No more "Mr Nice Guy": Gazprom hits Ukraine with huge $1bn gas bill

By bne IntelliNews October 30, 2013

Ben Aris in Moscow -

In an intensifying fight between Russia and Ukraine, the gloves came off on October 29 when Gazprom hit Ukraine with just short of a $1bn gas bill in retribution for Kyiv's decision to turn its back on the Russian-led Customs Union and throw in its lot with the EU with the signing of a free trade and association pact at a November EU summit in Lithuania. It has also rekindled talk of a gas war between the one-time allies.

"We're very concerned about the situation with Ukraine's payment for Russian gas supplies. We signed an additional agreement to the contract of gas deliveries worth $882m in August, which set a payment deadline of October 1," Gazprom CEO Alexei Miller said on October 29. "But October is drawing to an end, yet the gas bill remains unpaid, so the situation is very serious, taking into account the fact that the contract envisions the prepayment option in case of violation of terms."

People close to Gazprom told the Financial Times that if Ukraine failed to pay off the debt, a switch to prepayment could take place by December or earlier. "Then, if you are in prepayment mode, and you don't pre-pay, you don't get any gas," said one.

Both Russian President Vladimir Putin and his counterpart Ukrainian President Viktor Yanukovych were in Minsk on October 25 for a Eurasia Economic Union summit where Putin made a last-ditch attempt to persuade Ukraine to join his trade club.

But to no avail. Ukraine will almost definitely sign off on the Association Agreement with the EU. The Kremlin has made it clear that if it does, Ukraine's special relationship with the Customs Union will come to an end. And that will hurt Ukraine in the pocket: some 40% of Ukrainian exports currently go to Russia and enjoy special low import tariffs thanks to its Soviet-era ties.

The Kremlin has been using gas as a negotiating tool to get Ukraine to sign up to the Customs Union, a grouping which makes little sense without Ukraine's participation.

The carrot has been the promise of cheap gas, but now that Ukraine has thrown its lot in with the EU, the cudgel is to insist on the take-or-pay terms of a deal signed with jailed former Ukrainian PM Yulia Tymoshenko. The cash-strapped Ukrainian government has cut imports of expensive Russian gas to save money, but under the terms of the deal are obliged to pay for what they agreed to import, not what they actually used.

"According to our estimates, Naftogaz is unlikely to buy more than 17 to 18 billion cubic meters of gas from Gazprom this year, with the contracted volume at 41.6 billion cubic meters," Russia's National Energy Security Fund Deputy Director Alexei Grivach said, reports Itar-Tass. "Failing to take the contracted volume would cost around $10 billion as the average contract price is at $410 per 1,000 cubic meters."

The gap between the two has grown to be significant. The debt for gas supplies in Russian regions exceeded RUB100bn ($3.1bn) this year, according to Gazprom's Miller during a meeting on October 29 with Russian Prime Minister Dmitry Medvedev. "The situation with Ukraine's gas payments is coming to the boil," Miller told the meeting. "Ukraine has failed to pay fully for August supply."

Ukraine's state energy firm Naftogaz declined to comment on Gazprom's remarks, but Ukrainian Prime Minister Mykola Azarov said the government was "monitoring the issue". "This, primarily, is a question concerning two companies, and they have to sort things out," Azarov's was quoted as saying.

The Kremlin has rapidly ramped up the rhetoric and looks like it will insist that Kyiv sticks by the deal that Tymoshenko cut. The sabre-rattling is reminiscent of the previous two "gas wars" between Russia and Ukraine over unpaid bills that saw several European countries cut off from supplies during the winters of 2006 and 2009, forcing Brussels to focus efforts on diversifying the bloc's energy supplies. In the last two years, European customers have been able to force Gazprom to pay significant rebates on its long-term gas contracts.

Gazprom ships more than half of its gas to Europe via Ukraine. This year it aims to increase exports to Europe, where it provides a quarter of gas needs, to 152bn cubic metres (cm) from 138bn cm last year. Over the last two years, Europe has managed to find several alternative supplies of energy, but earlier this month Miller said that supplies to Europe were up by a third and so Europe's bargaining position has weakened somewhat.

Ukraine, which imports nearly all its gas from Russia, pays about $400 per 1,000 cm, slightly higher than the average price paid by European customers, but more than double what Belarus, a member of the Customs Union, pays.

The Kremlin's line has definitely hardened over the last 24 hours and it looks like it is out to make real trouble for Ukraine, which is facing a new financial crisis thanks to its moribund economy. "Everybody should understand that the forgiveness of all debts or 'gas communism' will be out of place in the future," Medvedev agreed with the Gazprom CEO at the same meeting, intimating that Russia will capitalize on Kyiv's weak position and punish it with high energy prices unless it does a volte face on its decision to move toward the EU.

Of course, none of this is official policy. In response to an Itar-Tass question if Gazprom's stance could in any way be associated with the discussions at the Eurasian Economic Union summit in Belarus last week or to the meeting between the Russian and Ukrainian presidents in Sochi on October 26, Dmitry Peskov, spokesman for Putin, insisted the issue is not related to Ukraine's plans to sign an EU free trade and association pact. "The topic of gas debts is certainly not among political issues and in no way relates to associated membership in the European Union," Peskov said.

Peskov went on to say that Gazprom had shown "maximum flexibility" for a long time, meeting its Ukrainian partners halfway, but that Russia's patience had run out. And Russia probably has a point when it says it has been very patient with Ukraine.

"In the recent time, Gazprom has repeatedly met Ukrainian colleagues halfway in the issues concerning contract terms," Miller said. "To ensure Naftogaz Ukrainy's timely and full payment for Russian gas, Gazprom paid an advance for gas transportation through Ukraine until January 2015. It also offered a significant discount, selling five billion cubic meters of gas to Ukraine at $269 per 1,000 cubic meters, which made up a $0.5bn discount."

Given the hoopla that surrounded the gas showdown in 2006, calling in Ukraine's unpaid debt now is bound to send tempers through the roof this time round. Ironically, the Kremlin's hard line will almost certain guarantee that Kyiv signs off on the EU deal in Vilnius next month.

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