News that Gazprom has dispatched a $7bn bill to Naftogas for its failure to take gas under the 2009 gas agreement between the two sides is a huge blow to Ukraine.
As the FT article over the weekend indicated, the Ukrainian economy is in a somewhat precarious state and this claim risks breaking both Naftogas and state finances. It will also put considerable pressure on the balance of payments which is already straining under a wide current account deficit (~7% of GDP) and much diminished FX reserves (
The claim comes out of the blue, as relations between the two sides has been reasonably constructive in recent years, and Gazprom had appeared somewhat understanding/flexible in terms of Ukraine's failure to meet the terms of the 2009 take or pay agreement. Before Christmas the two sides had appeared to be negotiating hard over a new gas pricing agreement, with Kiev appearing confident over securing a pricing discount from the approximate $440 per 1,000 cu metres paid at present.
What appears to have changed in just a matter of weeks is that Moscow seems to have been angered by Ukraine's reluctance to accept its terms for the revision to the gas pricing agreement - in particular Ukraine's membership of the CIS Customs Union, and joint control of gas sector assets. The final straw for Moscow appears to have been the recent agreement between Ukraine and a foreign energy major over investment in shale gas development in Ukraine. Specifically all the talk of this investment breaking the energy dependency on Russia, seems to have brought Moscow to the conclusion that the regime in Kiev was no longer a trusted long term partner. From Moscow's position the dispatch of a bill for $7bn is a crystal clear sign that the gloves are once again off in terms of the energy relationship with Ukraine.
The big advantage of the 2009 gas price agreement reached between Russia and Ukraine was seemingly that it put the gas supply/transit relationship between Russia and Ukraine on a firmer market/contractual basis, and has been working pretty well since. That is, the agreement has thus far assured undisrupted supply of gas from Russia to Ukraine and on to Europe - remember prior to the agreement that a perennial problem had emerged around the New Year of price disagreements and subsequent disruptions in supply which proved costly to the European economy. The pricing formula and the supply volumes were clearly set in the contract, with payment by Ukraine due by the seventh of the month after the delivery of gas - typically Ukraine has been paying $700-800m per month for gas over the past yer or so. Thus far Ukraine has been paying religiously, and the frequent past occurrence of payment delays and arrears in payment has been avoided. Importantly, the 2009 gas price agreement is subject to international arbitration in the Stockholm courts.
Back in 2009 the agreement was generally viewed as a reasonable deal by both sides. In 2009 gas prices were on the rise, and supply was constrained. By this deal Ukraine secured assured supplies of gas for its economy, and the link to market prices was viewed as braking the dependency ratio between Ukraine and Russia, assuring Ukraine's sovereignty. Subsequently, with the advent of shale gas and downward pressure on gas prices, plus the desire for the diversification of gas supplies the 2009 agreement is no longer viewed in such a favourable light.
The key problem for Ukraine is the "take or pay" nature of the agreement. Herein Ukraine is contractually obliged to buy 42 bcm of gas annually - it has the ability to buy 52 bcm. The problem in recent years is that higher gas prices, and reduced domestic consumption, has reduced Ukraine's appetite for imported gas. In 2012, for example, Ukraine is thought to have imported just 32 bcm, in theory leaving Russia with a claim for the outstanding 10bcm, and hence the latest $7bn claim, albeit it is unclear how with a $440 per 1,000 cu metres gas prices Gazprom ends up with a $7bn outstanding bill for Ukraine - perhaps this reflects accumulated debts since 2009 on below contract take up of gas.
Where do we to from here?
First, Ukraine is likely to dispute the $7bn claim from Moscow, and all this is likely to end up in the courts. That is unless some compromise agreement can be reached in the interim. I would put the probability of such an event as quite low, given that this was a very confrontational move by Moscow - a sign of the low point now in Russo-Ukrainian relations. Hence Kiev would now be forced into a humiliating about turn, likely forced to accept all of Moscow's conditions as the price for any agreement. Politically this would likely to impossible for a Ukrainian politician to accept, and especially with the incumbent, Yanukovych, lagging in opinion polls and facing presidential elections in 2015. I would also add that there is a not insignificant chance that this results in a broader deterioration in relations between Ukraine and Russia, akin to that which occurred in 2005 after the Orange Revolution, where a mini trade war broke out between the two states with a significantly negative impact on the Ukrainian economy in that year - Russia proved it still has a significant ability to disrupt the Ukrainian economy.
Second, all this comes as Ukraine is due to start negotiations with the IMF this week over a new financing arrangement. Perhaps Ukraine's return to the table with the IMF had also served to anger Moscow. Negotiations with the IMF over a new financing arrangement are however also likely to be difficult, a reflection of both foot dragging in the past by the Yanukovych administration on the reform front, and the fact that with key opposition leaders still languishing in jail, key Western IMF shareholders are unlikely this time around to be willing to lobby in Ukraine's favour for IMF conditionality to be relaxed. The IMF will likely demand tough fiscal austerity, gas price hikes/liberalisation and FX market liberalisation as the minimum price for any deal - any programme will also be long on prior actions and short of front loaded cash disbursements. Ukraine's room for negotiation has suddenly shrunk quite considerably. Presumably, the Yanukovych administration will try and sell the need for going to the IMF, and implementing tough conditionality as being required because of the aggressive and confrontational stance of Moscow. Nevertheless, this will mark a turnaround in the policies of the Yanukovych administration. There is also the question mark as to whether Ukraine's desire/need now to reorient towards the West will require political concessions from Kiev, including the freeing of key opposition leaders, including Yulia Tymoshenko.
I would argue that risks are again rising with respect to Ukraine, and for the Ukrainian economy, and its isolation both from Russia and more recently the West leaves it exposed. If the Yanukovych regime is to negotiate through this crisis it will have to make a stark choice between the West and Russia, but either choice brings with it risks.
Ukraine won't pay fine to Gazprom, willing to raise gas tariffs
The Ukrainian government is ready to lift residential gas tariffs to remove the main impediment to a deal with the IMF, Foreign Affairs Minister Leonid Kozhara told the Wall Street Journal in an interview published on Jan. 30. Earlier last month, PM Mykola Azarov suggested that might happen in comments to international businessmen.
Kozhara also said the Ukrainian government isn't going to pay a USD 7 bln natural gas bill that Gazpron is demanding for allegedly breaching a 2012 take-or-pay agreement in 2012. Meanwhile, state gas producer and trader Naftogaz (NAFTO) was less straightforward on Jan. 31, stating on its website that it will consider Gazprom's claim in due time, has sent a reply, and is going "to solve all the issues related to the contract in accordance with its clauses." Gazprom has yet to respond.
Alexander Paraschiy: So far, Ukraine's officials are speaking about boosting gas tariffs only when addressing an international audience. It will take a little time before they start to treat this option seriously and address it with Ukrainian citizens. Our argument is the Ukrainian government has no option but to deal with the IMF, which implies its officials will make concrete commitments that include a household gas tariff hike by mid-spring.
The state's reaction to Gazprom's fine looks a bit puzzle-headed and we are likely to see the conflict will develop in the coming days.