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Tortuous and tangled is the Russian gas route to the EU

By Stefan Korshak
DPA, KIEV
Saturday, Feb 16, 2008, Page 9

ILLUSTRATION: MOUNTAIN PEOPLE

Russia's No. 1 export earner -- natural gas sold to Europe -- travels to market by one of the most convoluted and lucrative energy distribution networks in the world. Square in the middle stands Ukraine.

The former Soviet republic is now locked in a dispute with the Russian natural gas monopoly Gazprom over a host of purported issues -- and a few real ones -- all related to updating the division of a massive income stream.

"It's the same old question," said Serhy Makhno, a Kiev-based energy industry analyst. "How do you divide up money with people you don't trust?"

Gazprom, the world's third-largest corporation accounting for roughly 3 percent of Russia's GDP, sells some 150 billion cubic meters of natural gas to European consumers each year. The business, in today's market of rocketing energy prices, is worth as much as US$45 billion every 12 months to the Kremlin.

The EU overall gets about 25 percent of its gas needs from Gazprom. The dependence is substantially higher in Central and Eastern Europe -- for Germany 36 percent and for Poland 86 percent, US government estimates show.

The lion's share of Gazprom's European cash cow, some 120 billion cubic meters of 150 billion cubic meters of gas supplied, flows to euro-paying markets through Ukrainian pipelines. The only other route is via Belarus, but capacity is limited to only some 30 billion cubic meters annually.

MUTUAL INTEREST

"Gazprom needs Ukraine to get its product to market and Ukraine needs Gazprom -- otherwise its factories can't run," said Viacheslav Bondarenko, an energy trader. "But so much money is involved that when the contracts aren't respected, the only way this structure can react is by moving from crisis to crisis."

The last gas crisis, back in late 2005, had its roots in failed price talks between Gazprom and Ukraine.

Gazprom, wanting a 100 percent hike, declared that since there was no contract it would not sell gas to Ukraine, but would continue to send gas to Europe.

The Ukrainians said they had no alternative (in the absence of the very same contract) but to take fuel as payment for transit services rendered and siphon off a portion of the gas destined for Europe. Gas volumes fell by about one-third across the continent and prices spiked in countries such as France.

Two days of accusations and counter-accusations later, the Russians and the Ukrainians came to terms, creating a pair of middleman companies selling Gazprom's gas to Ukraine, fixing the price of both the gas and its transportation about 50 percent higher and planning contract renegotiations every six months.

Things went smoothly for about a year. But as time passed, talks on updating the trading terms went nowhere, natural gas prices shot up from US$220 per 1000m3 to around US$300, and the Ukrainians in September parliamentary elections exchanged a pro-Russia government for a pro-Europe government.

NO GO-BETWEENS

Ukrainian Prime Minister Yulia Tymoshenko has made reform of Ukraine's natural gas distribution sector -- ironically, a business from which she made a fortune in during the 1990s -- a top priority for her administration.

Top targets for her anti-corruption campaign are the two go-between companies created in early 2006.

She wants the Russian company to sell its natural gas to the Ukrainian government -- an income stream worth some US$15 billion annually -- without intermediaries.

Beginning in October Tymoshenko, using a variety of pretexts, stopped Ukrainian government transactions with the companies.

Gazprom, owning as it does a 50-percent stake in both highly profitable intermediary firms, has been less than enthusiastic, its executives pointing out a contract is a contract and adding that Ukraine already has run up a US$1.5 billion debt to the firms, of which exactly half is lost Gazprom income.

The Kremlin has employed its own pressure tactics as well, arguing that since Ukraine stopped paying the intermediaries in October and continued to import gas, Kiev was consuming fuel directly from Gazprom at a current US$300 per 1,000m3, rather than the US$189 via the middleman companies as per the early 2006 contract.

Ukrainian energy official Ihor Didenko, in Monday remarks to the Ukrainska Pravda magazine, floated the Ukrainian riposte: The gas that Gazprom -- a product buyer in Central Asia -- is selling to Ukraine these days is not US$300 Russian gas, but rather US$65 Central Asian gas, imported by Gazprom specifically for the Ukrainian market.

Industry experts predicted an eventual agreement that would avert the present crisis, but do little to place Russo-Ukrainian gas relations in a stable contractual relationship.

"They'll solve this crisis," Makhno said. "But for sure it's not the last one."
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