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Gazprom finds it hard to break with Ukraine

An international court ruling over gas supply contracts has done little to resolve differences between Gazprom and Naftogaz

Gazprom is desperate to eliminate the need to use Ukraine's transport network to send gas supply to Europe, but a lack of alternatives means it will probably have to swallow its pride and sign a new deal beyond 2020.

Russia's gas export monopoly halted a planned resumption of gas supply to the Ukrainian domestic market in early March, forcing Kiev to take emergency measures to make up for the shortfall and warn that transit flows to Europe were also at risk. Gazprom had planned to restart supplies to its neighbour's domestic market for the first time since 2015, when Ukraine started buying gas from Europe to reduce its energy dependence on Russia.

The move came after a Stockholm arbitration court ordered Gazprom to pay more than $2.5bn to Ukrainian energy firm Naftogaz to settle a contractual dispute over gas supply.

That ruling was intended to draw a line under a protracted legal battle between the two companies. But the hostile atmosphere between Russia and Ukraine—and the long-standing use of gas supply stoppages to make political capital—made that a dim prospect and so it has proved.

Gazprom chief executive Alexey Miller said the ruling meant gas sales agreements with Ukraine were no longer commercially viable and that the company would seek to terminate them. The Russian firm also said it would appeal the Stockholm court's ruling.

Gazprom and Naftogaz have been in dispute for years over gas sales both for the Ukrainian domestic market and for transit to Europe. Gazprom claimed that under an 11-year transit and supply contract signed in January 2009, transit volumes were not underpinned by a minimum volume clause, insisting it would only pay for actual gas transited. Naftogaz argued the contract stipulated a minimum ship-or-pay level of 110bn cm annually, with the transit fee linked to the gas price of the supply contract. Gazprom has consistently transited less than 110bn cm a year throughout the contract.

The rift between companies' home countries was exacerbated by the overthrow of Viktor Yanukovych, a pro-Russian leader of Ukraine, in February 2014, and the following annexation by Russia of Ukraine's Crimea peninsula, as well as Moscow's backing for pro-Russian separatists in eastern Ukraine, where fighting continues.

Bargaining tactic? 

Gazprom's decision to halt supply to Ukraine was guaranteed to grab headlines, leaving Ukraine scrabbling to find alternative gas supplies during a cold snap and prompting talk by the Ukrainian authorities of possible knock-on European gas shortages, even though transit supply was ultimately maintained.

But Gazprom's actions may yet turn out just to be a negotiating ploy. Some analysts believe Gazprom will need to sign a new agreement with Ukraine, as it will have insufficient export capacity on alternative routes to Europe for several more years and European countries are not yet ready to accept gas from the Nord Stream-2 across the Baltic to northern Europe.

Gascade, the gas pipeline venture between Germany's Wintershall and Gazprom, said Nord Stream-2's Eugal pipeline, which connects to the Czech Republic and Poland, will not be fully ready until 2020. Eugal's first line is only due to come onstream in late 2019, which is when the current transit deal with Ukraine expires.

"Only 34bn cm of Nord Stream-2's 55bn cm capacity may be available in 2020 and this could make Gazprom reliant on the Ukrainian route, at least until the end of 2020," said Kirill Tachennikov, an energy analyst at insurance brokerage BCS Financial.

Despite its huffing and puffing, Gazprom remains reliant on the Ukrainian route to meet its contractual obligations to European clients. The Ukrainian route accounted for over 45%, or 94bn cm of Gazprom's exports last year to Europe and Turkey.

Gergely Molnar, a gas analyst at consultancy Wood Mackenzie, said Gazprom's refusal to pay $2.5bn to Naftogaz could result in further legal proceedings, while Ukraine has threatened to use international courts to enable the seizure of the Russian group's foreign assets.

"In the immediate future, Gazprom and Naftogaz are likely to enter a tense standoff that will encourage Gazprom to deliver on its promise to create viable Ukraine bypass options," said Molnar.

But Simon Pirani, senior research fellow at the Oxford Institute for Energy Studies, maintained that Gazprom "will not be able to fully close the door for Ukrainian transit" until 2024, due to rising European demand.

To make a deal, Gazprom and Naftogaz are going to have to park their differences—not an easy task with tensions between Moscow and Kiev still running high.

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