Analysis: Ukraine Needs Long-Term, Oil-Linked Gas Contract With Russia

LONDON, England -- Europe faces potential gas supply crises every winter unless Russia and Ukraine agree a long-term oil-linked gas contract that might require financial help from Europe, analysts said on Monday.

Russia has not offered Ukraine the kind of long-term deal enjoyed by its customers in western Europe which might settle the row for good.

Analysts said to do so would remove Moscow's favoured method of exerting politcal pressure on the pro-western government in Kiev.

"There has to date been little incentive to come to an amicable long-term relationship with Ukraine, so this is going to happen again and again. It suits Russia to return repeatedly to this gas relationship because it's a way of further destabilising the existing regime," Professor of Energy Policy at the University of Oxford Dieter Helm said.

"The Russians are holding them on a short-term exposure to the spot market and that's why we have this annual event," Helm added. "What is needed is a stable long-term pricing formula. That has to be pricing gas in relation to oil prices, which have fallen sharply."

Over a week after Moscow cut off Ukraine in its annual row over how much Kiev pays for its gas, the two sides have agreed an international monitoring deal that should see Russian supplies to Europe recover in a few days.

They have not agreed on how much economically-crippled Ukraine will pay for its gas this year, with Russia insisting Kiev should now pay "market prices" after decades of cheap supplies.

Ukraine's main objection to Russian gas export monopoly Gazprom's price demands is that western European buyers should see their bills halve by summer as a slump in oil prices since July feeds into oil-linked gas contracts.

Many analysts expect oil prices to remain low this year and possibly beyond as recession weighs on global demand.

This could give Ukrainian more time to recover from its worst recession in over a decade and give it a better chance of paying bills next winter.

But neither side of the bitter gas row has said publicly that a long-term deal is under discussion, posing the real threat of another crisis next year.

"They may well fudge a deal again this year, like they have done for the last three or four years, but then the same problem will crop up again next year until there is probably some help," David Cox, chief consultant at Poyry Energy Consulting in London, said.

"It is in Western Europe's interest that the Ukraine does start to pay market prices and the sooner the better. But in terms of making them move to fully market related prices they can't really do that in one step, or even in a couple of years -- it needs to be phased," he said.


"If we want the Ukraine in the EU and we want them on our side, rather than Putin's side, maybe we have got to pay a cost for that and that is partly helping them with the transition," Cox said.

Helm warned against Europe subsidising anybody's energy bills but said the European Central Bank could give additional funds to Ukraine, in addition to the $16 billion from the IMF, to help Ukraine get through its economic crisis.

"There is a good solidarity reason for the EU as a whole being in a position to help out particular countries," he said.

"So we might consider help for the Ukraine through its current financial difficulties. But it should not be tied to the gas."

Russia's price demands for this year have varied from $250 to $450 per 1,000 cubic metres of gas, with Moscow raising the price each time Kiev rejected its previous offer.

Analysts estimate the latest Russian offer of $450 per 1,000 cubic metres is much higher than other European countries will be paying for their Russian gas over the next few months.

They say Ukraine should not be expected to pay the same price as buyers in Germany or Austria because Russia uses Ukraine to ship 80 percent of the gas that it supplies to Europe.

"The Russians are trying to raise the prices to the same level at which they sell to western Europe. That's always been their intention, Niall Trimble, director of the Energy Contract Company in London said.

"Obviously Ukraine does not have the wealth these countries have, so it's very hard to do that." But some kind of oil-linked formula should ensure reliable winter warmth across Europe for years to come.

"That's what the rest of Eastern Europe's contracts are linked to as well, its not just Western Europe," Noel Tomnay, principal global gas research for Wood Mackenzie said.

"There are reasonable arguments being made here and its really up to the sides to conclude them."

Source: Kyiv Post