Gas Deal Gives Opportunites To Make Tough Decisions

KIEV, Ukraine -- Ukraine, by signing a normal, long-term contract with Russia for Central Asian gas, took a major step forward, bringing it in line with European economic realities.

An employee at the Orlovka gas-compressor station near the Ukrainian-Romanian border.

How will the new price arrangement impact on the Ukrainian economy in 2009 and beyond? Will the country be able to pay the new gas prices? Will it finally begin to revamp its energy intensive economy and live within its means?

For the past 10 years, Ukraine has been buying Turkmen gas, the price of which was not linked to the price of oil or to the laws of supply and demand. The formula for determining the final price was based on the arbitrarily negotiated price reached by Ukraine (later by Gazprom) with the unstable and highly corrupt former president of Turkmenistan, Saparmurat Niazov, plus the cost of transit from Turkmenistan to the Ukrainian border –roughly $40 for 1,000 cubic meters.

It is therefore incorrect to say, as Vladimir Putin often does, that Russia has been subsidizing the price of gas to Ukraine. RosUkrEnergo’s Dmytro Firtash also has spread this lie in his recent television appearances by claiming that he and RUE subsidized Ukraine to the tune of over $2 billion. The truth is that Turkmenistan sold gas at a lower price than Russia, and Ukraine took advantage of this. The only subsidy was the abnormally low transit tariff Ukraine charged Gazprom and RosUkrEnergo.

The large price difference between Turkmen gas and Russian gas – which was pegged to the price of oil – left a large margin of profit for intermediary companies such as RosUkrEnergo. It bought Turkmen gas as part of the Russian-Ukrainian gas contract and then resold part of the volume to European customers at close to European prices, making a huge profit on this.

According to experts, the average European price for gas in 2009, barring any major jump in the price of oil, will be in the range of $210-$240 for 1,000 cubic meters.

This will create mild hardships for the already ailing Ukrainian chemical and metallurgical industries, which will have to pay slightly higher prices for their energy-intensive production needs. These prices, however, will be lower than what European chemical and steel producers are paying, but higher than those paid by Russian producers, Ukraine’s main competitors.

Yet grave problems are bound to arise for Ukraine in the future. These need to be examined in order for future Ukrainian governments to prepare for the gathering storm.

The newly signed Ukrainian-Russian gas contract will expire in 2019. A major provision in the contract obliges Ukraine to pay the full European price for gas (without the 20 percent discount Ukraine will get in 2009) beginning in January 2010. Russia at that time will begin paying Ukraine the European transit tariff for gas going to Europe. Presently this tariff is $1.70 per 1,000 cubic meters for 100 kilometers; in 2010 it is scheduled to rise to about $4. According to press reports, the $4 transit fee will remain fixed until 2019, even if European transit fees increase – or decrease.

In the first quarter of 2009, when the new price of gas will be relatively high, Ukraine should be able to cushion the pain by continuing to rely on its own gas stored underground and not buy large quantities from Gazprom. By the second and third quarters of the year, the price should continue dropping in line with the price of oil 9 months earlier (thus in September 2009, the gas price will be calculated based on the price of oil in January 2009 - $50-$35).

If the world-wide recession ends by late 2009, oil prices are likely to rise. If the recovery continues into 2010 and beyond, it is almost certain that oil prices will rebound to $80-$90 or more per barrel and the European price for gas will reflect these price increases by mid-2011. Ukraine should be prepared to pay about $300-$325 for 1,000 cubic meters of gas at that time. If such a trend continues, it is altogether feasible that Ukraine will pay $350-$450 for 1,000 cubic meters of gas by 2015.

The price for Ukraine in 2015 will also be affected by the North Stream and South Stream pipelines (if they are operational by then) which would most likely lead to a decrease in the volume of Russian gas shipped via Ukraine –thus lowering income from the transit fee.

Ukraine has six years in which to complete a number of critical projects in the energy sphere:

It is essential for Ukraine to drastically reduce its consumption of gas.

The government of Ukraine must encourage new drilling for gas, including coal bed methane and remove the artificial barriers it has created which discourage foreign investors from entering the Ukrainian energy market.

Ukraine should proceed to build an LNG regasification terminal on the Black Sea in order to diversify suppliers. By placing all its bets on Central Asian or Russian gas producers, Ukrainian governments could well find themselves without gas in the future.

The price of gas sold to Ukrainian consumers, both industrial and household users, should be raised in increments to reflect the real price of gas and not maintain a foolish, politically motivated, subsidized price.

Those responsible for energy policy must once and forever come to terms with reality. There is no going back to the old, corrupt schemes with crooked Central Asian leaders or using fly-by-night intermediaries. If Ukraine is to survive as a country its leaders must make hard and painful decisions.

Source: Kyiv Post