any gas started to flow and a further $1.1 billion before the years end.
It is difficult to see why Commissioner Oettinger wishes to push such a deal on Kyiv.
To take three points on the proposed deal. First, the proposed price of $385thcm is significantly higher than the most Western European countries are paying for Russian gas despite the fact they are considerably further away from Russia than Ukraine. Furthermore, one of the major issues that the European Commission’s antitrust investigation is looking into is illegal pricing by Gazprom. One line of the Commission’s pricing inquiry focuses upon Gazprom pricing gas in Eastern Europe higher than in Western Europe, when there is no commercial logic for such pricing, and when in fact in any ordinary functioning market, transit costs should mean that consumers in greater physical proximity to the supplier should play less not more. It is difficult to see how the head of the Commission’s energy department can be proposing a pricing level which the Commissions competition department is currently challenging in its own investigation into the same supplier.
The second difficulty is gas debts dispute. Russia claims gas debts of approximately $5 billion. Ukraine disputes this amount and in fact argues that is owed about $6 billion. The Ukraine supply contract is governed by Swedish law, which includes a price review clause when significant market changes occur. Ukraine has asked for price reviews on several occasions and now the issue is before the Stockholm court of arbitration. Its therefore difficult to why Ukraine should be expected to pay as much as $3.1 billion of an amount it substantially disputes by 1st January.
The third issue is the proposed requirement for prepayment for all future gas deliveries. Prepayment would significantly undermine Ukraine’s cashflow at a time when the Ukrainian state is already under considerable strain.
What is also disturbing with the Oettinger proposals is that they will not be contained in a legally binding and secure standard energy supply contract, which would also bind in Gazprom. Essentially Kyiv will be left with expensive gas, having heavily paid down disputed debts and subject to tight prepayment terms with still no guarantee of supply security.
There is a compelling case for the argument that the EU could assist Ukraine far more by ensuring that its own rules were applied on its own territory rather than trying to broker a poor deal with Gazprom. The EU’s energy liberalization regime creates a single gas market, which are supposed to be extended in full in the gas sector to the members of the Energy Community including Ukraine from 1st January 2015. These rules provide for full interconnection between national gas networks. By applying EU rules in full Ukraine would be able to bring in gas into its networks from other European countries.
Ukraine does not even need that much gas from the EU. In 2013, it imported approximately 28bcm. However, with the loss of Crimea, war damage and economic slowdown it will need considerably less in the 2014/2015 heating season. Slovakia alone can now provide 10bcm, and if it followed through in applying the EU rules in full to all its interconnectors it would be able to provide up to 30bcm. The principle argument against is contractual arrangements with Gazprom. However, as such restrictions are in conflict with mandatory public law requirements set out in the third energy package and EU open market principles it is difficult to see how they can be easily sustained. Usually the European Commission takes a very robust at private contractual claims to restrict open markets.
The other practical argument is that Gazprom can just cut gas supplies to states providing reverse flows. However, this is in fact much more difficult than it first appears. If Gazprom goes below the minimum supply requirements of its customers, which it has traditionally insisted on being set at quite high levels it will be in breach of contract and subject to civil damages actions across the continent. Second, in an increasingly single gas market it is difficult for Gazprom to actually control the flows of gas. For instance, Slovakia has recently faced cuts in supply from Gazprom. However, it has been able to take gas from E.ON via the Czech interconnector to replace lost supplies from Gazprom reducing supplies to Bratislava.
Commissoner Oettinger does not seem to recognize that the EU has considerable leverage over Gazprom. The EU is now much more interconnected than it was in 2009; EU storage facilities are almost full; there is significant global LNG liquidity and the gas market is smaller than it was in 2009. Ultimately applying EU single market rules in the EU and Ukraine to the gas market, Brussels and Kyiv could cope with a full Russian gas cut off-which itself is improbable unless Gazprom wants to lose its $28 billion annual contribution to the Russian state budget-and its utter marginalization as a European gas supplier.
Commissioner Oettinger as an EU commissioner should apply EU law and not try and impose a poor gas deal on Kyiv.
Professor Alan Riley, City Law School, City University, Grays Inn, London.