Pipeline Politics: Russia’s Nord Stream Blows Cold Air On Ukraine’s Negotiating Position

Via STRATFOR (subscription required), thoughtful analysis on the impact that Russia’s now operational Nord Stream natural gas pipeline will have upon ongoing negotiations between Ukraine and Russia over natural gas prices.  As the article notes:

Ukrainian Energy and Coal Industry Minister Yuri Boyko stated Sept. 7 that Ukraine opposes a merger between its state energy firm Naftogaz and Russian energy giant Gazprom, adding that Russia’s proposition for such a merger is “humiliating.” This is the latest in a string of developments indicating that tensions between Russia and Ukraine are increasing as the countries continue negotiating over Kiev’s request to revise a natural gas agreement.

Meanwhile, the debut of the Nord Stream natural gas pipeline — which began pumping on Sept. 6 — will significantly affect these negotiations, depriving Ukraine of leverage as a transit state and improving Russia’s position. Kiev is facing circumstances in which, if it does not become more compliant to Moscow’s demands, a new energy crisis will likely occur before year’s end — a crisis that would be isolated to Ukraine, rather than affecting the rest of Europe as previous energy crises have.

The rising tensions between Ukraine and Russia stem from Kiev’s desire to change an existing pricing agreement for Russia’s natural gas shipments to the country. This agreement, which was struck in 2009 between then-Ukrainian Prime Minister Yulia Timoshenko and Russian Prime Minister Vladimir Putin, called for Ukraine to pay $360 per thousand cubic meters (tcm) in 2009 and then tied the price of natural gas to the price of oil in subsequent years. Because of rising oil prices over the past year, the price Ukraine pays has risen considerably from $264 per tcm in the first quarter of 2011 to around $350 per tcm currently. This price is projected to reach $400 per tcm by 2011’s fourth quarter, which is more than many European states — including Germany — pay.

This agreement has been controversial not only because it is stretching Ukraine’s budget while the country is experiencing a tenuous economic recovery from the global financial crisis, but also because of the Ukrainian government’s claims that Timoshenko struck the deal in order to enrich herself and her backers. Ukraine, under current President Viktor Yanukovich, has been trying to change the agreement, saying that the deal Timoshenko made was unfair and harmful to Ukraine’s interests ( Timoshenko is currently on trial over the issue). Representatives of the Yanukovich administration have said that a fair price would be around $230 per tcm.

However, Russia has said it will only change the agreement if Ukraine adopts the “Belarusian model” — meaning Ukraine would have to join the Russian-dominated customs union or give Russia control of its pipeline system through a Naftogaz-Gazprom merger. Ukraine has firmly resisted such conditions, saying that these actions would not be economically beneficial and would undermine the country’s sovereignty.

Instead, Ukraine has begun moving away from Russian energy supplies. Ukraine signed an investment agreement with Royal Dutch/Shell on Sept. 2 worth $800 million for the exploration and development of shale gas fields in Ukraine, and the country is also considering the construction of a liquefied natural gas (LNG) import facility on its Black Sea coast. Five companies are currently competing to develop a feasibility study for an LNG terminal, and the winner of the tender will be announced by Sept. 20. However, LNG imports would only make up for a fraction of Ukraine’s imports from Russia. More importantly, these are long-term plans that face significant financial and political obstacles and thus will not immediately affect Ukraine’s energy portfolio. In the short term, Ukraine has said that it could store Russian natural gas and sell it to Europeans directly when prices are higher in the winter, and the government has also threatened to take Gazprom to court if it does not change its position on pricing by November.


Russia's Nord Stream Pipeline Weakens Ukraine's Position
But Moscow is not too concerned about Ukraine’s actions, because Russia has been busy completing the Nord Stream pipeline. The line, which has a capacity of 55 billion cubic meters, will divert roughly 15 percent of the natural gas supplies that currently transit Ukraine and send them directly to Germany via the Baltic Sea. These supplies will begin reaching consumers in Germany and elsewhere in Western Europe in the next one to two months. One of Ukraine’s strengths in its negotiations with Russia is its role as a transit state to the countries that the Nord Stream line will now supply directly; thus, its leverage against Moscow has been diminished.

Russia has made it clear that it will not give into Ukraine’s demands without some acquiescence from Kiev, and Putin even directly referred to the change in circumstances that Nord Stream will cause, stating that the pipeline will allow Russia to “depart from the diktat of transit states.” Therefore, once Nord Stream starts fully pumping, this will simultaneously weaken Ukraine’s position and strengthen Russia’s. And this will mean that if Ukraine continues to hold out against Russia’s demands, Moscow will be more willing to return to using energy cutoffs as a political tool against Kiev — only this time the effects of the cutoffs will be limited to Ukraine and will be felt much less downstream.

This entry was posted on Thursday, September 8th, 2011 at 2:44 am and is filed under Russia, Ukraine.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

Comments are closed.

Wildcats & Black Sheep is a personal interest blog dedicated to the identification and evaluation of maverick investment opportunities arising in frontier - and, what some may consider to be, “rogue” or “black sheep” - markets around the world.

Focusing primarily on The New Seven Sisters - the largely state owned petroleum companies from the emerging world that have become key players in the oil & gas industry as identified by Carola Hoyos, Chief Energy Correspondent for The Financial Times - but spanning other nascent opportunities around the globe that may hold potential in the years ahead, Wildcats & Black Sheep is a place for the adventurous to contemplate & evaluate the emerging markets of tomorrow.