January 2009 Gas Shutoff to Europe


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July 2009 Article stating that Ukraine shut off gas to Europe in January 2009, not Russia

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January 2009 Gas Shutoff to Europe

  1. 1. Partner Posts Стр. 1 из 9 http://www.europesworld.org/NewEnglish/Home/PartnerPosts/tabid/671/PostID/575/Default.aspx 06.07.2009
  2. 2. Partner Posts Стр. 2 из 9 EN FR THE ONLY EUROPE-WIDE IDEA You are not Please log i comments o THINK TANK EUROPE “Who Shut Off the Gas to Europe in January 2009 and Why It Matters” 7/3/2009 NEW ISSUE OU Author : Sergei Komlev The twelfth editio it's fair to say that international relat as fast or widen Europe's World. Europe's World is the Arab World as well as cove Sergei Komlev, Head of Contract Structuring and Price Formation, Gazprom Export and Daniel issues include Se Satinsky, Esq., President, B.E.A. Associates, Inc. World and Sustai In the aftermath of the Russia – Ukraine conflict over gas shipments in January 2009, a certain understanding of these events has become entrenched “conventional wisdom” in European and American public opinion that as a result of an unresolved commercial dispute with Ukraine, Gazprom THINK TANK EUR shut off gas to its European customers. The facts show otherwise. What actually transpired is that Ukraine was unwilling to accept a decrease in the size of the price subsidy it has been receiving and a gradual transition to market-based pricing for natural gas. As a negotiating tactic, Ukraine shut off Gazprom transit flows to Europe and converted the pipeline system to serve its domestic market. The aim of this tactic was to put political pressure on Russia and Gazprom and to maintain subsidized gas flows for the domestic Ukrainian economy. Western media and analysts have not taken account of critical facts from this crisis and thus have created a distorted view of the conflict. Legacy Structure of Ukrainian – Russian Gas Relations In the natural gas sphere, Russia and Ukraine are tied together through their joint history as part of the Soviet Union and the unified energy and industrial complex created by the Soviet Union. Soviet industrial development of Ukraine was predicated on supplies of cheap natural gas from other parts of the Soviet Union. Gas was priced according to political priorities for industrial development, not by market considerations. Meanwhile export sales of natural gas at market price became an important source of foreign exchange earnings and Ukraine became the primary transport route to European customers. With the dissolution of the Soviet Union, Ukraine became the owner of the export pipeline system, but became separated from the cheap natural gas upon which its industry depended. As an independent country, Ukraine now transits 80% of Russia’s gas sales to Europe. It is also Russia’s largest single export customer, purchasing roughly 40 Bcm per year. http://www.europesworld.org/NewEnglish/Home/PartnerPosts/tabid/671/PostID/575/Default.aspx 06.07.2009
  3. 3. Partner Posts Стр. 3 из 9 In the aftermath of the breakup of the Soviet Union, Gazprom evolved into a market-oriented company operating on the basis of common international business norms, i.e. purchase and sale of gas under contracts based on market prices and transit arrangements on a contract basis, with cash payments. As part of this transformation, Gazprom has moved away from the political/administrative pricing and supply relationships with countries of the former Soviet Union. This has meant separating the transit and supply functions and having each governed by market- based contracts. The real long-term cause of the dispute between Ukraine and Russia has been Ukrainian resistance to transition to full market relations for gas transit and gas sales. Market Transition The first step in the transition to market relations between Russia and Ukraine was to separate the transit functions from the domestic supply functions in gas relations. In 2002, the national gas companies of both countries, Gazprom and Naftogaz, signed a transit contract that went into effect on January 1, 2003, governing the volumes and conditions for transit of Russian gas through Ukraine from 2003 to 2010. This contract introduced a transit fee structure and a mechanism for amending this transit fee through negotiations between the parties and for arbitration in Stockholm in the event of disputes. Although gas in kind substituted for transit payments in cash until 2006, the 2002 contract was a giant step forward in developing normal commercial relations between Ukraine and Russia. Ukrainian Domestic Gas Supply Given the economic crisis after the dissolution of the Soviet Union, the legacy fees for gas were either not paid at all or were paid using barter. This combination subsidized Ukrainian consumers and industry through relatively low-priced gas and provided enormous opportunities for private profit-taking through the complicated, non-market mechanisms at work. For the period between 2006 and 2008 alone, Ukraine received the equivalent of $30.3 billion dollars in subsidies through discounted prices, calculated as the difference between the price charged and the prevailing market price for the same period. By comparison, this subsidy amounted to as much as 45 times more than the total of European Union aid to Ukraine after 2005. By 2005, Gazprom had moved away from Soviet-era business practices and was establishing Western-style system of sales and purchase agreements using market