The gloves come off again in Russia-Ukraine gas fight

By bne IntelliNews January 28, 2013

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Russia hit Ukraine with a $7bn bill for unused gas deliveries on January 25, as the stand-off between the pair grows nasty once more following Kyiv's announcement of a $10bn exploration deal with Shell.

Russian gas giant Gazprom has presented Ukrainian energy company Naftogaz Ukrainy with the bill for gas it did not take in 2012, a Naftogaz spokeswoman told the UNIAN news agency on January 26. "There is such a bill," said Elena Yurieva, adding Ukraine paid for 24.9bn cubic meters (cm) of gas used last year. Other reports put the total amount of gas Ukraine imported in 2012 at 32.9bcm, just below the minimum it is allowed to under the terms of its deal with Russia.

Ukraine can't afford its current monthly gas bill of a bit less than $1bn a month, let alone a one time hit of $7bn. Under the terms of a controversial deal signed by then prime minister Yulia Tymoshenko in 2009, Ukraine agreed to buy a minimum of 33bn cm of gas a year in a "take-or-pay" deal. Tymoshenko is currently serving a seven-year prison sentence for exceeding her authority in signing the deal. Ukraine unilaterally cut imports of gas last year in an effort to save money and Russia said nothing - until now.

Kyiv has been complaining bitterly ever since that the deal was unfair, a claim that is given some credence by the fact that Gazprom has been forced to offer discounts to more than a dozen Western European customers due to the impact on the market of US shale gas and liquified natural gas (LNG). However, the Kremlin has bluntly refused to re-negotiate, mainly because it is trying to force Kyiv to join the Customs Union, a trade club between Russia, Kazakhstan and Belarus which went into operation in 2010. The trade club makes little sense without Ukraine's participation.

However, on January 25 Ukraine signed off on a deal potentially worth $10bn of investment with Shell to explore and exploit the country's shale gas reserves. Shell has already invested $400m and while it may never get to the headline figure, the deal is being presented by Kyiv as a threat to Russia's leverage over it.

"Clearly Kyiv angered Moscow by signing the deal with Shell, and selling it as a drive for Ukraine's energy independence (of Russia in effect)," Tim Ash of Standard Bank writes in a note. "The dangers are now building of a full blown trade war between Russia and Ukraine. The Ukrainian economy is acutely weak at present, and this will likely force the Yanukovych administration back into the Western camp."

The move only makes this week more important, with an International Monetary Fund (IMF) mission due in Kyiv to potentially restart a badly needed stand-by loan deal to the cash-strapped country. However, even if the deal is restarted, the first tranche due will still not provide enough money to cover an extra $7bn gas bill. That appears to leave Kyiv's only hope a turn to the West; after Kyiv opened a new investigation accusing Tymoshenko of murder, help from that direction appears unlikely.

"I cannot see the West cutting Yanukovych any favours while Tymoshenko remains in jail," suggests Ash. "It now makes me think that the appointment of Nikolay Udovichenko [last week], a reformer, as deputy governor of the [National Bank of Ukraine], and chief negotiator with the IMF was somehow linked, i.e. with the Russians now expected to play really hardball with Ukraine, the Yanukovych administration will want to try and open doors with the West. Things look set to get very testy in terms of the Russo-Ukraine relationship."

On that note, the size of the Russian bill looks finely judged. Given the $430 per 1,000 cm Ukraine currently pays, the 8bn cm or so of extra gas it is claiming for would cost around $34bn - more than the country's entire hard currency reserves. While "take-or-pay" charges are not generally made at full cost, the charge is enough to consume all of the $4bn or so that Kyiv could get from the IMF in any next tranche - plus a little more. In other words, enough to be extremely painful, but not too much to leave the economy on its feet.

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