Sunday, June 15, 2014

15/6/2014: Russia-Ukraine Gas Deal: They Are Where They Were...

So yesterday's (almost/nearly)last-ditch efforts to sort out as deal between Russia and Ukraine ended, predictably, in the same stalemate. The meeting was held in Kyiv/Kiev (or whatever we should call it nowadays). European Energy Commissioner Guenther Oettinger attended, seriously phased by the possibility that Ukraine (no, not Russia) will shut off transit of Russian gas to the EU (note: Russia is not threatening to stop supplies to its non-Ukrainian buyers, so let's dispense with this bit of propaganda).

We do not know if talks will resume today. Gazprom said yesterday that no new date for talks has been fixed, but that can change any time.

So here is where we are:

Last week, Gazprom offered Ukraine exactly the same gas contract terms that were extended to Yanukovych, including the discounts. That's official: President Putin confirmed as much in public. Gazprom agreed to delay gas payments until June 16th to sort out new contract.

The discount advanced to Ukraine was $100 per thousand cubic meters (mcm) and the first price offer was $385 mcm net. Again, this was confirmed by Russian President.

Ukrainian response was that they wanted lower price and they wanted that lower price fixed over a long-term contract. We do not know how long of a fix Ukraine expected (may be, Kiev wanted something similar to Chinese deal - which came at around $350-380 mcm but covers larger volumes and options to increase these volumes further), plus involves a counterpart (China) that never failed to pay on contracts. History of Ukraine-Russia dealings on gas has been checkered at best (see this note which only touches on some top level points relating to 2009 gas deal and more here on 3 years of consecutive violation by Ukraine of the gas purchase contract: here, albeit I do find the 2009 contract to be harsh for Ukraine).

So back to the current saga. $385 mcm is lower than price Poland pays for Russian gas, which comes at a price of around $465 mcm, and is slightly above the price paid by Germany or $370 mcm (though Germany has direct access to Russian-controlled, jointly enveloped Nord Stream pipeline).

Relating to Ukraine's demands/concerns with contract duration, President Putin instructed the Government to develop an option to fix contract terms 'for a certain period' - again, we are unclear as to what duration this period refers to or what duration fix Ukraine wants.

Specifically, president Putin said: “I would like to ask the government and the head of the cabinet to think on how it could be possible at the level of the government of the Russian Federation or upon agreement with the government of Ukraine freeze these terms and make them absolutely guaranteed and free from changes for a certain period…" Ukraine's concern that the $100 mcm discount offered can be unilaterally canceled: “We have never done so. We have always demonstrated that our agreements are reliable to the maximum."

Putin's point makes sense: he offered Ukraine exactly the same terms and conditions for gas pricing as Yanukovich faced prior to Kharkiv Accords. But Kiev has some valid points too - Khrakiv Accords have been annulled by Russia on foot of Crimean crisis (see below). So it's a Russian offer of 'Yanukovich deal, pre-2010' vs Kiev counter 'Yanukovich deal post-2010'.

In response, Ukrainian PM Yatsenyuk claimed that "Russia proposed to reduce the gas price. Still, our stance was and now consists in changing the contract, and not agreeing to a decision made by the Russian government regarding the change of gas price… We are holding short: we change the contract and set a market price. We have paid the market price of $286. We are ready to pay all debts according to this price, and other proposals are unacceptable.”

Where that price of $286 mcm came from is anyone's guess. Until the overthrow of Yanukovich's Government, Kiev paid $268.5 mcm which was a special concessionary price set under the agreement in November 2013 that shelved the Ukraine's association agreement with the EU. In Q2 2014, following Russia non-recognition of the Yatsenyuk Government in Kiev, the agreement was voided and Ukraine was switched back to 2009 agreement on pricing at $385.5 mcm. This is quite reasonable: agreement on $268.5 mcm was based on specific deal struck with Yanukovich and there is no ground, in my view, on which it should translate to a government that was not recognised by Russia. Hence, 2009 deal applied, and $385.5 mcm was legit.

Now onto a tricky bit of the deal. In 2010, under the so-called Kharkiv Accords, Ukraine signed a deal with Russia that suspended $100 mcm export duty from shipments of gas to Ukraine (internal consumption, not transit). This was done in exchange for Ukraine extending the duration of Russian lease on Crimean naval facilities from 2017 to 2042. Note: $100 mcm discount did not reduce the cost of lease paid by Russia to Ukraine, but simply underpinned extension of contract duration.

What happened next is dodgy: on April 2, 2014, President Putin signed a law annulling the Kharkiv Accords. Crimea was no longer a 'leased land' and the $100 mcm discount on export duties was gone. The price of Russian gas shot straight up from $385.5 mcm to $485.5 mcm. My view is that this was wrong.

Following Russia: $385.5 mcm offer and Ukraine's initial counter at $268.5 mcm, Kiev said on Friday that it was ready to pay $326 mcm, but only over an interim period of 18 months - a period it claimed will be required to negotiate a long-term price agreement.

Now things get a bit more convoluted. Per June 11 reports, (see here), Ukrainian Minister of Energy and the Coal Industry Yury Prodan said "Ukraine believed the temporary price for Russian gas could be the mean price of $268-$385 per 1,000 cubic meters of gas until the issue is resolved in the Stockholm International Arbitration Court." Which puts pre-negotiations offer at $326.5 mcm - on-the-dot with second round counter-offer from Ukraine. So the second round offer was there before the first round offer. But to confuse things even more, the $326mcm price was not even Kiev's idea, but the EU's idea: see here.

All around - a big mess...

Per latest:  Sunday talks failed to take place...

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