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Expert: Ukraine vs Gazprom: the price of the problem

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So, Gazprom and Naftogaz have reached an agreement. The match is over, there is no more conflict, but the fans are at loss who has won. It is actually hard to guess who won. There was a good deal lot of information during the conflict, much too many details partly technical (intelligible for experts only), partly unreliable. Many statements were made not just to inform but to pressure the partner or even to misinform him, and so on, and so forth. But we still can see what there is in the body — we will if we compare the position of the sides before and after the conflict.

The deal

Before the agreement. In 2004 the sides agreed on the supplies of Russian gas to Ukraine and on the terms of its transit. According to the agreement, Ukraine got Russian gas for $50 per 1,000 c m. Russia paid the transit services at $1.09 per 1,000 c m/100 km. The payment was made in gas strictly within the same $50). In fact, the agreement meant one thing: Ukraine got 1/6 of the Russian gas for allowing its transit to Europe via its pipelines. No matter, how much is gas in Europe — the share did not change at any price over $50 — Ukraine got its 1/6.

What Ukraine has got as compared with what it had before. Now Ukraine gets gas at an average of $95 during the first half year, including the Russian gas for 230 conventional units, and has raised the transit cost from $1.09 to $1.6. But (most importantly!) it will now pay in “live” money rather than gas barter.

Naftogaz CEO Alexei Ivchenko said after the signing that the higher transit fee is the victory of the Ukrainian side. Let's calculate. Clearly enough, no longer in gas barter, the fee has substantially dropped — before the agreement the actual tax was $4.22. The point is that the transit was paid in gas that, actually costing $230, was rated by Ukraine at virtual “contractual” price of $50. If before Gazprom lost 1 c m in each 1,000 c m pumped via each 4.59 km of the Ukrainian pipeline, now it loses 1 c m per 14.38 km — i.e. upon new terms and at new tariffs the transit for Gazprom (with the present basic $230) has got 3.13 times cheaper, and, much to Gazprom's pleasure, this over threefold decrease has been fixed in the new five-year contract.

For Ukraine — with the estimated basic price for the first half of 2006 being $95 — the drop in its gas equivalent transit earnings is less impressive — only 1.3 times. But you must admit that 30% cut from the service price of a monopolist (and Naftogaz is a monopolist) can be called a success for such a monopolist “only after a good New Year booze,” as Yulia Timoshenko phrased it. And this is only for as long as the agreed-on Rosukenergo price is in force (if the price goes up the cut will increase, if goes down — which is hardly possible — it will decrease). What does the Jan 4 2006 deal mean for the Ukrainian economy? Reuters experts say that “based on a rough calculation, the gas deal could cost Ukraine an extra $2.9 bln this year.”

They considered only the direct rise in the gas price, with no consideration given to the above-mentioned transit losses. And there will be indirect losses — Ukraine's key exporters, the power-consuming chemistry and mining will lose their competitive advantages and will inevitably see their outputs curbed and earnings and tax revenues trimmed. This will make Ukraine's negative foreign trade balance larger by as much as the difference in the gas price ($2.9 bln) and the cut in the competitively disadvantaged exports.

Besides, one should keep in mind that the regularly declared $40 (or $50) price for the Turkmen gas has always been conventional and never real. For quite a long while Ukraine paid for part of it in barter — this including some normally inapplicable trash. (see, e.g.: “Last year (2004) Ukrainian Naftogaz sent 5,500 fir to Turkmenistan as payment for gas. The trees were supplied under a deal with Turkmenneftegaz saying that in 2004 Naftogaz shall buy Turkmen gas for $44 /1,000 c m and shall pay 50% in foreign exchange and 50% in material values. In the last decade all the gas export deals with Ukraine have been made exclusively by Turkmenneftegaz.

Along with firs that Asian country has got diesel locomotives, pipes, metal, machines, light industry items, with the most noteworthy supply being a lot of galoshes in exchange for gas.”) This galosh-fir tree barter has pegged the real Turkmen gas price down to at least $30-$35. This clover is over for Ukraine and now the “independent” Ukrainian economy will have to pay double even for the Turkmen gas, a gas whose price is (yet) cheaper than in Europe. Yulia Timoshenko (the former prime minister, by the way) says that the deal with Gazprom will lose the Ukrainian economy $4.545 bln in 2006 — i.e. precisely $100 per each Ukrainian — from babies to pensioners.

All this, is certainly “a big victory of the President and the Government of Ukraine,” a victory we might well congratulate them on. But they will hardly be glad at being congratulated on this.

Now Gazprom. An over threefold reduction in the transit expenses. If formerly Gazprom spent as much as 17 bln — 18 bln c m to pay for the transit, now 6 bln c m will be enough. This means extra 12 bln c m, which, if sold to Europe at min $230, will gain the company $2.760 bln. This gain (comparative with the former terms) will grow if the gas price goes up. Even more, the new agreement clearly says that 1,000 c m of Russian gas cost $230, which means that should Ukraine decide to increase its supplies, it will have to pay the price it has agreed on.

