Russia-Ukraine gas war restarts as Gazprom cancels contracts with Naftogaz

Russia-Ukraine gas war restarts as Gazprom cancels contracts with Naftogaz
Alexey Miller, CEO of Gazprom, wants to cancel Russia's gas supply deal with Ukraine. /
By Ben Aris in Berlin March 2, 2018

A day after Gazprom was due to resume gas deliveries to Ukraine after a nearly three-year hiatus,  Russia’s gas monopolist has thrown down the gauntlet, saying it will cancel its supply contracts to Ukraine’s national gas company Naftogaz

The crisis comes a day after Russian President Vladimir Putin gave an annual state of the nation speech where he showcased a raft of new space-age weapons designed to negate US defence capabilities, threatening a new Cold War.

Gazprom has applied to the Stockholm Arbitration court to terminate its gas contracts with Naftogaz, according to Gazprom CEO Alexey Miller, reports Tass.

"The Stockholm arbitration, guided by double standards, adopted an asymmetric decision on our contracts with Naftogaz of Ukraine regarding supply and transit of gas. The decision seriously violates the balance of interests of the parties under these contracts. The arbitrators ground their decision by the fact that the situation with the Ukrainian economy has drastically worsened. We are totally against the situation when Ukraine's economic problems are solved at our expense. In this situation, the continuation of the contracts’ validity is not economically feasible and unprofitable for Gazprom," Miller said, as cited by Tass.

The Russian state-owned gas giant failed to restart gas deliveries to Ukraine on March 1 as agreed and returned the money Ukraine had already paid for the gas.

Relations between the two companies are particularly raw following the Stockholm arbitration court decision this week that ordered Gazprom to pay Naftogaz $2.56bn in compensation in a long running row over supplies and transit fees and reduced the contractual supplies of gas by Gazprom to 5bn cubic meters (bcm) from 2018.

Ukraine’s Naftogaz immediately issued a warning to the EU and its customers that it may face gas shortages over the weekend. It has already been forced to reduce supplies to thermal power stations in the country in the midst of a cold snap sweeping Europe that has been dubbed a “Siberian winter” in the UK. Some Ukraine cities were reporting temperatures of -21C at night on March 1.

Naftogaz has reduced its gas consumption at thermal power stations by 5-10%, Ukraine’s state-owned energy firm Naftogaz said on March 2.

Gazprom’s Miller is reportedly very unhappy with the terms of the deal that dictate both volumes and prices to the Russian gas company. He lambasted the decision, saying that the contract with Ukraine was no longer commercially viable and should be cancelled.

“Gazprom had to immediately start the procedure of the termination of the contracts with Naftogaz on gas supplies and transit at the Stockholm arbitration court,” Miller said in a statement, as cited by Reuters.

Gazprom said earlier today that it would not restart gas supplies, as an additional agreement to the existing arrangements had still not been reached, Reuters reports.

“Clearly, gas supplies to Ukraine’s Naftogaz will not be carried out from March 1,” Gazprom’s deputy head Alexander Medvedev said in a statement earlier on March 2.

The European Union (EU) has been panicked by the prospect of yet another gas war between the two rivals that will leave it freezing again in the midst of winter. Gas wars between Ukraine and Russia always come in winters and the EU has had to deal with previous crises in the winters of 2005-2006 and 2008-2009. Gazprom’s deliveries to Europe has been rising steadily and set a new all-time record in 2017 of 194bcm.  

Brussels rushed out a statement calling for calm and offering to be peacemaker. “The commission stands ready to steer a trilateral process which in the past has already proven to be effective in situations of disagreement,” European Union Commission Vice President Maros Sefcovic said in a statement.

“Guess given the current inclement weather in Europe, Moscow is trying to press the point on all that it still has leverage over Europe in terms of being able to turn on/off the gas/energy taps. Maybe this is also about further building the case for Nord Stream 2, which still has many critics in Europe,” Tim Ash, head of strategy at Bluebay Asset Management said in an emailed note.

The Ukrainians reacted badly to the news. Naftogaz CEO Andrey Kobolev took the return of the company’s money as a refusal by Gazprom to comply with the Stockholm court's decisions. Kyiv said earlier that it will fine Gazprom $500,000 a day for each day the payment of the $2.56bn is late. Ukrainian President Petro Poroshenko also said that the authorities would consider seizing Gazprom assets in the country if the company did not pay the fine.

The contract in question was signed by then prime minister Yulia Tymoshenko and was widely derided as Ukraine ended up paying some of the highest prices in Europe for Russian gas. Former president Viktor Yanukovych eventually jailed Tymoshenko for doing the deal, to the outrage of Europe that made her release a condition of Ukraine’s Association Agreement deal that Yanukovych was then negotiating.

The contract is due to expire on December 31, 2019 and in the meantime Gazprom has been racing to expand its Nord Stream pipeline with a second pipe that would allow it to bypass Ukraine entirely and send gas directly from its Yamal gas fields to Germany under the Baltic Sea. Work on the pipeline has been going well and the expansion is scheduled to be ready sometime later this year.

According to the Ukrainian contract Gazprom is supposed to supply 40bcm of gas in 2009, and starting from 2010, 52bcm annually, not the 5bcm figure decided by the arbitration tribunal. However, since 2012, the cash-strapped Naftogaz cut imports dramatically, leading to a row over the take-or-pay clauses in the deal. Kyiv has not bought any Russian gas at all since November 2015, replacing it with reverse-supplied Russian gas from Europe. The reason the volumes of contractual gas has been reduced to such a small amount is the take-or-pay provisions remain in place, but apply to only this vastly reduced volume of gas.

The court also ruled that part of the price Naftogaz was supposed to pay would be reduced. Gazprom was claiming $37bn under the take-or-pay clause but the court ruled only the price of gas received by the Ukrainian company in the second quarter of 2014 was to be lowered  from $485 to $352 per 1,000 cubic meters, whereas Naftogaz wanted a retroactive price change starting from May 2011.

All of these terms relate to gas that Ukraine buys for its own use. What is unclear is how the transit deal will be affected by the row: Gazprom delivers some 80% of the approximately 110bcm of gas it sends to its Western European customers via the ironically named Druzhba, or “Friendship,” pipeline that runs across Ukraine. In addition, most of the gas storage facilities to hold a reserve of gas ahead of the winter heating season are located on Ukraine’s territory, not Russia’s.

There has been a row over how much Gazprom should pay Kyiv as a transit fee in addition to the one over the cost of gas for Ukraine’s use. Naftogaz demanded that Gazprom should pay $17bn for the failure to supply the agreed volumes for transit. It also sought the revision of tariffs and conditions for the transit of Russian gas through Ukraine. The Stockholm court ruled that Gazprom should pay only $4.7bn to Naftogas. Summing the two awards,  Gazprom has been left with a bill of $2.56bn.