Gas terms favour Russia, leaving door open for another dispute

By bne IntelliNews January 27, 2009

Nicholas Watson in Prague -

The terms of the deal struck between Russia and Ukraine that got the gas flowing again to Europe are, it seems, slanted very much in Moscow's favour. That fact makes a repeat of the dispute likely, warn analysts.

On January 19, Ukraine and Russia signed a set of agreements resolving their differences over the pricing and volumes of gas both sold to Ukraine and transited through Ukraine on the way to Europe. The two sides have previously signed deals that were meant to clear up the murky trade in gas between the countries, yet those agreements only served to muddy the waters until yet another crisis erupted and the gas was cut off again.

However, unlike in 2006 when the last agreement was reached, this time around the contracts have found their way into the public arena. Both of the main contracts signed between Russia and Ukraine appeared on the website of the Ukrainian daily Ukrainska Pravda - the validity of which have since been confirmed by anonymous sources in both Russia and Ukraine in other media outlets.

According to those documents, the terms of the gas deal signed between Russia and Ukraine on January 19 show that the Russian gas monopoly Gazprom negotiated very lucrative terms. "The formulas in the pricing and transit contracts between Russia and Ukraine indicate that the Russian side won significantly better conditions than we had at first understood," say analysts at Alfa Bank.

The most important difference is that Gazprom has got Ukraine to agree to pay actual European prices for its gas rather than on a so-called "netback" basis, ie. without taking into account that the cost of transporting gas to next-door Ukraine is much cheaper than sending it all the way to Germany. By setting prices at the gross European level, Gazprom keeps as additional margin the roughly $40 per million cubic metre (cm) it typically spent on transit fees, generating an additional $2bn in revenue on the 50bn cm gas bought annually by Ukraine. "This is a significant amount," says Alfa. "As the gross European price in a $40-per-barrel oil environment is about $170 per million cm, the net revenue from Ukraine per unit is approximately 34% higher than the equivalent European netback."

This means that in 2010, after a 20% discount expires at the end of this year, Ukraine will begin paying the same gross price for its gas as European customers do, making the country by far the most lucrative market for Gazprom on a per unit basis, after export duties and transit fees.

Ukraine is also now subject to strict penalties if it takes for its own use too much of the pipeline gas, something that Russia has accused it of doing many times in the past. The sales agreement stipulates quarterly purchase levels for the next two years. Volumes in 2011 and beyond will be determined by additional contracts to be negotiated at some point in the future. Having a so-called "take-or-pay" clause, widely used in gas agreements, this contract has serious financial consequences for Ukraine should it fall short of its commitments. "In particular, the contracts call for punitively high prices should Ukraine take more than 6% over the agreed-to volumes from the system," says Alfa. "In that event, Ukraine would be liable to pay 150% over set prices in the summer period and 300% over set prices in winter for the additional volumes."

Broken promises

Such onerous terms have inevitably led to questions over whether Ukraine has either the will or the ability to meet them.

On Tuesday, January 27, Ukrainian President Viktor Yushchenko insisted during a visit to Brussels that Ukraine would stand by the terms of the deal negotiated between Russia and his prime minister, Yulia Tymoshenko, even though not all the details were to his liking.

However, Ukrainian politics are stuck in a perpetual state of war between President Yushchenko, PM Tymoshenko and Viktor Yanukovych, who won a flawed presidential election in 2004 but was then ousted by Yushchenko in the succeeding "Orange Revolution." Analysts note that opposition within Ukraine to the deal was almost immediate, with Yushchenko criticizing Tymoshenko for negotiating such a bad deal for consumers when Ukraine's economy is mired in such trouble. Ukraine has been battered hard by the financial crisis, which is crippling the country's giant steel industry. On January 26, Standard & Poor's said the credit crunch had left Ukrainian banks in the lurch and most would need additional capital to withstand the effects of the crisis, at a time when the country's central bank had limited means to help because of the conditions attached to its $16.4bn loan from the International Monetary Fund.

Given Ukraine is heading toward presidential elections sometime between the end of 2009/beginning of 2010, analysts say political jockeying over the deal will make a renegotiation of the terms increasingly likely, leaving Europe once again at the mercy of the squabbling politicians.

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