Ukrainian Foreign Minister Boris Tarasyuk says that Russia “has failed in its attempts to speak to Ukraine in the language of ultimatums.” May any country have such failures five times a day!!! But the main thing is that the transit fee paid in cash rather than in gas will now be legally and financially separate from the gas price for Ukraine. Now Ukraine will no longer be able to use the transit gas as pressure on Russia while negotiating gas tariffs. The former agreement gave it free hand to blackmail Russia. On top of all, Gazprom will gain from the resale of the Turkmen gas, sold at $95 (the price of the first half of 2006).

This suggests a question about the cost of the Turkmen gas transit. But experts say that there is no cost as there is no transit. No gas has ever been sent directly from Turkmenistan to Ukraine. Gazprom has always supplied Turkmen (and any Central Asian) gas to consumers in Lower Volga, Northern Caucasus, Southern Ural and Southern Siberia or exported it to the South Caucasus. Ukraine has got another gas — from long distance pipeline.

So, the transit of Turkmen gas to Ukraine means something conditional here. Having many gas sources (geographically different), Gazprom has always sought to optimize its gas flows to reduce the final cost of the transfer. And so, the company takes no direct expenses on the “transit” of Turkmen gas to Ukraine. Even more, its presence in the pipeline cuts the transfer costs for home consumers. Gazprom's transit fee has nothing to do with how much it actually spends to transfer the gas to the western territory (it has always been “in analogy” with the fees of other transit countries in Europe these including Ukraine itself). It was rather the “bonus” of Gazprom (who needs the Turkmen gas as a technology to cheapen home transportation — see above). In fact, the averaged $95 price for Jan-June 2006 (quite sparing one, by the way) reflects the low cost of the Central Asian gas and the lack of direct expenses to transport it.

Now about the talks

Ukraine stuck to the contract. The key point is the contractual law, i.e. the actuality of the contract. “There is a contract of 2004. It contains a price of $50 and a transit — a barter based on the $50 price. The contract must be respected. Of course, the costs and terms are negotiable each year, but they should be in force until new costs and terms are agreed on.” Any reduction Russia could make in its gas supplies for Ukraine would be easily compensated for by the “European” gas, with Ukraine making innocent eyes to Europe's anger: “We take the gas we have the right to under the contract. Why the Europeans have got less — ask Russia, the supplier. We are a country with market economy and European orientation and, unlike Asian rulers, we know that contracts must be respected.”

A position of iron and concrete. That is, legally it can be disputed only at court. And even if Russia won the case, the dispute would take as long as 1-1.5 years. But Russia would hardly win — there is a contract. Even if the court unchained Russia from this contract, it would most probably oblige the sides to meet its terms before abrogation. Had Ukraine stuck to this position till the end, it would have won. But it stepped aside by offering suddenly in the spring 2005 to change the contract of 2004, so it could “transit to 'market' relations.” That is exactly where Gazprom got it by the tongue.

Gazprom caught up the serve and took up a rigid “market” stand. "The fair price is the European price. The Europeans pay $230, why should Ukraine pay less than Germany, Italy or others do? There is a “European formula,” and as a sovereign European state Ukraine should pay according to it, especially as it was Ukraine who proposed to transit to the market relations. You need to do it gradually? Well, we are giving you a $3.6 bln loan. If you fail to pay in “market” way, we will stop supplying gas to Ukraine and you will have to steal it from Europe. The stand is fair. The market participants are “pro.” The same is for the rivals (from Europe also and not from mining or chemistry only).

But Ukraine moved aside and its arguments began to collapse. Ukraine's unbending position was bent by Yushchenko, who declared invalid the former contract (just what Gazprom wanted) and began awkwardly formulating what he thought to be the “fair” price. Ukraine got “all adrift” in Dec 2005, when the Naftogaz executives began arguing about the price formula before TV cameras in Putin's office. It looked funny: “We don't understand.” “You don't understand? Well, I will explain now — we take mazut, spread it on coal, multiply by 0.5… and get the total — you have to pay $230.”

Instead of saying that “market is not only ‘market prices’ but also compliance with contracts signed voluntarily, and that the compliance with contract prices is an obligatory condition for market to work,” Ukraine began talking about “political pressure.” By mentioning the Black Sea fleet, tracker stations and so on Ukraine was obviously trying to provoke a dispute on territorial claims. They wanted to say “just look, they want not the gas price, they want to choke us, to take our land away, to take our sovereignty!” Even the absolutely neutral comment by Russian Defense Minister Sergey Ivanov that the terms of the Black Sea fleet deployment in the Crimea cannot be revised was presented by Ukraine as a territorial claim.

