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No gas please, we're Ukrainian

Ukraine is on its way out of the former Soviet energy system - and that system will change as a result

Ukraine's direct imports of Russian natural gas may fall to zero in 2017, signalling the end of the country's long-standing energy dependence on Moscow.

Gas imports have been falling because of precipitous declines in consumption: full-year imports in 2016 are likely to have amounted to 9bn-10bn cubic metres, compared with 16bn cm in 2015, 22bn cm in 2014 and 29bn cm in 2013. In the first nine months of 2016, they were just 6.3bn cm, all of which were "reverse flow" - so called because the gas, mostly of Russian origin, physically flows back to Ukraine from central European countries.

During the past two years of military and political conflict, the EU has financially supported the notion of reverse flow, with the aim of minimising Ukrainian energy dependence on Russia.

Having applied for a $0.5bn World Bank loan to pay for 2.5bn cm of reverse-flow imports for winter, state oil and gas company Naftogaz Ukrainy is likely to have avoided importing any Russian gas directly in 2016.

Short-term causes of declining gas consumption include the removal from Ukraine's gas balance of Crimea (annexed by Russia in 2014) and of parts of the heavily industrialised Donetsk and Lugansk regions (controlled by Russian-supported separatists). The military conflict and international economic slowdown both contributed to a 10% fall in GDP in 2015, which hammered industrial output and energy demand.

The longer-term causes of falling gas consumption pre-date the military conflict. After reaching a post-1990s high of 75bn cm in 2006, Ukraine's gas demand had slumped to 50bn cm in 2013, with declines registered every year except 2011. The beginning of a shift from energy-intensive industries such as metals and chemicals to newer ones took its toll; so did some energy saving, after gas prices for industry were brought in line with import prices in 2006.

But Ukraine's declared aim of managing without direct Russian imports may eventually prove unrealistic: reverse-flow pipeline capacity is 15bn cm/year; domestic production is 20bn cm a year and rising slowly. A few billion cubic metres of direct imports may be needed beyond 2017, especially when economic recovery pushes gas demand up again.

In the long term, though, Ukraine's government aspires to an energy system that is more European and less post-Soviet. A mass of EU-compatible market-reform legislation has been passed, at the IMF's insistence, and in spite of sometimes stubborn parliamentary resistance. Gas and district heating prices have been hiked, and, with average real wages now under half their 2013 level, subsidies have been provided to more than 5m households.

Whatever happens next, the long, troubled Russia-Ukraine gas marriage is over, and the lawyers are arguing about who gets what (literally, at the Stockholm arbitration court, where Naftogaz and Gazprom have made $67bn worth of claims against each other for breaches of contract).

Russia has lost its largest gas customer, which, in the 1990s, imported 80bn cm/y; in 2006 imported 54bn cm (compared with Germany's 34bn cm); and may import nothing in 2017. In time, transit of Russian gas through Ukraine to European destinations will also fall to near zero.

Russia, not to be outdone, is pushing two transit diversification projects that would avoid Ukraine anyway: the Turkish Stream pipeline, on which an intergovernmental agreement was signed in October in Istanbul, and the second phase of the North Stream corridor via the Baltic Sea to Germany - which European political opposition could slow down, but probably not stop.

So, at some point after Russia's existing gas-transit contract with Ukraine expires, in 2019 - although not before then - the Ukrainian corridor will likely be used only for residual volumes that cannot go by other routes.

Russia's relationship with other post-Soviet states persisted through the past quarter century in part because of the gas-supply system, a 1970s engineering marvel. Now the strongest bond, with Ukraine, is breaking.

So are ties with the Baltic states. And, since completion of the Turkmenistan-China pipeline in 2007, the link with Central Asia has also been fading.

Ukraine's emerging energy system will be more efficient, and more diversified both by fuels and by trading partners; so, probably, will Russia's own.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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