prices, formulas and cash payments with all of its partners from the former Soviet Union. All of the countries of the former Soviet Union had either agreed with Gazprom both on the necessity of moving in this direction and on an algorithm of gradual gas price increases to European levels. Those that did not agree opted out of the Gazprom system. Ukraine remained the only country of the former Soviet Union that resisted any change in the pricing mechanism and refused to even discuss the issue with Gazprom. This conflict resulted in the first gas conflict. When no agreement could be reached by Dec. 31, 2005, Gazprom shut off gas flows for Ukrainian domestic supply on Jan. 1, 2006. This dispute was settled after a short 3-day interruption, but did not bring a complete solution to the underlying problems. As part of the overall settlement, Gazprom agreed to pay transit fees in cash only. However, market pricing for gas shipments for the Ukrainian domestic market remained an open question. There was a compromise solution in which discounted natural gas was supplied to the domestic market in Ukraine through a complicated network of intermediaries. Breakdown of Negotiations Prior to the January 2009 Gas Crisis As Ukraine and Russia approached the necessity of new agreements that were to begin on Jan. 1, 2009, Russia continued to push for market-based relationship with Ukraine for both transit to Europe and for sales of gas for Ukrainian domestic consumption. Gazprom’s goal was to establish a transition to market priced contracts for gas sales for the Ukrainian domestic market, after an agreed upon period of time. This objective was close to being achieved as Russian Prime Minister Putin and Ukrainian Prime Minister Timoshenko met in October 2008 to outline terms for a new Intergovernmental Agreement. The points of agreement realized from these negotiations were memorialized in an Oct. 24, 2008, memorandum “On the Principles of Long-term Cooperation in the Gas Sector,” which was later signed by the CEOs of both Gazprom and Naftogaz. The agreement included the principle of moving to market prices and direct sales from Gazprom to Naftogaz. As negotiations for a gas supply purchase agreement proceeded, Naftogaz rejected Gazprom’s offer of $250 dollars per 1000 m3 proposed for 2009. Naftogaz refused to budge from its proposal of $200 dollars per 1000 m3. It is important to note that market prices for natural gas were close to $500 dollars per 1000 m3 in December 2008, so Gazprom was still proposing less than full market http://www.europesworld.org/NewEnglish/Home/PartnerPosts/tabid/671/PostID/575/Default.aspx 06.07.2009
  4. 4. Partner Posts Стр. 4 из 9 price. The $50 dollar difference between the price offered by Gazprom and the price that Ukraine insisted upon translates to a $2 billion dollar subsidy for a 40 Bcm supply contract. This was a subsidy that Ukraine was determined to keep. The Ukrainian side had no commercial basis for insisting on such discounted prices for gas. The only conceivable basis was to demand that the Russian government, as the majority shareholder in Gazprom, should make a political decision to continue to subsidize Ukraine. The Russian government was unwilling to continue the level of subsidy demanded by Ukraine and insisted on a process that would move towards commercial relations and market-based prices. As a result of the breakdown of negotiations, Gazprom decided not continue to supply the Ukrainian domestic market after Dec. 31, 2008 without a contract and agreed-upon price. The shutoff of gas to the Ukrainian domestic market has nothing to do legally with Ukraine’s obligations under the transit contract to transport gas to European customers, which was still in force at this time. Transit as Leverage When price negotiations for Ukrainian domestic supply broke down, Naftogaz chose to use its near monopoly position for transit of Russian gas to Europe as its ultimate negotiating leverage. It made clear that it was willing to halt Russian transit to Europe as its major bargaining chip. The groundwork for this tactic was set in a letter to Gazprom dated Dec. 30, 2008, in which Naftogaz warned that without a new technical agreement addendum to the existing transit agreement, it would not be obligated to continue gas transit, even though the transit contract did not expire until 2013. Following an application from the Ukrainian Energy Ministry for an expedited hearing on Jan. 5, 2009, the Kiev arbitration court ruled in favor of the Ukrainian Energy Ministry and ordered Naftogaz to immediately stop providing transit services to Gazprom under the 2002 transit contract, ignoring the international arbitration clause in the transit contract. Even before the action of the Kiev arbitration court, Naftogaz already began a process of reducing the approved amounts of gas that it was shipping to European customers. As shown by the chart below from the two major gas metering stations of Uzhgorod and Orlovka (all numbers in million cubic meters), Naftogaz began to decrease shipments to Europe on January 2. The transit of gas is based on, and requires, a preliminary confirmation by Naftogaz of Gazprom’s request for transmission of the next day’s volumes. Gazprom can only supply as much gas for transit as is approved by Naftogaz. By reducing the approved volumes, as shown in the chart below, Naftogaz increasingly pressured Gazprom by reducing the amounts shipped to Gazprom’s European customers. The Western media either misunderstood or misrepresented that Gazprom shut off shipments of