“We are waiting for the Russian leadership to officially react to Ivanov's words!” They waited in vain. Putin beautifully parried Yushchenko's serve (he won the whole set). “I welcome the statement of President Yushchenko that a commercial dispute must not be politicized.” “Russia is pressuring us. It is taking vengeance for our revolution!” And in response — “one must not politicize a commercial dispute.” As they say: “Let the flies be separate from the cutlets.” Not now. Then later. Now the gas price. Then the Crimea. Russia aptly evaded political issues in the gas dispute. Silent were even radicals. The core of this success was consolidated position. Putin, Foreign Ministry, Gazprom, Duma — all said one and the same thing: “market relations,” “market,” “European prices.”

Compare with Ukraine: there is all at six and sevens there. One insists on the “legal” position: “there is a contract, Russia, fulfill it!”, the second on the “fair market” one: "the fair price is $80, the third says: “they are taking vengeance for our revolution.” Speaker of Supreme Rada Vladimir Litvin has tripped Yushchenko up at all by saying: “We started the contract's revision ourselves, what are we surprised at now?” Russia was lucky that every official in Ukraine is also a politician (the elections are close — and bad is the clerk who does not dream of being a hetman). The rivalry among politicians in Ukraine is inevitably growing into a fight among officials. As a result, on the eve of the gas cut off the news was not that Gazprom had refused to fulfill the terms of the contract, but that “Ukraine had rejected Gazprom's terms.”

When Gazprom cut its supplies, Ukraine, instead of saying that it gets the Russian gas honestly in accordance with the deal 2004, acted like some petty swindler (though “petty” is hardly the word here), blabbing something about not taking gas from Russia and doing well with one from Turkmenistan. Gazprom had nothing left to do but to expose Ukraine's theft by adducing contracts saying that there can PHYSICALLY be no Turkmen gas in Ukraine as it has been all bought out by Gazprom and by sending auditors to the border to record how much gas Ukraine steals. Ukraine now intends to sue the Gazprom press secretary for his saying that “Ukraine steals gas.” They have found the guilty! This intention looks as a petty revenge for the defeat in the information war. Quite a provincial way to act….

And the defeat was obvious. Gazprom's PR-policy had one end in view — business. To be more precise, to help the company to free itself from the bondage of the transit contract. Both the mass media and the opponent were misinformed that the price was the key. The attention of the Ukrainian negotiators (and immediate observers) was finally fixed to this false (better say secondary) goal when the claimed price was risen from $160 to $230.

As a result, disoriented by Gazprom, Ukraine focused on protecting a secondary position just find itself missing the enemys attack in the key direction and, ultimately, losing the secondary position as well — in the new contract the Russian gas price is $230!

One cannot help gaping at the insight of the former prime minister of Ukraine Yulia Timoshenko, who opined that “a criminal decision has been made in this contract to separate the transit of the Russian gas via Ukraine from the Russian gas purchase price.” Timoshenko is right — Ukraine has lost its last trump — “the transit-gas link.” For Gazprom the breaking of this link is hardly criminal though. Concluded is an agreement that has brought Gazprom almost $3 bln in 2006 due to lower transit fee alone (see above) and has lost Ukraine from $2.9 bln (Reuters) to $4.5 bln (Timoshenko).

The West has limply ground its teeth. Quite usual for all. They are constantly grinding. Russia is bad when it sells gas at $50 — “the Putin clique tries to buy love.” Russia is bad when it sells gas at $230 — “the Putin clique takes vengeance.” Russia is bad when it offers a $3.6 bln loan — “the Putin clique wants to make young democracy dependent.” The stance of the West was expected, predictable and therefore not interesting. But for the US, who tried to play some own game and even officially supported Ukraine just to see it quickly surrendering to Gazprom's pressure. The American maneuver has had no development, though the US seems to be trying to save its face and to continue the intrigue by pushing Moldova, Romania and Bulgaria into actions “against Gazprom's monopoly.” It will hardly succeed for Europe is glad that the conflict is over and wants no more crisis, especially for sake of some ephemeral goals of fighting the sway of the Russian gas. Skeptics warn: “Oh! They will now diversify their gas supplies! Oh! The civilized countries have seen that Russia is an unreliable supplier! They will buy gas in other places and have already decided to build a gas pipeline.”

These fears look far-fetched. By 2020 Europe will consume at least 50% more gas than now. The Europeans need heat, they need hot bath and shower, steaming coffee and tea. As a matter of nature, they will hardly do without the Russian gas in the near future, but, as a matter of fact, the Russian gas alone will be hardly enough for them. They will buy however much gas there is — just pump it! — from whoever, be it Turkmenbashi, Ayatollah, even the Pope, if they find gas in Vatican. For already five years Europe has been considering plans to access new gas resources and to diversify supply sources and transit routes, with the co-sponsor of some of these projects “to get protected from the Russian monopoly” being the selfsame Gazprom.

Noteworthy, Gazprom's ADR price went up 4.6% at London Stock Exchange right after the deal with Ukraine. The company's capitalization has gown by $7 bln. By the end of the week, the growth made up 10%. It would be interesting to know how much cheaper Naftogaz 's shares would get after the deal should they have any quotation at stock exchange at all.

As featured on News Now
April 2015
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