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Gas-price spat alarms West

MANY OF Gazprom's top managers spent new year's night, the most celebrated holiday in the Russian calendar, at the office, scrabbling to solve a dispute with Ukraine over gas pricing. Isabel Gorst reports.

Their sacrifice was to no avail, however. Ukraine flatly refused to accept the Russian gas monopoly's compromise offer to delay a fivefold gas-price increase until the end of winter. On the morning of 1 January, Gazprom began lowering the pressure in pipelines carrying gas to Ukraine.

The spat set off alarm bells in Europe, which relies heavily on Ukrainian pipelines to transit Russian gas imports. Gazprom claimed it would maintain supplies to Europe at contracted rates, but said problems could arise if Ukraine resorted to stealing gas from the transit pipeline to make up for any shortage in Russian deliveries.

Gazprom announced plans early in 2005 to start applying "market principles" in its gas dealings with the Commonwealth of Independent States (CIS). That meant buyers would have to pay European prices for gas and settle all the bills in cash rather than barter. Gazprom also pledged to increase and monetise its payments for use of gas-transit pipelines crossing various CIS states, including Ukraine and Belarus.

Like several of the reforms pursued by President Vladimir Putin's administration, the market philosophy underpinning Gazprom's new CIS gas-price regime was sound. No Western major would be prepared to sell gas at less than a third of its market value. But implementation of the reform was heavy handed, negotiations were badly handled and have dented Russia's reputation as a reliable source of gas.

Gazprom demanded that Ukraine pay up to $230/'000 cubic metres (cm) of gas in 2006, compared with $50/'000 cm in 2005. During tense negotiations in the first days of 2006, Gazprom and state-owned Naftogaz Ukrainy reached a complicated truce, which, by blending the prices of more expensive Russian and cheaper Turkmenistani supplies, will bring gas to the Ukrainian frontier at a more affordable cost than the $230/'000 cm Gazprom wanted to charge.

Ukraine's imports of Turkmenistani gas are handled by RosUkrEnergo, a joint venture between Gazprom and Raiffeisen International, the Austrian Bank, to manage the transport of gas from Turkmenistan to Russia and beyond. Under terms of an agreement announced on 4 January, Gazprom will now supply gas destined for Ukraine to RosUkrEnergo at $230/'000 cm. RosUkrEnergo, will then sell gas at the Ukrainian frontier at a far lower price of $95/'000 cm. Gazprom has agreed to pay Ukraine transit fees of $1.6/'000 cm/100 km. Both gas supplies and transit bills are to be settled in cash.

Russia's image has been badly damaged by the dispute. Western governments blamed the Russians for using energy as a political weapon to bully its neighbour. Although there was no slow down in the stream of Russian exports to Europe, buyers in Gazprom's most profitable market were shaken by what was the first serious threat of a supply cut in over 25 years of Russian gas trading. The wisdom of relying on one source for such a large proportion of supply is being questioned.

In what looked like an effort to shore up market confidence, Gazprom and Naftogaz Ukrainy issued a contrite joint statement, pledging in future to settle all gas questions "constructively, in a spirit of mutual understanding and respect".

Testy relations
This may prove a tall order. Gazprom's relations with Ukraine have always been testy. Gazprom has tried repeatedly to establish some form of equity or management control over the Ukrainian pipeline network, but to no avail. As long as Ukraine retains control over Russia's main gas highway to Europe, it will hold a powerful bargaining chip in negotiations with Gazprom.

Contractually, the new pricing arrangement runs for five years. Even if Ukraine complies, the deal is contingent on co-operation from Turkmenistan. History suggests five years is a long time to expect Turkmenistan's President Saparmurat Niyazov to stick to an agreement.

Alexei Miller, Gazprom's chief executive officer, rushed to Ashkabad on 29 December for talks with Niyazov to try to re-negotiate a price for the 30bn cm of Turkmenistani gas Russia plans to import in 2006. In what looked like a generous compromise, Miller agreed to raise the 2006 price to $60/'000 cm. Last year's $44/'000 cm price was settled only after a three-month embargo on Turkmenistani exports to Russia.

More serious negotiations will open in the first half of the year on the price Gazprom will pay for increasingly large volumes of Turkmenistani gas it has contracted to import between 2007 and 2028. Gazprom gas purchases from Turkmenistan will rise to 80bn cm/y over the next two decades, absorbing almost all the Central Asian republic's export surplus. Some of it will be sold on to Ukraine and other CIS customers.

In the past, Belarus, which, like Ukraine, hosts Russian gas transit lines on its territory, has fought bitterly with Gazprom over prices. But negotiations of the 2006 Russian supply contract passed smoothly.

Gazprom did not disclose what price Beltransgaz, the state-owned gas distributor, will pay for the 21bn cm of Russian gas it has contracted to buy this year. But it indicated that a special case has been made for Belarus, which agreed in 2005 to transfer ownership to Gazprom of the 575 km section of the Yamal-Europe pipeline that crosses its territory, transiting some 40bn cm/y of Russian gas to Europe. A separate long-term leasing accord gave Gazprom control over the land under the pipeline.

Beltransgaz has also reopened stalled negotiations to set up a joint venture with Gazprom to manage the Belarussian gas-transport network.
Unlike Ukraine, where the government has pursued a pro-Western policy since the Orange Revolution in late 2004, Belarus is drawing closer to Russia – negotiating to form a union state. Gazprom said the two nations should standardise their finances and economies.

Caucasus coughs up
Gazprom's customers in the Caucasus have agreed to pay more for Russian gas in 2006. However, prices will still lag far behind European levels, thanks partly to compromises with Gazprom on pipelines.

A contract inked by Tbilgaz, the Georgian gas distributor, and Gazexport, the foreign-trading arm of Gazprom, at the end of December commits Georgia to pay $110/'000 cm for the 0.92bn cm of Russian gas it expects to import this year.

Gazprom says the price was settled after agreement on a gas-transport scheme. The terms of a 25-year Russian/Georgian gas co-operation accord signed in 2004, call for Gazprom to help restore, expand and manage Georgia's gas pipelines and devise new schemes to exploit the republic's potential as a gas-transit country. Small volumes of Russian gas already move across Georgia to Armenia. Georgian pipelines could eventually provide an eastern gas route to Turkey.

Azerbaijan also secured a $110/'000 cm gas price in the last weeks of 2005. It will import up to 4.4bn cm of Russian gas in 2006. The country produces around 5.5bn cm of its 10bn cm/y needs. Output will surge when the BP-operated Shah Deniz field comes on stream in 2007. A five-year contract signed with Gazprom in late 2003 commits Azerbaijan to buy up to 4.5bn cm/y of Russian gas until the end of 2008. By then, the South Caucasus Gas Pipeline, to carry Shah Deniz gas to Turkey, should be on stream.

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