gas through Ukraine in retaliation for alleged gas theft. In fact, something more profound was being undertaken by Ukraine that led to Gazprom’s decision to shut down supplies. Although Naftogaz was diverting gas for its own purposes, this was not the main reason why Gazprom ultimately shut off supplies to Ukraine or better to say, was forced to do so. The real cause of the Gazprom shut down was the fact that Naftogaz was already refusing to allow transit to Europe and had already cut off supplies to European markets before Gazprom’s decision. To understand this key point, it is necessary to examine the sequence of events that occurred on Jan. 6 and 7. What Happened on Jan. 6 and January 7, 2009? On Jan. 6, Ukraine made good on its threat to shut down Russian gas supplies to Europe initiated in the Dec. 30 letter and later authorized by the Kiev arbitration court. On Jan. 6, Naftogaz completely halted supplies to the Balkans, Slovakia, Turkey, Romania and Hungary. Gazprom was unable to ship gas to Europe because Ukraine shut off all the major transit points on its western border. Gas for Europe was entering Ukraine from the east, but not exiting on the west. After extensive negotiations with Naftogaz on January 7 failed to re-open transit, Gazprom was forced to stop all shipments for European customers http://www.europesworld.org/NewEnglish/Home/PartnerPosts/tabid/671/PostID/575/Default.aspx 06.07.2009
  5. 5. Partner Posts Стр. 5 из 9 Naftogaz took this dramatic step of cutting off exports to Europe for two reasons. First, it exerted maximum pressure on Russia, with the expectation of political support from the European Union. Second, it allowed Naftogaz to service its own domestic energy requirements. It is clear from what happened next that Ukraine had prepared for and planned this step in advance. Ukraine accumulated huge reserves of gas in its underground storage facilities in the western part of Ukraine and then simply reversed the flow of gas in the pipeline system to service its domestic market in the eastern part of the country. Reversing the flow of gas in the pipeline is a challenging engineering and technical task that could not have been accomplished so quickly without advance preparation and conscious stockpiling of gas supplies in storage reservoirs. Clearly, the Ukrainians were prepared in advance to use this drastic measure as part of their negotiating position with Gazprom. This state of affairs continued until new ten-year transit and supply contracts were signed on January 19 and supplies were restored on January 20. Does It Matter Who Was At Fault? In sum, the events outlined above depict a different series of interactions between Russia and Ukraine than Western media have led people to believe. While the European Union did not officially blame Russia alone for this crisis, it failed to examine carefully what actually happened. Thus Ukraine was able to hold southeast Europe hostage to its desire to maintain subsidized gas prices, without any blame from the EU. In the process, Gazprom’s unbroken record as a reliable supplier of gas to Western Europe, even through the various crises of the Cold War, was ruined and the reputation of Gazprom as a reliable supplier has been under question. Looking at the course of events, it was Ukraine and Naftogaz, not Russia and Gazprom, who escalated a commercial dispute and negotiation into a gas stoppage. For the ordinary people who suffered in the cold, it matters little who was at fault. What they know is that the gas stopped and they had no means of heating their homes and offices. Given the way the crisis was covered in the media, most seem to blame Gazprom. This inaccurate understanding of the crisis is not sufficient for political leaders who have the responsibility of solving problems and of guaranteeing European energy security. If one has the wrong diagnosis of the problem, then one will choose the wrong solution. Russia and Gazprom clearly prefer to have natural gas relations governed by normal commercial contracts and to promote the security of gas supplies through multilateral cooperation. They look to their European partners to show balance in searching for effective means to prevent any future disruption. A de-politicized solution of European energy security would be advantageous to both European consumers and to Gazprom as a major supplier of gas to Europe. Report inappropriate content You need to be logged in to rate and comment on articles. Click the log in or register button in the top right corner of this page. Energy - Gazprom - INTERNATIONAL - Russia - Ukraine Back to ArticleList http://www.europesworld.org/NewEnglish/Home/PartnerPosts/tabid/671/PostID/575/Default.aspx 06.07.2009
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  9. 9. Partner Posts Стр. 9 из 9 MOST POPULAR JOURNAL MOST POPULAR COMMUNITY MOST POPULAR P Here's how we can live with a global How the EU could help cool tempers over Should centra population of 9bn the Arctic by Centre for E by Anna K. Tibaijuka by Alyson Bailes Studies (CEPS Policy options for modernising the Middle Turkey: Looking for a new strategic Development, East’s industrial base identity improving coh by Prince El Hassan bin Talal by Hanna Ojanen by Fundacion p Internacionales Making the most of the euro Copenhagen 2009 (FRIDE - Spain) by Joaquín Almunia by Isabelle Crosby About Europe's World Editorial Board Think Tank Europe Advertising Subscriptions Contact us Jobs http://www.europesworld.org/NewEnglish/Home/PartnerPosts/tabid/671/PostID/575/Default.aspx 06.07.2009