Russia drops bombshell offer to form gas supply JV with Ukraine

By bne IntelliNews May 1, 2010

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In an astonishing sign of the warming in ties between Russia and Ukraine since Viktor Yanukovych became president in February, Prime Minister Vladimir Putin has proposed in a meeting with his Ukrainian counterpart Mykola Azarov that the two countries' gas monopolies should form a joint venture as a way to smooth energy relations between the two.

Russia's Gazprom provides about a quarter of the natural gas consumed in the EU and Ukraine's Naftogaz transports about 80% of that Russian gas going to the continent, but the relationship between the two countries over gas supplies have been plagued by disputes over prices that have resulted in gas being cut off to Europe twice since 2005.

Putin's spokesman, Dmitry Peskov, told Reuters on April 30 that a deal between Gazprom and Naftogaz, put forward at a meeting of the Russia-Ukraine inter-governmental committee, could involve an equity swap. "It will not be a merger, given the size of Gazprom and the size of Naftogaz. Probably it will be an equity swap. A certain number of Naftogaz shares can be swapped for a certain number of Gazprom shares," Peskov said.

Gazprom chief Alexey Miller told The Voice of Russia that the transaction will provide Ukraine with access to Russia's gas reserves, while Russia would invest in Ukraine's exploration and gas transportation systems.

Talk of giving Russia some control over Ukraine's gas pipeline system will provoke fury among pro-Western politicians in Ukraine, who will see this is just another example of the new government eroding Ukraine's sovereignty in favour of a pro-Russian bias. On April 27, the Ukrainian parliament erupted into an egg-throwing melee following ratification of a controversial agreement to extend the lease of Russia's Black Sea Fleet in the Crimean port city of Sevastopol for at least 25 years in return for the signing of a new gas price agreement earlier in April, which saw a one-third price cut on the annual 30bn-40bn cubic metres in annual gas imports into Ukraine from Russia, saving Ukraine an estimated $3bn-4bn annually.

The issue of the ownership and control of Naftogaz is a hugely sensitive one in Ukraine, given that the company is responsible for running and maintaining the country's gas pipelines. The company at present is 100% state-owned, but only has a license for running the pipelines, as the pipelines are formally owned by the government. "Ukraine has thus far been eager to retain ownership and control of pipelines, seeing this as a key bargaining chip in regional energy politics. Clearly a joint venture between Gazprom and Naftogaz would risk, from the Ukrainian perspective at least, ceding of some substantial control of pipelines, which may be less than appealing," says Tim Ash of Royal bank of Scotland.

Analysts say this rapid warming and deepening in the relationship between the two countries will also cause alarm in western capitals. The 25-year extension in the lease for Russia's Black Sea Fleet in Crimea effectively ends any chance that Ukraine will join Nato. Now, it looks as though Russia could gain some hold over the gas lifeline to the EU.

Perhaps in recognition of the potential for this issue to cause consternation at home and abroad, the officials from the Ukrainian prime minister's delegation have described Russia's offer as "impromptu," suggestive perhaps of a somewhat lukewarm reaction. They have denied that any formal offer has in fact been made, only noting that they are awaiting firm proposals. However, Russia clearly hasn't read the script, with Peskov denying Putin's proposal was impromptu. "It was not an impromptu one. It was a thought-out, calculated proposal. Such proposals are not made in an impromptu way," Peskov said.

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