Escalating tensions between Russia and Ukraine
Russian supplies to Europe via Ukraine may be heading for an interruption next year
The odds of Europe experiencing a gas supply crisis similar to the one that occurred in 2009—when Russian gas stopped flowing through Ukraine in the depths of winter—have risen sharply in recent months. Even a decade on, memories of that supply disruption remain fresh.
The contract that governs transit of Russian gas through Ukraine expires on 31 December and it is looking increasingly unlikely that talks to agree a successor will bear fruit. Without such a contract in place, Russian deliveries to Europe will almost certainly stop on 1 January.
The seriousness with which some stakeholders regard this prospect is evident in their preparations for it. Hungary, for example, has decided to buy all its 2020 gas this year and put it into storage. Russia's state-controlled gas firm Gazprom has been booking extra storage in western European countries. And Naftogaz, Ukraine's gas company, is bracing itself for transit—from which its subsidiary Ukrtransgaz earns much of its revenue—to cease.
Transit diversification strategy
Russia has long made plain its determination to reduce its reliance on transit through Ukraine to reach markets in western Europe. In 2018 Russia's exports to European countries, excluding former member of the Soviet Union, amounted to 201.9bn m³, meeting 37pc of Europe's consumption, the highest share in over a decade; in 2019 Gazprom expects to export between 194bn m³ and 204 bn m³ to these markets.
Russia's transit diversification strategy has seen it invest tens of billions of dollars in pipelines bypassing Ukraine. The Nord Stream pipeline, which started up in 2012 connecting Russia directly with Germany across the Baltic Sea, last year carried 58.8 bn m³, more than its 55 bn m³/yr design capacity.
"If I had to put money on it, most likely it is a supply interruption" — Pirani, OIES
Construction is currently under way on two other major pipelines that would drastically reduce Gazprom's reliance on Ukraine: the 55bn m³/yr Nord Stream 2 pipeline, which, for the most part, will follow the same route across the Baltic Sea as Nord Stream; and the Turk Stream pipeline connecting Russia with Turkey across the Black Sea, comprising two 15.8bn m³/yr strings, one to supply customers in Turkey and the other to supply countries in south-eastern Europe.
Together, these pipelines will add 86.5 bn m³/yr to Gazprom's export capacity, bypassing Ukraine (some Russian gas reaches Turkey via Bulgaria). As the graph below shows, this is enough to make up for most, if not all, of the Ukraine transit capacity that Gazprom has used over the past five years.
Unfortunately for Gazprom and its western European customers, the diversification strategy has run into a snag. Gazprom had been hoping to start using both Nord Stream 2 and Turk Stream before the end of this year, but it now looks highly unlikely this schedule will be met.
Gazprom said in June that "more than 58pc of the Nord Stream 2 pipeline's length has been laid". However, Denmark has yet to issue a permit for the section of pipe that will run through its territorial waters and/or its exclusive economic zone. In April it insisted that Nord Stream 2 AG apply for a third possible route.
Nord Stream 2's operating company responded that it was incomprehensible that there had been no decision on the routes it applied for in April 2017 and August 2018. "Asking for a third route option to be developed, despite two fully processed, ready-to-be-permitted applications on the table, can only be seen as a deliberate attempt to delay the project's completion," it complained. It nevertheless made the third application in April.
From a wider perspective, Nord Stream 2 remains hugely controversial. Its proponents include Gazprom and the five European energy companies that are providing 50pc of the finance: France's Engie, Austria's OMV, Shell, and Germany's Uniper and Wintershall Dea. They see the pipeline as essential to Europe's supply security, as northwest European domestic production declines and demand for gas remains robust.
Opponents include the United States—where a bill has been introduced to impose sanctions on the companies involved—the European Commission and several European countries. They argue that Nord Stream 2 threatens Europe's supply security by making it ever more dependent on Russian gas, and that it is Russia's intention to punish Ukraine.
Nord Stream 2 also faces regulatory uncertainty following the recent decision by the EU to extend coverage of the Third Energy Package to import pipelines.
As for Turk Stream, the final weld on the offshore section was made at a ceremony last November attended by Russia's president Vladimir Putin and the Turkish president Recep Tayyip Erdogan. But the onshore pipeline capacity into Bulgaria, Serbia and Hungary is unlikely to be commissioned until 2021. Nord Stream 2 also faces issues with transport beyond its northeast German landing point.
"Nord Stream 2 and Turk Stream, in my view, will almost certainly be ready sometime in 2022 or 2023," says Simon Pirani, senior research fellow at the Oxford Institute for Energy Studies, "but they will not be ready at the end of this year. Even if they are built they will not be running at full capacity.
"So anything between 50bn m³/yr and 90 bn m³/yr of transit will be needed across Ukraine, not for the long-term but certainly for two or three years. And the talks we have seen so far in relation to getting the arrangements in place for that—the trilateral discussions between the European Union, Russia and Ukraine at a government level—have not borne fruit."
Source: Petroleum Economist
Nor are they likely to, partly because of elections in Ukraine and the European Union that have created huge uncertainties and limited the opportunities to hold meaningful talks, and partly because the political relationship between Russia and the Ukraine has created what Pirani describes as "an atmosphere of unprecedented friction".
Relations between Russia and Ukraine have been fraught ever since the dissolution of the Soviet Union. They worsened in 2014 after Ukraine's Euromaidan Revolution, which led to the ousting of the Viktor Yanukovich government, the subsequent annexation of Crimea by Russia, and Russian intervention in military conflict in eastern Ukraine.
This ongoing crisis is hastening an end to a mutual interdependence under which Ukraine imported much of its gas supply from Russia, while Russia transited much of the gas it exports to Europe through Ukraine. It stopped importing gas from Russia in 2015 and instead imports significant volumes from Hungary, Poland and Slovakia.
Meanwhile, the recent presidential election in Ukraine was remarkable for the fact that it was won by a television comedian called Volodymyr Zelenskiy—an unknown quantity with no political experience.
Zelenskiy called a snap parliamentary election, originally due in October but was held on 21 July. Zelenskiy's Servant of the People party won a decisive 254 of 450 seats, 56.44pc of the vote.
This also means that the next trilateral talks on the transit contract will not be held until September. Meanwhile, a new European Commission will take office at the start of November, following the European elections in May.
Complicating the transit contract negotiations further are a series of legal actions launched by Gazprom and Naftogaz, relating to a gas supply contract and a gas transit contract signed by both parties back in 2009. In December 2017 the Stockholm Arbitration Tribunal gave its ruling on the supply contract, following this up in February 2018 with a ruling on the transit contract.
The net result of the awards left Gazprom owing Naftogaz $2.56bn. However, Gazprom has refused to accept the verdicts and has launched a number of legal actions against Naftogaz, which has reciprocated with suits of its own. New arbitration proceedings loom.
Amid all this complexity, what is the most likely outcome of the transit negotiations? "If I had to put money on it," says Pirani, "it is most likely a supply interruption."
Source: Petroleum Economist