On Thursday, the state energy company of Russia (Gazprom) cut off Natural Gas supplies to Ukraine (Naftogaz). Why this happened, and how it can be resolved is discussed below.
There are two contracts in dispute, historical and prospective. Historically, Gazprom claims Naftogaz owes $2.1 bn in back payments. Prospectively, the countries need to agree on contracts for future gas supplies, which Gazprom is pricing at $418 per thousand cubic metres of gas, while Ukraine has offered $201.
Of course, the details are endlessly more complicated. Last week Ukraine paid around $1.6bn against the debt but Gazprom claims $600 mn of late fees must be paid. The contract for $418/tcf is paid by most Western countries, but it will probably decrease due to the falling market prices, thus it seems unfair to make Ukraine agree to pay it. However, Russian officials accuse Ukraine of stealing gas from the pipelines which travel through it. These pipelines are a major source of contention since 80% of Russia’s gas passes through Ukraine on its way to Europe.
Cutting off heating gas in the middle of winter may seem harsh, but Ukraine has at least seven weeks worth of reserves. The United Kingdom, however, has less than 15 days worth of reserves, so the European union is anxious to resolve the dispute before Ukraine takes drastic measures such as closing the thoroughfare pipelines.
Oil Energy Money is always the first to question Gazprom’s strong-arm tactics, but for once, this is not a case of Russia’s Goliath attempting to crush David. Political bickering between Ukraine’s President Viktor Yushchenko and Prime Minister Yulia Tymoshenko is making negotiations difficult and the Ukranian siphoning of other countries’ gas deliveries is a serious concern. According to a BBC report on the 2006 crisis, where Russia cut gas supplies to Ukraine for two days, many European countries suffered:
- Austria – supplies down by around 33%
- Croatia – supplies down by around 33%
- France – supplies down by 25–30%
- Poland – supply down by 14%
- Romania – supplies down by around 20%
- Slovakia – supplies down by around 33%
To prevent similar shortfalls this year, Gazprom has offered to reduce Ukraine’s contract prices to $250/tcf but Ukraine refused. In fairness, Ukraine has been badly hit by the global financial turmoil and sees little hope of a quick recovery.
Both parties are aiming for a resolution by January 7th, and with good reason. Without Ukranian demand, Gazprom may have to reduce production and shut down factories, a costly and time consuming process. Ukraine needs to negotiate before its reserves falter, but what’s the solution?
Oil Energy Money predicts supplies will resume by January 7th, though negotiations will continue long after. The final agreements will probably involve a delay in repayment of the debt and late fees as well as a renogotiated supply contract with variable or staggered prices.
Despite the mainstream press hinting at tearjerker scenes of freezing Ukranians, there’s very very little chance of the dispute escalating that far. Ukranians, and the rest of Europe won’t feel serious supply disruptions over some state fuelled corporate bickering. There may even be a small silver lining for the bulls amongst us- the potential for disruptions coupled with the invasion in Gaza have seriously boosted energy prices, oil is at a 4 week high and Natural gas is up 6% at $5.97/MMBtu.
