The cuts to transit tariffs for use of the Ukrainian gas transmission network, which were announced during the final days of 2018, are a major event that was undeservedly kept out of the media spotlight.
The reductions of nearly 50% are simply a downward correction but send a message.
Here are some corners in the analysis.
The first suspected casualty would be the revenue projections for the Ukraine circumvention projects. Their business logic has been substantially compromised, while the key argument Merkel and Putin continue to use is that the Nord Stream is “just business.” The direct costs of Nord Stream-2 so far are below $10 billion and, accounting for the extra funds spent on gas fields and infrastructure development on Russian territory, the bill skyrockets to more than $40 billion. Additionally, the cost of the South-Turkish stream has already gone up to $23 billion. In addition to the $17 billion spent so far, another $6 billion have been added for the second line on and offshore infrastructure in Turkey and the Balkans. Thus, the cost of circumventing Ukraine by Russia has risen to a spine-chilling $60 billion, which is equal to Gazprom’s total annual gas sales revenue in good years.
Gazprom’s only consolation these days might come from the assurances of the governments in Bulgaria, Serbia and Hungary that the upgrades to their gas transmission systems to accommodate the transfer of additional quantities of TurkStream-2 Russian natural gas will be financed by their national companies. However, neither Bulgaria, nor Serbia or Hungary can afford to extend the current subsidized transit prices for Gazprom. Additionally, the credits that the respective national companies have to take to boost transmission capacity will require long-term transit and capacity take-up contracts and guaranteed revenues.
As a result of Ukraine slashing entry-exit tariffs in half, the business case for Nord and South Stream as the cheapest and most secure routes for Russian gas to the EU hangs in the air. It is suffice to compare the transportation costs via the GTS of Ukraine – for identical volumes (80 billion cubic meters), it is slightly over $2 billion annually, and the Nord Stream option, where just the financial cost of servicing $60 billion in debt, is at least twice as much. The new tariffs do not leave much credibility to the key argument of the EU “streams” proponents that it is “pure business”.
The fact remains that Gazprom could attempt to conceal a large part of its genuine costs on Russian territory, using miscellaneous state subsidies, tax concessions and other hidden forms of state aid. This in itself should be the subject of attention and investigation by the EU anti-trust bodies, but even if one considers just the “EU” segment of Nord stream, it still pales in comparison, in terms of security and value, to Ukrainian gas transit.
The new tariffs will significantly limit the chances for commercial project financing. In itself, this can hardly constitute an insurmountable obstacle, as Gazprom has been forced to finance new infrastructure projects ending on EU borders out of its own cashflow. But this new reality will challenge project financing and exemptions for the EU legs of Russian gas transit projects via European banks and lending institutions.
The shift from long-term to short-term capacity trading and transmission contracts judged against the background of low capacity utilization rates in the EU spells an uncertain future for any new Russian gas-only transmission projects.
Sinking Ukrainian transit tariffs and unmatched gas storage capacities – more than 30 billion cubic meters – give Ukraine a chance to maintain it role in Europe’s gas market, and a fortiori it should succeed in launching a trading platform and securing liquidity at the Russian-Ukrainian border.
The variables in the equation are more than one, but most of them have in the interim shifted from the “unthinkable” to the realistic category. Changing the delivery points, under the terms of the EU-Gazprom arrangement ending the anti-trust legislation, is a right bestowed to both parties. Any EU gas trader can ask Gazprom to deliver gas under its current contract to a different delivery point, including to the Russian-Ukrainian border.
Such a scenario is possible, but hardly certain, as it implies willingness on behalf of Gazprom to offer the same terms and price at its border with Ukraine as at the entry points of Nord and Turk Stream. On top of that, given recent haste in shutting down compressor stations on Russian territory that serve Ukrainian gas transit, Gazprom seems committed to play the technical card as well – i.e. lack of technical capacity excuse.
In theory, Bulgargaz or any other gas trader should be able to profit from the lowest Ukrainian transit tariffs and buy gas from Gazprom at a delivery point on the Russian-Ukrainian border. Such a move is highly hypothetical and in reality unthinkable, but such a strategy could be well within reach for major European and international gas traders, should notably the US and EU design and implement a joint strategy plan.
Ms Merkel and President Putin could probably continue to insist that Nord Stream-2 is worth completing for reasons of security of supply and the perceived uncertainty of transit through Ukraine. It is no coincidence that Russian President Putin is conscientiously engaging in brinkmanship, keeping up tension and being unpredictable with Ukraine, aiming to scare Western elites into perceiving imminent or pending transit problems. But the wild card of playing politics at the edge can’t be played twice and can easily turn against the Kremlin, precisely because of its overriding geopolitical content.
A week ago, the CEO of Naftogaz Kobolev warned of a collapse of transit through Ukraine as Gazprom will cease using the Ukrainian gas transit and thus inflict irreparable damage to Ukrainian and EU energy security. This statement came shortly before the Ukrainian regulator passed its decision to reduce the transit tariff prices at the various entry and exit points of the country’s GTS.
The truth is Kobolev’s talk looks like a self-fulfilling prophecy that tries to shift the focus beyond the key question – why after so many years and decisions of the Ukrainian government, Naftogaz’s top management has failed to unbundle the GTS and create a separate and independent grid operator, attracting strategic investors from the West. It is not by chance that one of the best connoisseurs of the Russian energy market, Mikhail Krutichin, has directly accused the CEO and CFO of Naftogaz of sabotaging EU efforts and the Ukrainian government’s decision for an independent gas system operator and its privatization. It is now clear that the country needs strategic investors to shore up support and preempt Gazprom’s plans to bypass the Ukrainian gas transmission network.
One thing is certain. If the sharp cuts in tariffs in Ukraine are not followed by a comprehensive EU strategy to allow for a shift of purchase contracts for Russian gas to the Ukrainian-Russian border, and if Chancellor Merkel and Germany do not stop playing to the tune of the Kremlin by pretending they seem concerned about Ukraine’s interest, while ignoring blatant coercion by the Kremlin, the gross benefits of these transit cuts will end up with Gazprom, extending the Kremlin’s control over Ukraine’s economy.
The success of both ‘stream’ projects, as many politicians and experts on Russia warn, could free President Putin’s hands to ratchet up his hybrid war against the EU and NATIO with direct assaults on Ukraine and Belarus.